Back to basics by going vertical | Fintech Inside #69 - 13th Feb, 2023

Where does the next decade of fintech opportunities lie? That's in this edition. Also, details on digital lending app ban, everything is UPI and fund raise announcements.

Feb 13, 2023

Hi Insiders, I'm Osborne, Principal at Emphasis Ventures (EMVC).

Welcome to the 69th edition of Fintech Inside. Fintech Inside is the front page of Fintech in emerging markets.

I'm back! After an almost three month hiatus, I'm back and it feels good. These past few months have been pretty intense so I'd like to thank you for being a long time subscriber and sticking with me even when I was not publishing.

There's a lot happening in fintech and not a lot as well. That statement needs some unpacking, which I'll do over the next few editions. Stick around!

Lately, everyone's been wondering what the next phase of growth for fintech will be like, largely thanks to regulation. In this edition, I attempt to cover one such theme where I see opportunity to build fintech products - vertical fintech products.

You'll also find details on India's ban on digital lending apps, UPI for everything and round up of fund raise announcements.

Raising funding for your early stage fintech startup? reach out to me connect@osborne.vc

Enjoy another week in fintech!

🤔 One Big Thought

Back to the basics by going vertical

Since the beginning, the financial services industry adopted a one-size-fits-all approach. This meant, no matter who you are or what you did, you would get the same access and service levels to a financial product. As the years went by, financial institutions realised that majority of their revenue came from lending and they could lend if that had large deposits, where deposits largely came from HNI's and affluent users. So they doubled down on those users who brought in large deposits by providing bespoke "white glove" services, often with better pricing.

This was obvious - a traditional financial institution could only have so many employees and a single employee can only service a fixed number of customers in a day. If a financial institution had to grow revenue, it had to optimise services for the user base that brings in the most dough. As a result, the rest of us suffered with sub optimal services and high prices. In some ways, one would not be wrong to think that, till recently, banks were vertical focused - focused on the affluent, male customer.

Then came the rise of technology - everyone could access the internet at diminishing cost over time. This past decade of financial services has been about digitising existing financial products and reducing the cost of distribution. With digitisation came reduced cost to service and institutions passed on the cost benefit to users. Today, a sufficient majority of users have become accustomed to using technology for their daily lives including for financial use cases. There's a limited but growing trust in technology to deliver financial products and services.

If you zoom out and think about the evolution of the financial industry, we had the first era of new product creation (pre-1980's), then distribution (pre-2000's), then digital distribution (2000-present). I believe that now and this next decade will be the era of identifying and building financial services experiences for specific verticals. This era will predominantly involve manufacturing product experiences and eventually solving for distribution.

Why the next decade of opportunities in fintech will be vertical-first?

Increasing user trust in digital: Technology has touched and dominated several aspects of our daily lives. India has 700+mm internet users. Youtube has 467mm active users in 2022. 346 million Indians have engaged in online transactions including e-commerce, and digital payments. We have come to know and trust that a payment we make online will be received instantly, a package we order online will usually be delivered within 24 hours and so on. These have now become baseline user expectations from a digital experience. If your product meets this baseline, it's not good enough anymore. You have to exceed the expectation.
Large industries/markets with specific needs: Thanks to Covid and GST, most sectors and businesses have adopted digital in a major way - not only for payments but also for the way the operate. There are several multi-billion dollar sectors and users to build vertical-focused fintech startups. The market sizes here can create several large fintech opportunities. Many verticals have individually large addressable markets worth building for and the massive revenue potential of fintech products within each vertical makes the addressable markets even bigger. There are many tailwinds for each vertical and this is the main reason why I believe now is potentially the right time to build vertical-focused fintech startups.
Better value proposition in vertical-focus: There are many nuances in the way vertical industries function which are different from those of another industry. A one-size-fits-all approach to providing financial services fails to appreciate those nuances. A vertical focused, contextualised approach, addresses those nuances and offers an elevated experience for financial services. Contextualised value proposition offered in such cases helps build a significant moat.
Targeted Distribution with efficient CAC: Knowing the specific consumer profile helps to build better and targeted distribution channels. Currently, fintech startups carpet bomb all users equally with very poor conversion rates. This has driven up the customer acquisition cost. Being vertical focused could potentially lower acquisition costs, if the right channels are identified.
Potentially reduced competitors but more competition: In a world of vertical financial services, I believe there will be fewer competitors - building a truly unique customer insight is tough for most. Therefore most folks will not bother building, and those that do, will have a late-entrant disadvantage. Unless they build their own unique insight or have a unique distribution strategy.

