How Fin is changing Tech
Why technology companies are adding FinTech products and financial services to their ecosystems.
Finance has always been a tough area for innovation.
First off, financial institutions need to follow a plethora of regulations to even be allowed to operate. It is not uncommon for companies to put 75% of their IT spend on just keeping their IT infrastructure up-to-date with regulation. In addition to this, it is also not uncommon for up to 15% of the workforce to work in compliance functions. Citigroup alone had 30,000 of its 200,000+ employees working in compliance last year. Unsurprisingly, this costs both a lot of time and money, eating up resources that could be put toward innovation while it simultaneously increases costs to customers.
Secondly, the customer experience for the average financial institutions is bad to say the least: Customer satisfaction is low - only 28% of U.S. Millennials and Gen Z trust that their bank will act fairly. And available products are not good - many products and services are poorly built/designed and even worse is that 50% of the population lives “paycheck to paycheck” which means they only have a small (and bad) selection of these services.
Even though finance has been an area ripe for innovation, it has up until recently been difficult due to the high resources required to meet stringent regulations. However, this is now changing quickly due to the “API economy” and the separation of the extremely complicated “banking stack”.
The “Banking Stack”
Companies no longer need to operate in every part of the “banking stack”, handling everything from fraud and regulatory to payments, like financial institutions previously had to. With the API economy, companies can focus on building their core service while connecting with other companies’ services to cover the rest of the banking stack. This greatly reduces costs for development and innovation while also making for better products.
The company Plaid (bought by Visa in January 2020) has built a universal API that connects with thousands of financial institutions. When an app like Square’s “Cash App” wants to connect to a bank account for bank information or to settle a balance, they use Plaid behind the scenes. This is both more efficient and cheaper than developing this service in-house.
Similar to how companies no longer need to purchase their own servers because of AWS or build an e-commerce platform from scratch because of Shopify, these FinTech/API companies provide an essential infrastructure making it easier for any company to offer their own financial services.
The Kings of Data
Companies with already established user bases - SaaS companies, consumer marketplaces, social media companies - were obvious winners when the API economy hit finance. The access to vast amounts of data allows these companies to know exactly what products their customers wants and needs.
Many companies are already capitalising on the potential of integrated financial services: Today a majority of Shopify’s revenue (and a large part of their growth) comes from financial services! However, I still believe most companies are not capitalising nearly enough on FinTech and that there is still a lot of low hanging fruit out there - meaning that there is a lot of untapped revenue for these companies.
SaaS companies use a subscription model to generate income and grow either by growing their user base or by upselling their customers on addons to the core product. If financial services are added to the ecosystem (payments, loans, insurance, payroll, etc.) the company gets an additional vector for monetisation which captures their customer’s software spend AND the spend for financial services.
This means that the average revenue per user (ARPU) increases while also opening up new verticals where the addressable market has either been to small or where the customer acquisition cost has been too high.
The New Go-to-Market Strategy
This is because FinTech changes companies’ go-to-market channel by increasing ARPU while also increasing the stickiness of the product - having customers use more products in an ecosystem increases the friction of switching systems. This lowers the customer acquisition cost (or keeps it the same) while increasing the lifetime value of the customer!
This makes it possible to go after customers that have previously been to expensive to acquire. When lifetime value increases, companies can offer their core product (e.g. SaaS) cheaper to grow a user base on an otherwise impenetrable market and later add a FinTech product for monetisation.
Financial services work well as a secondary product since they offer a lot of value, but (to most customers) offer little differentiation compared to SaaS/marketplaces/Social Media companies which offer a more differentiated and compelling service making them better at attracting and locking in new customers.
With the help of a dedicated user base and the separation of the complicated banking stack the future of banking and financial services no doubt lie in tech - and most likely tomorrow’s big financial institutions start as something entirely different today.
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Original tweet from 12 September 2020: