While the internet breaks down barriers, tough regulatory environments remain an advantage for incumbents in digging competitive moats.
For fintech companies, expanding geographically poses a unique challenge, as regulations and consumer trust in financial institutions varies dramatically across countries.
Alfred Lin of Sequoia Capital pointed to the differences between payments channels in China and the US—Chinese consumers have “leapfrogged credit cards and bank branches,” while American consumers and merchants still hold the “card present swipe” as critical. “We have to shift our understanding of trust, and think differently about how we secure online transactions.”
But with so many people connected via the internet and social media, “cultural differences are kind of falling down,” said David Vélez, founder and CEO of Brazilian credit card issuer Nubank, speaking with Lin and moderator Alex Konrad of Forbes at CB Insights Future of Fintech conference.
Vélez believes that the millennial generation is in some ways more homogeneous than prior generations, and this homogeneity, along with a trust in digital channels, provides an opportunity to build better user experiences for consumers. Coupled with a lack of legacy systems, fintech companies can build digitally-native channels from the start.
Still, while the internet breaks down barriers, tough regulatory environments remain an advantage for incumbents in digging competitive moats. While Lin argued that developing countries might hold more growth opportunities for fintech companies than developed countries, he also offered three characteristics of a successful fintech company: unique technology, a unique business model, and a unique distribution model. While the market is challenging, Lin maintains that “the best companies have to build for the good times and bad.”
Alex: All right. Well, we’re gonna shift gears and head south to South America. You guys may know Alfred Lin from Sequoia and Zappos fame. But David, why don’t you tell us a bit about Nubank and what you guys are doing in the FinTech space?
David: Sure. We started 2014 as a credit card company, very focused on millennials, building a really strong consumer finance brand. And we’re in the process of eventually becoming a full-fledged financial services platform.
Alex: And so you were an investor originally, right, even at Sequoia? Could you just tell us kinda how you made the jump from investor to operator?
Alex: Usually it goes the other way around.
David: Yeah. So…and Alfred did the other way around, operator to investor. So, yeah. I started working with Sequoia in their U.S. office in Menlo Park looking at Latin America opportunities, going back and forth to Sao Paulo. I think eventually came to conclusion that there were more opportunities on the entrepreneur’s side of the table than in the investor side of the table.
And eventually, sort of proposed Sequoia that I wanted to leave to actually start a business. Being an entrepreneur has always been one of my goals. So had the luck that spent a few months thinking about what to do. I really like the opportunity in financial services in Brazil. Pitched it to Sequoia and they ended up backing my seed round. Anyway… And then the A and the B and then every single round since then, yeah.
Alex: So far?
David: So far.
Alex: So obviously we’re at a FinTech conference, but Alfred, was FinTech an area where Sequoia saw particular opportunity in Latin America or how did this kind of come about from your standpoint?
Alfred: Well, we, you know, from Sequoia’s point of view, we’ve been in FinTech before it was called FinTech. And we invest from idea to IPO and beyond. And so we’ve been in FinTech for a longer period of time, going back to PayPal, to Green Dot, to Think Finance, Elevate. And we’ve more recently, Square, and Stripe, and Clover that you heard from yesterday, and of course Nubank.
And so Sequoia is a global sort of firm where we make decisions locally. So we have a U.S. office, a China office, an India office. I think there’s a lot going on in FinTech not just in the United States but all over the world. And I think U.S. companies should look to the rest of the world. You just heard from Paytm in India. I think also like in India, the fastest-growing payments app is BHIM, which is launched by the government. Could you imagine the U.S. launching an app that consumers want to use? I don’t think so.
And then, you know, in China, of course you have Ant Financial that Ali has a big stake in, and WeBank that Tencent has a big stake in. So just think about sort of what’s going on globally and of course, we’re also talking about Brazil here with Nubank.
Alex: Do you guys think the developing world has more opportunity for FinTech startups today than the U.S.?
