The perils of customer selection
Borrowing credibility and off-boarding customers to maintain it
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Two years ago, my friend
and I wrote about how concentration risk in fintech infrastructure is often overstated given the degree of lock-in and switching costs that infra vendors induce by abstracting away regulatory complexity, citing the example of Marqeta and Square.Sure enough, at scale, infra vendors can accumulate enough dimensions of lock-in to mitigate churn, even if parts of the infrastructure itself becomes commoditised over time (e.g. bank APIs in the case of open banking). But the perilous decision of customer selection permeates all stages.
At the earliest stages, founders navigate the paralysing cognitive burden of choosing which customers to build for (and equally which ones not to build for), knowing that this key decision will snowball to have a material influence on the company’s future likelihood of success.
Chetan Puttagunta proselytised the importance of this formative choice to Patrick O’Shaughnessy, who quizzed Chetan’s fellow partner Miles Grimshaw about it:
Your partner, Chetan, was incredibly influential in my career building software around his notion of design partners where you pick five to 10 early customers that effectively determine a lot of what the product becomes. So therefore, picking those customers well is a huge part of like what's going to happen in your business. How do you advise people on customer selection?
You said earlier that some of these great examples pitched themselves to companies that were themselves moving really fast, and they were just trying to keep up. So they're sort of getting pulled rather than pushing stuff down on the companies.
There are a few things to unpack here.
For one, winning customers that are themselves on the path to becoming category leaders is a way to index the growth of an underlying market, as we’ve discussed before (this is clearly desirable at any stage of the company). Think Stripe indexing the growth of e-commerce with Shopify as a platform of platforms.
The second strand here is the degree to which your first set of customers can often shape your destiny. Marquee customers lend a ‘bridge loan of credibility’ to a startup that can often be the catalyst for a domino effect whereby the social proof of the first customer can be parlayed to land the next one, and the next one, and so on.
As
wrote about fraud/AML vendor Unit21’s earliest days:After raising their Seed round in December 2018, Trisha and Clarence got to work turning their prototype into a working product. They launched Unit21 in July 2019 with a major first customer: Coinbase. Even Clarence admitted that they needed a “weird champion” to stick their neck out and trust a two-person team to deliver on such a critical piece of the business, and Coinbase stepped up. Then the rest came.
After getting a high-profile company like Coinbase on board, Unit21 was able to go to the next company, say Intuit, and say, “Look, see, Coinbase uses us for AML! You can trust us.” Then they could go to the next company, say Chime, and say, “Look, see, Coinbase and Intuit use us for AML! You can trust us.” Then they could go to the next, and the next, and the next with a growing number of logos and votes of confidence behind them.
Coinbase was clearly an index company that lent a bridge loan of credibility as the product was developed, but Unit21’s founders had to tread a careful line that all infrastructure builders need to be mindful of -
spoke to this in his reflections building payments infrastructure at Balanced and Finix:Of course, you want to say yes to big customers that can bring a lot of revenue and social proof but there’s a risk of essentially becoming an outsourced development shop for them.
Winning large customers is an opportunity to evidence scalability and competence, but this must not be traded off against extensive customisation. When choosing your first customers, determining the extensibility of the use cases, integrations, and features being demanded is paramount.
Plaid’s founders Zach Perret and William Hockey landed their loan of credibility through an inbound inquiry from a friend at Venmo, shortly after they had been acquired by Braintree in 2012 (before Braintree itself was acquired by PayPal). As Plaid’s first customer, Venmo’s requirements were eminently extensible and conferred the social proof that filled the pipeline with a bevy of nascent consumer fintechs.
It was an early inflection point. Signing Venmo validated the need for Plaid’s product and brought a wave of end-users through the door. Critically, it acted as an important proof point, too. A new generation of “fintech” companies had bubbled up in Venmo’s wake; those upstarts turned to Plaid to address their infrastructural problems.
Wiz, the fastest growing software company of all time, intentionally pursued the highest value accounts at the start of its journey. Wiz’s team knew that the product was sufficiently differentiated to already compete with incumbents and that winning these accounts would help inform the company’s R&D investments, lend credibility, and fuel a sustained assault on incumbent market share in the enterprise.
