Insights from San Francisco: FinTech is growing up
A framework for thinking about how FinTech companies evolve
Authors: Sasi Desai, Nipun Jasuja
“Banks can’t keep up as FinTech upstarts innovate at a breakneck pace”, Forbes announced in 2014.
“The magical combination of geeks in T-shirts and venture capital… has put financial services in its sights”, The Economist claimed in 2015.
“Banks are right to be afraid of the FinTech boom”, Time warned in 2016.
In a relatively short span of time, FinTech companies have gone from being new kids on the block to becoming established players that are shaking the foundations of large financial institutions. In fact, the innovative established banks (such as Goldman Sachs) have come out on the offensive and set up dedicated in-house teams to build technology and scour the market for potential opportunities.
Last month, Wharton Fintech visited the San Francisco Bay Area for a two-day company trek. We met eleven companies across the FinTech spectrum — online lending and personal finance (SoFi, Earnest, Affirm, Inc., Credit Karma), automated investing (Wealthfront), B2B finance (Fundbox, Taulia), global payments (Square, Ripple), FinTech infrastructure (Plaid), and insurance (Ladder).
The offices were vibrant, our hosts inspiring, and the discussions candid. We got an invaluable peek into the vision of the founders of the companies we visited. As we reflected over the journies of these companies and the patterns in which they are evolving, a sector-agnostic growth framework emerged.
In this article, we present this framework, sharing how we think FinTech companies evolve across verticals. Along the way, we summarize our learnings from the exciting SF escapade.
Setting the stage with three observations
Before we delve into the framework, it is important that we establish three observations about the FinTech sector.
Observation 1: The retail / B2C space is generally smaller than the enterprise / B2B space
Observation 2: Traditional financial services firms are diversified and offer “one stop shop” solutions.
This is a natural result of organic growth in the financial services sector. Most large financial institutions started off with narrow specializations, and gradually extended their product lines to serve their customers better, and capture a greater share of their wallet. Wells Fargo, for example, started with just two services: checking accounts, and gold delivery.
Observation 3: The financial services sector is riddled with increasingly complex regulation.
Why do these observations matter?
If the end goal of the FinTech sector is to truly disrupt the financial services industry, the observations above make it clear that the only way to do so is to become a full-service diversified shop, which serves both retail and enterprise clients while skillfully navigating regulation.
But FinTechs are not going to get there overnight. Startups are resource strapped and face tradeoffs at every turn. Let us look at two such tradeoffs:
- MVP, not TAM: Minimum viable product (MVP) matters a lot more than the total addressable market (TAM) in the initial stages. This means that if the B2C market is easier to crack (and it usually is), the first few startups in any space are going to be B2C (regardless of how attractive the B2B market is).
- Product / Market fit, not one-stop shop: In their early stages, startups are less concerned with capturing a larger share of the total wallet, and more concerned with finding their unique product / market fit. Product of customer expansion captures top-of-mind attention only once the startup reaches a certain scale in its core product offering.
These tradeoffs usually determine the evolution of the space.
How FinTechs evolve — the evolutionary framework
Given the tradeoffs above, we believe the sector will follow a predictable pattern of evolution: Inception (B2C) → Expansion (Product range + B2B) → Competition → Regulation. To understand why this happens, let’s go on a short fictitious journey through the lives of our startup founders.
T = 0: Inception — A sector is born
“Solving a narrow personal need”
Meet Sophie: a driven, motivated individual facing a personal financial problem. She could be any of us:
Let’s focus on Wharton Sophie. Her student loan problem is real, and she can’t fathom why the existing solutions are needlessly complex / slow / expensive. The entrepreneur in her decides to tackle the problem. She starts her own company, determined to use technology to make life easier for future Sophies.
A sector is born.
T = 1: Expansion — A valley in full bloom
“Growth and contagian”
Wharton Sophie’s startup picks up steam. VC funding flows in and acts as a growth catalyst. Armed with confidence that only comes with founding a successful startup, she turns her gaze outward. She realizes her problem is not an isolated one. Others like her have various unmet needs. Remember Wealthy Sophie? Maybe Wharton Sophie can expand into asset management and serve Wealthy Sophie’s investment needs.
She decides to own the entire financial services relationship with fellow Sophies and expands her product offerings to serve her clients better. Her lending platform now offers wealth management advice, and her digital financial advisor now files tax returns.
Sophie’s success has an unintended, but positive effect in the B2B world. Paul, a financial services veteran, teeming with ideas but frustrated with the lack of innovation in his giant company, hears of Sophie’s success in the B2C space. Armed with confidence that only comes with watching others start successful startups, Paul decides to extend the power of digital infrastructure to the commercial space.
Paul could also be any of us:
Let’s focus on Invoice Paul. Invoice Paul uses his experience as an accounts receivable specialist to launch a FinTech in receivables financing.
The sector is expanding.
T = 3: Competition — Porter’s paradise
“Conquering the world”
Sophie continues to expand her services and capture more of the market. Paul also expands both the breadth of services offered and enterprise customers served, moving to larger-sized clients. Sophie’s and Paul’s success attracts many competitors.
The battle gets fierce.
T = 4: Regulation — Uncle Sam says ‘Hello’
“What happens next?”
The financial services market is big. But with expansion comes complexity, and with complexity, the potential for systemic risk. Regulatory burden begins to rear its ugly head in the form of FinTech charters and increased scrutiny in the land of Basel.
FinTechs will have to deal with regulation, one way or another. We discuss the implications of the current regulatory environment on FinTechs here, so head on there if regulation is something that excites you as much as it excites us.
In this phase, the Sophies and Pauls of the world begin to grapple with existential questions. Should they continue to expand beyond their core competence? Should they consolidate with other FinTech entities? Should they succumb to the ‘dark side’ and partner with banks?
The future is uncertain.
FinTech is growing up
Wharton FinTech has been following the space closely for a while now, and all signs point to a sector that is starting to grow up and mature. According to CB insights, the share of VC investments made in late stage startups (a sign of the maturity of the space) has more than doubled in the past two years. However, thinking back to our hosts in Silicon Valley last month, we found that different FinTech sub-sectors are at different stages of maturity.
As we can see from the chart above, Lenders and Payments firms have started to branch out / disrupt the B2B space while Insurance and Asset management firms are still disrupting the B2C experience. A summary of where the industries stand today is given below.
Though abstract, this evolutionary path provides a surprisingly robust framework to predict the kind of movement we can expect to see in the different FinTech verticals going forward.
- Lending and Payments firms are already looking to branch out and start offering new products and services as well as expand their client base (retail and institutional). The name of the game from here will be to try and capture a bigger share of their wallets while staying out of arm’s reach of regulation.
- Insurance and Asset Management firms will be looking to solidify their current product offerings. Meanwhile, new firms will begin to emerge, with increased exploration in the B2B space. E.g., current InsuranceTech firms may extend their product offerings beyond life and auto insurance to new verticals health, while new B2B insurance companies emerge to tackle new age risks such as cyber-security (where the traditional players have not yet cracked the code).
Wharton FinTech will be watching this space closely, continue to monitor FinTech movements, and keep you posted on new developments.
Until then, keep calm and evolve on!
