We will likely soon reflect on 2020 as the year that fintech became mainstream. The pandemic accelerated adoption of digital financial services across various verticals and early data from McKinsey suggests that this is happening across both income levels and generations.¹
Now that consumers have decided that fintech is here to stay, where do D2C / D2SMB financial services go from here? Where is there room for further innovation?
There’s a massive opportunity for the next generation of solutions to re-architect the way that we interact with financial products in our daily lives. While the first wave of consumer fintech focused on making familiar financial products — from checking to lending to investing — accessible digitally, the onus still remains on the user to stitch together offerings to serve their personal circumstances.
The next wave of innovation has an opportunity to go a level deeper: addressing base needs for day-to-day living (“I don’t want to worry about running out of money between paychecks”) rather than solving for access to specific products (“I want to be able to trade equities digitally”). These solutions will appear narrower as they are tailor made for the communities (or “verticals”) they serve while thoughtfully weaving together the right mix of financial products.
The problem: consumers and businesses are still underbanked
The way I see it, the majority of consumers and businesses of all sizes are still underbanked. While many may be “banked” in a literal sense — though financial inclusion is a serious issue that still needs to be addressed — bank accounts and financial products are often siloed or underutilized. Alex Johnson puts it in his blog post that reframes “underbanking” not in terms of access to a bank account but in the ability of a provider to “address the entirety of consumers’ financial needs.”
What’s missing is context.
Historically, banks and financial services providers had rich context on their customers; in many ways they were “vertical” by default. The general store owner in a small town knew who was safe to extend credit to and who wasn’t. No underwriting model necessary.
As banking developed in the United States, it was designed to be localized with state governments overseeing the issuance and management of charters.² Banks sprung up to serve local populations they knew well. In fact, Bank of America got its start in the early 1900s catering specifically to the Italian-American immigrant community.³ Credit unions are relics of that approach today: The “community-focused” mission and membership requirements allow these organizations to have richer context on their customer base. They were shown to not only have better stability and financial performance in the financial crisis but are also 2x more trusted by their customers.⁴
But the banking industry today looks very different from its beginnings — and even from the 80s. As of 2018, the top 4 banks today held nearly half of all consumer deposits.⁵ The industry has also consolidated at a rapid rate. Since 1990, the number of banking institutions has decreased by nearly 70%.⁶
The ramifications of this consolidation are huge: as these institutions expanded beyond their initial geographies and communities, the products and services they offered became increasingly commoditized. Between big banks, an average customer might see variations in fees, rates, or available services, but the suite of products (deposit account, debit card, personal loan, etc.) is largely the same. Operationally, the lens was no longer focused on individual, unique customers but rather on financial products or lines of business. The underlying technology also evolved in this way, leading to disjoint systems siloed by product. This shift means that individuals who don’t fit a general mold these systems are accustomed to — like immigrants with no credit history or non-traditional small business types (or those deemed “high risk”) — OR who are not profitable to acquire and serve on a single product basis end up poorly served or shut out.
Bringing back the view of the customer
The payments industry serving SMBs has been ahead of the curve realizing that “mass produced” solutions often just don’t cut it. Different kinds of businesses have different payment type mixes, payment cycles, counterparty risk, fraud risk, chargeback risk, working capital cycles, etc. In fact, many large payments companies got their start solving problems for a specific underserved segment — whether that was Fleetcor helping the logistics industry pay for fuel, Square taking on the risk of underwriting micro-merchants, or Stripe helping small ecommerce businesses accept payments online.
Coming from the opposite direction, savvy software businesses were quick to realize that since they were already powering their customers’ day-to-day operations, they were also well positioned to offer contextual financial services. Companies like GoDaddy, Mindbody, and Shopify had such rich data on their customers’ operations and needs that they could introduce financial products at logical points — particularly when it came to accepting payments or offering access to low-friction capital.
