Why We Need Differentiation in FinTech (Now)
For the numerous fintech startups that built and launched their program in the last decade, paid acquisition channels (marketing, ads, signup bonus) was a pivotal starting point. If the startup started to see some traction with user growth, finding lower cost ways to acquire customers became the priority. The challenge becomes scaling down the customer acquisition cost as user volume goes up.
Once growth marketing channels begin to deliver minimal gains, its time for startups to dig in on what makes their company, platform, and product offering unique in the marketplace. Differentiation helps new startups stand apart from others and achieve net new growth at lower acquisition costs. A sustainable differentiation creates a gap between a company and their competitors, which leads to ongoing success. Without this advantage, startups would spin their wheels in place burning marketing dollars to obtain new customers and more budget to keep them (through rewards and bonuses).
Why Differentiation is So Important for fintech
Where other industries have a physical, tangible product delivered to customers — financial services does not. Even when retail bank branches were the only option for opening new deposit or credit accounts, a welcome folder (filled with disclosures, starter checks, and new account details) was all that a new client received. When every bank is handing out a stack of documents as what a customer takes away, its hard to tell products apart (by bank).
On a fundamental level a deposit account at one bank is the same as another. Both accounts hold the funds of a customer and provide FDIC coverage (assuming the bank as proper licensing and in good standing). Features tend to be similar as well: debit cards, ATM access, digital app, and payment/transfer options. This level of ‘sameness’ is connected to the industry being tightly regulated and monitored by government agencies.
Since the base line of financial products is nearly the same for all banking companies, advertising & branding are critical. As mentioned in the start of the article, marketing efforts produce declining results over time. It comes down to what’s different and unique from a particular company. For startups looking for massive (not incremental) scale, this comes from strategies for sustainable product distribution and product differentiation.
Unfortunately, the funding environment plays a critical role in the ability for startups to run experiments and find what's best for differentiation. When rates were low and the economy was buzzing, funding rounds were abundant — many companies raised every 12-18 months (between 2015 - 2021) as investors were more open with checkbooks. Now that new rounds are slower and more difficult to come by, fintech companies must take measured approaches to growth based on their particular program and user demographic. Here are three different paths for founders and teams to examine towards building sustainable differentiation.
Path 1 - Conversion Rates
For new companies, accepting all users and delivering their new product leads to success. These customers already made it to a website/store with intent to purchase — now it becomes about closing a sale quickly and efficiently.
Because of the regulated nature of the financial services industry, fintech companies can’t function the same way. These startups must mitigate risk as part of business operations. Some of the users signing up for a digital wallet for banking (through an app) may be looking to commit fraud or some type of financial crime. New customers of a credit card may plan to default on their outstanding balances by not making monthly payments.
Unfortunately, there’s difficulty is predicting every bad actor and forecasting risk + losses. In particular, poor estimates for losses can derail business models quickly and long-term profitability. If a fintech decides to remove user requirements for onboarding in order to accept more customers quickly, the flood gates are being opened to mass scale fraud and potential shut down of a program (by bank partners and/or regulators).
Companies need to understand that proper risk controls can lead to quality users that yield a higher lifetime value. This can be executed through:
Routing by user type is critical for a company within a partnership ecosystem. This involves connecting specific tiers of users to the right partner (such low-med-high credit leads in a lending marketplace). This also goes for companies with a direct to consumer offering — routing (or screening) users unwilling to provide required KYC (Know You Customer) details is just as important as onboarding high-quality clients. As fintechs gain traction in the first months of launch, their operating teams can fine tune attributes to improve routing;
Custom underwriting based on use case and program scope can be a sustainable differentiator, especially if there’s an underserved need being fulfilled. Underwriting most often refers to credit & lending products, but it can also refer to deposit programs for high-risk individuals and businesses. Understanding the risk of certain users and making proper adjustments can open a greenfield of customers seen as too risky or with low profit potential.
