Sooner or later, everything old is new again– Stephen King
The thesis expressed today is that financial services are no longer a separate vertical component in consumers’ life. Consumers are going to be better served where they already hang out. So the natural extension for business with a large number of customers is to start offering financial services to their user base. In this model, financial services transition from a vertical component to a horizontal capability that all businesses will offer to their users. Hence the popularity of the term embedded finance.
Is this thesis valid? I’ve been thinking about this for a few years and this post is an attempt to work out a mental model and answer this question.
Short answer – this thesis is wrong. Long answer- it’s nuanced.
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In the last few weeks, the tech world has been abuzz with GPT3. There has been a Cambrian explosion in demos that look super cool. A16Z has a great podcast that goes through the details that is a must-listen.
You start by providing GPT3 a few example questions and answers that prime the model. After priming you can ask it questions and it correctly (mostly) predicts and generates the right answer. You could think about GPT3 as a super generalized inference model for text. You now how a generalized text-based interface that can understand what you are trying to ask/do well!Read More »
Every business will eventually have to get into the financing business. Financing is a fancy word for lending and it has been around since the dawn of civilization. In this post, I will attempt to describe a simplified mental model for lending.
What is lending at its core?
Lending is a contractual relationship between two parties. One of them has something that the other needs. The lender, who has the thing and the borrower, who wants the thing. Since the dawn of mankind, the thing to want is productive assets. You start with borrowing a plow, borrowing some land, borrowing some seeds – you get the idea. As mankind progressed and the next abstraction of money came into being, money is the asset that everybody wants. Money is the path to get to productive assets. The lender of money wants to get compensated for giving his asset to the borrower. He is giving up the use of the asset and needs an incentive to compensate for the lost opportunity cost – this is the interest. Every contractual relationship has to have a time frame specified. In lending, this construct is described by the repayment term i.e over what period of time does the lender get their money back.
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For our last 10K club we discussed Shopify ($SHOP). Giorgio has a fantastic post going into the 10k details. The bull case for Shopify is all over the interwebs but to truly understand the company, it’s useful to formulate the other side of the argument. In this post lets deep dive into Shopify’s business model and strategy and work out the bear case. Standard disclaimer: this is not investment advice and I do not hold any positions in $SHOP. This is a thought experiment using the good business/bad business framework.
What is Shopify’s business model?
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When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact. – Warren Buffet
As I age in the business world, I have internalized this buffet quote. I superficially understood it early on in my career, but now I understand it! With fintech as the backdrop, this post is a view of my mental model on business models and gross margins in general. What makes a good high gross margin business?
Let’s start with a 30,000 ft view of what forms a business. Businesses exist to provide value to a set of customers via the products they create. A firm solves a need and customers pay them to solve that need. At its core, a company is a machine that takes raw ingredients (physical widgets, human capital, and intellectual capital) and transforms them into products that customers pay for. Raw ingredients cost money (cost centers) and customers pay money (revenue centers) for the finished product. A good business, in the long run, generates a consistent profit i.e (revenue – cost) is a positive number. Profit takes various forms such as free cash flow, EBIT or EBITDA – but the simple model holds, value creation only happens when what you get for the product is higher than what it costs to make it.
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In this post lets delve deeper into the mechanics of channels. As mentioned in my previous post, do not start this exercise before you have locked down your product value proposition and positioning.
Think deeply about LTV and set guardrails
What does the economics of your business look like? The most important thing is to align on is the value of your customer to you. What is the long term value of the customer (LTV)? Don’t be confused by the term “Long”. It’s up to you on how long you consider a customer to be using your product. Early on in a startup, it is better to have shorter periods. The more mature you are, you will have actual data on how long users use your service. You have to start by nailing down the exact equation on how you calculate LTV. This also forces you to think about the unit economics of the business. The biggest issue isn’t in creating the equation for LTV rather it’ getting a broad agreement with the team on the equation. Everybody has to believe in the assumptions and understand the specifics of how LTV is calculated.Read More »