World's largest FinTech [ecosystem case study 📈] with Marc Rubinstein, author @Net Interest 📧

🎬 E24 is a case study of Ant Financial with Marc Rubinstein, Author of NetInterest.email newsletter, Financial Sector Investor & Advisor 🚀 We retraced the Ant Financial’s journey from building #partnerships to becoming the biggest FinTechs in the world. Ant is poised to be the biggest IPO of 2020. Marc is an early investor in many successful FinTechs, including Revolut, and he shares insights on all things finance in his Net Interest newsletter.



- Hi Marc! You are one of the most knowledgeable people in finance who I know, and you write this very thoughtful newsletter called Net Interest, which caught the attention of many prominent people in finance. In your last newsletter you wrote about Ant Financial, which is an ecosystem and arguably the biggest FinTech in the world. Not that many people in the West have heard about Ant Financial. Can you tell us why it's caught your attention and what is so special about your newsletter and this specific case.

- Hi Roman. I've been to China a number of times over the years, most recently I was there three years ago. And in the time I was there before that and the time I was there three years ago it was incredible the extent to which FinTech had become so popular in China. And what was particularly incredible when I was there three years ago was the way that I was able to use my phone to download an app and pay for everything. Whether it was a souvenir from a seller on the streets of Shenzhen or whether it was for a meal at a restaurant in the shadow of the Great Wall in Beijing. And in fact in that case it was simply a question of waving my phone in front of a QR code and we hadn't really seen that many QR codes previous to that in Europe. And the menu of the restaurant would pop up on the phone and I was able to make the order and pay for it all within the phone. And this is kind of a well-known phenomenon. It's well known now that these digital wallets are very prominent in China. But I came back to the UK and didn't really think much of it for three years. And then last week two events happened: one I went to a restaurant in London for the first time in five months and they made me wave my mobile phone in front of a QR code in order to order. Exactly the same process as I'd experienced in China. And the second event was the announcement that Ant Financial, which is one of the two companies behind this technology in China, was going to IPO. It hasn't happened yet, it's going to be a $200 billion dollar IPO, the biggest IPO of 2020. And these things made me think, you know QR codes, etc. So I wrote this report in my newsletter, which is a newsletter that looks at financial industry themes, goes out once a week. I wanted to address a simple question which is can an Ant Financial emerge in the West?

- Can you tell a little bit about Ant Financial story, because it's in many ways mind boggling, right? They have more than a billion customers and they've emerged out of almost nowhere. And as much as everyone here in London for example, interested in FinTech, very few people know about Ant Financial. And even people who I know from the East, are not that aware how they build this massive company. What do you think is compelling about their story?

- It's very interesting. You've got to go all the way back to 2004, when Alibaba had been around for five years. Alibaba was founded by Jack Ma very famously at the end of the 1990s, but the problem in China is that e-commerce wasn't really taking off. And the reason why it wasn't taking off is because it was very difficult for people to pay online, there was a lack of trust between the buyer and the seller and so what Jack Ma introduced in 2004 with Alipay was a mechanism whereby people could transfer money to Alipay, the money would sit in Alipay the seller would be informed that the money was there they dispatched the goods to the buyer, and only when the buyer confirmed he was happy, he received the goods, that he would confirm that to Alipay who would then release the money to the seller. So he set up this process not dissimilar from the sorts of processes that PayPal introduced in the United States. Remember they worked alongside eBay initially in the same way that Alipay worked alongside Alibaba. So that's how it kick-started and it helped to put rocket fuel behind the e-commerce movement in China. And so in 2004, 2005, 2006 e-commerce started to grow in China. In about 2006-2007, Alipay realized that there was something of value here that not just facilitating payments for Alibaba, it could also facilitate payments for any online seller, and so they started to recruit other merchants with this offer "we've got this mechanism that enhances trust between the buyer and you and will help your e-commerce sales". And they got new clients, gaming platforms, travel websites, airline websites, other online stores. They picked up more and more clients and very soon Alipay became its own ecosystem, became what we now know as a digital wallet or an e-wallet. It still did business with Alibaba, most of its business. In fact, today a lot of its business is still with Alibaba, but it had other customers as well that it was able to facilitate payments for.

- They basically piggybacked on Alibaba's growth, but then they actually quite successfully branched out into multiple other areas right? I think what is interesting is how do you think they managed to build such a scalable platform and moved to this ecosystem play. What are the insights there?

