Chasing inflection curves – the importance of “why now” in venture

I’ve always been fascinated by the butterfly effect. How small changes in the system can lead to monumental, unforeseen impact.??

As a venture investor, I hold this idea quite close to my heart. There can be certain systematic changes or “why now” moments - be it technology shifts, regulations, macro events, customer preference shifts that can often lead to irreversible impact. These moments are the core reason why something that has failed multiple times in the past, can exist only NOW.

Think about UPI, Jio, demonetization, COVID. These are some of the most obvious changes but there are many non-obvious transformational ones that are subtle and hidden in plain sight. Most impactful outcomes in start-up ecosystem have exponential J curves and non-linear unimaginable growth, only when backed by strong underlying “why nows”.

This series of blogs would be an ode to the butterfly effect. I plan to capture some subtle changes that are in action now, which might lead to exponential growth in future. It’ll be slowly at first and then all at once.?

But before that, let’s appreciate where this has beautifully played out in the past. Picking out examples of F&O trading, micropayments and unsecured lending.

Origin of discount broking: Ever wondered why Zerodha became the first discount brokerage back in 2010-11 and why flat fee model didn’t exist before that? The most obvious answer is tech advancement in exchanges and rising internet penetration. But the nuance here lies in what happened during the 2008 crisis.

Back in the day, the broker with the highest capital access used to have the most superior value proposition for traders. Capital was the moat. SEBI required brokers to provide 3-5% of the F&O contract value as margin, but there was no regulation that enforced them on collecting it from customers. Brokers competed by offering lower margin requirement to traders. It made sense as brokers used to earn a commission on trading value flowing through them.

All was well until the 2008 crisis where mismatch in margin led to collapse of a lot of the longtail brokers. This volatility was detrimental to Indian stock market and in response, SEBI introduced regulations in 2010/2011 that required brokers to report all customer margins on a daily basis. This eliminated brokers' ability to compete solely on offering lower margin requirements, as a value proposition. Instead, it opened the door for new business models focused on better customer experience, new pricing structures, and transparency.

This meant that a new age broker like Zerodha with flat fee structure could finally exist and go head on with the existing incumbents. This in turn led to the rise of retail traders. A small part can be luck but a lot of this is having a sharp nose for value and understanding the second/ third/ fourth order effects of small changes that happen in front of us.?

Rise of retail participation in F&O: India options have grown at 70%+ CAGR over last 5 years with retail F&O traders increasing from 0.5m to ~4.5m. This is the steepest trajectory any market has seen in a while, with India becoming the largest derivatives market globally by volume (11x size of US). Retail investors are now 35% of overall derivative market and majority by volume.?

When we think of their rapid rise, we typically thank the discount brokers and COVID that led to this tremendous rise. But a beautiful nuance we miss is that of regulatory changes and new product introduction.

In the last 5-6 years, India has moved to “sachet-fication” of option buying, making it ideal for retail investors. We have introduced ample set of short-dated option contracts that have “weekly expiration”. We have also seen availability of “0DTE” (zero days till expiry) contracts – meaning traders are buying options that are going to expire the same day. ??

Weekly options are far more cheaper to enter (premiums can be <15% of monthly expiry) have much higher volatility to index, esp on the day of expiry and hence offer higher leverage (sometimes even 200x leverage on expiration date). Imagine putting INR 2k and getting access to INR 4L price.

The effect of this is now 75% of monthly index option values are traded on expiry days, with a holding period of <30 mins.

To add a cherry on top, NSE and BSE are further competing with each other and making lot sizes to enter even smaller, to attract more retail investors. Additionally each day of the week has a separate weekly option that expires (MidcapNifty on Monday, FinNifty on Tuesday, BankNifty on Wednesday, Nifty on Thursday and Sensex on Friday).

All in all, this means that there are many avenues for retail option traders to participate (gamble?) at low cost and very high reward.

Creation of large outcomes in gaming and content

In the last six years, we have seen success stories of many players in gaming, social/ entertainment reach to $50-100m revenue with ease. Think real money/ core gaming (e.g., Dream11, MPL, Probo, BGMI), virtual gifting to creators (Sharechat), episodic OTT (PocketFM/ Kuku), byte sized service (Astrotalk). Majority of these paying customers are time-rich, $$ poor and were bucketed in a stereotypical category of “Bharat doesn’t pay”.

The commonality in all these players is innovation of micropayments as monetisation model. Imagine charging customers only INR 10-100 for availing a micro service digitally (e.g., palm reading, gifting a INR 9 digital rose to my favorite creator, consuming 5 mins worth of an engaging audio or web comic episode). The largeness here would come from monetizing millions of customers, which wouldn’t be hard to imagine given the low ticket size. This has only been possible at scale in India post introduction of UPI, which enabled platforms to accept micro transactions seamlessly in a fast and cheap manner. ?

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Give me “unsecured credit” where due

Unsecured lending ($140b+ large in India) grew massively at a 25%+ CAGR post 2018. This was complemented with loan volumes growing at 45% CAGR and fintechs accounting for 40%+ of all origination. We started seeing the share of small ticket size loans increase like never before. Imagine from 35% share in 2017, it expanded to 90%+ in 2022. Before that, the sector was growing but it wasn’t flying! What changed??

The right tech and regulatory infra was laid out. Just before this, the cost of KYC for a personal loan declined by 85% (thanks to e-KYC), processing cost of a loan decreased by 70%. The rise of fintechs led to turnaround time for processing a loan application reduce to a single day and time to transfer the amount decrease by 90%. The rapid decline in cost and faster TAT solved for economics and better value prop to customers that was initially not possible.??

These stories have heightened my appreciation for understanding what is different this time, what is changing quickly and what is leading to that change.

All these stories look too perfect in hindsight, of course. The real art is identifying markets and ideas before the breakout happens, before they become obvious to the world. When these powerful currents of “why now” are coupled with force of nature, visionary founders, magic happens.?

Reminder to self: Powerful question to always ask is “what is changing this time”??