From the conversations I’ve been able to have, my view is that the end of 2016 marked the end of the “R&D phase” in fintech, where the majority of institutions largely talked about the market and its implications, largely surveying the market and circling it, where 2017 is the year of practical implementation. This raises the questions; what will drive behavior and what type of collaborations are likely to emerge?
I’m a staunch believer in what we refer to as ‘distributed finance’, which alludes to distributed technology as well as distributed source of innovation and progress. We’re going to be seeing new innovation shape the financial services market both from upstarts as well as from the establishment. This innovation will go through all the market phases of cooperation, competition, acquisition and integrations on various fronts. Where can we expect these movements to play out?
Evoking a passionate brand experience around a global retail bank is difficult. Yet at the same time brands such as Citi, BNP Paribas, HSBC, still signify a strong signal to stakeholders. Especially in an investment banking context, sophisticated investors take strong signals of operational quality from the association of a big name brand, likely in part due to the knowledge of conservative and risk averse internal processes.
Among the biggest assets the existing establishments have are their brands. Therefore the question that stands is where can that type of a brand be used in the best way to serve the organization’s mission. Combined with the notion that there are several organizations that have an excellent track record of acquiring businesses, even more so than rolling out proprietary greenfield projects. This may be a reason that so many organizations have rolled out internal venture funds (see e.g. the global exchanges, like Nasdaq) dedicated to fintech.
I’ve seen first hand how institutions get intimidated by changes in their market segment by upstarts that do not have the same impediments as they do, such as cost structure or internal compliance requirements, and thus can approach the market in a vastly different way. This may come in the form of targeting smaller investors or serving smaller transactions that are simply out of reach for larger market participants.
For an existing diversified behemoth of a company, this type of cost efficiency may be out of reach. However, the benefit that such an organization has is the clear reach and breadth of service. Through upstarts emerging as very specialized and policy requirements pushing an unbundling of services (e.g. PSD2), the future will likely look much more unbundled and distributed than the current incumbent sector.
Sweetspot #1: Significantly lower cost of operations in an industry dominated by benefits of scale.
Taking the premise that fintech is about serving end clients better, the most natural areas of collaboration are the ones that represent indirect competition. For example, online lenders may target clientele that would not satisfy a traditional lenders risk profile, yet the cost of operations makes it attractive for the online lender. Or similarly an online digital investment bank may be able to source and transact in smaller size of deals (e.g. sectors such as private equity and real estate) where traditional players may have a difficult time adding value.
User experience is also vastly different. Being able to acquire and onboard clients in a retail service may be a vast competitive advantage or being able to originate and process a loan application with a fraction of the cost. Usability and a more transparent decision making process, explaining to the end user how their data helps them get a better deal through their mobile app, will go a long way in competitiveness and in order to appeal to those larger scale organizations focused on exactly these questions internally.
Seeing the overlap is a fundamental part of the collaboration and potential consolidation to start, before we can start talking about mechanics (for arguments sake, there may be a clear benefit in the lack of integration in some models to keep the competitive advantage making it appealing in the first place). However, getting all parties to recognize this overlap and mission of serving the end user better may indeed be trickier than it seems. This understanding is key in order to generate the drive to see these joint models emerge.
Sweetspot #2: New offering on smaller scale attractive to establishment.
Even to this day, fintech remains often misunderstood. It’s disadvantaged by the fact that technology centric publications charge forward with buzzwords as their weapon talking about great disintermediation and largely the innovative approaches taken by upstarts. Unfortunately this often translates to innovation being written off to new market participants that have no respect for the sector or its rules, when the reality is in fact far broader.
I’ve also seen first hand how management of institutions have no fintech strategy, and quite frankly don’t see a need for one when the top focus of the company is to increase short term shareholder value, cut costs and improve operational efficiency. Internal politics may also come into play, when, let’s face it, this type of automation and efficiency isn’t always a popular topic within an organization.
For all of the reasons fintech may represent a misunderstood or uncomfortable discussion, I believe we are past the large-scale resistance and are accepting fintech as a means to serve our end clients better. Like a waterfall, this push to adopt new models to serve clients doesn’t always happen in the most calculated way and we are likely to see calculated, as well as hasty moves in the model to integrate solutions into existing establishment. On a macro level I believe this will work out to the end customers benefit, with more diverse expertise making it into baking and brokerage roles, however not each integration will see a vast shareholder value. On the other hand, such is the life of M&A.
“Sweetspot” #3: Existential threat and strategic blue ocean strategy.
One of the most exciting things for me to see, as an entrepreneur in fintech since 2008, is when the upstarts are able to not only make ripples but truly generate waves. Marketplace lenders applying for banking licenses, N26 delighting clients with a client onboarding lasting minutes through their smartphone and Transferwise taking on hidden margins. These are interesting anecdotes, even though over time upstarts often end up integrated into existing institutions.
However, technology has changed and so have business model needs since the financial crisis. Through disintermediating forces such as PSD2 and possibly even MIFID 2 with its implications, we will see a deeper specialization in the financial services offerings. There are areas that do and will benefit from a true scale benefit, but I would argue there are areas that not only will benefit from specialized service, the end user may even pay a premium for a very focused and conflict free offering.
Gritty entrepreneurs and upstarts that are passionate about client value and serving their users at the highest level to no end will hopefully always have a role in the world of finance, maybe even an independent one.
Given the benefit of having a strong brand, the appealing choice for many organizations is to roll out their own proprietary greenfield projects. I’m fortunate to be able to see many of these in my day to day, and can attest to the fact that there are far more projects making their way through internal new business groups than apparent from the surface. Notable examples so far in the market have been Marcus by Goldman Sachs or Vanguard’s robo advisor platform. The latter is interesting given the fact that the organization is member-owned and an insistent member focus is true to the very DNA of the organization.
I would expect the large organizations to roll out far more innovative ways to serve their clients in retail and investment banking 2017 onward.
Through these trends, a clear re-imagination of services is underway. A notable additional trend is the winding down of legacy technology within large organizations, which has been underway a long time. The need is clear, many projects work on technology where the experts would much rather spend time with their grand children and worse, no one understands the modules, their dependencies or implications. This type of ‘black box’ technology is on the way out and organizations are loath to start new projects in a way that repeats past mistakes.
If the assumption that we are past a large-scale resistance and the R&D stage of the market, we’re sure to be seeing much practical innovation being unleashed to the market and co-operation emerge to maximize end user value.