The term ‘Fintech’ has become quite popular in recent times and is commonly used in mass media to refer to a new type of companies specializing in applying technology to improve financial services and the impact this new players are having on the traditional banking sector. These companies are growing everywhere with relatively easy access to Venture Capital funds and with value propositions with focus on specific market niches. It’s often said that fintech companies have created a strong disruption on the market and are threatening the future position of the banks for their greater specialization and understanding of new customer generation. However, how true is this statement? Are these new companies really being able to compete with traditional banks?
Accelerated technological development
The past 40 years have witnessed an explosive adoption of new technologies (IT and telecommunications, social media, retail, transportation, financial services, life sciences) and the emergence of new industries, markets and type of consumers. The performance and cost of three key elements in the evolution of the digital economy –computing power, storage and communication bandwidth- have been improving at an exponential rate for many years and this is fueling the development of new technologies supported on these key elements at a pace and speed unprecedented in history and which shows no signs of slowing down.
Not only the number of new technologies is growing, but also the rate at which these technologies are causing a disruption in the market. This impact is amplified when new technologies come together in platforms and open ecosystems that reduce the level of investment and development time of new products, since the scale is not a basic premise to start competing anymore, and thanks to the ease of distribution of these innovations through online platforms and mobile devices
The banking and financial services industry is one of the last affected by this technological disruption. New companies have emerged redefining completely user experience and business model in areas such as payments (Square), loans (Lending Club), currency exchange (Kantox), remittances (Transferwise) or personal finance (Mint). These companies have a revolutionary and disruptive nature, but still need the support of traditional financial institutions and access to their infrastructure (accounts, payments, licenses, etc.). At the moment, many of these new Fintech startups are customers of banks because they need them to develop their activity, and thus generate profits for them, following a model of ‘coopetion’ (a term that comes from merging the words ‘cooperation’ and ‘competition’). On the one hand, they represent a distortion for the banking business, but on the other hand they bring them additional income. As an example, Lending Club has obtained up to 80% of its liquidity from financial institutions and not from individuals.
Competitive advantages of fintech companies
Above any other consideration, new fintech players have a clear cost advantage. They are small organizations that grow around a specific product that is scaled when they find and test the right value proposition, after having pivoted on the initial idea. As access cost to technology is so low the initial product development is an affordable investment (the real need of fund comes for scaling the company), and additionally they must not deal with legacy IT infrastructures, some of them old and obsolete. This allows fintech companies to offer their products at very competitive prices or even for free, as the final goal is to achieve massive growth and negotiate a successful exit for owners/founders.
Banks, however, are large organizations with a very heavy cost structure that is reflected in the pricing assignment process. This regardless of the fact that banks have an established and profitable business model that they try to protect by all means (as is logical and normal), which does not allow them to provide the right product answer all the time. On the contrary, new entrants can afford to pull prices down and destroy value for the industry as a whole because they do not have to worry about protecting any position and this approach benefits consumers and attracts them on a massive scale.
Another crucial element in the ability to create value of fintech companies is their strategy to focus on specific niches of customers and products. This strategy allows fintech companies to develop products with a high degree of specialization and adaptation, eliminating unnecessary elements in both customer experience and pricing levels, keeping all the efforts of the organization focused on a single product to achieve a better performance and results. With this strategy, they are able to develop high quality, easy to use, visually attractive and very competitive products, which are difficult to beat by banks on each segment.
There is another generational aspect related to the perception of new millennials customers (those born after 1980). This group of clients are digital natives who have grown up with the Internet and mobile as central elements of communication, and they are much more demanding about the quality and price of the products they consume. Therefore, they are looking for a new type of more digital and flexible banking products that do not impose so many restrictions, so fintech companies have a clear starting advantage over traditional banks to serve this new generation of consumers. In addition to this, fintech companies are not considered banks and are save from the negative perception associated with the financial sector since the economic crisis of 2008.
The bank of the future
Under the pressure from new competitors, technological development and changes in customer demands, the financial services industry is evolving towards an increasingly modular structure with a separation between the creators of financial products and the distributors of such products. In other words, the model of a vertically integrated bank covering all products and customer segments will not be the dominant structure in a the incoming years, and will be replaced by a modular and lighter bank whose key elements will be a ‘core’ banking open platform accessible with an API that connect to external services, a banking license and compliance associated processes, the customer database and the associated CRM to manage them. The bank will provide basic services (accounts, cards) and other advanced services will be offered by other financial institutions through the open API to have access to the best products at any time.
This modular bank may be created as an evolution of existing banks or from scratch by new fintech competitors, but it is clear that traditional banks will have to change radically in their digital transformation process, delivering new value propositions and strategies to capture and serve their younger customers. As in any industry transformation process, some banks will be able to successfully manage this process and remain relevant and others will not succeed and will be absorbed by other entities. However, to argue against the most pessimistic predictions, traditional banks will not disappear in favor of fintech companies, they will simply have to evolve and adapt to new competitors and market conditions.