Is it a retailer? Is it a bank? Is it … both?

For modern retailers, the journey to scale feels like a well-trodden path.

It often involves evolution from a first-party (1P) platform to a third-party (3P) marketplace. Instead of the retailer just selling its own inventory, it provides a platform that allows third parties to leverage its customers and tap into the logistics infrastructure of the platform for order fulfilment.

Consider Takealot as a good example locally, or Makro within Massmart (now effectively Walmart). Speaking of the global retailer, Walmart is joined by Amazon and Alibaba on the list of players that have followed this route with great success.

The journey from 1P to 3P is made possible by the significant investment in infrastructure required to support the 1P business. If the 3P business turns out to be successful, the return on capital starts to resemble platform economics rather than traditional retail returns because the infrastructure can generate incremental revenue without the retailer having to inject working capital in the form of inventory.

The cost base spans back-end logistics such as fulfilment centres, as well as the front-end web and mobile applications and the associated cost of acquiring a user. If these costs are spread across a wider range of products and revenue opportunities, it stands to reason that the economics should improve over time.

There are downsides to this approach as well, most of which relate to a lack of control over the user experience with 3P sellers and products.

In the pursuit of scale at the expense of curation, marketplaces can easily become bloated with product, leaving consumers confused and irritated. Destructive pricing strategies can become an issue, ranging from inconsistency in price to harmful undercutting. Customer experiences can vary dramatically, leading to negative reviews of the platform despite the 1P goods offering a far superior experience to the 3P goods.

Perhaps the biggest risk of all is the cannibalisation of the core 1P business. Incremental 3P gross margin adds to bottom-line profits if scale is achieved, but high-quality 1P revenue is replaced by lower-quality platform income over time. The shift from a full gross margin on 1P sales to only a take-rate on marketplace sales isn’t always rewarded by investors, even if it intuitively feels like it should achieve better return on capital. At an extreme, 3P sales can dilute 1P sales and become value destructive.

To offset some of these challenges, marketplaces have been tapping into digital sources of revenue such as high-margin advertising. This is made possible by the combination of strong data on users and the intention to transact that is a feature of consumers browsing these retail sites. Goodness knows we’ve learnt from big tech names such as Meta that if you can build excellent recommendation engines, then you can probably attract advertisers alongside them.

A small number of retailers take it a step further. Instead of just using their 1P foothold in the market to scale into 3P and entrench their retail offerings, these retailers also offer fintech products. This is where things are getting really interesting, leading to opportunities for retailers to differentiate themselves and generate lucrative returns.

With great distribution comes great opportunity

The latest earnings transcript from Latin American e-commerce giant Mercado Libre has metrics that you wouldn’t expect from a retail platform. Alongside gross merchandise value and notes on how free shipping is driving sales, you’ll find references to a credit portfolio and even to assets under management.

Is this a retailer or a bank? Or is it both?

The answer is complex, thanks to regulations and how the group’s licences work across its various core markets. But the ambition is clear: Mercado Libre’s long-term objective is to become Latin America’s largest digital bank. And in the meantime, it is using clever partnerships and regulatory trade-offs to build an offering that looks and smells like a bank, even if it isn’t one.

Mercado Libre is not just paying lip service to its dream — it is actively building it

Mercado Pago is the brand through which Mercado Libre is building digital payments and a financial services platform that allows for services such as digital wallets and merchant acquiring. It is even moving further along the duration curve, with consumer loans and related products that have a term of several months. With 2.7-million credit cards issued in the latest quarter, Mercado Libre is not just paying lip service to its dream — it is actively building it.

The magic of this strategy is that it creates a scalable ecosystem that is highly complementary to the retail offering. If customers are already transacting on your platform, why not build payments and digital wallet solutions that win a greater share of that economic profit pool? And wouldn’t it be incredibly valuable to generate value from your users shopping at other platforms using your payment tools?

Building this synergistic environment requires strong distribution. If you have a loyal user base, you have the opportunity to cross-sell products from other verticals. If Capitec can do it with airtime and funeral plans locally, and Mercado Libre can do it with pseudo-banking products internationally, then get ready for more South African retailers to jump onto the fintech bandwagon and add surprising products to their arsenals.

At least, the ones that aren’t being left for dead in a rapidly diverging market.

Winners keep winning

Layering fintech onto a retail platform is far from trivial. Aside from the development cost for the platform and associated regulatory considerations, there’s the obvious capital-hungry nature of a lending model. This is a different skill set to retail, requiring a team that looks more like a financial services business than anything else.

The risk profile of the business also changes dramatically. Instead of just looking at like-for-like growth and gross margin, the focus will shift to credit provisions and how different curves are behaving across various regions and demographics.

The potential impact of an economic downturn is amplified by this strategy. Instead of just lost sales or pressure on margin, an economic shock can drive credit losses and changes in funding costs.

For investors to be willing to stomach these risks, they need to feel confident about the core retail model. They need to believe that the financial services elements will be built onto a rock-solid foundation that can keep growing market share and achieve the flywheel effect that platform businesses always hope to enjoy.

There also needs to be sufficient capital available to defend the existing moat and further entrench market leadership in areas such as back-end logistics. It won’t do investors any favours if the addition of a financial services layer creates a worse business than before.

This is a strategy for relative winners, not relative losers. This could be why there are so few examples of it playing out in global retail environments.

Enter Pepkor: a retailer that wants to be a bank

Among local retailers, Pepkor is clearly on the winning side of the equation. Instead of scrambling to save its income statement (and reputation) with silly offshore deals, Pepkor is building market share and plugging product gaps through bolt-on acquisitions. This makes it a great candidate for a leadership position in fintech services.

The truth is that Pepkor is already there. It has been pushing the fintech-into-retail strategy for as long as anyone can remember, with a coherent offering of services to the value-focused customer base.

But Pepkor is taking it a step further now by doing something that even Mercado Libre hasn’t done: it is building a bank. This strategy is predicated on a Venn diagram of banks, retailers and traditional telcos, with Pepkor targeting single-platform convergence across marketplace, device and financial services.

The importance of this differentiator cannot be overstated.

Instead of trying to build wildly expensive banking infrastructure that gets launched to an existing financial services customer base (as is the case with Discovery and Old Mutual), Pepkor can launch into an existing user base of smartphone owners with whom it already has a credit relationship. It is already trusted with money transfers, cash transactions, funeral policies and other financial products. Adding a bank to this equation seems obvious.

With a plan to go live in 2027, this strategy has the potential to drive another stake through the heart of legacy banks, which have already lost immense market share to Capitec. Even Stellenbosch’s finest may be given something to think about by Pepkor, as the retailer would no doubt have studied Capitec’s success and learnt from what has happened in the past few decades.

Pepkor’s plan is to achieve breakeven after three years and lock in full payback after five years. By then, it expects to have 1.8-million primary banked customers with R8bn in deposits and loan advances. It doesn’t require heroic assumptions to believe that these customers would be beneficial to the broader retail business as well, as Pepkor would no doubt incentivise banking clients to shop in its stores (and vice versa).

In South African retailers and banks, we are seeing a split of the market into leaders and turnaround stories. As fun as it is to speculate on struggling businesses and hope that they come right, the more sensible investment strategy is to pick out the winners that aren’t priced for market dominance.

On an earnings multiple of 14 and with the share price down 18% year to date, investors might be extremely tempted to take a long-term position in Pepkor. There are good reasons that this banking strategy just might work. It feels like it deserves a place alongside Weaver Fintech in adventurous portfolios.