D2C/D2SMB fintech 1.0 has done a great job of taking that same view of what our banks offer today and making it cheaper, easier to access, and a better overall experience. A nimble digital architecture means these institutions are able to innovate on product and smooth common frictions. Early wage access is a great example — insights from historical transactions and direct deposit data made it easy to advance funds before the ACH officially cleared. However, these players had to build their infrastructure from the ground up and go through the painful process of integrating into traditional rails and institutions. To cover a high initial fixed cost base, it made sense to cast the net for users as broadly as possible and optimize for scale from day 1.
The emergence of API-based fintech infrastructure means there is less upfront investment needed to get started and companies can focus more on building a personalized experience for a tailored customer persona. I believe we’re still in the early days of this infrastructure development and that the continued maturing of this ecosystem will help support an acceleration of new innovative consumer and SMB-facing solutions.
A sample of the wealth of infrastructure options that are available today (this is by no means a comprehensive set):
It’s time for contextual financial services
Over the last year or so, the landscape has flourished with new startups that are serving the needs of specific segments of the market — whether that is an industry, life stage, or demographic. The rise of freelance work, gig work, influencers, and micro-business owners means that the line between business and consumer has blurred. That grey zone in between is where startup activity has flourished. On the business side, many solutions start as workflow or operating software that helps their customers run day-to-day operations before layering in financial services like payments, payroll, invoicing, lending, etc.
But what about TAM?
Whenever I bring up this topic, the looming elephant in the room is always — but what about the TAM? Yes, narrowing the focus to one group means there’s a smaller number of theoretically addressable customers. However, the “jack of all trades, master of none” approach most traditional banks have taken yields two outcomes:
- For a “standard” customer: the exact same pitch and products as all 5,000+ banks with no discernible difference
- For a “non-standard” customer: 5,000+ sub-optimal or irrelevant options that don’t fit their needs
Financial products built for specific communities might have a smaller theoretical TAM but can benefit from:
- Laser-focused messaging and natural network effects → lower CAC
- Viral adoption within communities and strong word of mouth → strong organic growth
- Strong community and mission alignment → low churn / strong retention
- High engagement and customer buy-in → more likely to become “primarily financial institution” → successful cross-sell and higher ARPU
Coupled with the wealth of infrastructure that exists means that vertical solutions can be spun up quickly and reap the benefits of strong unit economics early on.
However, this is not to say that verticalization is a silver bullet. Some categories can support a large vertical fintech player but not all. When the target customer base is narrowed, there’s less large marketing budgets can do to mask a lack of product-market-fit. It will quickly become clear which solutions have truly struck a chord. Winning solutions need to solve an acute initial pain-point, find an effective initial wedge, and then rapidly expand the product set from there. Evidence of achieving this will look like best-in-class metrics across growth, unit economics, retention, and new product adoption.
Where am I excited?
In many ways, vertical fintechs are continuing the spirit of community banks and reimagining it for the digital era. As this trend continues to develop, there are a few opportunities I am most excited about:
- B2B software + fintech: Businesses — particularly SMBs — have been historically underserved when it comes to financial services. The banking industry continues to treat “SMBs” as some monolithic category — when in reality a high-growth startup couldn’t be more different from a family-owned auto repair shop which couldn’t be more different from a freelance designer. As new tailored software is built to address these categories, there’s an opportunity to layer financial tools and services into the same suite.
- Community or network-driven neobanks: For more individual-facing solutions, I’m excited by players that are tapping into a strong (and underserved) community — the shared strand could be profession, financial status, or life circumstance. The key is a strong enough pull that unlocks viral demand in a way that enables best-in-class unit economics.
- Enabling infrastructure: Both of these categories are only made possible by a rich supporting ecosystem of infrastructure players that are abstracting away what used to be massive BD and engineering undertakings into clean APIs.
If you’re building something in these spaces or just want to jam about the future of fintech, please get in touch with me at firstname.lastname@example.org.
2. Gilder Lehrman, The US Banking System: Origin, Development, and Regulation
3. Bank of America, Our Company
4. Northwest Credit Union Association, Credit Unions Twice as Trusted as Big Banks
5. Federal Reserve Bank of Minneapolis, Rising Bank Concentration