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The Visa-Plaid deal made international headlines a few weeks ago. But why is it happening? Visa is one of the largest networks in the world, connecting issuing banks to acquiring banks—a network of banks that service consumers and merchants, respectively. How does a Capital One credit card pay for a burrito at a Bank of America merchant? It goes through Visa (see a YouTube primer here). Plaid is one of the largest networks of the new era of banking — connecting banks with developers of new financial services (and vice-versa). How does your Robinhood or Coinbase account connect to your Bank of America account? Plaid. To a certain extent, Plaid *is* the Visa of fintech, and for Visa, this is a smart bet on the future of financial services, one that goes well beyond Visa’s core of networking payment cards.
Last week, British neobank Revolut joined many of its US contemporaries (SoFi, Credit Karma, and Wealthfront among them) in offering a high-yield savings account to its users. But if 2019 was the year of the high-yield savings account, 2020 is shaping up to be the year of the prime bundle—packaged banking services for prime customers (high-yield savings included).
The US-based neobanks that have seen the most traction to date have largely focused on underserved or unbanked consumers, those typically not sought after by big banks, since high servicing costs make low balance accounts unprofitable. So why are neobanks now taking an active interest in prime consumers? The calculus is obvious: They’re betting they can lure these profitable customers away from incumbent banks with substantially better bundled perks. The bundles currently offered by the big five banks are, frankly, fairly lackluster. (In exchange for saving more than $20,000 at Bank of America, for example, members receive a 5 percent interest rate boost—on a paltry 0.03 percent.)
In that prime banking users typically have investments, student loans, auto loans, and mortgages, neobanks recognize that a basic bundle of debit, checking, and high-yield savings accounts likely isn’t enough to pry them from established banks. Rather, a better bundle will connect two or more of these products in a novel way that creates consumer value and drives engagement. That might mean providing 4 percent cash back on card spend, which is then automatically invested into an associated brokerage account if you’re saving 10 percent or more of your income. Or perhaps that means offering 4 percent interest on savings for a downpayment after the user has been pre-approved for a home loan. Whatever the hook, engaging a prime user likely requires two or more products working together seamlessly.
As prime banking develops in the US, there are three particularly interesting categories of fintech players to watch. The first is the European companies, such as N26 and Revolut, which are expanding stateside. So far, they appear to be offering the same set of features that were successful abroad (such as unlimited exchange between 30 fiat currencies for Revolut), which may prove to be less relevant in a US context. The second subset is robo-advisors, which aim to unify the experience of banking and investing. Wealthfront, for instance, is betting on its own vision of “self-driving money”: automatically routing funds from a paycheck or elsewhere into the most appropriate accounts. Finally, there are the upstarts, some of which are still in stealth mode, which are launching with multiple products from day one. HMBradley, for example (in waitlist) offers a unified checking and savings account with 3 percent interest, and “one click” credit that proactively pushes the best credit offerings.
The prime-focused neobanks that will be successful five years from now are just getting started. High-yield savings are just one crucial component in the wider quest to build a more enticing bundle.
Earlier this month, Shopify announced that it would be offering $200 loans to any Shopify merchant as “starter capital.” The loans, which are intended to help new businesses get off the ground, can be spent freely on expenses like branding, inventory, and ads. They’re paid back as a fixed percentage of the merchant’s revenue over a 60 day period. If the merchant can’t pay back the $200, Shopify doesn’t have recourse; the company requires no personal guarantee. It’s a gamble, not least because small businesses have a high rate of failure, particularly in the first year. The question, then: what’s in it for Shopify?
The company likely considers this offering a low-cost acquisition tool to persuade people to start businesses with Shopify. Notably, this is a much different tack than simply offering a $200 discount for trying Shopify, which is the more common customer acquisition technique. Instead of extending a cost-saving measure, like a discount, here Shopify is incentivizing the merchant’s revenue growth. Since Shopify makes a fee for every transaction made on its platform, if a merchant spends $200 on ads and generates more sales, Shopify makes out. The company also connects merchants to services to assist with fulfillment, shipping, marketing, etc. Moreover, as the business grows, the merchant is more apt to layer on additional services, such as upgrading to Shopify Plus (the enterprise-level product suite) or borrowing from Shopify Capital (the company’s lending arm). Shopify is betting that if it can acquire merchants earlier in their lifecycles, they can capture more of the subsequent growth.
