When Fintech Succeeds: The Three Ds
Fintech is on the rise globally.
As the Economist reported, there has been a substantial increase in fintech market cap globally, rapidly encroaching into bank territory. Astoundingly, over 64% of consumers around the world have used a fintech product.
However, despite the promise the trends and market statistics might reflect, the fintech space is becoming increasingly crowded (since fintech is eating the world) with over $20 billion in venture capital invested in fintechs globally just in the first half of 2020. So where and when can fintechs break through the noise and succeed? The answer is the letter D.
Three of them to be exact.
Financial services’ customer acquisition costs (CACs) are high and are on the rise. Just look at the hundreds and in some cases thousands of dollars incumbent banks are willing to pay for new direct depositors.
The fintech challengers who win are those with a distribution advantage.
A few years ago, nimble challenger banks like Chime (an investment of my firm’s), Nubank and N26 leveraged digital acquisition strategies, which incumbents were largely ignoring, to grow rapidly. Today, Chime opens hundreds of thousands of accounts each month. Of course, digital distribution will not be a long-term advantage since incumbents can catch-up and replicate, but if capitalized on quickly, it translates into an enduring brand loyalty advantage.
Companies like Truelink, which offers financial products and services to vulnerable older adults, people with disabilities, and people in recovery, benefits from a distribution advantage via a network of advisors. This type of distribution via business partners (”B2B2C” acquisition) can dramatically decrease cost of acquisition of customers and increase reach. Others like USAA leverage an affinity group for distribution. Distribution advantages can manifest themselves in different ways but ultimately depends on having a unique and unfair advantage to acquire customers.
Perhaps the ultimate distribution advantage exists in the growing embedded finance space, where the financial product is built into a broader customer experience. Non-fintech companies can become fintech players in this way. Shopify and Amazon
Fintechs can also develop an advantage through data. One reason is because fintechs can benefit from “data liquidity”, to have a unified view of a customer across multiple systems, a feat that is hard to orchestrate in legacy systems. Another dimension is fintech’s willingness to leverage new types of data to deepen their understanding of their customers.
In lending for instance, a growing class of fintechs are pioneering the use of alternative data to offer (more) affordable and accessible credit. M-Shwari, Kueski, Tala and others in emerging markets use mobile phone, social and psychometric data to evaluate credit risk, in the absence of formal credit scores. Clearbanc, which offers revenue share financing to ecommerce startups, also leverages a deep understanding of its customers’ unit economics and marketing efficiency.
Similarly, insurtech players are using additional types of information for underwriting. In climate risk for instance, players like Kin Insurance model fire or flooding risk to underwrite with precision. KwH Analytics leverages detailed understanding of solar panel performance to underwrite policies that guarantee their performance. Root insurance, which recently went public, leverages driver behavior in its underwriting.
Here again, embedded finance has a structural data advantage because it can leverage data from the platform. Shopify for instance has a good sense of the health of its merchants based on its platform sales, and can use this as the basis of decisions.
In short, the data advantage translates into an ability to better price and customize products for customers.
Delivery advantage (to delight customers)
Often one of the more underappreciated, is the delivery advantage to delight customers (yes that’s technically 4 Ds). By rethinking the product and experience, fintechs can offer a radically better or cheaper product experience, at the moment a customer needs it.
Companies like Lemonade have built in an intelligence chatbot for claims processing, alongside clever behavioral economics to create delightful customer incentives and to decrease fraud. Trov and others have developed intuitive on/off insurance to allow easy customization of the product with meaningfully more customer control.
One of my favorite examples is ZhongAn’s partnership with Xaomi to automate claims processing on phone insurance – leveraging a screen sensor in the phone, ZhongAn can detect a break, and mail you a replacement before the phone is even picked off the ground.
Parametric insurance players can simplify claims processing radically by basing claims payments on objective events. Worldcover does this in East Africa for small farmers, offering weather insurance.
An often under-appreciated delight advantage is in the technological “stack” that fintechs develop. Rather than being beholden to legacy technologies, fintechs are free to rethink their back-end, which enables them to be more creative on their product, but critically, lowers their cost structure. This means customers that look marginal for incumbents are profitable for fintechs. In banking for instance, incumbents are laden with antiquated core banking systems. Neobanks (like fintechs across all categories) can start afresh, allowing the creation of more delightful and affordable experiences.
What does this mean?
A successful fintech has at least one of the Ds. The most successful often have two or three.
And taken together, fintechs that master the 3Ds offer the potential for greater inclusion. Ultimately, I believe the true driver to the fintech chart is that fintechs are radically reinventing business models to serve a greater number of people’s needs. There are over 1.5 billion people who are unbanked, and a multiple of that who are underbanked.
What is truly driving the fintech growth in the Economist article is an expansion of the pie. I’ve said it before and I’ll say it again, fintech is eating the world. But for the meal to be properly digested, fintechs need to follow the 3 Ds.