Fintech 🧠 Food 8th Mar 2021 - Square buys Tidal, Klarna at $31bn, Kings of Leon NFT, and pace of change is a power-law rant

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Weekly Rant 📣

Pace of change is a power law.

Everything that made senior bankers successful is what makes them less able to thrive in the digital economy.  Bankers who graduated business school in the 80s and 90s became successful in building ever-larger balance sheets and working with large suppliers over multi-year deals to reduce their cost structure. This was the right thing to do at the time. When the supply of low-cost goods is scarce, those who can get to low-cost win.

This model has worked since the industrial revolution. Successful senior leaders continued to focus on what brought them success. The larger the deposit base, the more competitive a lender can be in pricing and the higher net interest margin they can squeeze from their core business.

If you're late to digital, you can't buy back in with scale; you have to recognize first that everything has changed.

Digital has changed the game.

We live in the attention economy. The focus has shifted from reducing the cost of supply as the scarce resource to demand being scarce. In this game, everything the senior execs know starts to change.

• Annual budget cycles work when you have to drive scale 

• Long vendor contracts work when you have to drive scale 

• A culture of centralized decision making makes sense when you have to drive scale

• Operating models have to manage the analog world when you have to drive scale

But in the attention economy, this all breaks down—annual budget cycles and centralized decision-making dis-empower product teams and those closes to the customer.  Long vendor contracts and the assumptions baked into the operating model create a drag on delivery and pace.

You can see banks' decision-making in their tech estate.

Banks had to have mainframes in the 80s because networks were not fast enough to really support distributed workloads. So engineers wrote code to run inside the mainframe to meet the business's performance demands at scale. This codebase became so complex that change became riskier as the years moved. To meet market demands, incumbents layered new tech on top of the old tech until most incumbents' tech estate resembled sedimentary rock.

Banks that try to lift and shift their existing workload into the cloud are lifting all of their assumptions about culture, operating model, vendors, and how they make decisions into the cloud. This won't reduce cost; it will just add another layer to the mess. (Although it will no doubt make big consultancies a ton of money). 

Winning in the digital economy is about pace.

Pace of change is a power law for growth.

A power law is an exponential curve, where the winners share the majority of the benefit. This applies to finance, where those shipping features faster are also growing users and revenue faster.

Incumbents are trying to make change faster but without paying their tech debt. They're hoping a lift and shift to cloud or adding some microservices around the edges might help. It won't.

In the attention economy, buyers will virally adopt the solution that has the most functional utility. It has to solve their problems. Customers are awful at telling you what they want. Customers are very good at telling you their problems.

Square is an example that

• Solved a customer problem for underserved customers (small merchants)

• Made the initial product super easy to use, driving virality

• Layered in adjacent services to drive profitability 

This is where the banker that lives in the back of my head says, "but customers have their direct deposits with us and are very satisfied." Firstly, those deposits aren't making the margin they used to. Secondly, they're dwindling as the "window" banks can address in the market shrinks. Thirdly, as the old researcher adage goes, "you can satisfy anyone so long as their expectations are low enough." 

Square is growing its profitable revenue, banks are not. At best they’re standing still.

Like many born-digital businesses, Square focuses its teams on capturing the attention (daily active use) of its users as a core metric. It is now adding lending as it reaches scale to own more of the economics, but that's not where it started. 

Banks have paid consultants 10s if not 100s of millions to implement "the Spotify model" of tech delivery and missed the point.  Running your tech teams with Spotify governance makes no difference if a strategy team takes product decisions, vendor contracts are fixed for 10 years, and the operating model cannot change.

The new architectures for banking will move.

• From monoliths to primitives

• From whale vendors to schools of fish

• From silo'ed platforms to horizontals

But only those who fix their budget cycles, incentives, culture, procurement, and operating model will get there.  

Banks can do it. But it's going to require betting big on solving tech debt, being brave enough to make a multi-year investment, and empower the teams to make their own decisions.

4 Fintech Companies 💸

1. Eco - The single balance that replaces checking accounts

• Eco provides a simple balance that lets you spend money in-store, online, or P2P. It also provides 5% cashback on all spend and up to 5% APY on all dollars (or assets) you store in the wallet.  It is not a Neobank; it's a consumer-focused wallet that completely hides the fact it's actually running on crypto rails behind the scenes and focuses on the consumer problem.  

