Quo Vadis FinTech?
In the last few months, I had a lot of conversations about where FinTech is at. I’m also being sent newspaper articles and studies from renowned consultancies, all more or less concluding that FinTech didn’t hold up to its promise to revolutionize and “disrupt” Financial Services. This has led me to sit down and write about it.
A matter of definition
It's all a matter of how you look at it. The press and most consultancies look at how many FinTech startups have grown into big companies threatening incumbents. This perspective most likely results from other industries, such as the music industry, where companies like Spotify dominate. However, I think that the far more important perspective is to look at the consumer and how the (Fin)Tech industry has changed the user's behavior and expectations towards modern financial service products.
Disruption = Rate of Change of Customer Behaviour
Companies are often called “disruptors”. There are definitely a few Startups that really do offer a radically better product and make the rest of the industry look like the stone age. Most of these companies operate in ‘“low trust” environments (B2C) or low complexity business process change environments (B2B).
Let us take a look at Financial Services in which “FinTech” is at home.
Trust is Key
People forget that Financial Services is all about money and, therefore trust. Entrusting a company with one's money isn't something you do, like buying a t-shirt from a random e-commerce company. Consumers don't care where they buy the t-shirt they really want, but people take utmost care to whom they will entrust their money and the data derived from these transactions.
This creates a very high barrier for customers to want to switch to a competitor's product. This stickiness is mainly driven by the trust factor but also by the cost of change.
The full adoption of a new product takes many months (probably years) of building trust and overcoming this stickiness. "Neo Banks" are a good example of this. The holy grail in traditional retail banking is to receive the customers' salary a.k.a "salary account" (this view has somewhat changed over time. Owning the customer interface is becoming increasingly important and will be the winning factor over time). Leaving the revenue potential aside for a moment, the much more important factor to consider is that a customer fully trusts your bank if he or she carries out this move.
Customers often just send a Cent (SEPA transaction) to the new account with "test" in the description. This behavior I have seen in multiple products I have built and shows how customers take it real slow and see if they can trust this new company.
The challenge most "Neo Banks" have is to fight the fact they are being used "just as a proxy". Customers transfer some money to their account for payments since they want to profit from the better and more streamlined service that "Neo Banks" provide. Here lies the big chance, but also the challenge of the Neo Bank to keep the customer happy, build trust and make them use their salary account less and less. The second you misstep, you have lost your trust and probably also the customer. Hacks, bad customer service, unethical data processing, etc. can be the cause of this.
The real power is owning the customer interface and to be in the customer's pocket. The permanent interaction with the new brand lets customers forget about the incumbent brand and only need to return there if the new product cannot deliver something (yet). As "Neo Banks" start offering products that cover more of the customers' financial needs, they are an unstoppable force, pulling customers away from incumbents. Nevertheless, this is a much slower process than FinTech startups often imagine when they set out.
Regulation = The Braking Force
Let me start by saying that the majority of regulation is good and absolutely necessary to protect the consumer. Regulators don’t sit in their offices all day long and think about how they can make the lives of regulated entities more difficult. Nevertheless, regulation could be handled differently. This is a topic for another article though.
A vital success factor within startups is what is called agility and speed. These two buzzwords are nonetheless big success factors. No newly released product ever has “Product Market Fit” right away and needs to iterate to hit the nail on the head. Time and funding (the “burn rate”) are the enemies of any startup. It’s a race against time to figure out which product really works before you run out of money. In an unregulated environment, a company can test anything they want and break and fail fast. This approach, however, cannot be played at the same speed in a heavily regulated environment, making it harder for FinTechs to be successful compared to other startups.
A good example is the reporting that you have to produce if you “just want to test” a trade in production. The regulator doesn’t do much differentiation between “testing with real money” and “real money in production”. If you just want to test the order process of t-shirts, nothing stops you from doing that. In financial services that is not possible.
So fast, light testing is not as easy.
There is certain infrastructure in Financial Services that FinTech companies have to abide by. I call it the “physical laws of financial services”. This includes payments or securities clearing and settlement rails. This legacy infrastructure is hard to change as it is often backed by regulation. So FinTechs cannot make money move “physically” faster. They can use some fancy intermediate magic to do so, but this opens them up to all sort of edge cases and operational challenges, such as risk management.
This makes it harder to make an even bigger difference for FinTech startups. This is why infrastructure play, such as the blockchain space, is so powerful and has such a high potential. It has nothing to do with the customer intersection (front end) but can radically renew the infrastructure below.
As a FinTech startup, you cannot defy certain “physical laws” and cannot sometimes fully innovate end-to-end so easily due to these.
FinTech = FinTech Startup?
When people talk about “FinTech,” they often mean FinTech startups. I honestly think that it is more a driving force initially driven by FinTech startups, but of the last few years changed to a “movement” as also non-startups such as the GAFAs have joined. Then there are companies, far from startup status, that take on a very similar approach when it comes to utilizing technology and approaching customer-centric product development. Moreover, there are non-financial players that consumers interact with every day and through which they get in the habit of enjoying very customer-friendly UI & UX. These players set the standard of what consumers expect from all products and services.
So FinTech comprises more than just FinTech startups. A single company is only rarely able to change a whole industry or customer behavior. Extremely successful GAFAs have certainly done this, although it is important to note that this was only possible in unregulated markets.
I like to think of FinTech as a colony of ants. There are thousands of small ants, and each individual alone cannot fight a big insurgent, but when thousands of ants join forces, they can beat much bigger animals. My favorite visualization of this image is the “Unbundling of a Bank” shown on the Wells Fargo website:
FinTech Startups Success
The public perception of FinTech distills down to a number of very large FinTech companies that exist. The argument often used is that no FinTech company has beaten a bank directly or has become larger than a bank.
But this is a very short-sighted view. I also argue that it is incorrect since the list of large FinTech companies is ever-growing. This does not even take into account the GAFAs that are pushing into FinTech. Square, PayPal, Adyen, Alipay, Tencent (Wechat), Stripe, and Klarna are just a few examples of companies that most of us will be familiar with. These are some of the biggest, but there is a much longer list of smaller FinTechs that have accumulated staggering amounts of customers, such as N26, Revolut, Funding Circle, etc. …
People also forget that the fail rate of startups also applies to FinTechs. Mistaking this fail rate for “FinTech has failed to deliver” is the wrong takeaway.
This factor also cannot be taken out. VCs have to produce a return and look at this pretty emotionless. If “FinTech” had failed, then the amount of money that is pouring into this space (investment activity) year over year also shows that the space is driving change and leads to successful returns.
Judging from the positive trend, the world will see even more “FinTech” in the years to come.
At the end of the day, it depends on how you want to define FinTech for yourself, but the bottom line is that customers want different products today and that incumbents still have big problems delivering what people deem as good UX. This is the reason why FinTech is flourishing in the form of FinTech startups and big tech players that are moving into the space.
People compare FinTech with other industries, such as e-commerce and then yes, FinTech has changed less than e-commerce has, but then they forget that change in highly regulated environments and environments where trust is a driving factor is much slower. Within financial services, “FinTech” is still moving faster than the incumbents and with the consumers on their side, I can only conclude (and observe) that the established financial services industry is feeling the pain more than they admit.
So if you are looking for “high disruption,” such as the music or movie industry has gone through, than you won’t find that in FinTech at the same rate, but then every industry works differently and has different dynamics.
FinTech is more than just startups. FinTech is a driving force initiated once by “FinTech startups” and is now driven by consumers that demand state-of-the-art UX & UI.
Last but not least: As long as venture capital is investing more and more money into the space, it cannot fail.