David: Yeah. I mean, I think our own perspective has been and as we see some of the cases that Alfred mentioned, is we see what has happened with some technology companies in China, with Tencent, and Alipay, Paytm in India, our case in Brazil, it seems that there is the real potential for FinTech companies or technology companies to really take a significant share of the banks. It’s hard to see how that actually could happen in the U.S. or Europe.
This tend to be more developed markets, way lower margin, very competitive, where incumbents seem to be doing all the right thing and really becoming almost technology companies. We heard yesterday from what Goldman Sachs is doing. And funding cost is a real differentiator for incumbent banks in developed markets. In developing markets, they all tend to be very concentrated oligopolies owned by four or five banks that have never seen competition in decades. They suddenly see the threat of entrance in FinTech companies and most of their analysis ends up being, “Let’s do a better app. Let’s do a better website.” And they have a hard time actually realizing that what they need to do eventually is completely rechange their corporate culture.
And so, as I was told, my point of view at least, is that in some of these emerging markets, you’re actually going to see FinTech companies taking a meaningful share of the entire banking market cap versus in some of developed markets, that might be harder just because of the overall differentiation between incumbents and some of the entrance in the different verticals.
Alfred: I also think in the developed world, the banks have a long history of being FinTech companies themselves. The, you know, the amounts, the budget that’s spent on technology is relatively high. A lot of it has to deal with just compliance, for trading, for doing things faster. I would just encourage the incumbents to think about the customer experience.
I think a lot of the innovation around the world is serving the customer better. And you have a lot of these startups that are going after unbundling the banks because the customer experience is not as good as if you focus on just the customer experience. So we go through trends of unbundling and bundling all the time in lots of industries. When you bundle too much, the reason you bundle is because you want to get to minimum efficient scale and get more and more scale and you have economies of scale from there. But sometimes when you get economies of scale, you don’t think about this particular customer wants a very very different experience than this other product. And so thinking through that is fairly important.
Alex: Now, is a consumer, let’s say in Brazil, more malleable, where they don’t have, you know, years or decades of behavior that you have to kind of reprogram? Because one thing I wonder with us FinTech apps as if they’re kind of just trying to replace what an established bank already does. There are a lot of kind of heavy factors encouraging us to have that Bank of America app on our phone instead. And I’m wondering if you know, without that established sort of legacy interest, there’s more opportunity in a place like Brazil to kind of skip that step kind of like what we see with mobile phones versus computers in the developing world as well.
David: Sure. I mean I would say, the common denominator of a lot of the FinTech companies that even we discuss today are, you generally compete through price and consumer experience. And in a market like Brazil, in our case in credit cards, the average interest rate is 15% per month. We’re talking about 500% APR. While the funding cost, the government free rate in Brazil is 12%.So you’re talking about a net interest margin of over 400%. You don’t find those type of margins in, you know, I think only Zimbabwe and Malawi have higher net interest margins than Brazil. So it’s easier for FinTech companies to, you know, in our case, we have, as a start-up, we have one of the highest funding cost in the market. Definitely way higher funding cost than the banks. But we can still offer one of the lower interest rates for certain type of customers because funding cost doesn’t really play a big role.
Same thing, we’re able to build a technology platform from scratch which means we can focus on technology since the very beginning, becoming way much more efficient. And that’s why we don’t have to charge fees, we don’t charge any fees in our credit card product. For banks, they would have a lot of a hard time replicating that. Cost structure is closing 5,000 branches, firing 100,000 people. So it’s easier for us to compete on price, and then it’s also easier to compare on consumer experience because again, we are building on our complete new technology platform.
We can really think about the consumer and work backward and create a product that consumers really, really love. So I think eventually banks are able to catch up on user experience, some of them are doing a better job than ours. But on competing on price, that really requires a complete revolution in their cost structure, firing building new technology platform from scratch and that’s extremely hard to do. So that’s why I think in sort of emerging markets, you sort of see these opportunities, where you do have opportunity to compete on price, opportunity to compete on user experience. Versus U.S. and Europe, competing on price is harder, margins are way, way thinner. And banks have gone faster into developing the user experience advantage.
Alex: I’ll tell too many people that you have such great margins.
David: We don’t have that margin.
