Thread by @fintechjunkie

Fintech startups have been on a tear for the past decade and some gigantic companies have emerged including @stripe, @nubank, @Affirm and @Klarna.

The question I get asked all the time is: Is there room for the next wave of fintech startups to succeed?

A few thoughts: 🧵👇

2/23: If you were to study any specific financial services product at any point in time, you’d find a few companies dominating that product’s ecosystem. These “incumbents” typically operate with similar business models, products and end-user experiences.

3/23: Some eras are defined by stability where the incumbents trade market share back and forth, but in other eras a small handful of innovators emerge that behave like annoying gnats. Sometimes the gnats go away but sometimes they end up thriving.

4/23: The innovators can easily be identified because they aggressively shout from the rooftops about the benefits of their product/service and have business models based on unproven but supposedly armor piercing innovations that threaten to change the landscape.

5/23: The innovators start out sub-scale and under-capitalized, but the best ones find ways to grow rapidly. Hyper growth attached to an unproven business model (plus a bit of grandstanding by Founders and Investors) creates uncertainty about whether an innovation is “real”.

6/23: But over time clarity emerges for one of two reasons:

💥The business model implodes because the model wasn't “real”

💥The business model's fundamental premise is proven to be correct.

7/23: If the new business model turns out to be real then the leaderboard is up for grabs over the next handful of years. It’s near certain that market share will shift over time to the new business model and incumbents could be in trouble if they don’t adjust quickly.

8/23: The reason why “fast follower” strategies don’t typically work is that most incumbents are neither fast nor followers. They don’t take emerging models seriously and rarely have the testing apparatus to experiment and learn on their own.

9/23: Innovators usually end up winning market share during the “proving out” period. By the time the answer is "known" and “safe”, the innovator is typically approaching scale, still growing rapidly, and attracting massive amounts of talent and capital.

10/23: With infusions of talent and capital, disruptors with truly innovative business models are destined to double and double and double again until they're the same size and scale as the major incumbents.

11/23: But just like the discovery of Sutter's Mill in 1848 kicked off the Gold Rush with 300,000 “miner 49ers” flocking to California in 1849, successful disruptors will inevitably attract another wave of start-ups that try to capitalize on the discovery of “innovation gold”.

12/23: The truth is that this second wave of "innovation" is fundamentally challenged by the simple fact that the good land has already been taken. The first movers with new/better business models that attract talent and capital are set up to win.

13/23: This implies that getting there first matters!

The second wave players have to find room in an ecosystem that’s occupied by the incumbents as well as the now well capitalized, at scale first wave innovators that are also nimble and chock full of talent.

14/23: A slightly better model won't cut it in this environment, and history suggests that second wave “me too” innovators have little impact on an ecosystem when looked at in the rear view mirror. There are exceptions to this rule but the rule mostly holds true.

15/23: So what does this mean for the current fintech ecosystem? It means that once a new insight has been introduced to the marketplace and proven to be "real", it's only a matter of time before that very specific game is over and the winners have been crowned.

16/23: Unless a new insight emerges that could become the foundation for a vastly superior model, the best a second wave startup can hope to build is a small, niche business. These startups can be sold to incumbents or disruptors if successful, but not for a right tail outcome.

17/23: This means that all new startups should be evaluated to determine if:

💥The model is based on a truly disruptive insight that could become the foundation of an entirely new wave of innovation

💥Is it 1848 or 1849 (i.e. - has Sutter's Mill already been discovered)?

18/23: If the answer to the second question is "1848" then the new startup has the potential to produce right hand tail outcomes. This is where alpha is in the ecosystem and investors should be happy deploying money in “1848 businesses".

19/23: But if the answer is "1849" then most of the alpha could be gone and investors/Founders will most likely be frustrated panning for gold. Selling picks and shovels (infrastructure and enablement) to the miners (incumbents) is probably the best play.

20/23: Which leads me back to the original question: Is there room for the next wave of fintech startups to succeed?

My answer is “Hell Yes!”. I’m personally super bullish because there are still many problems to solve and processes to fix in the global financial services space.

21/23: And it shouldn’t be lost that a new set of building blocks is emerging that can be assembled in creative ways that we don’t yet understand or appreciate. APIs, middleware layer tech, new core systems, improved payments rails, 3rd party transaction specialists, etc.

22/23: If I were to take the over/under on the next vs. the last 10 years, I’m all-in on the roaring 20s. Across every category of financial services we’ll see new leaders emerge. Well-known incumbents will fall and be replaced by rising startups.

23/23: The key is looking for “1848 business model opportunities”. At @QEDInvestors we think we’re seeing and investing in “1848 businesses” every day so I’m super excited about what the future will bring!