•  If that sounds too good to be true, it's because it's not a bank; it's not FDIC insured. This is a feature, not a bug. The rates are so high for a few reasons 1) They don't have to use expensive old rails, 2) There are fewer middlemen in crypto, and 3) The assets that provide the return are arguably riskier than the lending a bank does (although when you think about it, that's much more perceived risk than real)

• Fun fact: The Eco head of product told me they got the idea to completely hide the crypto and show balances from an episode of the Fintech Insider podcast. Maybe you should subscribe and have your next killer idea that a16z and founders fund will invest in :)

2. Stoovo - $100 credit for Gig workers on a card

• Stoovo provides cash advances, boosts income, and helps manage taxes for gig workers. It has no interest, no fees, and no credit checks. It is essentially "fronting" the $100 for 30 days and using that to begin to build a credit history.  The Stoovo card is actually a commercial card, which likely means they're doing some funky interchange/regs math behind the scenes.

• The need for solutions that are alternatives to payday lending is still massive.  Solutions that are willing to write off $100 as marketing to identify who might take the $100 vs. who will demonstrate creditworthiness by paying back are interesting.  Stoovo is essentially risking $100 as a marketing cost but using that to build a risk profile for someone with irregular income slowly. Nice.

3. First Boulevard - The Neobank rewarding you for supporting black-owned businesses

• First Boulevard is "unapologetic banking built for Black America." Its tagline is playing to the core of what banking is about. Trust.  The bank features look familiar for many Neobanks, like getting paid early, no hidden fees, round-ups, etc.  But the cashback for buying black gives up to 15% when spending at Black-owned businesses.

• First, Boulevard is living its brand promise with representation in the board and executive team (two-thirds Black Women).  Representation matters, trust matters, and social utility matters. By hitting on all three of these points, First Boulevard is another Neobank that uses digital to serve the underserved and bring fairness to the historically overcharged. That makes a ton of business sense.

4. Hepster - Embedded Insurance for Europe

•  Hepster has built APIs for the entire insurance lifecycle across Auto, Travel, Bike, Device, and sports insurance.  Uniquely, they have a flexible product creation capability that means merchants can customize products to suit an e-commerce journey. Seeing real traction with revenues up 6x YoY over the past 12 months and very few competitors with coverage in the markets Hepster operates.

• It feels like I could do a weekly stripe-for-insurance corner; these things are coming thick and fast. There will be a land grab for this type of service and regional traction matters.

Things to know 👀

1. Big week for Square buying Tidal & they're a bank now

• Square announced Thursday it would acquire Jay-Z's Tidal platform for $297m. Tidal had struggled to compete with rivals like Spotify, and the acquisition has puzzled analysts who know Square for its financial products. In a series of tweets, Jack Dorsey said it's about "finding new ways for artists to support their work" and "Given what square has been able to do for sellers, we can work for artists and bring them the same success."

• 🤔 My Analysis: Square's Cash App is culturally relevant in a way few other services are.  Artists and low-income communities have embraced cash App to massive success.  Cash App has consistently been the early adopter, driving Bitcoin into the mainstream and now bridging the creator and artists communities with finance. Tidal historically was the music service that paid artists the highest. While it may not have gained traction vs. Spotify, it won favor with artists by balancing the power between creator and middleman.

• 🤔 My Analysis: Everything Twitter is doing at the moment is oriented around creators, from super follows to spaces; Twitter has found its groove (as Packy and Marc pointed out here). Square can "bring fans closer together with simple integrations to sell merchandise, a collab with fans and create new revenue streams."  Chances are most artists already use Cash App; now imagine if they could sell merch through it in a sort of mobile-first, mini Shopify.  This is the beginning of Square for Creators.

• Square has launched its in-house bank after completing the charter approval process with the FDIC and Utah DFI. Square will provide loans and deposits to its sellers.  

• 🤔 My Analysis: Square wrote the playbook on building functional utility for users by creating a beautifully simple experience, then solving adjacent problems.  Having done so, Square reduced its CAC and grew its daily active use massively. They're the canonical example of creating a viral loop by offering a disruptive product that disrupts through simplicity and changing the business model.  Now they have scale; it makes sense they'd want to own more of the economics with their own charter. Square should be the #1 case study in any fintech course.

