It’s that time of year when every agency and consultancy packages up a bunch of half-truths and cultural observations as “trends” impacting the business world. To counter this, I have packaged up some of things that I am finding interesting in fintech and its periphery. Things that create business model threats or opportunities for both challengers and incumbents.
This year has been a repeat of the last few - lots of bank bashing by product designers claiming to understand banking, a scattering of expensive corporate innovation failures and impassioned defences of the fintech challengers, no matter how poor their decision making or questionable their ethics.
But it has been a great year in many other ways. There are some really interesting macro movements, like the advances of the GAFA and the oncoming SoftPOS regulations in payments. And there are some other emerging spaces like workflow-based financial services, both in banking and vertical SaaS solutions that represent a collision of financial services (fin) and software (tech).
Here is my take on a few of these themes, and what it means for all of us that design fintech products, and their underlying business models.
Fintech continued its trajectory from the business pages to the front pages when Anne Boden’s memoirs were released and published in The Telegraph. Central to the story was a tale of backstabbing and betrayal, involving protégé turned nemesis, Monzo founder Tom Blomfield. Underlying the story of the characters involved a more sensible debate is swirling.
Starling became the first profitable neobank in the UK in October 2020, as its new customer acquisition doubled over 12 months, whilst its operating costs only increased 30%. Importantly, the bank has now taken £4bn in deposits and lent £1.5bn to its 1.4m retail and 256,000 business banking customers.
Conversely, Monzo, who have seen an executive reshuffle, abandoned its US assault, suffered a down-round and customer trust scandals in 2020 have been unable to get lending firing. Despite having three times as many customers as Starling, it’s only managed gross lending of £129m vs Starling’s £1.5bn - whilst reporting average deposits 1/3 of that of its rival. In fairness we don’t yet know if Starling will do any better than the 7% loss Monzo faced on its lending (especially with rumours that many of the loans issued under the government’s CBIL scheme are onerous), but the principle still stands.
The two neobanks have quite famously taken different approaches - Monzo favouring customer experience-led services, and Starling building a bank first and foremost. In a case of unfortunate timing, Monzo unveiled its new paid plans (in an attempt to move to more account based revenues), including a premium card that costs £50 to manufacture, just as Starling was announcing its very strong lending progress, thus sharpening the debate on card based vs lending based neobanks.
It remains to be seen who has ‘won’ (depending on how you define winning) but this battle has become an interesting barometer for viability vs vanity. Big numbers and nice apps might mean high valuations, but they don’t guarantee profitability.
There are echoes of this everywhere you look in fintech. Whilst many scale quickly, few have landed upon favourable unit economics. Most neobanks are dependent on card-based revenue, in a world of low interchange and reduced consumer spend. More worryingly, many model their value on becoming the primary account / card in a customer’s life but in reality, few secure this status. This is why so many boast millions of customers, but rarely do more than a few thousand switchers per month.
Unit economics are crucial to any venture design. In banking, there has proven to be no better alternative to lending. As card-based revenues struggle to generate meaningful customer contribution margins, we are starting to see the traditional banking business model become fashionable again. It will be interesting to see the impact that this has on implied valuations in fundraising efforts.
Marc Andreessen often states (and gets wrongly credited for inventing the sentiment) that there are, “only two ways to make money in business: One is to bundle; the other is unbundle.”
Fintech’s genesis was really around unbundling as a concept. Following the financial crisis, there has been a slew of fintechs picking off a corner of the banking monolith, many of which are now worth billions of dollars. MarketFinance formed to do invoice finance better than anyone. GoCardless solved the problem of easy access to antiquated direct debit infrastructure. In the US, SoFi made its money refactoring student loans. Plaid became hugely valuable linking apps to banks (in the absence of Open Banking in the US).
Unbundling has its perks and is step one of the disruption playbook. Find an underserved segment or use-case and deliver it more cheaply than a bank ever could. Create a service around this need and slowly start overtaking incumbents in that field.
