Recasting incumbents in fintech
It's hard to topple banks and other incumbents in fintech. This is a framework on building fintech businesses that compete with banks and eventually overtake them.
Sarah Tavel (Partner, Benchmark Capital) wrote a post on building multibillion-dollar startups. The core idea is to build a 10x product at a lower cost while “recasting incumbent cost structures.”
Andy Rachleff (Co-founder, Benchmark Capital) says - Take your competitor’s biggest advantage and turn it into a weakness.
These are really powerful concepts. Read them again. Then once more.
Every fintech founder should apply these 2 lenses when competing with incumbents. Following these concepts will help you build valuable and enduring companies. As we build Stilt, I always keep these in mind - with every product and new initiative. We agonize over finding ways to recasts incumbents’ strengths.
Fintech incumbents have deep moats in a few areas - trust, regulations, and cheap capital. They built these moats over decades and won’t be dismantled anytime soon. It is difficult to win against these moats especially with a commodity product.
But startups can turn an incumbent’s strength into weakness using innovation. I have seen all types of B2C and B2B startups use 4 areas of innovation. Startups need a strong foundation in at least one of these areas. If they can check off multiple boxes, they can build really valuable companies.
The 4 areas that startups can compete on:
Product
Acquisition Channel
Target Market
Business Model
Product
Banks are bad at innovating on products. They are also slow followers. I have never seen a bank develop competing products in a span of months or even 2-3 years. It is exponentially more difficult if the product differentiation is rooted in technology.
This happens at incumbents because of 2 main reasons:
- Organization Structure - multi-decade old organizational structures prevent incumbents from executing quickly and competing with new threats. Everything needs to go through many departments and decision making is slow.
- Technology Stack - building new experiences on old technology stack is not even possible in many cases (their tech stacks are 20-30 years old.) And incumbents can’t just switch their core systems overnight.
*I think the only other industries with similar structures are healthcare and education.
Startups that build products that are differentiated, and have that differentiation rooted in technology, do really well. But it is important to have technology as the core differentiating factor. This can manifest in many ways including a better experience, lower cost, or a new value proposition.
e.g. Robinhood built a product that was 10x better than anything else on the market. They also made it commission-free and were mobile-native, so banks/brokerages couldn’t compete. Robinhood also inverted the traditional business model (which we’ll talk about later). Incumbents couldn’t even get close to catching up. As a result, they maintained a strong lead for 5-6 years. Now, all brokerages offer similar mobile products (at zero commission), so Robinhood will need to continue innovating.
Another example is Opendoor**. Their product was so different that incumbents didn’t know how to respond. Opendoor used data science (and technology) as the core differentiator for valuing homes. Because of data network effects and economies of scale, I don’t think Opendoor will have any big competitor for many years.
Stripe - Stripe’s product was also really unique. Stripe allowed online businesses to accept payments instantly. The alternative was to wait for weeks. Stripe product was technologically superior to everyone else in the market. Stripe’s product velocity is also one of the world’s best, so no incumbent will be able to match them for decades.
One caveat
Many startups use technology to provide instant access to financial products. However, products made faster without using deep technology are copied over time. In some cases, the advantage goes away quickly. In other cases, enterprise startups build the same technology and sell it to the incumbents.
e.g. The online lending industry reduced processing time from days to minutes. They brought the industry online but the banks caught up and the differentiation got copied over the years.
Enterprise companies help banks compete with startups. e.g. Blend for mortgages. Treasury Prime for bank accounts. Amount for loans.
Acquisition Channels
Acquire in a way that incumbents can’t. In the early stages, startups need their own way to acquire customers (which should be scalable). Most startups have product differentiation but don’t have any differentiation in acquisition channels. They will have to eventually compete on large channels with incumbents but should delay that as much as possible.
Acquisition is the toughest problem to solve for fintech companies. It is more important than “product.” An average fintech product with great distribution wins every time. When building a product, design it with distribution in mind because that’s going to define its level of success.
Startups can also use new channels that incumbents don’t even understand. TikTok, Snapchat, etc. are so far from any incumbent’s core competency that startups can easily scale without seeing any real competition. Another way is to leverage a fast-growing platform that is not proven yet. Incumbents won’t touch anything that’s not at scale or proven.
e.g. SoFi started in 2011 and initially acquired customers through campuses and social media. They scaled quickly and got a lead before others. Social media ads in 2011 were a differentiated and scalable acquisition channel for SoFi. Now, not so much. Facebook and Google Ads are saturated and difficult to scale profitably unless there’s a demonstrable unique angle.
