Years ago, at a banking conference in New Orleans, I attended a presentation by Michael Porter, the legendary Harvard Business School professor of strategy. Porter was presenting his theory of competitive strategy to a hall full of bankers. Whatever you want to be, he said, be different. A “me too” strategy is no strategy and an un-differentiated product is condemned to ultimate oblivion. The bankers in the audience were mainly operations people and looked a bit puzzled.
Porter was of course right. But can banks really differentiate because, generally speaking, the products and services they offer are broadly similar and differentiation is often on price? People do not change banks because they often do not see the point, except for specific products where they can get better rewards or cheaper prices.
Today, however, the emerging new digital banking start-ups are trying to de-commoditise banking and deliver services in a different way. Can they differentiate their services from traditional banks? They are already doing so. But can they differentiate from each other. That remains to be seen.
This year’s Money 2020 conference in Las Vegas hosted banking start-ups pitching their prowess and how different they are from each other. But one thing that came across clearly - in their thinking and strategic assumptions they were remarkably similar.
It is early days of-course but so far, despite some successes on-boarding new customers, start-ups have not made significant inroads in the world of retail banking. Some of the most hyped start-ups have not fully set up shop yet even though they have been shouting breakthrough thinking from the rooftops for several years and have already burned millions of dollars of investment.
To be fair they are not all similar and are following different strategies. But the field is becoming crowded and highly competitive which will surely result in industry consolidation. Here are some of the strategies that digital banking start-ups are pursuing.
- Focus on acquisition
Traditional banks have taken notice. Some, worried about the impact on their market, have acquired a start-up or two. One cannot name any specific outfits as this is not a declared strategic intention but most start-ups would be willing to be acquired if the price was right. Hence the razor-sharp focus on customer acquisition, easy on-boarding, and tapping multiple markets to build their takeover credentials.
- Banking services providers
Banks have fostered partnerships with Fintech innovators to use their technology to improve and enhance products and services. This collaboration has provided essential lifeline of funds to many start-ups. An interesting example of a banking start-up offering a unique service-set is ClearBank, the first clearing bank in the United Kingdom in 250 years, all digital, providing choice, and cheaper processing to smaller banks and financial regulated business and fintechs in the country. Edgar, Dunn & Company’s December client publication will carry an interview with its founder, Nick Ogden.
- Enablers and tech stack services
This is possibly the most likely path that most technology oriented digital start-ups may end up traversing. Start-ups who have created engaging technology features in specific areas may end up licensing elements of their technology to banks thus helping them but threatening the traditional banking software providers.
They are offering outsourced services providers to other start-ups as well as traditional banks. An interesting example is the partnership between JP Morgan Chase and OnDeck which was this year renewed for another 4 years. OnDeck a start-up focused on lending to small businesses, provides the technology that enables JP Morgan Chase deliver lending services to its business clients. The market likes such strategies and the announcement of the contract renewal in August pushed up OnDeck’s stock even though it turned a net loss in the second quarter this year.
- Stand-alone value propositions – the BIG challenge
Digital banking start-ups hoping to offer a full-fledged alternative for retail customers to switch their existing banking relationships have some waiting to do. Even those who have been able to acquire customers in impressive numbers have not displaced primary banking relationships and almost all are far from making any money.
Some start-ups have developed targeted strategies in areas where they have spotted pockets of opportunity. But there is a mad dash for these segments such as, for example, lending to SMEs (focus of OnDeck mentioned above) which traditionally have not been served well by banks because of the difficulties of assessing the risks of lending to them.
The most formidable challenge belongs to the mobile-app-only banking start-ups who are hoping to disrupt the industry and are thinking big. It is time to change their strategic thinking.
Time to change strategic thinking
One reason why digital banking start-ups have not been able to develop truly differentiated and sustainable value propositions – so far - is that they all singing from the same hymn sheet. In other words, they have the same set of core assumptions that are true but are not necessarily applicable in all markets and in all situations. Below are some areas where start-ups need to revisit their assumptions and strategic thinking.
