How retail banks are being displaced, diminished and disintermediated by tech startups — and what they can do to survive
Tech companies have disrupted retailing, media, transit and travel. Now the retail banking business model looks set to be transformed too.
In Bye Bye Banks? James Haycock and Shane Richmond describe these startups, and to which areas of the banking industry they are laying siege. It shows that this assault is already well underway and that many incumbents are poised to be displaced, diminished and disintermediated. It draws on extensive research and on-and-off the record interviews with senior executives in some of the biggest banks.
Haycock and Richmond conclude with the recommendation that traditional banks need to reinvent themselves by launching a ‘Beta Bank’: a lean, stand-alone organisation fit for the future for which they provide a ten-point operating model.
Below is the first chapter and the 5 minute version of the book.
The 5 minute version
“We need banking but we don’t need banks anymore”
Bill Gates, 1997
It is nearly twenty years since Bill Gates predicted the demise of banking. At that time he was Chairman of Microsoft. He has since stepped down from that role and reinvented himself as a global health campaigner and philanthropist. But the banks are still here. Are we reaching the point where Gates’ vision is realised? Could we see the end of banks as we know them in the next twenty years? We believe that we could, and this book explains a new scenario of how that might happen. We have kept it short — you’ll be able to read it in less than two hours — but if you are really pushed for time, then here is the five minute version of our argument.
The corporate playing field has been changed irreversibly in recent years by a new generation of companies and leaders who have torn the rulebook to pieces, adopting new technology, new working practices, and serving customers whose lives are increasingly orientated around their mobile phones.
Take the example of Jan Koum. Born in the Ukraine in 1976, Jan moved to California with his mother and grandmother in the 90s, eventually taking jobs with EY and Yahoo!
In 2009, Jan founded WhatsApp, a mobile messaging application. In February 2014, WhatsApp was bought for $19bn by Facebook, a company that itself was just ten years old at the time. At the point of its acquisition WhatsApp had 450m users globally, 7m more than Vodafone had subscribers. Together these users were sending more messages than the total global volume of SMS, an industry worth $100bn. This shift in consumer behaviour hit the network operators hard. According to industry analyst Ovum* apps like WhatsApp led to a $32.5bn decline in telco revenue globally, while Ofcom** identified a £300m decline in the UK.
The speed of growth that WhatsApp realised is eye watering, but when you hear that it had a team of just fifty-five, your jaw also hits the floor. In five years a young, small team had built a business that was competing on a par with one of the world’s biggest brands and telcos.
And it’s not just the telco operators who are feeling this competitive threat. Incumbents in the media, entertainment, travel and numerous other sectors have also been feeling the pain inflicted by tech startups chipping away at their businesses – startups, that are much more nimble, with smaller teams, less physical infrastructure than traditional companies, and a product that is, in essence, simply computer code.
Uber, AirBnB, Spotify and Buzzfeed have become household names, but there are many more firms that we haven’t yet heard of. Research by venture capital (VC) firm Atomico*** identified 134 software businesses founded since 2003 that have reached a $bn valuation. TransferWise and Funding Circle are just two UK-based Financial Services startups that have achieved that scale in the last five years, demonstrating that new entrants are already challenging the retail banking model and the established brands we all know so well.
Like incumbents in any sector, traditional banks find it difficult to keep pace with change, due to their size and the fact that they still make considerable amounts of money. To explore new business models could cannibalise or compete with their existing one. They also find themselves hamstrung by legacy. Legacy technology, legacy processes and, often, legacy thinking.
Banking giants face a further challenge, with a very high cost of compliance making it hard to deliver change at the rate of the new, agile entrants. Many in the industry feel that regulation protects them from the tech startups though. That protective cushion might be slipping away, however, as governments act to promote competition by changing regulation to encourage new entrants.
It’s plain to see that a perfect storm of competition, technology, shifts in customer behaviour and regulation looks set to wreak havoc on the businesses we trust with our money, and we’ll be exploring how in this book.
The book starts by outlining the significant drivers of change that impact incumbents in all sectors. The main driver is technology, which is advancing in capability and availability. This, in turn, drives two further factors: consumer behaviour, which is changing as ubiquitous connectivity and channel shifts alter the way we interact with, well, everything; and market competition — lower cost of entry means there are more competitors. In addition, the very low cost of production and distribution means these new competitors can achieve tremendous scale in no time at all.
No sector seems safe from this change. That’s especially true of banking, where every aspect of the business model is being unbundled and targeted by a range of VC-backed technology companies with a very strong focus on customer experience.
Chapter 2 takes the retail banking business model and highlights a small, but by no means exhaustive, list of key new entrants targeting each aspect of it. Here are a few of the areas we cover:
Thanks to regulation, this has been one of the least-contested areas of banking, despite the arrival of a few so-called ‘layer players’ or ‘digital skins’, such as Simple and Moven, who leverage another bank’s technology and licence. However, a March 2013 change in banking regulations and authorisation processes led to a significant increase in companies looking to offer current accounts. We touch on Atom, Fidor, Good Bank, Mondo and Starling as just a few examples of companies looking to obtain a new banking license and launch within the next year to leverage the dramatically lower cost/income ratio that a branchless model offers.
P2P lenders, now increasingly known as marketplace lenders, have attracted a lot of interest in recent years. The UK’s Zopa was the first to launch, in 2005, while the SME-focused Funding Circle has recently been valued at over $1bn. In the US, Lending Club has the highest profile and IPO’d in 2014 valuing the company close to $9bn. Another type of lending, point-of-sale credit has been offered for a long time, enticing shoppers with store cards that promise an instant discount in return for credit at, very often, high interest rates. Newcomers are seeking to disrupt this by using smart software. Affirm, for example, promises instant credit decisions on purchases based on social media data as well as traditional credit scores. Sweden’s Klarna is another player in this space, claiming to have 35m customers in the ten years that it has been operating.