Alex: you just invite competition.
David: It’s a very regulated market, so that’s what you’re asking.
Alex: You’re looking for fights in and out of Brazil.
David: We welcome that.
Alex: So I was catching up with one of your China partners, Neal Shen, a few weeks ago. And he was blowing my mind with some stats on how a handful of apps in China you know are used more than an hour a day by users. And for a sort of a whole range of services that here, I think we’d probably use in five or six apps for, and all of them included payments or micro payments in some way. So I’m curious you know is there anything we can be learning from China and maybe the sort of willingness to adopt mobile payments there, you know, in other markets?
Alfred: I think we’re actually way behind on mobile payments than emerging markets, especially in China and India. And I think part of the reason is because, back to your point earlier, the incumbents have the customer base and we have been used to a certain way of doing things. Just to your point about how it’s been a lot harder even though it has transitioned from desktop to mobile, whereas in India or in China, they just get the whole desktop, sort of, era.
And in China and India, they kind of, they’re skipping the traditional branch bank sort of relationship and they’re just going straight to mobile. And so payments is much sort of fluid in China, it’s embedded in a lot of chat applications and as well as in India. Where some…here, I don’t think we would ever think about sending money through a chat application, at least today.
David: Yeah. We…I went…I was in China with a few of my partners last month and we had these credit card holders from Nubank to give to companies. And after the first meeting, we realized that it was almost as if we were offering people a holder for their DVD or their VHS. And we had to kind of completely keep it for ourselves. And I think the way we’re seeing this market is certainly we feel that the credit card today, the physical card is almost as the physical DVD that Netflix used to send before they completely re-shift their business model to full digital.
And so we have our own point of view about how markets will evolve on payments since we are in the credit card space. But certainly, they’ve leapfrog a lot of the physical payments into a way where, you know, Alipay has 500 million users, they have complete ecosystem control. People are only using that wallet, they provide lending, they provide payments, they provide absolutely any and every single need that the consumers might need. So in effect, they’ve almost made the banks in China, which are obviously state-owned, almost irrelevant to the point where they have this…they really control the consumer experience in all products in financial services.
Alfred: But just another example to your point about how seemingly backwards we are relative to the rest of the world, when I was at Zappos, we had the card-not-present rate versus card present. And just thinking through like is fraud actually higher at Zappos? Well, we have our back charge… our back charge rates were extremely low, but we’re still being charged a rate for being card-not-present. And we could prove that our rate of fraud is actually very, very low because we took time, we have data on our customers, we know we’re being shipped. We have more data about our customers than having them physically present giving someone a card.
And so I think we have to shift our perspective on trust, for example. And that’s a legacy thing that I think we need to sort of think about in the United States where, yes, we had banks where you go to the branch, you develop a relationship with the branch manager, the branch manager knows you. That’s slowly gone away. But we still had that legacy of like card-present, card-not-present and thinking that the card present swipe or the chip is better or more trusted than an online transaction, even though there’s way more online transactions today. We just have to think about how to secure the online transactions with other pieces of data.
Alex: So Vlad from Robinhood said earlier today, I think he said the New York Stock Exchange is basically a museum. How long would it take for a credit card to be actually a DVD in the U.S.?
David: Great question. I mean I don’t know if you have that for a point of view in terms of payments here.
Alfred: I think it takes a much longer time than we imagined. I think customers still like doing certain things. I remember the first time when I saw an ATM and I was like, “Well, this is really cool.” But my mom still went into the branch to deposit her check and withdraw cash for another 10 years. And so I think credit cards are on the decline, it’s being sort of tokenized and put on to apps like Apple Pay and Google pay.
So we’ve replaced the physical card with a digital card but we still have this notion of a card. Like, that should just go away, why do we have… It’s just a payment mechanism. Why do we have to…pull out your Apple Pay wallet? It still shows you like a digital representation of a card. It seems a little silly but that’s the transition we’re gonna go through. And maybe in a few years, we won’t carry physical cards but we’ll still have the digital cards in our Apple Pay, in our Google pay wallet.
