Welcome to base camp | Fintech Inside - Edition #83 - 17th May, 2024

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

Welcome to the 83rd edition of Fintech Inside. Fintech Inside is the front page of Fintech in emerging markets.

In my many interactions with folks in the fintech ecosystem lately, there's a noticeable glum mood. In today's Big Thought, I wanted to highlight the progress of the last 15 years of India's fintech sector, take stock of what's done and what's left to be done and how we can build for the next 15-20 years.

If you were to think of India's fintech ecosystem as a startup, I think Indian fintech has achieved PMF and entered Series A stage. There's a lot more still to be built but the way we built fintech startups so far will not be the same way we build in the next 15 years. The regulators are collaborative, the industry is competitive and the opportunity is massive.

Read on to learn more about I how think founders can address the massive opportunity ahead of us.

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As usual, there’s also a beautiful song recommendation at the end.

Thank you for supporting me and sticking around. Enjoy another great week in fintech!

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Welcome to base camp. Next stop: Summit.

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As an investor in startups, I have the good fortune of meeting folks across the ecosystem - founders, people wanting to be founders, product managers, other investors, CXO's and many more. All are in some way contributing or figuring out how to contribute to making financial services accessible, transparent and innovative. In my many interactions lately there's a noticeable glum mood. In today's Big Thought, I wanted to highlight the progress of the last 15 years of India's fintech sector, take stock of what's done and what's left to be done and how we can build for the next 15-20 years.

The post is intended to achieve two things:

1. Attract more people to this sector: Given the spate of regulations over the past year or so, talent and founders seem to be leaving the financial services industry. Executives from fintech startups are not starting up in fintech. Talent is leaving the sector in search for jobs in other sectors. This is purely "anecdata" from my conversations. I'm not saying that regulation is solely responsible for the talent exodus, there are other factors too, but regulation is a driving factor here. We need more people building and innovating in fintech, not less.
2. Present the opportunity that lies ahead: As they say, misery loves company. Seems increasingly the mood is glum and that's turning into an negative echo chamber. This is just not great for India's financial services sector or startup ecosystem. There still is immense opportunity to build large fintech businesses. This post is my presentation of how one can address the opportunity.

India's Fintech sector has achieved Product Market Fit:

For the uninitiated, the basics of a startup lifecycle are as follows:

1. A startup goes through several phases in its lifecycle. The lifecycle curve is never up and to the right. At each phase, the size of the startup increases, the difficulty mode increases and the chances of survival aren't that high. There is also a fairly high failure rate at each stage of a startup lifecycle for various reasons.
2. Idea Stage - Idea to MVP: First the idea is turned into a minimum viable product (MVP) for a small set of users. Characteristics: largely run by founders and a couple of early employees. This early team is made of very high-agency generalists who'll do anything needed. They have a scrappy prototype and are iterating the product almost daily. They have no license to operate and so they seek partnerships to grow. They have no revenues and still figuring out/innovating the right business model and unit economics. They would have raised $100K to $2mm from family and friends, angel investors and micro VC funds. The product is barely fully formed, it's still at the bleeding edge of innovation and will break from time to time. Growth rates across metrics are/should be 50%+ MoM albeit on a small base. The product in this stage is also largely addressing efficiency or convenience. There are significant risk factors here including team, product, market and more.
3. Seed Stage - MVP to PMF: If the MVP has fast growth across metrics and strong user retention, it's said to have found early signs of product market fit (PMF). Characteristics: Still largely run by founders and 20-50 employees, made up of high-agency generalists, who will develop skills as needed to grow the product. They have a working product in the hands of users with frequent iterations/updates. They've probably applied or are thinking of applying for a license to be in the flow of funds. They have limited revenues have identified a business model and unit economics to scale. They have raised $2mm to $10mm from VC funds and corporates. The product is inching towards PMF and seeing strong user adoption and retention. The growth rates across metrics are still high at 50-100+% YoY. The early team risk is somewhat mitigated but product and distribution risk remains.
4. Series A Stage - PMF to Scale: To keep the fly-wheel of a strong PMF going, distribution becomes important. Strong distribution channels help the product reach newer audiences. At scale, the product grows and the PMF evolves to solve for scale and maturity. Characteristics: Startups at this stage are growth engines - organisational hierarchy is being established, leaders are hired/promoted to lead charters within the company. This team is composed of a mix of generalists and specialists as the skills required change. The startup has achieved PMF with a fully formed core product in the hands of many users with scheduled improvements/updates. The company is now innovating on adjacent product lines that could be launched to retain this growing user base. They have an established business model and unit economics with growing revenue lines. They have raised $10mm to $40mm from global growth VC funds. Growth rates across metrics are tempered to 20-40% YoY on a higher base. Team and product risk are mitigated but risk of unit economics holding at scale and ability to sustain the growth flywheel remains.
5. Growth Stage - Scale to Maturity: With strong PMF and sticky distribution channels, the product scales to the point of maturity. Maturity is when you expect the startup to go public, when it's a household brand name and other attributes. Characteristics: The company now has an established organisational structure with CXO's and leaders hired/promoted to lead departments. This team is largely composed of specialists and a few generalists. The talent is largely execs with decades or years of experience to maintain growth rates at scale. These companies have a full suite of products and features in the hands of users. Usually would have a license to operate at this scale. They have scaled revenues with an established business model and unit economics on the verge of maturity. They have raised $50mm+ from global funds and PE funds. Growth rates across metrics are steady at 5-20% YoY - nothing crazy. The is mature and growing at a decent page with stable and predictable user metrics. Most risks are mitigated at this stage.

