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Customer acquisition cost: probably the most valuable metric for Fintechs

With the word "tech" in Fintech, there is automatically a strong focus on technology in this sector. As a result, we tend to think that the biggest cost of a Fintech company is in building and maintaining the underlying software (tech) solution.
In some bottom-up organized firms, which are usually built on top of an open-source core product, this might be the case, but in the majority of companies, the biggest cost is in customer acquisition. No wonder that advertisement is such a profitable business (think of the fortunes generated by Google and Facebook).

Customer acquisition is the process of finding prospects and converting them to customers. It includes all steps from creating awareness (getting your brand known, reaching prospects, getting people to visit your sales channels…​) to getting considered (e.g. ensuring people spend time reading your material), all the way to converting the prospect/lead to a customer. This means it covers the marketing and communication department, the sales department, but also a part of the product management and UX design department.

Many start-ups fail by insufficiently considering this process (i.e. too much focus on the technology and product aspect), while others burn through their cash by an overspend in unsustainable customer acquisition (growth at any cost).
A good measure for growing start-ups is therefore the customer acquisition cost. Growing start-ups are often not profitable, making it difficult to judge their future/value. Usually the growth figure is therefore considered as the key metric, while this is not necessarily sustainable (scalable and profitable) growth. It is therefore better to combine the metric of "growth" together with the metric of customer acquisition cost. More specifically the LTV/CAC ratio, which divides the LTV (customer life-time value, i.e. average revenue generated by a customer in a 1, 3 or 5 year period) by the CAC (customer acquisition cost, i.e. total money spent on customer acquisition divided by the number of new customers). This ratio gives a good indication if the investments done in customer acquisition are smart investments. If the ratio is less than 1, serious concerns can be raised on the sustainability of the growth.

There are many examples in Fintech where a-growth-at-any-cost story is applied. Often those are inspired by other tech sectors, where a "winner-takes-it-all" story is applicable, meaning growth at any cost (and being unprofitable) can be a strategy, till all competition has disappeared, after which prices can be increased and a switch to a sustainable business model can be made.
Fintech companies play however in the existing mature market of financial services, not in a new sector (often not even in a new segment). Fintech is therefore not a new business but instead an improvement of the existing financial sector through technology, improved usability (removing frictions) and offering of niche services to underserved customer segments (like the unbanked/underbanked individuals or SME segment). A "winner-takes-it-all" story is therefore not an option. Furthermore incumbent banks and insurers evolve as well, meaning customers have a very decent alternative, if Fintech companies fail to deliver on their promise or start increasing prices too much.

Typical examples in the Fintech space of such aggressive customer acquisition are

  • Commission-free stock trading. Historically investment brokers charged considerable commissions to their customers for trading. The rise of free-trade platforms, like Robinhood, Freetrade, eToro, Revolut…​ changed this model. Unfortunately, this aggressive customer acquisition model will likely come to a halt now that large existing brokers have also cut their online stock-trading commissions (e.g. the largest US broker, Charles Schwab, also decided in October 2019 to bring their commissions to 0).

  • High interest rates on saving accounts and term deposits: a model often used to quickly acquire customers in new markets, but very few examples have actually turned this into a successful strategy. Usually this leads to a rapid inflow of cash deposits, but a difficult conversion to other (more-profitable) products and also a fast outflow of deposits once rates return to a market conform level.

  • Very low rates for credits. As with the high interest rates, this usually attracts very price-sensitive customers, who are not very loyal and rarely consume other more profitable products (as they will typically shop for other products as well to find the cheapest alternative).

  • Removal of fees and commissions, like free credit cards, no costs on current accounts, no margins of forex transactions…​ These types of commission-free services are attracting a lot of new customers, but often these customers are difficult to convince to also opt for products with commissions.

  • …​

As customer acquisition is so important, but also so costly, it is important to define a good customer acquisition strategy and keep a good control over these costs. A well-defined customer acquisition strategy should therefore make use of 2 very important elements:

Eco-systems and partnerships

As customer acquisition is so expensive, especially in the B2C space, it is important to partner together and create eco-systems (see my blog for more info).
This need is not only driven from a cost perspective, but also by customers demanding a more customer-centric user journey, rather than a product-driven journey. Such partnerships can often be mutually beneficial, as both parties can create cross-sale opportunities for each other.
The existing brands, with large customer bases and a lot of customer interactivity (like the incumbent banks or telcos) are especially well positioned in these eco-systems, as they can bring almost instantaneously thousands of users to a product. Many companies that started off in a B2C or B2B model, are therefore not surprisingly shifting to a B2B2C or B2B2B model. In this model, the Fintech will sell its products or services not directly, but via an intermediate party, like a bank or telco (Trov is a good example of a Fintech that made such a shift).
Of course passing via such a party can be expensive. In my company we use as rule-of-thumb in partnerships that 50% of revenues are going to the party that does the customer acquisition and the customer relationship management, while the remaining 50% goes to the party managing and delivering the product/service (i.e. infrastructure, software, operations…​). This revenue sharing can therefore be an interesting source of revenue for large established players, while for the young Fintech it can be a much cheaper and more sustainable model for customer acquisition.

A customized, adapted (individualized) customer targeting

As indicated above it is important to keep a good control over the customer acquisition costs. Ideally the lowest amount possible should be spent to acquire a specific customer. This means prospects should be well segmented, so that a specific prospect can be targeted in the most effective and cheapest way possible, but also that prospects which are too expensive to acquire (i.e. an expected LTV/CAC ratio of less than 1) are excluded.

A typical example of such a customized strategy is to acquire customers either via direct external sales (i.e. a physical sales meeting at the prospect), internal sales (i.e. telephonic contact with the prospect) or a full online sales process (i.e. prospect doing self-onboarding). While customer acquisition cost (excluding the setup of the solutions) via external sales easily runs up to multiple thousands of euros (considering the preparation and mobility, the actual meetings and the follow-up) and internal sales to a few hundred of euros, the cost for self-onboarding is only in the range of tens of euros. It is therefore important to select the right approach for every prospect, taking into account the likeliness a prospect will be convinced by a specific approach, but also by the expected (future) LTV/CAC ratio.

But this type of diversified approach is only a first step. All other aspects of customer acquisition should also be adapted to each customer segment, i.e. from diversified advertisement and diversified content delivery, all the way to AI selecting the right approach to address every prospect/segment and manage the (future) customer relation.

Hope this article demonstrates the importance of customer acquisition for Fintechs and that its importance should never be underestimated, i.e. not too much (as too costly), but certainly not too little (as your business will not grow) and with a well-adapted approach to the characteristics of every prospect. It’s a delicate balance, which can only be obtained by continuous monitoring and adjustment (probe, sense and respond) and making use of the latest trends in campaign management, AI, eco-systems and many others.

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Comments: (3)

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 04 June, 2020, 12:19Be the first to give this comment the thumbs up 0 likes

Great post!

We regularly come across fintech founders, often from tech background with finserv domain expertise, concentrating 100% on product and engineering, under the mistaken notion that consumers will queue up to buy their products because of x-y-z reasons. Obviously life doesn't work that way. By the time they realize that, they have exhausted all their money on product development and fade away into oblivion because they have nothing left for marketing / customer acquisition. I have seen this movie countless times.   

I totally agree that Winner Takes All does not happen in finserv because there's no new product. But, I'm curious to hear your thoughts on whether it has actually happened in any other industry, either? At least, I have not. According to basic principles of Economics, even a monopoly can dictate only price or demand, but not both. If last man standing tries to engage in price gouging, either the regulator can clamp down with price controls or the customer can always switch to a substitute or, if no substitute exists,  exercise the option of buying nothing at all. 

Joris Lochy
Joris Lochy - Capilever - Brussels 09 June, 2020, 20:36Be the first to give this comment the thumbs up 0 likes

Thanks for your feedback. Indeed I agree there are very few examples of the "Winner Takes it All" principle, because competition immediately rises and regulators tend to intervene. Nonetheless there are some examples where principle seems to apply (at least for a number of years). Netflix seemed to have a monopoly on streaming for years, but is now being strongly attacked by Amazon (Prime), Disney (Disney+), HBO (HBO Now)... Same with Facebook, which has had quite some competition of Snapchat and TikTok. But some examples are still there, like the Search Engine of Google or the marketplace of Amazon.

Clearly the strategy of many large venture capitalist firms (like SoftBank) is still to pursue this "Winner Takes it All" principle. Obvious examples are Uber in the ride sharing app space, Uber Eats, Deliveroo or Doordash in the food delivery space, Bird or Lime in the shared mobility space or WeWork in the office rental space. Recent evolutions have however showed that this is probably not the most successful strategy to follow in the long-term.

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 10 June, 2020, 16:42Be the first to give this comment the thumbs up 0 likes

Thanks for the detailed response. 

There are still many functioning search engines. Online sales is less than 10% of total retail sales, Amazon's market share in online sales is 49%. Ergo, I sorta differ that Google Search and Amazon are monopolies.

But, for the sake of argument, assuming that they are, I see no evidence of "after which prices can be increased". Whose prices have they increased? Not Users, not Advertisers. Coming to Netflix, yes it was the only streaming video service at one point but, during that period, memory serves, it increased monthly fees from $9.99 to $11.99 or some paltry figure like that. 

So, IMO, Winner Takes All does not happen by Market Share, at least amidst new-age companies. Even in the rarest of cases when it does, it does not necessarily lead to price gouging, as usually claimed by antitrust regs.

Despite all this, I have a theory for why VCs still promote Winner Takes All: It stokes the "Greater Fool Theory" and helps pump up the startup's valuation, thus enabling VCs to fulfill their fundamental goal of achieving "multibagger returns in 2-3 years". My related post: Fintech Shouldn’t Stop Chanting The Disruption Mantra.

Winner Takes All also works for Economic Profit (= Profit - Charge for Capital used to get that Profit), whereby 20% of companies in Winner Takes All sectors tend to have 80% of Economic Profit. But this seems to be true not just for wannabe monopoly players in new age sectors but also in highly competitive traditional sectors in mature markets like Insurance, where a McKinsey analysis of economic profit of 209 insurers identified a power curve.

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