Whilst unbundling is good from a product development perspective, it isn’t from a customer’s perspective in financial services. Retail and business customers don’t want dozens of service providers. The average small business has more than half a dozen service providers to carry out their annual financial needs, and many have established their own quilt-work operating systems to get by.
Enablers like Codat, who provide single integrations to accounting platforms are beginning to facilitate a closer bundling of financial services products around customer needs. On the retail side, Open Banking theoretically opens up a whole range of aggregation and bundling opportunities. But there has historically been little done on aggregating financial products - like, for example, merchant acquiring capability and bank accounts, or accounting services and lending.
As we now see a fintech landscape that is unbundled to the point of fragmentation, we are already starting to see convergence and bundling starting to take place with Square Cash, Xero / Rapid Cash, Stripe launching Treasury and Starling <> iZettle integrations. With the barriers to entry coming down on both the issuing and acquiring side, we can expect to see a lot more segment-based bundling, and fintechs crossing the issuing/acquiring chasm in business banking.
There has arguably been no more notable year in terms of the GAFA making their move on financial services. Facebook has launched Facebook Pay, Google has finally entered checking accounts. Last year, Apple announced its credit card, this year it was its $100m acquisition of Mobeewave, a Canadian-based startup that allows merchants to use their iPhones as payment terminals.
Asian markets have seen tech giants become financial services giants with ease. The BAT (Baidu, Alibaba, Tencent) have all played active roles in the nascent and massive markets in Asia, offering lending, wealth management, insurance, credit scoring, payments and more, all integrated within ‘superapps’. Ant financial, the most active, is on course (albeit slower than planned) to have the largest IPO in history - despite attempts by the Chinese authorities to regulate microlending more tightly.
Banks in Western markets will be hoping that the assault of large technology groups will be less severe, with regulation and deeper incumbency defending against their advances. But they should be fearful of the power of the ecosystems that the Amazons, Apples and Googles of this world are building.
Apple in particular have made huge advances this year in developing their ecosystem - they have lowered the barriers to entry with lower cost devices, bundled content subscriptions and linked it all within a seamless customer experience. Their assault on content streaming was seamless, so why would their assault on banking not be? Particularly when, between ApplePay and Mobeewave they have the ingredients for a closed-loop commerce system.
The best defence against ecosystems is ecosystems, so banks should align their own product and service hierarchies around building customer value and creating lock-in. This requires a deep understanding of customers and some real attempts to build new services, not new interfaces.
I remember once sitting in a Visa account review at a previous employer, and the lead strategist of the time flashed up a picture of a ship in a harbour. “Card schemes, like ours, are ships in the harbour”, he said. “We rise with the tide” - (the tide in the card payments harbour being global consumer behaviour). There is a reason why Warren Buffet swears by American Express, Visa and Mastercard shares!
The trend towards cashless societies was given a hearty nudge by a well known virus this year, but it was already on its way. eCommerce spend will be nearly 5x higher globally in 2023 than it was in 2014. Meanwhile, at the point of sale, contactless has proliferated faster than anyone expected, in every market it touches, including the US (a relative laggard in payment acceptance terms).
All of these trends have created secular growth for payments companies, many of which used to be bank assets before being stripped in bailouts in the GFC. They have also created a new popularity for the acquiring side of the payments coin (or lack of coin). Digitally-native companies like Checkout.com and Stripe have sewed up the ecommerce markets, whilst ecommerce carts like Shopify have also grown sharply. Enablers like Finix, who make it easier for companies to become payment facilitators, have also started to arise as enablers to the new cashless society.
With Apple’s advances into payments with their Mobeewave acquisition, we are also at the precipice of a new movement. SoftPOS (using a smartphone as a card reader) has the potential to transform the acquiring industry in the same way that mobile banking did on the issuing side.
All of these factors leave the old guard (Worldpay, Barclaycard etc) vulnerable, as their strategies of pan-regional consolidation and cost leadership will be challenged by digital natives who are the best in the world when it comes to value added services.