If you were to think of India's fintech sector as a startup, I believe India's fintech sector has achieved early stage Product Market Fit (PMF) and is primed for scale. It's easy to confuse Indian fintech to have reached Maturity phase. But I beg to differ.

There are several definitions of PMF online from some seriously smart people. To me, PMF is when the product finds organic growth across all metrics while maintaining high retention over a period of time.

India's fintech sector meets that definition to me. Most fintech startups across the sector have found strong growth and high retention, across use cases, better than incumbent banks as well. Moreover, if you think about it from a product perspective, fintech startups have broadly digitised existing financial products or made significant process improvement for onboarding to these existing products. Fintech as a sector has roughly attracted 20-25% of all startup funding every single year and has consistently been one of the deepest markets for capital allocation. Startup news is becoming prime time news. Lastly, fintech products have reached the scale where regulators are sitting up and taking notice. Regulators are also intervening when needed. All this is PMF to me - not maturity, yet.

To use another metaphor I love, we've just made it to base camp. Over the last couple of years, we've only just begun the long, hard journey to the summit. See you there!

Taking stock: the last 15 years of fintech in India - Indian fintech is now a pre-Series A startup

The past decade and a half was the Idea to MVP to PMF phase of Indian fintech. It's important to remember that India's financial services sector (not fintech sector) itself is no older than 30-35 years (considering 1991 economic liberalisation as the pivotal point in history). The entire industry made great strides during this period. Who was the ultimate beneficiary? users and the Indian society.

This "Seed Stage" of Indian fintech sector was characterised by:

1. Innovation: In the past 15 years, India's fintech sector launched new or better existing products. The discount broker model. UPI. prepaid wallet, small ticket lending or new to credit (NTC) lending, sachet MF products, and many more examples of products that don't have a corollary globally or have been contextualised and made better for India.
2. Digitisation: The majority of Indian fintech of the past 15 years, was defined by process digitisation. Moreover, this digitisation over the past 15 years, has helped set a new benchmark from the financial services industry in terms of user experience. Instant payments from bank account using a smartphone, digital KYC and onboarding, data access for loan approvals, instant stock trades, simple IPO subscriptions, and many more interactions with financial products are now the baseline user expectation from any and every product or service used. The bar is raised. Anything less than this experience and you're DOA.
3. Accessibility: Affordable data plans and smartphones helped us leapfrog the landline and desktop to the smartphone. This smartphone growth coupled with affordable labour, has made every product or service available via an app. These tailwinds helped bring financial services to scores of new users. Digitisation also helped dramatically reduce cost structures which helped make financial products more affordable.

These direct benefits of accessible, affordable and transparent financial services were accelerated by the fintech sector. It was driven by "outsiders" - people with limited to no financial services background. Yet, we've seen tremendous benefits and continue to reap the benefits.