By doing some rough math—dividing new merchants added by the sales and marketing spend—we can deduce that Shopify spent more than $1,500 to acquire each new merchant in 2019. So while customers that take advantage of these $200 loans may have a higher churn rate, they also cost the company a lot less to acquire. When viewed through this lens, these small-scale loans start to look like a smart strategy: Not only do they allow the company to acquire customers more cheaply, they also provide intangible brand value by reinforcing Shopify’s reputation for supporting small businesses at their earliest stages.k
Similar to what AWS did for compute and storage, new infrastructure companies are rebuilding each layer of the banking stack, providing modern software solutions “as a service.” This is considerably lowering the cost and complexity of adding financial services. As a result, startups will be able to launch companies faster and more cheaply. Existing financial services institutions will be able to introduce new products quickly—and spend less on IT maintenance. And most importantly, this will mean more choices, better products, and lower prices for consumers, regardless of geography or socioeconomic demographic.
In the not-too-distant future, I believe nearly every company will derive a significant portion of its revenue from financial services. Thanks to those enabling this transformation—including Synapse, Comply Advantage, Sentilink, and Plaid—every company, even those that have nothing to do with financial services, will have the opportunity to benefit from fintech for the first time.
Take ride-sharing companies like Uber and Lyft, for example. If you’re a driver, those companies might also be your bank. For Uber and Lyft, offering financial services has two benefits. These companies both spend hundreds of dollars acquiring drivers, a cost they then must make up through margin on rides. But it’s much faster to make up that cost if they also have margin on banking services. Furthermore, drivers are more likely to stay with a company that is also providing his or her financial services. Ultimately, if successful, Uber and Lyft might need to acquire fewer drivers, due to better retention.
Over the next five to ten years, with new financial services companies spinning up—and some of our favorite brands launching financial services—existing banking services will improve significantly. With time, financial service products will become more affordable and accessible to everyone.
Fintech’s holy grail is the concept of self-driving money—software that automates and seamlessly optimizes your finances across categories. But while many companies are pursuing that goal, it is yet to be realized. Few fintech companies have built more than one successful product at scale, much less bundled many products together. As with most product problems, the challenge here isn’t in the vision; it’s in the entry point (the “wedge”) and the sequencing (the roadmap) needed to achieve said vision.
But self-driving money’s product sequencing is particularly challenging—and interesting—because of the valley that exists between failure and success: in this case, a little automation may be worse than no automation at all.
Why? A consumer’s financial life is made up of three core engagement loops. One’s cash flow and transaction data is accessed most frequently; their term loans and “balance sheet” are consulted less often; and tax information, asset management, and retirement and wealth planning receives the least attention. Automating one of these loops usually requires knowledge of the others. So, if a product promises to automatically refinance term loans on the consumer’s balance sheet, it must have a deep understanding of his or her week-to-week cash flow, as well as a sense of the customer’s assets and wealth. Similarly, if a product promises to sweep cash into a retirement account to maximize yield, it must have a sense of term loans and the overall borrowing cost for the consumer. (Your periodic reminder: the best yield you can get is paying down your credit card!) Attempting to drive automation in one of these areas of a consumer’s life without knowledge of the others would be clumsy at best. Automation is only magic when the decision-making improves upon our own impulses.
As fintech companies move from pitching self-driving money to building that vision, they invariably confront the tension between the short-term opportunity and the long term potential. In the near-term, they will be tempted to drive growth through traditional product cross-sell—that is, marketing to existing users without developing products that work together to improve upon the sum of their parts. The alternative is to pursue the “strong” technology—a holistic, intuitive product that comprehends the user’s financial goals and automatically optimizes for the ideal outcome. This requires finding product market fit over and over again. Each incremental product must increase the overall value delivered, with an eventual goal of full financial automation. I’m optimistic that many entrepreneurs will choose the latter, and I’m eager to see how the combination of ambition and creativity will manifest in the next phase of fintech products.
After the financial crisis in 2008, banks were tasked with repairing their balance sheets and reducing their risk exposure. Today, more than 10 years later, banks are still mitigating that risk by tightening their lending criteria: they’re shunning risky borrowers in favor of those with good credit.
The rate of severely delinquent consumer loans has fallen for at least 22 consecutive quarters at Wells Fargo, according to American Banker, and at Bank of America, household debt has dropped 23 quarters in a row. This trend is particularly striking when coupled with the fact that only 11 percent of Wells Fargo’s outstanding loans are from those with FICO scores of less than 680—a 50 percent reduction from 5 years ago.
Lending is a powerful financial tool. It allows people without immediate access to capital to invest in their futures, whether by getting an education, starting a business, or paying for medical expenses. But when lending is restricted to one subset of the population—that which is deemed more creditworthy—it further contributes to the imbalance in the market and opportunity set.
The silver lining? The shift to more restrictive lending among incumbent banks has allowed new lenders to swoop in and and better serve overlooked subprime and near-prime customers. Startups like Chime and Earnin have tailored their efforts for the underserved by offering lending products that are both short-term and interest free. As banks continue to focus on mitigating risk, fintech companies are working to make the financial system more accessible and inclusive for all consumers, regardless of socioeconomic status.
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