- Well, there's two reasons. One is they had the resources which I'll talk about and two is the regulators let them do it. They had the resources. Basically if we look at FinTech broadly, most FinTechs will start with some product and it might be some price arbitrage, it might be some regulatory arbitrage, it might be something around user experience. Revolut started doing foreign exchange because they could do it more cheaply than the high street banks. Lending Club started doing online lending, because it was more efficient for small businesses who the big banks maybe didn't want to give loans. Every FinTech started with a product. What was interesting and unique about Alipay is that the product it started with, is the one that enabled it to gather two resources. One was money, basically customers would park their money with Alipay, and that's inherently very useful, and initially they were able to make money by lending that money out. So the customers would park their money with Alipay for two or three days, and for the two or three days they had that money Alipay could generate an incremental return by lending it out risk-free. Eventually the Chinese authorities basically said "no you can't do that anymore" because there was a systemic risk, but for a long time they were able to make a lot of money doing that. And whilst they were doing that, they were accumulating savings. And the second resources they're accumulating - data. So Revolut initially was doing foreign exchange transactions, its data was quite small, quite narrow. It knew when people were abroad and what they were buying when they were abroad, but not much else. As the ecosystem of Alipay grew, Alipay would became the cornerstone for its customer's payments online and so Alipay knew everything about these customers. He knew where they were and knew what they were spending money on, what times they were spending through what they were spending. And enabled them to get insights into who they were and where they were in their life story, everything. And so they were able to use both of these things, customer savings and data, to launch then other products. So we'll talk about partnerships in a while, but they were able to launch all sorts of financial services products, which stem from saying to customers "we've got your money, what do you want to do with it? And we've got your data, we can either suggest things that you can do with your money or through that data we can authorize loans, for example, because we've got better insights into your credit than maybe the banks have. And this brings us to regulation - the regulators let them do it. Because the innovation happened very very quickly, they had a big head start on the regulators and were able to accumulate market share. They were able to accumulate these resources before the regulators basically made them not stop, but basically made things a little bit more difficult.

- Now that you mentioned partnership and ecosystem, Alipay, sorry Ant Financial, becomes almost a case study for everyone who is interested in ecosystem thinking. I think what is interesting about them is that, as you wrote, they tried to do financial products in-house. And then they almost flipped the model, focused on distribution and data and they partnered instead with hundreds of different companies. Can you share this part of the story?


- It's very interesting. So they tried to do it themselves initially. Initially they rolled out their first product, a money market fund. They said to customers "okay, you're leaving your money with us for a bit, the bank will give you 2.75%, we'll give you 5%". And this was fantastic, because it actually locked the money in. And it was very important for them to lock the money in, because there was a cost to get the money into their ecosystem. So having paid that cost to get the money into the ecosystem, they wanted it to stay in the ecosystem and one way to do that was to offer customers a better return in the ecosystem. So launching the money market fund enabled them to do that and they launched it themselves. Again a number of things happened, this money market actually grew to be the largest money market in the world. It became very very quickly the biggest money market in the world, bigger than J.P. Morgan was the number two, it was bigger than that.

- That's fascinating right?


- Right, but then they realized actually that their real franchise was with the customer, not in managing a money market fund, which is a very technical thing to do. They did it through a subsidiary and the expertise was there, but they realized that maybe by offering customers a choice of funds and not doing it themselves once they had the critical mass in distribution then they had market power to go to the partners, to go to the manufacturers, to go to the guys who ran these funds and say "look, we can deliver to you you know, right now it's 1.3 billion customers we can deliver to you, back then maybe it was a billion maybe less, we can deliver to you close to a billion customers. So we should capture a bigger share of that value than maybe we would have done otherwise. They realized the value actually was in distribution and because they were so big, and they were a lot bigger on the distribution side than they were on the manufacturing side, even though it was the biggest money market fund in the world it was still a small market share, that they were able to negotiate very high share of the value. And so that's what changed.

- Let's dig a little bit deeper into their credit scoring algorithm or part of the business, let's call it that way. Because I think everyone who is interested in partnerships or ecosystems, they are very much thinking about data and what we do with that. Can you share more on what they [Ant Financial] do with data and what is the advantage they have right now compared to anyone else who is doing credit scoring, for example?


- So again, we’ve got to bear in mind that the history in China is very different from the history in other markets like the US. In the US there's a well-developed credit infrastructure. A lot of people in the US have got a credit rating and there's a company called FICO, which generates credit scores and these things are very well developed. Not so in China. And so just as it was able to do through Alipay, where it short-circuited the credit card product and went straight from cash to digital wallets. Similarly, in credit it was able to short-circuit the credit bureau, because it accumulated all this data itself. Typically, a credit bureau would have data on customers' credit history, but what Ant Financial was able to add to that, it had that as well, but it was able to add to that all sorts of other data that you know anyone carries around on their mobile phone. Again regulation is very helpful, data privacy threshold is very different in China compared to the United States, so they were able to gather a lot of that data. And again to this point about regulation catching up with them, right now there's a question that some of these privacy laws may be tightened up, which could be an obstacle for them. But up until now they've had free sailing in terms of accumulating all sorts of data. And it manifests out very clearly. So when they give loans their loss rate on loans... So for the typical Chinese bank, in 2019 Chinese banks lost three percent on bad loans, Ant Financial lost one percent. And the argument is because they've got better data, they can make better credit decisions. And that data as we've described comes from their access not just to classical credit data, but to so-called alternative data sources as well.