In terms of scale, the early fintech ecosystem was still <1% of overall financial industry, but generated serious demand from users. This demand, forced our financial institutions to catch up. And at least to my surprise, these institutions more than caught up. They also used regulatory capture to their advantage to get things going their way, but still on a broad basis, they caught up and did well - as I've also pointed out in Edition #36.

As of 2023, fintech startups accounted for an estimated 1.7% of total revenue generated in the financial services industry and about 8-9% of the total valuation of the industry. There's a lot more detail on this in Edition #82. Fintech seems to have so far outpaced itself in terms of valuation, but it still has to catch up with the industry in terms of revenue and profitability - it's not too far out though. The market conditions of 2024 are forcing reasonable valuations with improved economics. We'll see a far more resilient fintech ecosystem in the years to come.

Leaving aside the valuation, revenue and profitability, if you look at the macro indicators of the impact fintech startups have had on users, there's another story to be told. Other than (maybe), the payments sector and the stock broking sector, startups in other sectors have a long way to go. I've told this section to many people over the past few months, with mixed feedback. Would love to hear your thoughts on this.

Groww managed to become the largest stock broker in India with 9.2mm active investors. Fintech stock brokers account for 30% of the top 20 stock brokers in India by active investors. Payments in India is completely dominated by fintech startups - Razorpay, PayU, Paytm, PhonePe and more.

Other sectors have a long way to go though. Insurance penetration is still 2.9% for life insurance and 1% for non-life insurance. There are only 40mm+ unique investors in India's mutual fund industry. The pandemic and the 2021 bull run did more to bring investors in the fold, than the prior 11 years since the global financial crisis - 5.9% CAGR in MF folios between 2009-2020 vs. 18.0% CAGR between 2020-2024.

The total credit outstanding by fintech startups (37 members of FACE) was only $4.9bn as of Dec, 2023, whereas the total unsecured credit outstanding of the financial sector was $166bn. Fintech startups have played a role in providing form credit to new to credit customers but the ticket sizes are clearly small and there's still a long way to go. Lot's more to be said about other sectors in financial services, including SME finance, B2B payments, housing finance and much more, but you get the gist.

The most important benefit of this Seed Stage for the fintech sector was that it attracted talent (including myself) from other sectors to this sector. The talent migration to financial services was large. These were generalists from other sectors who saw the opportunity and decided to build a career in this sector. In the more recent years, this sector started attracting specialists to take a risk and innovate in the fintech sector.

Framework for a successful financial services company: Before we get into what the future holds for the fintech ecosystem, I wanted to reiterate a framework that I think is required for a successful company in financial services. I wrote about this framework in Edition #25 in Mar, 2021.

For a company to be successful in financial services, it needs at least one or all three pillars (depending on stage):

• License: If the company is in the flow of funds, then it needs to a regulatory license to operate. Meaning, if the company intends to control where money gets sent to, who sends the money, how the money gets through or even how much money gets sent through, then it needs to have a license to operate as such. Let alone the consumer and regulator's trust that comes along with a license, the company can operate like a well oiled machine in a clear regulatory environment. The license can also function as a competitive advantage.
• Distribution: If trust is the glue, risk management is what makes the financial industry thrive. Risk allows the financial firm to have differential pricing for users thereby maximising revenue potential. Distribution is spreading the risk across the user base (portfolio management) thereby minimising loss. This industry is the only industry (that I can think of) where users can be charged differential pricing based on risk factors. Distribution makes the product available to the right users and is the key that fuels the flywheel of building brand, which helps in distribution and further helps grow the brand presence.
• Brand: Trust is the invisible glue that holds the entire financial services industry together. Without trust, there would be no financial industry. Trust in a brand is built by having a strong brand presence with the right messaging and brand values. As I've written in Edition #75 in May, 2023, this trust of users, regulators, global capital providers and others in financial institutions, is critical for growth. A strong brand will continue to command user retention even with an inferior product (not recommended).