#1: Mobile first – not mobile only.
Mobile devices are now at the top of the pecking order of personal peripherals vying for consumer attention. This is true. But it does not automatically mean that customers want banking services that can only be delivered over mobile device via apps. Some may. But it is not a universal truth. Biometrics and apps may be catching on but internet banking is still most popular in developed markets. Even the reports of the death of branches have been greatly exaggerated. In the United Kingdom, a new bank – Metro Bank - has done well in a highly saturated and mature market against formidable incumbents with a multi-channel approach that includes the much-maligned brick-and-mortar high street branch (or “store” in new parlance).
#2: Cannot differentiate on Customer Experience – everyone is doing the same.
Start-ups believe they can deliver customer experiences that are streets ahead of what big banks can offer. Apple showed us that a true understanding of consumer behaviour can help design better products and services that, though not technically superior, could outclass competition. Apple’s iphone when introduced (and still today) though technically not superior to the likes of Samsung ranks as the most desirable phone in many markets. So far, digital banks have not been able to design customer experiences that are so much better than big banks that they will encourage customers to switch. In any case, customer experience is only a temporary advantage until others catch up. It has to be reinvented on a continuous basis. A tall order in banking.
#3: Data analytics beyond “how much I spent on coffee this week” is deviously difficult.
Data can be used to gain ground breaking insights. This is more Amazon than Apple in the way that company predicts consumer demand based on buying and browsing habits. Digital banks analyse customer data to provide spending analysis back to customers: how much did they spend on food, coffee, fuel etc. This is good but no more a source of differentiation because most banks and most credit card issuers can or will be able to provide this as standard.
#4: If you want to emotionally connect with your customers - Good luck.
Brands, as we all know, can create emotional attachments that defy logic. Banks do not have the Apple techs-appeal. Ever seen the lines outside Apple stores? Has that ever happened in banking? It has. But for the wrong reasons. Many digital banking start-ups have invested substantially to develop websites and apps that are attractive and “cool” and use language and graphics designed to appeal to the young customer and provide services for free. But now everyone is doing that to some extent and in any case, young customers don’t make money for the bank. They do as they grow older. But then they may not be so attracted by the cool interface. The catch-them-young-and-keep-them-forever is not a new strategy and certainly not one available just to start-ups.
#5: Sustainable advantage does not come from killing revenue.
Understandable because it is early days but some of the relatively more successful digital banks have been able to acquire new customers quickly because they engage in the age-old price competition such as waiving ATM fees or foreign exchange fees on credit or debit card transactions. The “gain-customer-quick-and-worry-about-profitability-later” approach has been a successful strategy for many start-ups that have been able to sell themselves.
#6: Having a lower cost base than traditional banks is not innovation.
At the Money2020 conference, responding to a question from the audience about how they are leaving traditional banks behind as banks are likely to catch up to whatever innovation is introduced, one start-up CEO said their main advantage over traditional banks is that they have a much lower cost base. For those of us who have been around for long enough this echoed the strategies of failed internet only banks such as Wingspan Bank from two decades ago.
#7: Scale will not solve the problem.
One European start-up that has been able to acquire half a million customers announced at the conference that they have decided to enter the United States. This is a strategic priority and will give them scale. Scale is the holy grain of banking and payments as margins on most products are thin and more volumes mean more contribution towards profits. But if the strategic plan has only been mildly successful in one market and even that because of lower fees, not sure if doing the same thing on a bigger scale will prove wildly successful.
Digital banking start-ups have a tough task at hand. There is no doubt that they have already contributed positively to the banking industry injecting a sense of urgency and unfettered innovation to improve and enhance delivery of banking services. But they have not yet shaken up the industry and drawn customers on a large scale. Digital banking start-ups, however, are pushing the envelope through multiple strategic avenues and in the end, will provide greater choice to customers directly or indirectly.