In our next article, summer analyst William Pook explores how Big Tech has changed the modern financial landscape by challenging the dominance of traditional financial institutions, and suggests how these institutions could fight back to remain competitive in a rapidly changing, digitalised world.
As we entered the new millennium, the financial services industry was seen as lacking innovation and stagnant – a view which was even supported by the former head of the Federal Reserve, Paul Volcker, who in 2008 famously stated that “the only useful thing banks have invented in [the last] 20 years is the ATM.”1 However, times change, and the modern financial landscape is a far cry from the placid market of the early 2000’s, new entrants abound – each hoping to capture market share from incumbent titans.
In this piece we will focus specifically on four of these new challengers, specifically four icons from the technological landscape made famous for their domination of the online world: Google, Apple, Facebook, and Amazon. These giants have each made significant inroads into the financial space by offering innovative digital services and currently represent one of the biggest threats to financial institutions. Below we examine how the conditions came to be that led to their entry into the marketplace, what their current strategies are for expansion, and whether there is anything traditional financial institutions can do to fight back.
Holes in the market
There are three primary motivators for the shift we are seeing in financial providers: the introduction of newer regulations by financial overseers across the world, the rise of the smartphone as users' preferences shifted towards financial interfaces and, finally, the difficulty financial incumbents have had in building digital infrastructures.
A New Regulatory Paradigm
What signalled the beginning of banks losing their stranglehold on the market was a series of initiatives pioneered by government authorities around the world under a variety of different names (Open banking in the UK, PSD2 in the EU or the Open API framework in Hong Kong).2 These new regulations were designed to increase competition in the payments and banking industries by forcing banks to exchange customer data with third parties at the request of the end user. This levelled the playing field as banks no longer enjoyed the advantage of being the sole holders of users’ financial data,3 which to this day still plays an important part not only in pricing and risk scoring activities, but also in the development of new financial products.
The Rise of Digital Finance and the Smartphone as the New Financial Hub
The rise of digital finance and the advent of the smartphone dramatically changed how the end user interacts with their finance provider and introduced a whole new generation to the world of savings, loans and payments.4
With this shift in interface, we also saw a shift in user demands from key service providers. Consumers showed that they were willing to forego traditional finance partners in favour of new entrants who were able to deliver an app-based experience which was convenient, secure and tailored to their specific preferences. Typically, this would only be a temporary problem; an institution could simply develop new capabilities and products in order to rise to the expectations of the marketplace. However, many players found this not to be an easy task, which leads us onto our next factor.
Antiquated Digital Infrastructure from Existing Banks
In the face of many new entrants into the marketplace, many banks found that their core banking systems were antiquated and neglected.5 Whether this was from a historic lack of investment or from having to combine various code bases from decades of mergers and acquisitions, the fact remained that many processes were highly manual,6 or were reliant on software written in outdated coding languages. The end result was that many existing services (e.g. applying for a mortgage) were frustrating and slow for end users who were now demanding a seamless, mobile experience. Yet banks and lenders were unable to update their offerings as they were constrained by technology that was simultaneously complex and totally inflexible. For these same reasons they were also prevented from developing new products on top of their existing software frameworks.
In comparison, start-ups and challengers were able to create their technology from scratch, allowing them to focus on using the latest innovations in fields such as data science and machine learning to ensure that the consumer was presented with a fast and slick mobile based product which was constantly being enhanced with new services and features.
Enter the Titans
Considering the above, it is obvious that market conditions were ripe for companies to attempt to disrupt the space and seize market share from the longstanding incumbents, by catering specifically to the needs of a new segment of consumers; needs that had not yet been met.
It is also important to note that the technology giants were well positioned to rise to the challenge. Their strengths in the UI and UX spaces allowed them to build cross platform applications that were user friendly and intuitive - in contrast to the rigid spreadsheets typically seen in online banking. In addition, their peerless data analytics and insight generating capabilities (particularly with regards to the younger segment of consumers)7 allowed them to create desirable products that people wanted and ensured that their offerings were considered ‘killer apps’ by their massive existing audiences who had already integrated these companies into their lifestyles.8
In the next section, we will look at the financial products currently being offered by each member of GAFA, how it ties into their existing ecosystem, and what their plans are for the future.
From the constant release of new products,9 we can see that GAFA is now at a stage where they feel comfortable within finance, their products have proven their worth and have captured a significant share of the retail payments marketplace whilst continuing to grow in other key areas. Now we are seeing stage two develop, as each company takes a unique path in order to achieve greater dominance.10
The primary theme of Google’s current strategy is consolidation, as they wish to combine all of their various services into a single one stop shop for personal finance.10 More precisely, in order to provide broader retail banking services missing from their current offer, they are forging partnerships with financial institutions in a few key marketplaces,11 with the goal to provide a holistic personal finance platform in their Google Pay product.12 Key reasons for taking this approach are to increase ARPU per user in the Google ecosystem (a common metric for success in the technology sector) as well as increase customer ‘stickiness’.
We also see an expansion into the rapidly growing e-commerce space, as evidenced by their recent partnership with Shopify to allow their collection of 1.7 million merchants to reach customers through a Google search.13 It is clear that Google wishes to end its history of being used simply as a portal to other storefronts and would like to profit from the multi trillion-dollar market as well.
