Fintech 🧠 Food - Jan 23 2022 - Affirm & Verifone, Apple vs Visa & JPMC is going all in vs. Fintech companies 🔥

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☀️ gm Fintech frens. 

The whiplash of my day job is sometimes spectacular, from meeting great Fintech companies to meeting with some of the largest banks in the world. 

This week I had two back-to-back meetings, the first with an early-stage company pushing the boundaries of Fintech and DeFi was about finding the balance of UX and messaging. The second was with a top 20 global bank, whose team had decided it's not worth the fight to suggest to their superiors they might adopt or use open banking or Plaid.

Sadly that's still the reality at many of the world's largest banks, but not all of them.

Incumbent banks are about to get their moment in the sun again as interest rates rise. Banks will be profitable once more and perhaps can relax; maybe this Fintech threat was all a tech bubble?

JPMC has been the best performing bank of the past two decades. It is best placed to benefit from an interest rate rise. It made me wonder why JP Morgan Chase is going all-in on tech investment? 

No giant organization is without its challenges, sure, but if you're interested in Fintech, the prospect of Fintech IPOs, or how the market plays out, we have to unpack why JPMC zigs when most others zag.

🔌This week, 11:FS published its first annual Pulse Report, a curated look at the best in Fintech UX globally. If you work in Fintech and build experiences, you have to check this out. 

Weekly rant 📣

JPMC is going all-in vs. Fintech

As interest rates rise, public market Fintech stocks are getting a beating, especially those that went via SPAC. Are we past peak Fintech? Are the banks making a comeback?

Temporarily yes, the banks will do well as interest rates rise. Overnight banks become much more profitable, especially those with scale. So why is JP Morgan Chase increasing its spending massively when it could sit back and be profitable?

JPMC is going big

JPMC announced it will increase its tech budget by 26% to $12bn, substantially more than BofA ($10bn) Citi ($9bn). This sent the stock down, as analysts expected it to hurt profit, especially as interest rates rise. Banks are about to be super profitable again, so why is JPM going so hard?

Timing is everything. JPM is playing a longer game (Jamie Dimon said as much), and they know the battle isn't to produce next quarter's numbers; the war is vs. Fintech companies. 

Threats JPMC sees from Fintech companies.

Even if public market Fintech companies are down, BNPL providers are likely squeezing margins on overdrafts. Jamie Dimon described Fintech companies like this. 

The boxing metaphor to bobbing and weaving says (to me at least) he sees Fintech companies moving quickly, executing, and finding opportunities rather than focusing just on size or power. 

What's the $12bn going on?

Ron Shevlin wrote a great piece that pointed out JPMC is global and has countless products for countless segments. It costs a massive amount just to maintain all of that. JP Morgan estimates that $6bn of spending just to "run the bank." This leaves $6bn for things like:

1. The usual buzzwords (AI, transformation 🥱)

2. Building end to end digital mortgages 

3. Building an entirely new payments platform (Onyx) 👀

4. Macro trading and investment bank tools (e.g., Execute)

5. Launching a digital bank in the UK (Chase)

6. M&A (e.g., Nutmeg)

7. Talent (They're going to "redesign" how they attract and retain talent)

It's an industry norm that anywhere between 70 to 80% of tech budget is actually on "run the bank," so yes, JPMC is spending substantially more than its peers. 

I'd wager most other banks have on their 2022 strategy things that look similar to the list above, so we need to go a layer deeper to see why there might be more going on at JPMC than just a bazooka of cash being injected. If you read the words, the outputs, and the M&A activity, there's something else going on here.

It's not what you do; it's the way you do it.

Focus on talent. Before 2008, one of the most attractive jobs was to work in Finance and investment banking. Talent flocked to the financial markets for the innovation and thrill of it all. And in many cases, it was (and still is) at the cutting edge of technology and maths. 

For decades, incumbents had made poor technology choices driven by procurement, spreadsheets, or culture. Tech budgets are set annually, managed as a cost, and outsourced to large incumbent providers who enjoy long contracts and little competition (Think giant professional services firms, old school database providers, offshoring firms, et al.).