To compete with a crowded market including Palo Alto Networks’ Prisma Cloud and startup unicorns like Orca and Lacework, Rappaport & co. pursued the market’s highest-value customers first.
“It was really interesting right off the bat,” says Costco CISO Jon Raper, who tried Wiz in the summer of 2020 and had it up and running across all of Costco’s internal apps and databases within a day. Adds Igor Tsyganskiy, until recently the CTO of Bridgewater, and who signed what was then Wiz’s largest multiyear contract in the fall of 2021: “A bunch of people had the tools, but to deliver ROI almost instantaneously, no one else was there.”
Much has been said in the last few days about Adyen’s results and the sell-off that followed, but couched in Adyen’s first truly global merchant win lie some of the nuances of the H1 results. Founded in 2006, Adyen went on to process its first transactions in 2007 with smaller local gaming businesses in Germany. It’s only in 2009 that Adyen signed its first global merchant, Groupon.
Michael Willar described the significance of this in an excellent Business Breakdown of Adyen:
But the pivotal moments for Adyen was the Groupon win in 2009, which really put them on the map. And in payments, you need volume to kind of get volume. It's similar to fund management. You kind of need AUM to get AUM.
Fast forwarding to this week, management attributed lower than expected volume growth to customers’ focus on cost vs. innovation which made lower cost providers more attractive. Adyen was not willing to chase this volume at a lower price, deciding to maintain their take rate.
There was a lot of commentary on Twitter, with some insightful analysis to go around:
Adyen's primary audience? Multinational enterprises operating in numerous countries. Their distinct authorization model is a magnet for these global giants.
Now, addressing the US market: While many argue it's commoditized & Adyen has less leverage, Adyen isn't truly chasing the expansive US commodity market. They eye US enterprises with global ops or vast omni-channel footprints. Adyen thrives where complexity lies.
Adyen’s decision not to chase merchants prioritising cost is emblematic of a strategy to onboard the right customers for Adyen that see the value in its unique unified platform offering, as Groupon did.
Checkout, on the other hand, has had to actively off-board certain crypto customers like Binance that are drawing the ire of regulators; Binance was Checkout’s largest merchant by net revenue in 2021, per the FT. Of course, as with managing the trade-offs of serving enterprises in the early days, companies should embrace emerging categories of customers that have elements of ambiguity but are also the likeliest to try new vendors (or in this case, working with new processors), but it’s just as important to be more discerning about which customers are more trouble than they’re worth.
Again, Miles Grimshaw:
You take Segment. The whole point was to connect up all your customer data, therefore, everything should run through us, really hard to run all of that at scale. One of our biggest and most challenging customers earlier on was actually Hotstar, which is the cricket show of India, which literally 10x where it's cricket shows. And so I would forget what they have the week it would happen. But when it would happen, the whole platform's volume was 10x every other day. As a function of them, really bad for margins.
We talked about graduation risk. There's also bad customer risk. Almost every team I know I've worked with has let go of a customer. Segment let go of Hotstar.
Actively off-boarding customers that are hurting margins, affecting brand, or imperilling the business is just sensible long-term thinking.
Reading List
The Economic Case for Generative AI and Foundation Models
How to Read: Lots of Inputs and a Strong Filter
Scaling Go-To-Market for MLOps Startups
My playbook to write better B2B content
☁ "Nobody wants a Hiroshima moment"
Plaid: Finance's Next Great Network
Institutionalized Belief In The Greater Fool
SaaS: From Scarcity to Overabundance
Nobody Beats Wiz: Meet The Hyper-Aggressive, $10 Billion Startup Shaking Up Cloud Security
The Surprising Science Behind How Super Connectors Scale Their Networks
Quotes of the week
One of the most un-dealt with ramifications of a 13-year bull market is the institutionalized belief in "the greater fool." People can make money, not because a business is sound, but because there is always someone else down the line who will buy you out. Kyle Harrison
This applies to more than reading books. It’s true for all kinds of data, research, conversation, and learning. Without flooding your brain with inputs you’ll be stuck in the tiny world of what you’ve personally experienced. But without a strong filter you’ll be overwhelmed with choice and paralyzed by inaction. Morgan Housel
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