With the headwinds of consumer behaviour and in an industry that is being unshackled by regulatory shifts resulting from M&A, we can expect to see acquiring become as fashionable and widely debated as issuing with VCs and corporate innovation departments alike.
If the objective of the government’s forced divestments in business banking, and the resulting BCR scheme was to stimulate competition in the SME lending space, it has succeeded.
There has been a wave of activity in the space, from all corners. Challengers like Starling have started to issue more loans, Monzo and Revolut have both begun to prioritise business customers, whilst Tide continues its steady ascent and eyes up new markets and products. Accounting providers like Xero, who many business customers consider to be their primary financial interface, have also developed new lending workflows with partners, including working with NatWest to launch Rapid Cash.
SMEs have been underserved for a while, but now there is a new challenge - becoming their primary service. For the average business selling products, they have a bank, accounting service provider, an acquirer (sometimes two), maybe a shopping cart provider and potentially other sources of lending. The business model for SMEs is well understood, and similar to retail, but the reality of acquiring SME as customers is a lot tougher.
The Co-operative Bank
The Currency Cloud
Virgin Money UK
Service providers are beginning to understand that SMEs in general buy like businesses and use like consumers - they want to feel more special than retail customers but are ultimately driven by financial habits born in their retail banking activities.
This has driven some interesting corporate innovation attempts from incumbents, RBS and HSBC took on the challenge head on with their own non-brand current accounts, Mettle and Kinetic respectively. RBS also launched Esme loans, Rapid Cash, NatWest Tyl and a handful of other services, most of which are challenger alternatives to their own products. This is massive progress from 5 years ago, when the business bank was given little or no flexibility to develop new digital products specifically for businesses. Other incumbents have been slower out the blocks.
With a rush of very similar services being funded through VCs, the BCR and corporate innovation, it will be interesting to see what sticks in a segment where very little happens historically. Early indications are that copycat mobile apps won’t cut it, but better workflows will.
Just as enterprise software packages like SAP and Salesforce have been developed by understanding underlying business process and building the products to solve them, fintech product strategies should follow. The average small business doesn’t hire full-time finance directors until it has 20 employees, so there are a huge number of jobs to be done for small companies. Services like contextual invoice financing, task-level accounting integrations and revolver lending products linked to annual operating plans are all interesting prospects.
A lot has been written about Banking as a Service platforms (BaaS), their value and the change they are having in the industry. One interesting effect is on verticalised SaaS companies (companies that offer specific functionality for an industry, like Mindbody for the fitness industry or Toast for restaurants).
Software companies historically have made their progress by growing their user base. This has a natural limit as even the biggest markets have addressability ceilings. Fintech has changed that, making it easier for a software company to up-sell other products using financial services.
Andreessen Horowitz, the iconic venture capital firm suggests that SaaS businesses can increase revenue per customer by 2-5x and open up new SaaS markets that previously weren’t possible by offering financial services. As an analogy, think about the impact that car finance has on automotive margins vs being a strict OEM.
Historically this works on a referral basis - e.g. a company that helps entrepreneurs to run a hospitality business have a referral agreement for a lender. This affiliate model can have a positive impact on customer lifetime value, because it increases ARPU without increasing operating costs.
Embedded financial services, made possible by APIs and license sponsors create a whole new opportunity. It means that software companies can fairly quickly and cheaply enter fintech to take more of a share of the value chain by leveraging their ownership of context. Finix, for example, makes it easy for SaaS companies to become payment facilitators, meaning that they can reclaim a substantial part of their transaction costs.
Embedded services can also go further - if a vertical SaaS company has specific data on its customers’ hourly business performance and activities, it can use that data to inform lending decisions, even underwriting of insurance, and in return get a slice of the premium.
When you consider that two of the greatest assets of banks are distribution and trust, SaaS companies that are used daily and reliably by business customers, at scale, can quickly replicate this success. In reverse, it also opens up a new pathway for incumbents to engage with technology companies to offer co-branded products and revenue shares. We should expect to see some new partnerships in this space, as we’ve seen with Goldman Sachs in the us.