That all changed as the big tech firms rose to prominence in the past decade. Early in the 2010s, the hottest talent was drawn to tech companies or early-stage companies (perhaps in the past year, we've seen that really shift to Web 3 and Crypto).  

Big tech changed the talent experience; they worked with modern tools, empowered staff with autonomy, and challenging work. Tech company salaries skyrocketed, and while engineering was a skill being outsourced by big banks, the engineer was celebrated in tech culture.

I think JPMC has properly understood this shift, and it's not just about pay and comp. The best people want to work on the most challenging problems and solve things correctly. As the market corrects and stock options suddenly don't look quite as compelling as they did last year, will talent look at the high 6 or low 7 figure salaries at a bank? Yes, especially if that bank has projects or programs doing exciting stuff in the right way.

There's also a class of talent who can't (or shouldn't) take as much family risk. 30 to 40 somethings, who live near a major city with kids, often have a high cost of living. The risk/reward of joining early stage to make it big often doesn't calculate for these folks. The folks that haven't made it rich but are ultra-talented, stuck in some other job in another bank is a huge source of intellectual capital an incumbent that gets it can draw.

Focus on the how. "Innovation" in most incumbents is live-action role-playing (LARPing) for corporate executives that want to feel like they're digital too. You can see so many big corporates copying the symptoms of digital success without the results. My go-to anecdote for this is like buying the jersey of your favorite sports star and expecting to be as good as they are. No matter how many Mo Salah jersey's I buy, I'll never be as good as him at soccer (football!).

You can see the rationale of the incumbent here: "Big tech has lots of data and machine learning, so let's launch a big data and machine learning project." The problem is that project is a bank project, not a tech company project. 

A bank project has its budget set annually and is approved centrally. Before it can go anywhere near a customer, it must be approved by countless committees, teams, or executives. Any change to the "roadmap" must also be approved, even if early testing shows customers don't care. I've seen banks go live with products they knew wouldn't gain traction because it worked out better to go live and get the expenditure capitalized from an accounting perspective. 🤦‍♂️

A good tech company project may have an annual budget, but once it receives that, how it uses the budget has much more autonomy. The product team is then in control of how this gets delivered to a customer and can pull expertise from across the group to make it happen. The unit can adjust features, experiences, or even pricing (within reason) to drive towards a set of KPIs.

Anecdote time, my co-founders at 11:FS, David and Jason, were invited to a bank board meeting and discussed the above based on experience building these project teams and getting Neobanks live and scaling them (multiple times). 

On hearing this, the CEO said, "We know all this already." And yes, every bank CEO has likely listened to those words and hired McConsultants who've said those words. Likely annually, in "agile transformation programs," where tech teams are organized into "cells" or "pods" and given whiteboards. 

Which begs the question, if you already know this, why aren't you getting results? The answer is always, it's you. A personal trainer can show you how the equipment works, they can even do the reps and move the machinery, but they can't make you get it. 

I think JPMC gets it (or at least is showing signs of it). They've announced a product-focused operating model that aims to shorten the release cycle. As I've pointed out before, the pace of change is a power law in Fintech. Those with the fastest release cycles learn faster.

Dealing with tech debt smartly. While every bank has a "cloud migration strategy," adopting modern tools and using them well are two different beasts. 

Consider the metaphor of the early iron bridges for the railroads. When engineers constructed an iron bridge, they used the techniques, rivets, and tools that had worked with wooden bridges. Yet, when they tried to test those bridges with a steam engine, the bridge would often collapse. How can this be? Surely, the new material with higher tensile strength should be stronger, not weaker? It wasn't until new techniques were developed that the real benefit of iron (and then steel) could be seen.

The same is true in modern software engineering vs. legacy. If I take an old codebase, data structure, and business "into the cloud," it doesn't copy+paste well. This is why most incumbent cloud migrations are doomed to failure (or, more likely, to become a net increase of tech cost that benefits the cloud vendors much more than their customers).