How can financial services be verticalised? There are three broad categories to verticalise fintech offerings - by use cases, by income levels and by customer type. Money flows for each of these types are nuanced and require nuance and contextualisation. A fintech offering built addressing any of these categories could be a large opportunity. In some way, this verticalisation has already started happening in India.

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Based on use cases:
- by industry: Several large industries have nuanced money flows that are unique. Building vertical fintech businesses could be lucrative. Examples include: agriculture, hospitality, logistics, housing, manufacturing, FMCG, healthcare, pharmaceuticals and many more.
- by product penetration: There's the famous Marc Andreessen quote - "Software is eating the world". IMO, software is eating the world at a different pace for different sectors and use cases. Some sectors see more digital adoption than others and therefore the service standards expected by a user are different. For example, in Indian payments, UPI has made digital payments ubiquitous, and a company offering a UPI solution is not better in anyway. However, making an insurance claim is still cumbersome and it's waiting for a better solution. Similarly, there are several verticals where full digital product adoption is waiting to happen.
- by customer segment: Financial products can be designed to suit the needs of specific customer segments. Examples include: teens, women, farmers, couples, NRI's, D2C brands, entrepreneurs, employees and many more.
Based on income levels: Each of these income levels have different financial requirements, have varying disposable incomes, different incentives, different level of comfort with digital and many other nuances. While I have given my own estimation for income brackets, you can choose your own but it's important to truly understand your customer.
- High net worth individuals: IMO, these are typically individuals with income higher than INR 5 lacs ($ 6,100) per month. New products can be built for their banking, insurance and wealth requirements.
- Affluent: These individuals recently coming into some wealth. Their income would typically be more than INR 75K ($914) to less than INR 5 lacs ($6,100) a month. Their appetite for risk is increasing, but trust in parting with their income is not as high, unless one's able to build that brand.
- Mass market: These individuals are typically living paycheck to paycheck but are aspirational. Their financial requirements are few, but can be serviced only through technology or an tech-assisted model.
Based on customer type: There are many types of customers to build financial products for. The main thing is to know your customer. Founders need to understand where their strengths lie while starting out because it's ridiculously difficult to course correct after one's taken a certain path. What I mean by this is, if your strengths as a founder don't lie in building a retail customer-facing brand but you decide to start up as a retail brand, it will be very tough to pivot to selling to enterprises because you've already built an organisation for retail customers. Below is a non-exhaustive list of types of customers. There are definitely many more.
- Retail
- Enterprises
- Small businesses
- Governments
- Banks

Here's the thing though, it's not like building a vertical focused fintech product comes without its challenges. There are some serious challenges that will make it tough to scale in any given vertical.

Fine line to discrimination: Serving a particular set of customers means not serving another certain set of customers and this could mean a very fine line to discrimination. For example, a product cannot be built to limit access to customer from a particular location or religion. That's straight up illegal with regulatory consequences. One needs to be very careful when building vertical focused financial products.
Customer acquisition challenges: Distribution channels might not be established leading to a platform building out its own distribution. The second-mover here might find it easier to build distribution. In the near term, this also means more expensive customer acquisition. All of this thought, will be needed to build trust.
Some verticals are deceptively small: Not all verticals are large enough to accommodate even a couple $100mm revenue startups. For example: the debt collection market - the credit market is large and by that signal the debt collection market may seem large, but if you peel back the layers and do the math, it's tough to build even a $50mm revenue startup. Thorough market analysis is super important.
Tough to expand to other verticals: Some verticals are shallow (not just in terms of market size, but also in terms of digital penetration) and a startup building in the vertical could outgrow that vertical's potential in as quick as a couple of years or less. Unless there are close adjacent verticals, it's very tough to launch new verticals. Market and customer perceptions are hard to change and often unforgiving. Pick your vertical wisely.
Some verticals may not need a specialised fintech offering: It's quite possible that certain verticals operate fine without tech or fintech or with existing solutions. Force fitting a solution may not add step change value, leading to retention problems.