In contrast to Google, Amazon appears to be focusing solely on increasing the scope and depth of the Amazon ecosystem built around their enormous online marketplace.10 By starting to offer banking services to merchants and customers, Amazon is looking to greatly increase participation within their ecosystem and profit even more as a result. This does not mean that Amazon will aim to become a fully-fledged financial institution, rather it will leave the back-end work to a select number of partners (e.g., Goldman Sach’s Marcus)14 whilst they focus on attracting greater numbers of users and merchants to their e-commerce platform.
Similar to Amazon, Facebook appears to be using financial services to enhance their existing core market further in terms of profitability.10 It is well known that the platform acts as the primary interface between brands of all sizes and audiences, and they are looking to insert themselves between the two to tap into the so-called ‘creator economy’.
To first achieve this, they have announced plans to consolidate all their payment options across their various apps into a single offering, Facebook Pay, which will oversee all payment activity across their ecosystem.15 They will then be hoping to have their payments services be the primary tool in which creators and brands monetize their followings through paying for goods and content.
Apple seems focused on ensuring that their Apple Pay platform becomes the sole way in which financial transactions are conducted. Their recent acquisition of Mobeewave,10 whose technology allows merchants to transform their smartphones into payment terminals, seems to further this goal. By incorporating Mobee’s technology into their Apple Pay service, Apple would like to capture a further share of the physical retail market space whilst growing their number of users even further.
This seems to be in line with Apple’s new direction of turning themselves into a software and services-based company rather than just an IT hardware producer.16 Evidently, Apple see offering financial services as another way to keep consumers locked into their burgeoning Apple ecosystem alongside other products such as media streaming and cloud storage. Also of note is the launch of the Apple Card.17 By partnering with Goldman Sachs, Apple also wishes to offer lending and credit services to further embed users within the Apple community by offering cashback on purchases tied to their products and services.
Can Big Finance Fight Back?
In this final section we take a look at how banks can try to navigate this shifting marketplace effectively to secure their futures. To this end we have identified three distinct routes that incumbents can take in order to protect their future.
Route 1: Surrender the Interface and Operate as a Provider of Financial Services
One thing our readers may have noticed is that many of the financial products being offered by GAFA beyond payment services involve a partner from the world of finance. It appears that Silicon Valley typically wishes to avoid the restrictions and regulations that come with being a fully-fledged financial services provider and would prefer to work solely on the consumer facing side of finance - whilst leaving the back-end work to their bank partners.18
This provides an opportunity for those banks willing to surrender the user interface to big tech whilst focusing on being the ideal partner in order to cater to their enormous consumer base. Banks may have to reorient their operating model to swap from a net interest margin model to one based on fees or profit sharing. Still, should a bank choose to go down this road, they will have to bear in mind that the discretion of choosing a partner lies primarily with the technology industry who will have stringent standards to be met in terms of technological integration. Banks that have failed to update their tech stack will find that they may miss out on key partnerships and may lose income as a result.
Route 2: Use the Existing Fintech Ecosystem to Boost Digital Offerings
For those banks less willing to surrender the user interface so easily, one option that allows them to compete more readily with the tech giants would be to use the existing fintech landscape to their advantage. The fintech ecosystem that has developed in the past few years contains a slew of start-ups and small businesses which have found a specific niche to cater to.19 By partnering with (or acquiring) a select few of these companies, a bank may be able to gain products, technology and consumer bases to rival the Silicon Valley behemoths, albeit with a large price tag.
However, as with the previous strategy, banks must avoid having outdated digital infrastructure underlying their core banking systems. The presence of legacy technologies will greatly increase the integration risk from any purchases made and in worst case scenarios could prove extremely difficult to reconcile with the codebases of newer firms.
In addition, banks should deploy their capital wisely, using their knowledge of the market and their customers to partner solely with the right fintechs who will enhance their digital offering in a meaningful way to customers based around their lifestyles.
Route 3: Build New Digital Businesses
For those banks who wish to forgo partnerships entirely but want to remain at the forefront of their consumers’ minds, there is a third option. By combining their capital and expertise with new innovations, financial institutions can build new, digital businesses which could prove key to their future.20 As shown by the flurry of fintech start-ups appearing daily, the barriers to starting a digital business have never been lower and could allow for the development of new services and products without being tied down by the parent organisation’s legacy infrastructure and associated drawbacks.
In order to properly develop a new digital business, banks should pay special attention to developing a single value proposition which is able to be monetised quickly and focuses on customer acquisition – all of which could be accomplished by leveraging existing knowledge. The benefit of this approach is that, if done correctly, the incumbent will be able to rebuild itself based on new innovations, much in the same way many tech companies do, and be able to better cater to its users’ needs whilst drawing them into their wider financial offerings.
One thing is clear from recent events, the presence of GAFA in the financial marketplace is here to stay. What matters now is how the existing players within the industry respond to these new threats who (unlike start-ups from the fintech world), are able to bring to the table enormous pools of cash and resources in order to claim market share. Banks, and increasingly other financial institutions, will have to use all of their industry knowledge, digital talent and customer understanding to counter these emerging threats.
Should you wish to understand more about these recent developments in the finance industry, or discuss any of the issues raised in this piece further, please do not hesitate to contact our team of experts at Evolution Partners.
20 Building a digital bank: How incumbent banks can disrupt the disruptors | McKinsey