Early stage startups will never be able to own all three pillars from the get go. They will need to choose between Distribution or License in the early days and scale to own all three pillars i.e. License, Brand and Distribution, eventually. Brand is a very tough pillar to own in the early days. Each of these

The future - fintech sector's Series A to Scale Stage

Going by the startup stage analogy, India's Fintech sector now reached its Series A stage. There is a lot of generalisation below and there are exceptions, but there's a lot of nuance as well. From here on, the fintech sector will see the following characteristics:

1. License: It's common knowledge now that if you want to build a fintech startup, you have to be regulated and need to have a license. Without a license, it'll be tough to operate in this sector or find partners to collaborate with. There will need to be a periodic interface with regulators (even from the early days) to update on metrics and new product launches. This will mean having a compliance function early on, having a higher cost structure and weighing pros and cons of launching a product on the edges of regulations - there's still a need to innovate for better user experiences.
2. Product: I believe we will see less "process digitisation" financial products and more rounded financial products with a productive, tech-enabled services layer to better target users. The process digitisation will happen more on the backend, but consumer facing products will have a significantly better all round user experience. We may see fewer radically new financial products and more head on competition with incumbents.
3. Brand: I truly believe we may start seeing fintech startups going offline (maybe even launch offline "branches") in the next few years to build trust with users and grow offline distribution. These offline "branches" will not look like the financial branches of the past. They'll be dramatically different to appeal to a whole new generation of users being onboarded to this sector. Digital distribution continues to be expensive and rarely helps build trust the way offline does. None of this is to say that digital only companies have not been able to build strong brands - we've seen more than a handful of Indian fintech companies become household names. Brand and trust are going to play an even bigger role for this next phase of fintech sector's growth.
4. Talent: In this Series A stage, the fintech sector is going to attract few folks from other sectors, as is already happening. The growth of the fintech sector in this stage will be defined by majority specialists and fewer generalists. More senior, experienced folks from the financial sector are going to startup and build the next gen of financial services. As this happens, we could see an exodus of talent from incumbent financial firms to newer fintech startups.
5. Growth rate: We are likely to see tempered growth rates of 15-20% YoY, averaged out across the industry. Newer startups might not see 100%+ YoY growth rates like we used to, but neither will growth stage startups see 5%-odd growth rates. As most of the population is "financially included", we may see the race to "financially retain" these users.
6. Funding: Given the growing maturity of the sector, including everything mentioned above, I think global financial firms will be even more attracted to invest capital and resources in India. It's very likely that India's fintech startups will raise more capital than we've ever seen in the past 15 years. Confidence in stable and fair regulations, depth of India's financial sector and high growth opportunity - all reasons for global growth investors to deploy more capital than ever before.

The fintech sector may be at Series A stage, but what about early stage startups in fintech? From reading the above, you're probably thinking, "sounds like, a young founder in their 20's, with limited capital raised and no license to operate, will not be able to start up in the fintech sector". To a large extent, that's true. I don't think it's impossible, but I concur that it's become very tough for a founder with those attributes to find success in financial services. This is the most unfortunate outcome.

To some degree, it's required as well. The fintech sector needs more experienced people building the future. When you deal with people's hard earned money, they need to know that the folks running the show are serious, trustworthy and with high integrity - folks who will do all that's needed to safeguard the user's life savings.

In my experience though, and I know how weird this sounds, some of the best businesses in the world are built by relentless founders who didn't know what they were getting into to begin with. If they knew what they were getting into, how hard starting a business is or how many times a day they'd hear people tell them "no", they would take less risk and wouldn't swing for the fences, or question the status quo to push the boundaries of what's possible. The financial services industry needs people like this as well, people who can approach a problem with a fresh lens, innovate and take risk as needed to ultimately benefit the customer.

There's a lot still to be solved in Indian financial sector, and I'm hopeful that younger people will continue to want to build in this industry. The regulators are collaborative, the industry is competitive and the opportunity is massive.

To conclude, for many, base camp was the destination... and that's fine. For the few of us though, the summit is what always mattered. That's our ultimate destination. We've dreamed of scaling to the summit all our lives. This is our time.

Welcome aboard. Next stop: Summit.

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?? Song on loop

Fintech updates can get boring, so here's an earworm: Didn’t like the song initially but Beyonce’s latest song grew on me and how. Here’s Texas Hold ‘Em by Beyonce (Youtube / Spotify). It’s very unlike Beyonce and its good.

???? That's all Folks

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

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