August 6, 2017
This week is all about moats. Warren Buffett has popularized the term which is now commonplace in business analysis (and a hallmark of a sustainable business). It’s a great metaphor to describe a business’ competitive advantage – you can easily visualize how much a business needs to worry (or not) about invaders. For FinTech, it’s the question of the incumbents’ moats that makes following the space so interesting. Nobody's quite sure these days. Branches are dying, aren't they? Challenger banks are coming! (But can they make money?) Regulation (a moat). Oh, and blockchain.
Anyway, let’s take a look at some moats in FinTech.
Many Americans are happy with plastic, but many smaller stores and restaurants prefer cash, for both tax reasons and the oppressive POS charges and fees that crush their margins.
When thinking about moats, it’s easy to focus on one part of the equation: what a company has direct control over (i.e., products and services). The other part, which is easy to forget: external factors enabling a company’s success. In the case of Visa (and Mastercard), one of the unlikely reasons is the remnants of their success, taxes, and a dash of legacy infrastructure.
Their Success: Could payments in the United States be better? Leverage mobile better? Be more a seamless user experience? Certainly. However, payments in the United States has been a pretty great experience for a long time now thanks to the technology built by the credit card ecosystem. Go to a store, swipe (now insert) a small plastic card, wait a few seconds, and be on your way. Oh, don’t have the money right now? Pay later that month. That is, relatively, pretty great.
Taxes: A lot of small businesses and restaurants, particularly restaurants and bars, prefer cash. While this is changing, it’s important to remember many small businesses and restaurants don’t want to pay the interchange fees (a tax), lower-income customers can’t/don’t want credit cards, their employees want cash (e.g., tips). On the other side, having payments digitally tracked has other considerations, like easily being tracked! We don’t have time to go into labor laws, immigration, service industry wages, or income taxes but it’s clear that neither the cashless economy nor the credit cards companies are meeting some important needs of the market.
Legacy Infrastructure: The (relatively) great experience the United States has today comes at a cost. First, changing consumers has a pretty significant switching cost. The difference between continuing to use your credit cards and using a payment method is slim for most transactions (some merchants are successful.) Otherwise, a consumer has to know when a new payment method is available and, more importantly, why that new method is significantly better for their lives.
There is no shortage of a FinTech challengers coming after Visa and Mastercard but they have a pretty a wide moat for now.
"Achieving a competitive advantage in the global digital arena has become a key priority for governments, businesses, and citizens who strive for inclusion and relevance in this global marketplace.
Moats don’t just appear overnight and typically aren’t by chance. Astute business operators recognize an advantage and start digging as fast as possible! For example, in the last decade, the tech world has shown the ‘network effects’ moat as one of the most sought after lucrative models. (Side note: You have to wonder if any of them studied Visa and Mastercard, the ultimate ‘network effect’ model in the financial services industry.) So what makes a new moat?
The internet and digitization of everything are at the heart of every new moat. Distribution of information, data, and low marginal costs of software continues to power the business of the future. In a mobile world, it’s easy to connect people and business any time, any day, at any location. More importantly, this goes beyond corporate competition. It’s a new way for governments, nations, and even groups of people to start building their (digital) moats today. The impacts of digitization are unfolding every day which ripple through FinTech.
I would be remiss not to mention that blockchain, cryptocurrency, and app tokens add an entirely new dimension to the moats digitization will create (and destroy). A digital protocol removing the middle man should increasingly worry a lot of the legacy financial system.
As it currently stands, P2P is largely not monetized – the majority of customers don’t pay fees on these transactions, but PayPal does, to issuers and banks, which means they come at a loss.
The prevalence, popularity, and promise of a product don’t make a (sustainable) moat. It does buy time to build a (revenue-generating) moat but there is no guarantee. Look at Venmo – Venmo’s continued popularity makes a great story. It’s a better customer experience, massively popular, and its social element is unique; however, PayPal’s bright-eyed acquisition comes at a substantial financial burden. The PayPal team is working around the clock to convert Venmo’s moat of network effect to significant revenue before it’s too late.
Thank you for your time this week! Share with your friends and see you next week.