This first appeared in the monthly a16z fintech newsletter. Subscribe to stay on top of the latest fintech news.
An operating system is a mission critical piece of software used daily to manage a business. Toast is the OS for restaurants, Mindbody for gyms, ServiceTitan for field services, and so on. As we noted in our post on Fintech Scales Vertical SaaS, many of these businesses start by selling software as a service, and layer on financial services once customer captivity is achieved. Operating systems can be extraordinarily sticky, in many cases are across the flow of funds, and possess a wide array of logical points for upsell and cross-sell.
But why aren’t operating systems the norm across more, if not all, industries? What will it take to bring the long tail of certain categories online? The key may lie in not selling software at all. Enter the “Freemium OS.”
Many legacy industries still face challenges in gaining adoption of operating systems where a clear wedge is necessary to break in. This could be for a variety of reasons: a long tail of small businesses with a low willingness to pay (e.g. real estate agents), inertia in moving off of paper (e.g. freight brokers), or incumbent operating systems that make a rip and replace challenging (e.g. commercial insurance agents). Offering a specialized OS for free can provide a compelling wedge by convincing otherwise unwilling customers to try a new product. And if that free product becomes a critical piece of every day workflow, there are plenty of ways to monetize over time.
We believe this wedge can take many different forms, but one we’re fascinated by right now is a freemium model that helps working capital constrained businesses smooth cash flows. This can look different across industries: for example, if there’s significant spend and a spender (as there might be in construction), a charge card combined with software might make sense. If there’s a sales commission awaiting payout (such as in real estate), an advance might make sense. If there’s significant receivables that create working capital issues (as there might be in freight), embedded lending might make more sense. It’s not hard to see how owning the OS for a business would give a prospective lender better visibility into cash flow dynamics and future prospects, ultimately creating a secured environment to lend to its customer while also potentially offering banking, spending, and insurance services.
That said, freemium doesn’t mean these companies are just a distribution platform for financial services. Engagement and relevance of the vertical-specific SaaS is still important. It should still drive stickiness by being an integral, tailored part of the user’s day-to-day workflow, and as a depository of critical data for their job (e.g. customer or transaction data). So, the software is still valuable, the barrier to adoption is just being lowered by making it free. Sometimes, it can also make sense to charge some de minimis amount just to drive commitment (i.e. if you’ve paid, you’ll use it) and avoid adverse selection. Ideally, over time, a company can charge for premium offerings as the customer gets more hooked into using the software, or the company goes upmarket.
We’re excited to learn more about businesses with these characteristics building in industries that have been tough to break into historically.
A decade ago, there was a sense that fintech companies would soon replace all aspects of consumer banking. Instead, we have seen fintechs gain tremendous traction on the customer-facing, demand side of the ecosystem (banking, payments, overall customer experience), with traditional financial institutions continuing to enable the supply side that is largely dependent on capital (deposits, lending).
But what might the future of consumer banking look and feel like as the roles of these players continue to evolve? We see seven areas across the consumer banking stack with the potential to yield some of the biggest yet-to-be built companies in fintech.
Medical debt in the United States is a problem of staggering proportions. Fully half of Americans now carry medical debt, up from 46% in 2020, and between debt sitting with collectors ($140B), on credit card balances, and in unpaid medical bills, Americans owe a total of $1T for healthcare services they’ve already received. To make matters worse, the top drivers of medical debt are often unpredictable, unavoidable procedures, for people who simply don’t have the money to pay for them.
Once a patient is in debt, their options are limited. Most Americans (75%!) who have medical debt choose to try to negotiate it down. This often requires scouring their Summary of Benefits and Coverage, asking for itemized bills, or inquiring about qualification for payment assistance programs, all of which can be frustrating and time consuming. While 66% of those who negotiate do so themselves, 26% use a third party service to help them. Because these services are doing all the heavy lifting outlined above, they typically charge 30-40% of the savings they uncover.
But new legislation around transparency in healthcare could empower those negotiating medical debt. These strong regulatory tailwinds could mean there’s a big business to be built in helping consumers reduce their debt.
On July 1, 2021, part of the Cures Act went into effect giving Americans the ability to access their health and insurance data via an API call, which companies like Automate Medical are making possible. This could empower those negotiating medical debt to grant access to their data to a negotiating company with a single click, arming that service with the information needed to better negotiate on the consumer’s behalf. On the provider side of things, the PRICE Transparency Act will require hospitals to publish their prices to the Internet, and the No Surprises Act will protect against a lot of surprise medical billing – both further empowering negotiators of medical debt.
This month, Apple announced its plans to launch Tap to Pay on iPhone. Once launched later this year, this product will unlock payments for the smallest end of SMBs and solo merchants. SMBs will no longer need a separate terminal and can accept payments with their existing iPhone, which lowers the cost and complexity of processing payments (even further than Square already did by removing the minimums and upfront fees, for example). It makes it easier for someone starting a business or side hustle, or a solopreneur, to get started taking payments from their iPhone. Merchants with both an online and offline presence can also see all their payments in one place (e.g. Stripe), rather than having separate payment systems for each.
To be sure, Tap to Pay on iPhone is not the first contactless payment solution available for SMBs in the U.S. That said, past attempts failed to gain meaningful traction due to friction for the merchant or the consumer, creating a classic chicken/egg issue. For a while, there was limited mainstream consumer awareness or incentive to tap to pay. QR payment options from PayPal, Square, and others did not require a reader, however, they did require the consumer to access an accompanying payments app to checkout. Square tried Pay with Square in 2012, where consumers and merchants could connect via GPS and charge a linked card. But merchants still needed the Square point of sale (POS) and mainstream consumer awareness. Many small businesses take payments via CashApp, Venmo, or Zelle but using a credit card usually means a 3% fee.
This time though, the timing is right – U.S. issuers have recently rolled out contactless cards in huge numbers. Plus, the early stages of the pandemic drove adoption of tapping to pay because customers and merchants didn’t want to handle cash.
So what does this mean for the payments ecosystem?
Stripe is Apple’s first payment partner (though Apple plans to support other payment platforms). For Stripe, this is also a great distribution play. It can now capture offline payments alongside online transactions, so Stripe has a better, more complete picture of a merchant’s transactions.
For POS providers, like Square/Block or Toast, Tap to Pay on iPhone doesn’t necessarily mean that they are going to start losing business. First of all, Tap to Pay on iPhone unlocks merchants that are typically smaller than the current Square/Block customer and someone who may not want a register or permanent device. For larger businesses, however, it will continue to make sense to have a separate register and all the functionality and features – payroll, inventory management, shift management – that it provides. These POS providers are payment platforms with hardware on top, and they could also partner with Apple to serve the smaller end of the SMB market.
For Apple, this product brings it one step closer to having a closed loop payments system and also makes it easier for more vertical software companies in offline industries (e.g. healthcare, personal services, beauty, home services) to bring payments online. We’re excited to see the ecosystem it enables.