Distribution, Banking and the Innovator’s Dilemma

Or why embedded fintech is embedded distribution.

Welcome to Coin Labs, a newsletter that will hopefully make sense of the changing commerce and fintech landscape. I’ll be sending out newsletters twice a month (the second and fourth Tuesday) with extra newsletters in your inbox occasionally. On to today’s post!


I think the application of the Innovator’s Dilemma (TID) as an explanatory business theory has shifted dramatically with the rise of the internet. We’ve heard about TID and how it neatly explains the disruption we’ve seen in the technology industry in years past. But I have a question: Why don’t we see more disruption, not less?

I think it’s because distribution in the tech industry became owned and operated, thanks in part to the internet. Back in the day, software and hardware distribution meant efficient use of someone’s else rails. Whether that was CompUSA, Circuit City, or pick your defunct electronics store.

Senior managers and execs knew their industry and customers. They knew their pain points and could resource to effectively to solve them with new products. Why didn’t they then? (AKA TID). It was due to the assumption that disruptive technologies lacked a significant ROI.

Here’s a great explanation of the theory in Wired:

What the theory — and the extensive evidence — in fact support is that incumbents often are the ones to spot and develop new technologies while easily reorganizing themselves to do so. The problem is they fail to value new innovations properly because incumbents attempt to apply them to their existing customers and product architectures — or value networks. Often new technologies are too new and weak for the more advanced and mature value networks that incumbents operate.

This leads to the ROI needed to advance the innovation to be seen as low. In other words, management acts sensibly in rejecting the continued investment in these new technologies and act in the company’s best fiduciary interests. Moving into new markets is rejected as they are seen as too small to make a dent for them and their cost structure prohibitive to enter at sensible margins.

Here’s the thing: the lack of ROI and market size was probably due to the distribution models and the immaturity of internet at the time the great Clayton Christensen wrote The Innovator’s Dilemma in 1996.

Owned and Operated Distribution

Since the original print release of TID, the internet has grown all markets, dropped marginal costs to effectively zero, but it did something else. The internet allowed the world’s largest tech companies to own and operate (O&O) their distribution, the original DTC movement. No longer did you have to sell through a retailer or commerce middle man. You could go to where user/customer is, which was one of your existing products. Think Google Search and Maps, GSuite; Amazon.com and Prime, Prime Channels, Whole Foods, etc.; iPhone and Apple Music, Apple Pay, Apple TV.

Now that distribution is O&O and super-charged by the internet, the market opportunities are massive, measurable because users/customers are already using one of your existing products, and you can now justify investment in new disruptive technologies.

Where The Innovator’s Dilemma Still Applies

I think companies that don’t actually O&O their distribution still suffer from TID. Banks are a good example of this. Physical bank branches were banks’ O&O distribution and they thrived for decades. Branches allowed banks to efficiently upsell and cross-sell their customers. The rise of the internet devalued branches in the value chain forcing banks to find new distribution channels.

Consumers and SMBs had begun to loosen their connection to physical branches, due in part to banks’ own web and mobile apps and mobile experiences provided by other tech companies. With search, ads and affiliate plays like Nerd Wallet, banks in search of new customers shifted to relying on partners for demand generation and distribution. This strategy continues to this day.

At the same time, this evolution created the consumer neobank and vertical neobank opportunity of the 2010s and 2020s. Bolstered by the disintermediation of physical branches, better internet experiences and most of all the Durbin admendment, neobank upstarts like Chime had begun to target the least profitable customers for banks. The Durbin amendment limited the amount of revenue that banks could earn from debit card interchange/swipe fees. This legislation made it difficult for the largest banks to profitably serve entry-level customers carrying low balances.

Embedded Fintech AKA Embedded Distribution

Vertical SaaS software providers have seized the opportunity to O&O distribution for financial products meant to solve their customers’ needs. These companies are able to determine which customers might have a need for financial services at the earliest stages and serve those customers using their existing products as a distribution point. This is known as embedded fintech. Embedding fintech solutions in vertical SaaS products where you can capture some of value (eg. interchange fees from debit cards, float from lending) will generate more revenue per user.

These new revenue streams will allow companies to fund sales operations that will expand their market opportunity and create a path to profitability. Embedded fintech should also be called embedded distribution. A generation of SMBs may soon be banking with the trusted service provider that helps them run their business, bypassing traditional banks all together.

Combine traditional banking’s shift from O&O distribution to partner-driven distribution and the rise of neobanks and vertical neobanks, and you can clearly an example where the Innovator’s Dilemma still holds its applicability as an explanatory business theory.