Fintech is about lowering friction and building consumer centric business models
A few years ago the economist, Larry Summers, said consumers haven’t seen a meaningful financial innovation since the ATM, which was first introduced by Barclays in 1967. But he has since relented noting that fintech is starting to reduce meaningful frictions. But I think Larry Summers misses a key point. Reduced friction alone is necessary, but not sufficient for meaningful innovation in financial services.
What makes changes in finance most exciting is when they point to a future in which business models are aligned with the interests of the consumer. Many traditional players, are hamstrung by their profitable existing business models and, quite reasonably, are unwilling to invest in products that cannibalize profits (a rational response described in the innovator's dilemma). For example, let's look at three verticals in finance and see how new entrants, founded between 1975 and today, challenged the incumbents with new, radically consumer centric business models.
Example 1: Wealth Management — Vanguard, founded 1975
The most exciting story in wealth management is not robo advisors. It’s the story of Vanguard, hardly a startup, as Jack Bogle founded the institution in 1975. Vanguard pioneered ETFs and the concept of passive investing, but what is even more radical is its ownership structure. The company is 100% owned by it’s customers, meaning incentives are completely aligned.
Such a radical alignment of incentives has allowed Vanguard to charge incredibly low fees and grow into the largest fund provider with over $4 trillion in assets under management. Amazingly, Vanguard continues to outstrip the competition and in the last 3 years added $823 billion in assets under management, more than all its rivals combined. Other mutual fund managers have bemoaned that competing with Vanguard is unfair, since they are effectively competing with a non-profit that returns all earnings to its customers.
Actively managed funds and hedge funds in particular have been described as “compensation schemes masquerading as asset classes.” No one would ever make such a claim about Vanguard, it is clear the customer comes first.
Example 2: Credit Data — CreditKarma, founded 2007
Credit scores emerged as a means to solve a problem not for consumers, but for banks. Banks wanted a means to efficiently underwrite their customers. Consumers did not know (1) what their credit scores are or (2) why they were what they were. The big three credit reporting agencies (Experian, TransUnion and Equifax) make money by selling banks access to that data. Consumers interests are, at best, an afterthought.
CreditKarma, on the other hand, has tackled the problem of credit from a consumer perspective. They offer consumers access to their credit score for free and provide information to explain how a consumer can improve. They have been crushing it with over 60 million customers, $320 million in annual revenue and profitability for the last two years.
Example 3: Overdrafts — Dave, founded 2016
Banks earned $33 billion a year in overdraft fees in 2016. As such they are highly incentivized to keep charging these fees.
Dave is by no means a guaranteed success, after all they are making loans at 0% interest to people who have trouble managing money, charging no fees and asking only for donations. But even if they fail, it doesn’t matter. Dave demonstrates how radical new companies are willing to be in challenging existing institutions.
Network effects of customer centrism
What’s even more exciting is how this new ecosystem of customer centric financial companies becomes self-reinforcing over time. As more companies adopt customer centric business models, they can become platforms for a marketplace of other customer centric businesses.
For example, Vanguard ETFs have become a building blocks in robo advisor assembled portfolios. CreditKarma is a platform for other customer centric financial firms to sell their wares. If you look at recommendations on CreditKarma for home, student or personal loans, you’ll see some of the biggest names in fintech, many of which are not traditional financial institutions. Dave is not an example of a platform, but it is an example of how extreme approaches can get when you orient towards the consumer.
It took Vanguard, over 30 years to become the largest asset manager, but in retrospect it looks inevitable. Looking at today's startups, you can see a similar trend towards thinking first and foremost about the consumer. 30 years from now, who knows where that will take us :)