Cloud vendors will often front cash to a big incumbent to migrate to the cloud and deliver some new products along the way if the incumbent commits to volumes. But this, too, is dangerous if you don't get it. I've seen a few banks make the big migration push and hire professional services firms to deliver. That firm is paid by the hour, not for success. In the worst-case, this can be a lose-lose for the incumbent, who is now contractually bound to pay for cloud volumes they're not able to use. They're likely still running their legacy platform or data centers too.

On this one, I have no insight as to if JPMC is doing it right, but their recognition that it's not easy to do and long term in nature are encouraging. (To quote the CFO, edited slightly for clarity and emphasis mine).

Producing results. Chase launched in the UK and, by all accounts, is doing quite well. Since launching in September, early customer and market feedback has been that the digital-only bank offering from Chase is quite good. Sure, they're essentially buying customers with 1% cashback and 5% interest on round-ups, but nobody (other than Santander) was really doing that in the UK. 

The app is also 100% digital-only, so they have no branches or legacy tech to manage. Their "hurdle rate" to make a customer profitable is much closer to what a Neobank would expect. 

It's not all good news.

JPMC is right that it faces headwinds. Hidden costs in its legacy, new competitors that get it and have their own war chest to spend, and entirely new competition categories.

Hidden costs. I cannot underemphasize how challenging it is to take an old mainframe with 59 million customers and make that work in the cloud. Not least because that mainframe is the beating heart of 1000s of other systems and manual processes. Many of the people who built Mainframes are retired or dead, and yet they are the engine that drives the incumbent's revenues and profits. Turning off the legacy tech is simply not an option.

The old cost isn't going away; new costs are being created. As banks invest in innovation to compete, their "run" costs aren't going down; they're actually increasing. Incumbents have often duplicated their cost base. So the analysts that can't see the return on investment have a point. Bank tech spending is predicted to increase 10% YoY for the next half-decade (much to the joy of every professional services firm). 

I actually don't think that's all bad. If you can prove a low-cost digital-only operating model in a separate Geo (like the UK), then perhaps it could work in the US. The trick everyone misses here is that instead of migrating customers with their existing products, you're better off just bringing them through a slick re-application for a new product. You might lose some customers in churn, but frankly, modern digital-only product applications are so frictionless it's worth it for the cost/benefit.

New competition. BNPL is a monster, and it's eating away at overdraft and fee revenue. Block and PayPal can invest as many retail customers and so many ways to monetize. They're also much more experienced at the digital operating model.

The digital community banks are focussing on niches. Whether it's consumer groups (LGTBQ, African American, Gamers) or SMBs (tradespeople, dentists, therapists), there's a niche Neobank for everything. Each of these steals some transaction volume and potential growth from incumbents. 

Then there are folks like Goldman on the larger end or the community banks on the smaller end who embrace partnerships, BNPL, banking-as-a-service, and more. There are plenty of well-funded, savvy competitors bobbing and weaving.

JPMC is unlikely to reduce its tech spend in the next 5 years, nor should it. But to get the results it craves it can play to its strengths and do what others can't or won't. Let legacy migration continue over the long term while focussing on new revenue lines that take advantage of assets like its global payments connectivity and diverse balance sheet.

Now that JPMC came to play, what should Fintech companies do?

Direct to consumer or direct to business Neobanks can focus on their niche, deepening customer engagement and cross-sell. Neobanks with 5m+ customers might not threaten JPMC any time soon, but they can be great businesses in their own right. With a much lower cost structure, their hurdle for profitability is much lower.

The SuperApps are gonna SuperApp. If Block and Paypal create a true consumer/merchant ecosystem and flywheel, they could be unstoppable (same for some BNPL providers).

JP Morgan might be the best of the big incumbents, but it's changing because its new competition plays a different game.

As an observer, I'm excited to see Neobanks, SuperApps, and Fintech companies react to this. The next 5 years are going to be interesting.

ST.