- Moving forward and where they're actually going right they become almost unstoppable now. And they're trying to branch into like a super app right adding more and more services. And actually this follows a trend, which is happening across Asia with Grub becoming not only ride hailing, but also almost everything app, Xiaomi is trying to launch their own platform as well, and DiDi is the same. Can you share more on what they are up to now?


- You're absolutely right, Roman. They've actually changed their name from Ant Financial to Ant Technology. One of the reasons is to escape regulatory scrutiny around financial services. Inevitably financial services is a much more highly regulated industry than many other industries. Changed the name to Ant Technology and they rolled out a super app. So within the app ecosystem phase one was you can buy products from Alibaba, phase two was you can buy financial products, you know money market funds, loans, like we talked about. Phase three is you can now do online food delivery, medical services, entertainment. All the things that as you say other Asian super apps have been able to do from the non-financial perspective. It clearly increases competition - no longer are they just competing with Tencent, which was their competitor in the digital wallet space. They've got over 50% market share, they've got about 55% market share Tencent, which is WeChat, WePay have got 40% market share. You've got two players, it's now more competitive because they're competing against DiDi, they're competing against all the people you've spoken about. But that's what they're going to do, and I guess with their 1.3 billion customers they think they've got a fair shot at doing it.




















- What is actually mind-boggling for me personally is how they actually managed to integrate, even on the financial side all these hundreds of partners. And now they're trying to do that at like 10x scale, I think this is what you're saying. How do you think they managed to do all of this orchestration of this entire ecosystem?



- It's a really good question. I mean they've invested very very heavily in tech, they did that very early on. In fact, right now they're also launching, they've been talking about AI, everybody talks about AI, they're launching a blockchain, they call it the AntChain solution. But yes, you're absolutely right. Clearly when they did that pivot into partnerships, they invested very heavily and it's a global network of partnerships. And it's something that they've invested very heavily in doing. I'm sure they're using more than an Excel spreadsheet I hope, but it's obviously a question. I'm sure when they come to IPO, the scrutiny from the investment community will be intense and I'm sure it's a question that they'll have when they do their IPO roadshows.

- Obvious question is what can we learn from them here in the West? And can they actually scale into adjacent markets. I mean they apparently already are there, but can they scale more broadly and what are the lessons?

- I think it's unlikely that... I'll give you an example. In Brazil WhatsApp, which is part of Facebook, announced that it was going to be launching a payment product through WhatsApp. They began doing it, but they were stopped by the regulator. The central bank of Brazil basically said whoa, hang on, you know. And it came as a surprise from the central bank of Brazil, but the central bank of Brazil said whoa, hang on, we need to really study this in detail, we're not actually sure about this. So what's happening now it's very difficult to replicate Ant Financial, regulators all over the world being a lot more cautious. Whenever this [episode ] goes out it will be a few weeks after the hearings in Washington DC of the four large US tech companies A lot more scrutiny increasingly. Financial services got a lot of scrutiny in 2009 and today tech companies are getting a lot of scrutiny because of their market power. It's very difficult to replicate another Ant Financial. Ant Financial itself as I say is becoming a lot more competitive, now that they are looking to become a super app. One of the reasons why they're doing is because regulators are squeezing them a little bit, the regulators increasingly are looking at privacy. The regulator's already stopped them from making money off the float that they gather from customers who park their money in Alipay for a short number of days. So the regulators are coming a little bit more aggressive. So that makes it difficult to replicate, it makes it difficult for them, it's a challenge for them. But against both of those things there's a huge incumbency advantage. One of the things about ecosystems that you know very well is these flywheel effects. And they've proven that very clearly from getting the money in to accumulating the data, to getting more money in to accumulating more data. It enables them to offer products more cheaply, to do credits with lower losses and that has huge advantages to them.

- From a perspective of being an aspiration for many other FinTech companies and other companies that work in technology in general. Do you think it gives you a picture of what is possible in general? Or do you think this picture is valid, but only on Asian markets?


- It's a really good question, because on the one hand you can't create an Ant Financial again, but on the other hand the two things, one is the value of data and the value of partnerships. I think historically it was very difficult to do these partnerships, because there was some conflict and some tension over how the value should break between the various players. Now what Ant Financial is doing and companies like Ant Financial are doing is they're creating a convention they're creating some benchmarks they're making it more acceptable to do this profit sharing, to break down distribution and they're creating a structure whereby partnerships can thrive. And then the second point is clearly Ant Financial itself can't be replicated, but then other things there's always innovations and other things no one knows what the next big thing is.

- That's for sure. Thank you so much for sharing all of this and first of all thank you for writing about this case, which very few people know. I hope now they will be able to learn more and I would encourage everyone to subscribe to your newsletter.

- Yeah, they could do that on the www.netinterest.email

- Looking forward to following you and reading at Netinterest.email about other aspects of finance, which are not well understood. So thank you so much for your insights and newsletter.

- Great, thanks Roman.


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