• 🤔 My Analysis: Arguably, Square is a "technology company that became a bank." When everyone wondered if it would be Google, Amazon, Facebook, or Apple, Square just did it.  If I worked in a bank strategy team in the US, Square would be who I'd be holding up as the #1 competitor.

2. Klarna valued at $31bn

• Klarna, the BNPL lender and Swedish bank, has raised $1bn at a $31bn post-money valuation. Klarna was an early mover in what's now called BNPL because in Europe, buying online with cards wasn't popular; consumers preferred to receive their goods before paying and having the option to return. Klarna offers BNPL options at checkout and a consumer "shopping app" that lets users browse stores that offer Klarna.  Klarna is slowly becoming a fully-fledged challenger bank with savings and deposit accounts in Sweden and now Germany.

• 🤔 My Analysis: Klarna, like many BNPL firms, has done well in the pandemic-driven e-commerce boom and helps merchants with increased conversion at checkout.  However, this $31bn valuation makes it 1.5x larger than Affirm, which is valued at $20bn at writing. This impressive valuation is with headwinds like possible regulatory action, so why are investors willing to value Klarna so high?

• 🤔 My Analysis: BNPL is the perfect customer acquisition tool for a bank, and Klarna already has a charter.  Klarna isn't selling banking services; it sells more revenue for merchants and low-risk product returns for consumers. It can create a viral acquisition and adjacent product loop that banks could only dream of.  Instead of paying $200 to acquire a deposit customer, Klarna has the merchants drive acquisition to them willingly. BNPL as a wedge into other financial products is neat.

3. Crypto happenings. 

•  Kings of Leon released an album as an NFT to get closer to fans.  The album will be available via regular services like Spotify. The NFT version on the Yellowheart service will be the only product with special perks (like a moving album cover). There will also be 18 unique "golden tickets," each of which contains unique art.  So a band did a collectors edition digitally; what's the big deal? With the NFT baked into the contract, every time the collector's edition is sold and re-sold, the artist gets a cut of that sale. It's like if DRM was artist-friendly.  Everything is creators.

• PayPal is bidding to acquire Curv for $500m, which offers secure storage for Cryptoasets.  It makes sense PayPal would want to own more of the economics given the sheer volume of cryptoasset sales moving through the PayPal service. Owning a custodian also speeds up the cycle time on innovation as PayPal moves deeper into other cryptoassets.  It will be interesting to see if wallets like PayPal (or Square) could start to operate on crypto rails increasingly without Visa or Mastercard by owning their custodian.  They have the buyers, they have the sellers, and they're making moves to own more of the economics. Ruh-roh card schemes.

4. Plaid launched income verification

• More than a Payroll API, income verification lets the 30% of workers who don't receive a pay stub from payroll software photo and upload their data. Given the slew of Payroll APIs (e.g., Finch, Argyle), I guess the question these days is, "what if Plaid does it."  I can imagine them baking in creditworthiness and affordability checks over time to really add value to people who want to use this data to lend.   

Good Reads 📚

1. Payroll fintech

• Speaking of Payroll, the incredible Alex Johnson covered the subject this week.  The picture above could launch 1,000 conversations, but if you imagine the higher up in the waterfall, the more complete the picture of a customer you have.  Alex notes during the pandemic looking at repayment history isn't helpful because you don't know how a customer is doing today. Are they still getting paid?  

• Alex outlines three futures 1) Payroll systems play ball because, unlike banks, they're not being threatened as much by new payroll companies in the process 2) Payroll providers get screen scraped 3) Employers get into the game to improve the financial wellbeing of their employees.  "Fintech as a benefit" increases engagement, productivity and reduces attrition.  It may be some time before every CEO wants to offer this, but the results speak for themselves.

• 🤔 My Analysis: The key point for me is we have to get off relying on historic repayment data only. The picture above outlines it perfectly.  We're only just scratching the surface of how we can improve wellness for consumers with a complete picture of their financial pressures.  No matter their income, everyone should have a private banker in their pocket, gradually easing them towards better outcomes.

Tweets of the week 🕊

That's all, folks. 👋