David: And kind of going back to… So I imagine, Mike, what you’ve seen is, you know, in the U.S., Europe, you see Apple coming up with an Apple Pay platform, Google, Android, but they tend to be, somehow they haven’t really reached mass adoption and it’s been hard to really see adoption, versus China, India, you do see people just paying absolutely everything via Alipay.
And you look at the solution in the QR code and it’s incredibly simple. There’s no hardware, there is no real sort of tokenization issues, and instead of it’s not a technology problem, is sort of how do you solve the network effect of getting everybody to adopt a very simple mechanism. And given our benefit or other needs that you might see in emerging markets beyond the monetization in India, that’s how they allow them to kind of expand lead promise on the payment. So who knows how long it’s gonna take in the U.S., but it’s hard to see people, 10 year from now using a physical card to pay for something.
Alex: I know you guys are all busy tweeting at us but, can I just get a quick show of hands who’s an operator in the room? How many people are working at a start-up or a company in this space? Okay. A few. Got a lot of people maybe looking to invest in the space. For either side, I’m curious how local is this market today? Can one actually build for multiple markets from the get go or do you guys feel like you know, it’s sort of a national play from one FinTech company to the next? You know, we won’t see Nubank Egypt anytime soon.
David: Well, I mean, we do spend a lot of time thinking about the question. The reality is just Brazil as an economy has a lot of opportunities and they’re opportunities to kind of grow horizontally in all products. And so that’s one vector of growth, then a potential divisional vector of growth on another market. There is a lot of issues about localization, mainly related with different regulatory issues in each country. In our case, we think we started the hardest the hardest country in Latin America, to begin with. It’s the only country that requires the president to sign an approval if foreign investment actually wants to invest in Brazil.
So that has been one of the issues, is figuring out a relation. We’re looking at markets that’s actually easier. The other thing that ends up being very local is just local data sources, the sort of part of the credit engine. But at the same time, a lot of the data that we’re using now for underwriting ends up being related to transactions, to data from the iPhone, from the Android, transactional data. A lot of sort of data sources that we could grab in our markets.
So I think the answer for you is a prioritization question. There is a lot of the technology of the platform both back-end and front-end that is transferable to other markets, but to us is always a sort of a prioritization conversation. What should we go do next to expand horizontally? Should we go to a different country and how much we can take at once?
Alfred: Yeah. And at Sequoia, we’re a global firm, and we try to learn globally, but we invest locally. So the U.S. team makes U.S. decisions, the China team makes China decisions, the India team makes India decisions. And the reason we believe that and this is not just in FinTech, but we just believe investing is local. In FinTech in particular, I think the customer differences and in particular the market structure differences are very, very different from country to country. So the regulatory differences, the customer experience differences, lend itself to having a startup focus on their home market first and then expand from there. And I think that that’s what you’re seeing right now.
And anything in particular in the United States, the incumbents are much stronger and the regulations may be a lot tougher for startups. And so how do you sort of build a company in that realm? Is a little different than you know, in Nubank’s case, where they have the net interest margins to sort of work with. We don’t have that in the United States. So you have to be a little bit more clever and do things a little bit differently.
And in, you know, sort of our view at Sequoia, there are FinTech companies that have good technology. There are some that have a unique and insightful business model, and then there are some that have unique in insight into distribution. If you want to be, on day one you know, you probably don’t have all three of them, but over time you, need all three of those things to build a real mode for it to build a real enduring company.
You only have one of those things, if you just have a unique insight into the distribution, you’re probably going to be a lead giant company and that might be okay, can get to a big size as a lead giant company. But if you want to win in the long run, you want all three of these things. And it’s in the sort of unique business model, it’s a little hard when people are fighting for bases points. You have to figure out a different way to charge. And in technology, I think there is an advantage for being a startup where you know before us, Robin Hood, they said that they have 50% of their employees are an engineer and they have double-digit PhDs on data science. It’s a very different team than incumbents, where a lot of the employees are in sales, marketing, and distribution.