Startups with unique value propositions can be successful with proven channels. e.g. In the early days, Opendoor used direct mail to acquire customers - which was competitive and expensive but worked because of their unique product. No one was sending direct mail with a 30-day cash buy offer.
A new approach for acquisition is B2B2C (point of sale). Startups like Affirm scaled through partnerships with online retailers. Banks couldn’t compete with Affirm because of a differentiated product and partnership-driven acquisition model. You can argue that Affirm’s product is still a loan at 30%. But their integrations with online merchants were unique. I believe Affirm’s core differentiator is its acquisition channel.
Many industry verticals like auto dealerships, credit cards at physical retail stores have been doing B2B2C for decades, but new startups democratized the small-dollar personal loans for online retailers.
Target Market
One of the moats for banks is regulation. But it is also their weakness because it prevents them from serving all types of customers profitably. They can’t innovate on new products at a fast pace. This leaves room for startups to compete.
There are millions of people who are adequately served by the banks and they won’t switch unless the product is 10x better. But a large section is still underserved by the US financial system. I know that most people think of retail customers, but small businesses, startups, and even large cross-border businesses aren’t adequately served by banks. One way to build a big company is to build products for users left out of the system.
e.g. Brex - built the best credit card for startups. Anyone who has tried to apply for a business account understands the pain. It takes days/weeks to get a credit card but Brex used technology to offer credit cards in minutes. It doesn’t work for every business but worked really well for startups.
Cash App - targeting people with inconsistent income and low balances. Banks don’t open accounts for this population because of their cost of running an account. Now, Cash App is the fastest-growing mobile app in the US with 40M active accounts.
Venmo - P2P transfers for millennials. The younger population wanted an easier way to transfer money to friends but it wasn’t easy with the banks. Venmo filled that gap and has 40M active accounts. Zelle is a competitor product from incumbents that is catching up. Venmo will have to continue to innovate.
We started Stilt to target immigrants - a population currently underserved by the banks. As international students, we faced challenges with the US financial system and decided to build a product for this market.
New markets emerge due to fundamental shifts in the world. Influencers, gig economy, and remote worker markets are much bigger today. Building products for these growing markets before incumbents can be really profitable. e.g. Karat is building a card for online influencers.
Some startups build delightful products for a target segment even if they are adequately served by the banks. The strategy is to pick off an incumbent’s best clients and offer a product that is suited only for them. But it’s important that this product is enabled by deep technology. You will find product-market fit faster because customers are using an inferior version of it.
e.g. Remittance companies have built billions of dollars worth of businesses by doing one thing really well. All banks offered remittance but startups built a fast, reliable, and delightful product.
Stilt loans for immigrants at better rates and high approval enabled by technology. Prior to Stilt loans, they were not able to take loans or taking loans at absurdly high rates.
Business Models
Innovating on business models is the holy grail. The best way to compete with incumbents is to invert their business models. Many startups have successfully recast cost structures of incumbents using technology.
What it means is that startups don’t make money on things that are the lifeblood for incumbents. They cut the oxygen with superior business models. A better, faster, and cheaper product helps considerably, but once the business model is inverted incumbents are toast.
e.g. Neobanks - traditional banks make money on fees but most neobanks don’t. The primary business model for neobanks is interchange revenue when a user swipes a debit card. Large banks can’t earn this interchange because of Durbin Amendment.
Inverting risk-taking: Brex inverted the risk model. Banks try to lower their risk as much as possible and that’s why it takes weeks for them to open accounts for startups or offer them any credit line. Brex used technology and the market shift to serve startups really well. A product that was delightful for a specific target market.
Make the product free: Robinhood started commission-free trading which attracted millions of new investors. Banks made money on large account balances and commissions while Robinhood makes money on small amounts and no commissions. Robinhood gamified investing and makes money on order flow, so it incentivizes trading frequency.
Remove the incumbent: Lending Club built a $10B company by creating a platform to match borrowers and lenders. This P2P platform removed banks as the source of capital.
Credit Karma started doing free tax filings threatening Intuit’s market dominance and got acquired swiftly after that.
Startups can also subsidize their revenue sources by making money on a different product. e.g. Zenefits did this beautifully by giving away a full HR management system for free and making money on insurance commissions.
Hope this is helpful to new founders when building a fintech startup.
I wouldn’t have learned all this without help from a lot of people.
I am always around to help if you need any feedback or advice. Feel free to follow me or send me a note on Twitter @rohitdotmittal.
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**I own $IPOB - which is Opendoor’s SPAC with Chamath.