SAVING AND INVESTMENTS
Digit and Acorns are two US startups helping people to save by automatically depositing into a savings account. Digit does this based on analysis of spending, while Acorns’ approach is to monitor spending on any cards that have been connected to the account and round up any figure to the nearest dollar, adding the difference to the savings. While Digit doesn’t currently offer any interest on its savings account (probably because they’re currently not licensed to do so) Acorns offers an investment account. Other startups with a focus on investments are the UK’s Nutmeg and Betterment, and Wealthfront in the US. All lower the barrier to entry for investors, offering more transparent pricing and simple, online portfolio construction and management tools supported by a digital operating model they hope will allow them to pass better returns to their customers than the alternative of a traditional wealth manager.
The payments market is a hotly contested area, particularly around digital wallets and P2P payments. PayPal, which massively simplified the online payments process, has been freshly spun out of eBay, so is sure to pick up the pace of innovation. And of course the tech giant that many fear, Apple, has launched Apple Pay, which aims to do a similar thing but with in-store payments using an iPhone or the recently released Apple Watch. In the P2P space, companies such as Venmo are proving vastly attractive to the under-thirties, a generation that is mobile native and sees little need for banks.
INTERNATIONAL MONEY TRANSFER
Transferring money overseas has long been expensive, and slower than it could be. Companies like TransferWise, which was valued at $1bn in a recent investment round, are arriving and are looking to improve on the norm. They cleverly aggregate and redirect the money going through its system so that it can transfer cash without actually sending money across borders. Azimo and WorldRemit are two similar, UK-based startups. WorldRemit says 90 per cent of its payments are received instantly, compared with the days a payment might take using traditional transfer services.
Personal Finance Managers (PFM) help consumers to manage their money by collecting all their financial data into a single website or app. US-based Mint was one of the first. It was founded in 2006 and was acquired by accounting software firm Intuit in 2009 for $170m. Level Money, started in 2012, targets Millennials who have student loans to pay back and also want to start saving.
Finally, there is disruption of money itself. The rise of Bitcoin and other virtual currencies, built on a cryptographic system called the blockchain, could radically alter the way that financial transactions are carried out. The cryptography behind the blockchain means that transactions can be verified without the need for a trusted third party — a role typically played by a bank. While these technologies are in their infancy at the moment, they are being seen as the foundation for a change as profound as the Internet itself.
In Chapter 3, having given a broad overview of the new entrants in banking and the aspect of the banking model they’re attacking, we outline a scenario that we believe is already well under way. We start by introducing it using the example of the telco sector and how the traditional players are being challenged in that industry, before applying it to banking. The scenario proposes that incumbents are becoming displaced, diminished and disintermediated by software businesses and new technologies.
Displaced — by a superior customer experience and price offered by new entrants, enabled partly by the luxury of being free of legacy technology and cost base, and teams closer to the needs of their target customers.
Diminished — as their business model is squeezed and they’re relegated to utilities in a market with higher switching frequency. We believe this will be spurred on by the revised Directive for Payments Services (PSD2), which will require banks to offer Open APIs (Application Programming Interfaces – we’ll explain what these are in the book).
Disintermediated — as a new technology challenges the core competency of the incumbents, which the arrival of the blockchain, an innovation still not fully understood by many, suggests it might do.
It would be naive of us to ignore the fact that there are many very smart individuals in banks who are clearly aware of the changes that are coming. To ensure a balanced perspective, we spoke to a number of senior banking executives through faceto- face interviews, a survey and a series of round-table dinners. The insight gathered through this has been used to explore, further and challenge our position. You’ll find comments interspersed throughout the book sharing their view of the impact of the tech startups, the cost of compliance that the existing players are burdened with, and the contention that customers won’t trust a startup with their money, as well as the blockers for innovation, for example: how can you expect an MD with P&L ownership to disrupt her business? In these conversations a theme emerged around three particular topics — people, culture and technology, which we focus on in Chapter 4.
In the final chapter we briefly outline the various options that the banks are already pursuing: digital transformations, service and product innovation and partnering or investing with startups. While we believe these can deliver change, our opinion is that they’ll struggle to impact on those three critical components of an organisation highlighted as a challenge in the interviews: its people, culture and its technology. With that in mind, we outline what we believe to be the answer: the Beta Bank.
A Beta Bank is a standalone organisation with a separate leadership and HQ. A fresh start, offering the opportunity to rethink from the ground up. We outline a ten point operating model for banking leaders to consider. We believe this approach is the best opportunity for a bank to design a proposition, servicing model and, critically, an organisation built for a future where the pace of change is only set to increase, not an adapted version of a business model that hasn’t changed in hundreds of years.
That is a summary of our position, and you will find more detail in the following pages. The scale of this coming change should not be underestimated, and it has not gone unnoticed by banking leaders. Neelie Kroes, Head of the European Commission’s Digital Agenda, said at Davos in 2014: ‘I’ve met with bank CEOs who tell me all their business models are about to be torn to shreds, that the future is mostly virtual banking and their main competitors are tech companies not other banks.’
Speaking at Davos a year later, the Bank of England Governor, Mark Carney, stated that the banking sector was vulnerable to an Uber-type incursion and that such a situation was imminent. The forces driving this change are undeniable. It is a matter of when, not if, banking is reinvented.