David: To your point, I would mention on that question is, and a lot of this a lot of fin techs that we’re talking about here and that’s certainly the case of Nubank is, we focus initially very much on Millennials. And Millennials, as a generation is probably the most homogeneous generation across countries, they all actually…A Millennial in Brazil looks very similar to Millennial in the U.S., that look for similar to a Millennial in India, they all use Uber, Netflix, Spotify. They all don’t have any patience to go to a branch and would be willing to pay to actually not have to go to a branch.
They have the trust digital channels. Effectively, they really appreciate human consumer interaction in a certain vocabulary that there is important. So give they all use obviously smartphones and they’re in WhatsApp. So given how homogeneous it is across countries, there is this opportunity, the opportunity of being a global or regional friend services company that approaches this millennial from a kind of consumer perspective.
It’s easier than I would think in all generations where different type of behaviors will be different from, you know…50 years ago, a Chinese person would be very different from an American person or European. So that’s an opportunity and maybe an argument to see more regionalization of financial services companies.
Do you guys think…we see this more, I think, on the B2B side, but with a consumer facing, you know, financial services app, you know, I think the technical side is almost the easy part but, you know, you think eventually someone will solve for the cultural differences, they can kind of be adaptive enough to work from one country to another there because it seems that would be the issue, right? It’s not so much the back end but user behavior varying and regulations varying from country to country.
David: Yeah. Regulation is I think the hard part. The cultural aspect is I would say the easier one based on that sort of how homogeneous it is, you know. Facebook now has 2 billion people across the world. They are sort of seeing each other. Those barriers are our differences in cultures are kind of coming down especially younger generations. And generally, you see sort of the same patterns following. When we launched, the average age of our customer was 21 years old, now it is 32 years old.
So a lot of these businesses end up focusing on very young population and then suddenly the 21-year-old really likes the product and tells his older brother that is 27. And his older brother likes it until starts telling his parents. And similarly, as Facebook began, you know, with university students, and eventually you have your grandma and everybody there, you see these shifting in generation where the kids are telling their parents, “Hey, it’s actually safe. And by the way, you don’t have to go to the branch. You can do it safely online and digital.” And I think this is the same, this is a common denominator across countries now. You sort of see this behavior. So again, that’s part of the argument of seeing more of regional companies.
Alex: Do you guys expect developing markets in FinTech will go through a phase of consolidation that would look kind of like some of the consolidation that’s happened or is happening in the U.S., or where does this go, in your mind?
David: I think it’s very early days. Really, really early days. We’ll have to kind of monitor this over 10 years, 10, 15, 20-year horizons. It’s still very…you know, if you look at least in Latin America, in Brazil, there might be just that handful of FinTechs that have reached a bit of scale, that maybe have passed 100,000 customers. You look at Mexico, great, great economy too, also developing very quickly, but it’s yet to still see if you are able to see a very dynamic FinTech ecosystem in southern markets.
There are regulatory constraints, there’s capital constraints, it’s hard to raise capital locally a lot of the times from local investors. Traditional local investors don’t believe a FinTech can compete with a big bank. They just…in their history, what they’ve seen is big banks crushing small firms. So if you’re talking to a local investor in one of these countries, it’s almost asking them to completely defy their conventional wisdom and defy their own personal experience. So capital and regulatory ends up being constrained to create and maybe 10 years from now, you’ll see some larger platforms that would open space for consolidation.
Alfred: I think you should expect consolidation because there are a lot of companies being started and not all of them are going to make it. But I think, you know, people always ask me, “What’s your investment thesis around a specific area?” And I said, “If I had the perfect investment thesis, I go start the company.” And I just I think that’s just like one way of saying, “If you have true conviction about what you’re doing and you’re doing something that serves the customer, you’re gonna figure it out and you’re going to make it work.” And if you have true conviction around your company, then you shouldn’t sell. You should build for the long run. And it may so happen that you’re given a price that you will find it very, very hard to resist and take. But I think we should expect some of these FinTech companies to be built for the long run. And there’ll be a next generation company that we don’t expect, that is being formed today.