4 Fintech Companies 💸

1. Cryptosimple - Betterment for Crypto (EU initially, then the US)

• Crypto simple offers three plans to invest in Crypto for people who want exposure but find the whole space confusing. Conservative allocates 90% to stablecoins, 10% to volatile assets, balanced is 65% stable / 35% volatile and growth is 65% volatile / 35% stable. Cryptosimple manages the portfolio through its app and applies the compounding for users, so they have to set their auto-pay and forget about their investments.

• 🤔 There is a huge need for this kind of product, and I'm surprised someone hasn't done it sooner. Just this week, I've had conversations with three people who work in Fintech but find Crypto too confusing to fully engage with. Instead of being an exchange, or a bank account, Cryptosimple has started with taking the Robo approach. They're a registered Digital Asset Service provider in France, with plans to expand across Europe, the UK, and the US. I can see them later adding debit cards and becoming the "on-ramp for normies" who feel like buying Crypto directly is too risky, but having someone else manage it, given its growth, is ideal.

2. Payflow - Earned Wage Access for Spain

• Payflow partners with corporates to provide salary advances for blue-collar workers. Payflow is free to the worker, and workers can request up to 50% of their next paycheck as an advance. Payflow says that it's uptake and companies it partners with average 40% and can be as high as 90% with some employers. 

• 🤔 Earned wage access is complicated in Europe. We don't have the suite of Payroll API providers (like Atomic and Pinwheel), so the EWA Fintech company often starts with building 1:1 employer relationships. Payflow seems to have cracked that nut with 175 companies and 100k users on their platform. I'm curious to watch if EWA Fintech companies can back into becoming Neobanks and fully-fledged Fintech super apps in time. They have the perfect wedge product, but the task now is scaling. 

3. Burnt Finance - DeFi NFT Marketplace on Solana

• Burnt Finance is building an NFT marketplace that supports DeFi functionality (e.g., NFT lending or game financing). Users can buy, sell or borrow against their NFTs. Burnt Finance says it has 160,000 users on its waitlist. This focus on DeFi means users can become owners and benefit from the platform's growth and receive a share of the platform's take rate (which sounds a lot like it would pass the Howey test to me, no?). 

• 🤔 Given the massive scale of Opensea, the mainstream NFT marketplace, it's not surprising to see competition emerge on other chains. The main benefit of Solana is its relatively low cost of transacting and high speeds. One of the core criticisms of Opensea is how "centralized" it is and how little the users of Opensea have benefitted from its massive increase in valuation. As a result, recently, we saw a decentralized competitor Looksrare launch an NFT marketplace by airdropping tokens to Opensea users. We could see similar things start to happen in the Solana ecosystem. Interestingly one of the leading investors here is Alameda research, the sister company of FTX. FTX is a major Solana backer and building its own centralized NFT platform, but by investing in Burnt, it's also hedging against a "Looksrare" scenario in Solana. Also, Multicoin investing in something is a significant signal.

4. Wealthkernel - Drivewealth for the UK (EU soon)

• Wealthkernel provides API infrastructure for embedded investing, portfolio management, and asset custody. Wealthkernel is building deeper integrations across Europe in the coming months. They also offer "product wrappers" for regulated products (e.g., tax-free accounts like ISAs and Junior ISAs). 

• 🤔 I struggled for a fitting tagline for Wealthkernel because their platform is a mix of quite wide and quite deep. Despite being founded in 2015, Wealthkernel recently raised $7m and is beginning to see client traction.

Things to know 👀

Bit of a BNPL flavor this week

1. Affirm partners with Verifone to be available at physical Checkout

• Affirm will offer its Buy Now Pay Later options to merchants who use its Verifone payment terminals in-store. At checkout, either the clerk or consumer selects Affirm as the payment option, and then the consumer is presented with a QR code to scan. The customer then completes the transaction with the Affirm app. 

• 🤔(It's a no-brainer, but) The partnership grows the addressable market for Affirm. Affirm has an active consumer base of 7.1m and 29,000 active merchants. This move with Verifone brings massive bricks and mortar retailers like bed bath and beyond into reach for Affirm. 