Conversion from add-on products is for existing customers signing up for a secondary product or service. If a company established a strong relationship with a user, there’s a higher likelihood for a successful cross-sell or upsell opportunity. For example, Chime started with a banking account as its core product and then offered its new credit builder card (customized to spending habits & usage of its clients). For the customers actively using Chime, it’s an easy call to sign up and test out this new credit product.
Path 2 - COST OF CAPITAl
In the current economic environment, this second path has become very challenging for companies of all sizes — especially startups. The two options towards in gaining a lower cost of capital:
Better fundraising capabilities & terms: This option has become increasingly difficult in the last year. The fundraising landscape went from free flowing to slow drips between end of 2021 and mid 2022. Market dynamics, economic sentiment, reduced consumer spending, and inflation are dampening the likelihood of startups gaining new funding. For founders to successfully gain quality terms in a funding round, there must be a clear strategy in scaling a large volume of business with strong margins.
Aggressive spend on marketing that leads to substantial user growth can compel partners to discount fees and lower operating costs for startups. These savings can then be used by startups to build their own core infrastructure in providing financial services (such as processing capabilities), which are expensive and time-consuming yet come with improved unit economics. New competitors would be unable to overcome this moat by running comparative business models due to a small customer base and no in-house capabilities.
Creating value without minimal taking risk: Scale is the barrier between startups and established companies (including financial institutions) that manage high volumes of users an activity. When a new banking program launches, there’s no existing customer base to tap into and startups must look for partners/vendors with the lowest operating costs. Besides hard negotiation tactics, there’s no true way to getting substantially lower pricing than competitors. Ultimately, it comes down to business model providing a user high value at a low risk for the startup.
We saw this first hand with overdraft protection and small-dollar advances in 2017 - 2020 — fintechs (like Dave) provided users access to $100 on a monthly basis and charged a subscription fee, but many didn’t use the advance and we’re fine with paying the fee (like insurance). As more customers signed up and increased transaction activity with these fintechs, better cost structures became available from partner/vendors.
Path 3 - OPERATING COSTs
Startups can quickly gain advantage in this area if they are able to pinpoint inefficiencies within established competitors. For financial services, banks & institutions tend to operate through legacy technology, maintain data in silos, and employ staff to handle manual review and administrative tasks. Once a startup finds an opening to focus on, it’s all about the approach (the ‘HOW’):
Sustainable process improvement: A startup may have found a way to streamline certain process that established competitors have, but it only becomes significant if the method is unique and unable to be duplicated by others. Artificial intelligence (AI) and machine learning (ML) have progressed from industry buzzwords to solid trends enabling companies to imporve margins and make better decisions. In financial services, this can positively impact user onboarding, credit underwriting, transaction monitoring and fraud management;
Reduced marketing spend: Revisiting one of our earlier discussion points about financial services being intangible and easily commoditized, marketing and branding are then a crucial component of doing business. The multitude of commercials from insurance firms is a clear example. There is an opening for new companies to uncover paths to selling their product without marketing spend through partnerships. Connecting with firms that have an established base of customers to directly sell to would eliminate the need for this spend — the savings by the startup could then be passed to users with a lower priced product. Enterprises accustomed to high marketing spend would find it difficult to suddenly stop branding campaigns and switch to partnership-only models.
Finding a winning formula
For startups, founders, operators, and product teams, the road ahead is more complex than ever. Finding ways to grow and stay ahead of the competition are in high demand, especially with approaches that aren’t capital-intensive.
One (or a combination) of the paths above can lead to sustainable differentiation for companies in FinTech. Having this competitive advantage means longevity for a company at this uneasy time for the financial services industry.
At the minimum, the newest wave of founders and entrepreneurs should think deeply about how their product or program will be differentiated in the market. Too many ‘look-alike’ wallets, neobanks, and investment platforms have had to shut down recently based on a lack of uniqueness.
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