It may seem that fintech opportunities are few and far between but I believe that's only because we've exhausted the "low hanging fruit" opportunities over the past decade. Now it's time to go deeper, understand value chains and build new fintech products. Verticalisation is one such phase that fintech startups will go through over this decade, before we see fintech becoming one-size-fits-all again. It requires deep sector knowledge and we could witness the largest crossover of non-fintech talent to fintech startups - the one crossover I always knew I needed!

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3️⃣ Fintech Top Three

1️⃣ Digital lending apps were banned and then un-banned

Indian government banned several digital lending apps including LazyPay, Kissht and others. Later in the week, it was announced that the ban on some of the banned apps will be lifted.

Takeaways:

A lesson in how not to execute a ban: This ban was so badly executed that no one, not even the founders of the banned apps, knew what was going on. Complete chaos all around. This had serious impact on user trust in those apps - some, for no fault of theirs. The apps weren't even banned uniformly - some users were able to access it, other not. Though it seems there's no learning from these abrupt bans. Unfortunately, this haphazard banning happened several times - demonetisation, SBM ban on cross border payments, 2020 ban on Chinese funded startups, now this ban and several more. And just like the past, this abrupt ban helped no one and was later revoked (except the Chinese investment ban).
Impact on perception of stability: In financial services, stability is the holy grail. Stability in products, services, leadership, regulation and everything else. As soon as there appears to be a chink in the armor of stability, trust is broken and its very tough rebuild. This incident along with those in the past, are shaking the foundation of stability that Indian financial services have. The result? Founders are thinking twice to build in financial services, innovation is restricted as everyone retreats to building tried and tested products and services and global investors will hold back from investing in India. None of these are good outcomes.
Make sure you *really* know your investors: Building in financial services is tough as it is, but you need to be even more cautious about who you take investment from because you're building in India. Don't be afraid to ask where the investor is domiciled, who are the main decision makers, who are the ultimate beneficiaries and more. It's basic questions that your bank will ask anyway before allowing you to bring investment inbound.

2️⃣ Everything is UPI

PhonePe launched UPI payments for Indians traveling to select countries. Paytm launched a product to link one's RuPay Credit Card with UPI. RBI allowed inbound travelers, initially from G20 countries, to use UPI payments for merchant payments in India.

Takeaways:

The search for the next killer UPI feature begins: Just this past week, 3 new UPI features were launched that were in the works for years. 1. Pay with UPI in select countries. 2 Pay with credit on UPI. 3. Inbound, non-Indian travelers can pay with UPI. Many other UPI features are expected to be launched. What will be the next killer UPI feature?
UPI as customer acquisition: Given UPI is free to use and little revenue can be earned from it, I'm not sure why all these companies are eager to launch new UPI features - except credit on UPI. The only reason I can think of is that UPI is now becoming a customer acquisition strategy, similar to why platforms use Facebook or Google for customer acquisition. UPI has an existing, large user base and it probably doesn't cost much to offer a user UPI payments on the app. Any incremental feature launched should be part of the core UPI offering.

3️⃣ India fintech fund raise announcements have not picked up yet

No fund raise announcements this week in India but there was one acquisition: LendingKart acquired Upwards, a consumer credit startup, for $ 14.6mm (INR 120crs). Southeast Asia on the other hand saw 6 fintech companies raised $150mm this week.

Takeaways:

*hot takes loading*

🌏 International

Revolut launched cryptocurrency staking for customers in the UK and EEA. A Senior Board Member of the Bank for International Settlements called for a co-ordinated regulatory response to restrict the incursions of big tech firms arguing that the current rules are "not fit for purpose".

🏷️ Other Notable Nuggets

🎵 Song on loop

Fintech updates can get boring, so here's an earworm: Lay Low by Tiesto (Youtube/Spotify). Excellent chill track with banger vibes.

👋🏾 That's all Folks

If you’ve made it this far - thanks! As always, you can always reach me at connect@osborne.vc. I’d genuinely appreciate any and all feedback. If you liked what you read, please consider sharing or subscribing.