• 🤔The user experience is better than traditional POS lending, but for new to Affirm customers, it's not ideal. The use of QR codes for existing Affirm customers will be slick, but the friction for downloading an app, to install, to then checkout might reduce conversion vs. e-commerce. But we know once BNPL has a customer, their re-activation rates are astonishing. So even if onboarding is poor, Affirm just got a significant acquisition channel. Between that and Amazon, they're making partnership moves.

• 🤔 I can imagine physical merchants starting to accept Afterpay, Klarna, etc., in-store. Why wouldn't merchants look to support it if it increases order value and conversion? Watch for more here.

• 🤔 BNPL has been rocket fuel in e-commerce; it could do the same for physical retail. BNPL is different from POS lending because it increases the average order value and conversion %. If this business value translates to retail, it's hard to see why merchants wouldn't want it. 

• 🤔 It's hard to see this as anything other than Affirm bootstrapping another payments network. Affirm sees a consumer's preference and intent outside of the single transaction. This data allows them to re-activate consumers and bring them to merchants. If merchants start adopting BNPL more, would consumers also use the "pay now" feature?

2. Amazon vs. Visa Update: Will keep accepting Visa cards

• After much drama, Amazon has announced it will continue to accept Visa Credit cards in the UK. Previously Amazon blamed high fees for processing credit card transactions. 

• 🤔 This was always about interchange. Big merchants vs. transaction fees have been an ongoing struggle for decades. Still, Amazon is especially sensitive to those fees since everything they do is about an ultra-tight focus on cost and value. 

• 🤔 It's also about tax jurisdictions and Brexit. Amazon's headquarters are outside the UK (in Luxembourg). In the past few months, both Visa and Mastercard increased the fees for European merchants to accept payments from UK cardholders. Having made this change, Amazon would face a potential cost rise and went public to try and give it a bargaining chip.

• 🤔 I wouldn't be surprised to see Amazon experiment with other payments types. Following the Affirm partnership in the US, we may see things like that expand globally (Amazon partners with Barclays to offer installments in the UK, but it isn't a direct Affirm competitor in a true sense).

• 🤔 Open banking payments offer merchants an exciting alternative/complement to BNPL in Europe. Across Europe, all banks must allow 3rd parties (like Tink, Truelayer, and Plaid) to initiate payments. We're also seeing specialists like Vyne and Banked specialize in "pay by bank app" offerings for e-commerce. The checkout looks like any other payment button to a consumer, except clicking it triggers my bank app to ask me to authenticate the payment. What makes open banking payments unique is combining account data with the payment. In effect, merchants could build loyalty and data feedback loops (which has made BNPL special). 

Good Reads 📚

More BNPL than you can shake a stick at

1. BNPL's coming avalanche of complaints?

• BNPL providers' complaints to the CFPB relate to consumers receiving negative reports at the credit rating agencies (e.g., Equifax and Transunion). While the short-term products (e.g., Pay in 4) don't report to the agencies, longer-term products (e.g., 12 months) do. Affirm sees the majority of complaints because its longer-term product has the highest usage.  

• Compared to other sectors, this complaint level is exceptionally low. Still, Jason suggests as the much more widely used, short-term products are brought into the rating agencies, complaint volume will skyrocket. Currently, the CFPB is investigating the BNPL sector, and the rating agencies are also starting to add BNPL to individuals' credit files. 

• 🤔 The honeymoon period for BNPL could be ending. BNPL has been all momentum for the past couple of years and boomed during the pandemic. This could be growing pains, or it could be the beginning of a consumer credit crisis. I believe it's growing pains. BNPL's strength isn't that it does a soft credit check; its power is the lack of friction in e-commerce and the data it uses to re-activate consumers.

• 🤔 Does BNPL compete more with overdrafts than credit cards? Alex Johnson wrote a great piece about where BNPL fits and what gap it's filling. BNPL, he argues, is primarily used for low-ticket price items like overdrafts, but instead of consumers paying fees, merchants are paying the fee. So yes, in terms of what bank revenue it's displacing, BNPL competes with overdrafts more than credit cards. But it's also much more consumer-centric than overdrafts by default. 

Tweets of the week 🕊

That's all, folks. 👋

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