Why did Fintech Customer Acquisition Cost (CAC) go out of Control?

This is Part 1 of our Fintech series. This week, we dive into Fintech high CAC problem, what caused it and the industry outcomes. Next week, we will dive into successful fintech growth strategies.

Past and Present Fintech Growth

After years of explosive growth, the fintech industry is now shifting gears towards sustainable, profitable expansion. This rapid growth has allowed fintech to go from the periphery to the core of financial services, driven by rapid technological advances, changing customer preferences, and robust investor support. Fintechs have transformed parts of the financial sector with innovative, customer-focused solutions, collaborative business models, and agile teams.

The market capitalization of publicly traded fintechs hit $600 billion, doubling since 2019. Additionally, since 2019 there were over 272 fintech unicorns valued at a total of $936 billion, a sevenfold increase from five years ago.

However, in 2022, the fintech sector experienced a market correction, slowing its rapid growth. This shift has led to a decline in funding and deal activity, fewer IPOs, and a slowdown in unicorn creation. The macroeconomic environment remains uncertain, pushing fintechs into a new phase where sustainable growth is crucial. Gone are the days of rapid, unchecked expansion. Now, fintechs must adopt a more measured approach.

The second half of the 2010s saw record capital influx into fintech. Venture capital funding jumped from $19.4 billion in 2015 to $33.3 billion in 2020, a 17% annual increase. Deal activity also rose in tandem.

However, the funding boom of 2021 proved to be an anomaly. By 2022, funding levels had returned to more typical patterns. This correction led to significant valuation drops and funding cuts. VC funding plummeted from $683.1 billion in 2021 to $459.6 billion in 2022, with fintech funding falling 40% year-over-year.

So why did CAC Skyrocketed for Fintech?

It was the combination of 2 main factors:

• A huge part of the VC money was used to fuel growth through digital media buying at any cost. Leading to huge competition increase for users attention on the web where most of the acquisition came from for fintech.

• Privacy regulation like GDPR and new privacy technologies like iOS 14 made online targeting even more complex for fintech. Making it harder for them to find their target audience on the web and thus making more expensive.

It led CAC to blow out of proportion making growth harder for these digital native businesses.

Small definition aparté:

Customer Acquisition Cost (CAC) = (Sales expenditure + Marketing expenditure) / New Customers Acquired in a given period.

Customer Lifetime Value (LTV) = (Customer Value * Average Customer Lifespan)

LTV:CAC a general rule of thumb says that this ratio should be higher than 3 for the business to be considered healthy.

What’s a good CAC?

Speaking of a general CAC for the entire fintech industry is purely irrelevant but you can always compare a company to a category leader. So, here is a benchmark of fintech category leaders and by digital channel for 2023:

A Nascent Industry in an Expanding Ecosystem

Despite these challenges, the fintech sector is still poised for growth. Over the next few years, fintech revenues are expected to grow at nearly triple the rate of traditional banking, with a projected annual growth rate of 15% compared to 6% for traditional banks.

In 2023, the banking industry generated over $6.5 trillion in revenues, showing growth in both volume and revenue margins. Fintechs on their end made up 5% of the global banking sector’s net revenue, totaling between $150 billion and $205 billion. By 2028, this share could exceed $400 billion.

Emerging Markets and Revenue Growth

Emerging markets are set to drive much of this growth. In 2023, fintech revenues from Africa, Asia-Pacific (excluding China), Latin America, and the Middle East accounted for 15% of global fintech revenues. This is expected to rise to 29% by 2028. North America's share, currently at 48%, is projected to drop to 41%.

Fintech penetration is high in these emerging markets, thanks to a significant underbanked population. For instance, in Brazil, 46% of adults use Nubank, a fintech bank, doubling its user base from two years ago.

Despite substantial growth in private fintech firms over the past decade, their presence in the public market remains limited. From 2014 to 2023, only 44 modern fintechs went public, with a combined market cap of $0.3 trillion, compared to 2,500 legacy financial companies with a $11.1 trillion market cap.

The Path to Sustainable Growth

In today's market, fintechs must rethink their strategies to ensure sustainable growth. Previously, access to huge amount of capital allowed fintechs to prioritize rapid revenue growth over cost management. Now, with tighter funding, profitability has become the focus.

Cost Discipline: Fintechs now emphasize cost management and operational efficiency alongside growth. Research shows that 50% of public fintechs were profitable in 2023, primarily due to effective cost control, not just revenue growth. Profitable fintechs saw a median 3% decrease in costs YoY, while non-profitable ones faced a 27% increase YoY.

Unit Economics: Fintechs should embed profitability across their business. For instance, evaluating customer acquisition costs against lifetime value can help assess the return on investment for acquiring new customers. In Latin America, 68% of fintechs reported an LTV/CAC ratio greater than five, indicating potential for growth without sacrificing profitability.

From our research it appears that growth goes through 4 main paths. Sustainable growth can be achieved through three main strategies: building a strong core, expanding into related markets, strategically downsizing to grow and M&A.

Strengthening the Core

The first step is to focus on the local market and develop a robust core business. Research shows that companies emphasizing their core business and strong home markets are 1.6 times more likely to outperform peers. For fintechs, this means concentrating on their main products and ensuring they are stable and viable.

Tailoring value propositions to specific markets is essential. For instance, B2C fintechs in emerging economies, like Brazil, experience significant growth from cross-selling, whereas those in developed countries grow more by acquiring new customers. Other companies, like Ramify, understood that focusing on one service in one market was key to strong sustainable growth. They just focus on consumer wealth management in France and nothing else bringing them a staggering growth over the past 3 years.

Expanding Strategically

Once fintechs have established a solid core, they can explore growth by entering new segments and geographies. Our research shows that companies expanding beyond their core are 1.2 to 1.3 times more likely to achieve significant returns compared to those that stay focused solely on their main business.

However, expansion is no longer a necessity for every fintech. It’s most beneficial for those with a strong presence in their core market and some competitive edge or ownership advantage to leverage. The key is to aim for measured, value-creating growth.

Take OPay, for example. It started as a mobile money platform in Nigeria but has since diversified into various financial services. Today, OPay offers peer-to-peer payments, merchant services, and card services, illustrating how strategic expansion can lead to substantial growth.

Downsizing to Grow

Fintechs are shifting from hypergrowth to sustainable growth, but this doesn’t mean every part of the business will grow equally.

Several fintechs have adopted this shrink-to-grow strategy. German robo-adviser Scalable Capital decided to end its Swiss operations in 2020 to concentrate on other markets, avoiding the complexities of managing two regulatory frameworks. Similarly, Wealthsimple, a Canadian online investment platform, withdrew from the UK and US in 2021 to focus on its local market and expand its financial services portfolio. San Francisco-based LendingClub also pivoted in late 2020, shutting down its retail peer-to-peer platform, Notes, to focus on other products.

Mergers and Acquisitions

Many companies find that acquiring new features, building capabilities, and exploring new revenue streams and segments can be faster through acquisitions and partnerships rather than organic development. For instance, fintech firm Block acquired the buy-now-pay-later platform Afterpay in January 2022 to boost its strategic goals for its seller and Cash App ecosystems.

Mergers and acquisitions (M&A) tend to rise during economic uncertainty and often deliver higher returns. During the global financial crisis, about 45% of banking M&A deals showed positive excess two-year total shareholder returns (TSR) from 2007 to 2009. In contrast, less than 30% of deals posted positive returns between 2010 and 2020.

However, not all M&As succeed. Many fail due to differences in values and cultures, mismatched product-market fit, and unrealistic revenue forecasts driven by the pursuit of customer engagement and growth at any cost.