You know, so if you sort of went back 35 years, I don’t think anybody would have predicted that Silicon Valley Bank would be, 35 years later, it’d be one of the top 35 banks in the United States. They served a very niche market, an underserved market. They were called technology companies back then because there were not that many of them and nobody wanted to lend to them. And so I think in the FinTech space, you have a lot of people trying out different business models and trying to serve people who are underserved today with a different experience. Some of them will become larger companies of tomorrow.
David: Maybe also relative to your question, there’s a bit of a challenge also in sort of the mentality of the founder in some of these emerging markets. Given a history of a lot of volatility, a lot of the companies are sort of built to be sold in two years, three years to a big bank. And there hasn’t been a lot of…you don’t see the sort of mentality that you see in Silicon Valley of, “I’m gonna be building this company for the 10, next 10, 20 years and I’m gonna ride it all. The market is big and this is sort of my personal project.” And that’s something that needs to change in a bit of the mentality of the founder and in certainly in Brazil is, hey, the market opportunity is so large and there’s so much to do, don’t go selling to the big bank in two years. Really stay there, build something for the long run. And the type of decisions you make once you have a long term view in, you know, how you build your first team, how do you build your technology, once you know you’re doing that for 20 years, very different than when you think you’re gonna do that for the next two years. So they’re fundamental different decisions.
Alex: Yeah. So I guarantee you that at least someone in the audience is wondering how the macroeconomic outlook in a country influences growth. I mean, Brazil, we all know is a massive economy and a growing one but it’s one that’s had some very public struggles and a lot of upheavals as you just alluded to. I just read an article I think yesterday on private helicopter pads being turned into yoga studios because, you know, there aren’t as many choppers in there. And I’m curious, do you guys face pressures when, let’s say, money gets tighter or how does, you know, a FinTech app that’s kind of doing its own credit ratings navigate that?
David: Yeah, sure. So we launched to public end of 2014 when Brazil was going, you know, starting to went to a really bad crisis and this has been the worst recession in Brazil in 80 years. We don’t disclose necessarily number of customers that we have. We have a few million, but we know we’ve said no to 10 million people right now since we launched. Ten million have ordered our carrier and we said, “No, you cannot have our product.”
And I guarantee that in a better environment or the cushion of conservativeness that we’ve been using would be lower and would have had more customers. We’ve definitely made probably decisions of customers that would be a good customer that we said, “Sorry, no. We cannot take your credit right now. We’re giving credit to people at the end of the day so it’s dangerous when you’re growing so fast in the middle of such a macro recession. So, you know, GDP has contracted 8% since we launched. I think generally our mentality is, “Let’s hold. Let’s grow. But be very closely looking at a kind of cohorts in economics credit and make sure we can still kinda grow.”
Now, the flip side of that is we know that this is, when you look at our data or credit loss, this is as bad as it is going to get. This is the worst macro environment. And we know that it’s a cyclical market, the cycle will pass, Brazil will once again be one of the most interesting economies to invest. I don’t know if it’s 12 months, 24, but it will happen. And at that point, the macro will help us. Different from other countries where lending companies are growing really, really fast in the good times and everybody asks, “What’s gonna happen in the bad times?” Nobody really knows. So, yeah, in a way, we’ve been conservative, but we’re kind of really stressing our models in a bad…in a better scenario.
Alfred: And to that point, I think the best companies are built. First of all, for start-ups, macro matters less. You have a smaller customer base and to double a small customer base is a lot easier than when you have a big customer base. So macro matters a little less, it still matters. But if you’re building an enduring company, you have to go through good times and bad times. And the best companies are built during…being able to get through the bad times.
And I often sort of tell entrepreneurs like you’re…this is a heated market, you’re fighting for talent and the best companies will still figure out in this heated market how to get the best talent. And then when you’re in a cold sort of market where you can’t raise funding and it’s really, really difficult, well, the best companies don’t fail because they can’t raise money, they figure out how to innovate their way out of this crisis where they don’t have enough funding available to them. And so I think company’s going through that early is better than going through it later.
Alex: On that note, can we get a round of applause for our panelists?
David: Thank you.