“FinTech, as an investment category, has been incredibly exciting because of the size of the industry — and the size of the opportunity,” Alex Niehenke, Partner at Scale Venture Partners, told Karen Webster.
Venture capital firms, of course, are a key conduit to offering up the capital that fledgling and smaller firms need to scale new technologies and innovation, making the leap from concept to go-to-market reality.
And, as Niehenke put it, the next great opportunity within payments lies in a modernization of B2B transactions, on a vertical by vertical, specialized basis.
The Evolution
The opportunities of today have been shaped by the payment industry’s evolution through the decades — a consistent history where software and tech providers are bundling and unbundling what’s on offer to their client firms.
First came the network giants — Visa and Mastercard among them — that created and fostered the standards that enabled communication and settlement of all manner of transactions — a critical wave of bundling.
Then there was a “unbundling” on each end of the payments ecosystem as PayFACs and other providers emerged to help businesses manage their physical and digital payment methods.
Said Niehenke: “In the early days, there was a huge opportunity in taking the physical payments technology and importing that into the online world. This created an ‘alphabet soup’ of different vendors that helped firms accept payments, or issue them, and it all became incredibly complex.”
And amid all that fragmentation, enterprises had to grapple with multiple payments products and services on offer from a slew of vendors. Through the past five years, the emergence (and burgeoning market caps) of Stripe and Adyen have reflected the appeal of bundling, consolidating a range of payment functionalities with a platform/single vendor approach.
Looking at What’s Next
The question, of course, especially for VC firms is: What’s next?
Modernization of B2B, he said, is about more than payments and is about more than payments orchestration. In fact, it can help shape entire ecosystems.
Different verticals have different needs, he said. He offered up the example of two different businesses – one sells iPhones, the other sells digital goods. In the case of the latter, the vendor must navigate the high risk of fraud (as the phones have a high resale value) and low margins. The digital goods firm enjoys much higher margins. Both firms may need to grapple with customer returns in an eCommerce age that demands a speedy response and smooth workflows to enable those timely responses.
“The fraud approach and the fraud technologies,” and the returns policies, “necessary for those two products might be quite distinct,” said Niehenke. “If you’re using a centralized payment aggregator it may not be possible to customize functions that are needed for those businesses.”
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The modern economy, he said, demands that companies meet their consumers wherever the needs must be met.
“We’re seeing the next wave of unbundling,” he said. Companies are examining what they need from their vendors across a variety of functions, and are picking and choosing from a variety of software tools and APIs, reducing the complexities inherent in everything from procurement to back office reconciliation.
“We see the next wave of payment companies as being vertical specific,” he said, acting as middleware to integrate into dominant software systems within specific industries, while simultaneously offering payments options and integration of the data flows that are necessary to keep operations humming. As he noted to Webster, “every business transaction needs to be reconciled into an ERP system.”
Along with the great unbundling, he said, we’ll see a shift in the business models of these providers themselves, too. These companies will likely not take a percentage of every transaction. They’ll charge for software based on the number of modules deployed.
The Amazon Effect
Increasingly, it’s what happens in addition to, and sometimes after the transaction that might determine whether a customer relationship remains sticky or if they’ll depart to a competitor.
Amazon has done much, he said, to set expectations of what happens online amid all manner of transactions, and the companies that fail to meet the litmus test are doomed to fail.
That applies not just to consumer-facing eCommerce, said Niehenke, but to the B2B interactions that can transform industries that have been traditionally reliant on paper-based processes and payments. The rise of online marketplaces and embedding functionalities such as credit, merchant acquiring and other functions can help improve SMB cash flows (and payment terms) as buyers and suppliers find one another and transact. Those functionalities are critical, as decreasing frictions in B2B payments are more complex than simply making sure that each party has a bank account or are able to accept/pay with credit cards.
“We’re starting to look at businesses that are ‘enablers’ of small niche markets and marketplaces that enable firms to move into the online and digital realm,” he told Webster.
The Current Climate: Challenges and Opportunities
With a nod to the current investing climate, and portfolio performance, the macro environment has shifted considerably in the last few months. More companies are wrestling with the challenges of their chosen verticals, with inflation and, in some cases, the need to run more efficiently and even reduce employee headcount. He recounted one portfolio holding, focused on refinancing mortgages, that now is facing the headwinds of an industry that has seen activity decline by 40% year on year.
But looking ahead, there are opportunities in modernizing verticals such as construction where there still remains friction tied to paper-based payments and documents between contractors, builders and subcontractors. Cross-border money movement, he noted, continues to be a large and growing opportunity beyond simple consumer remittances.
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As he remarked to Webster, the hypothetical wine importer with three employees and about $10 million in sales is still mired in paper processes, rife with risk as payments cross currencies and time zones.
Beyond the current challenges, he said, the great digital shift will continue, and continue to present new VC opportunities.
“It’s exciting when these new technologies and functionalities are adopted – and then ripple through these traditional industries,” he told Webster.
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