How Will Fintech Innovation Scale?

There is a lively debate in the fintech ecosystem about which firms will be able to scale fintech innovation and how they will do that. Will fintechs scale through organic growth and acquisitions or will they partner with more established providers? Three models are currently being discussed when pundits and the companies themselves attempt to predict how this will take place.

The Go It Alone Model
Those who think that fintech companies should go it alone believe that companies themselves will rise and beat incumbents by providing superior digital experiences and highly intuitive products to their customers. Supporters of this model point to three significant supporting facts. Disruption has happened in every other sector. Just as Amazon and Uber have changed the landscape when it comes to books and ground transportation, companies that grow quickly and join PayPal and Intuit will offer financial services beyond those provided by traditional banks.

These go it alone supporters point out that unlike most banks, fintechs are not built on top of clumsy legacy systems and therefore can offer cheaper and faster products. Those who believe that fintechs can grow organically see banks as being too slow to provide the innovation that consumers want and too stubborn to pay the appropriate multiples to buy fintechs that have a proven record of success. Unfortunately, there is a small but growing list of investors that refuse to back fintech startups that plan to distribute through banks. Early forays into distribution through banks have been sufficiently difficult to repel some investors.

Many in the ecosystem think the go it alone supporters are missing key points. They argue that the cost of customer acquisition is very high for these independent fintech companies. Getting to 80,000 users seems doable, but getting to 250,000 will be extremely difficult for most fintechs, in part because the cost of funding is much higher without bank deposits. Most fintechs rely on the capital markets and other institutional sources of money, including private equity investors, for their funding. Go it alone skeptics also believe that regulators will eventually demand expensive and complex compliance from fintechs that will increase their costs while decreasing their nimbleness. They are concerned that many of these companies are growing by subsidizing the cost of their products, and also lack business models that would make them independently profitable.

Financial Service Incumbents as Innovation Partners Model
A significant number of thought leaders believe incumbent financial services players such as banks and insurance companies will build platforms for best-in-class fintech partnerships. They believe this will be necessary because customers, having seen and heard the promise of new innovation, will demand better products. Supporters of this point of view emphasize that banks do not have the high customer acquisition costs of fintechs, are already familiar with regulatory expectations and have a much lower cost of funds. They argue that such competitive advantages will give them time to partner with or acquire any innovations that they will need. There may come a time when financial service incumbents build their own fintech products. However, at least in the near term, the sheer number of potential innovation needs—ranging from from machine learning tools and data analytics to natural language voice interface–will mean they will need to partner in order to keep up.

Skeptics of this model believe banks make bad partners when partnering with fintechs seeking scale. They insist banks are slow and generally do not do a good job of selling their customers on products they do not own or control. There are also concerns about the cost of partnering with banks. Some fintechs see integration with legacy solutions as a long and clumsy process and believe that meeting vendor risk management standards and other bank regulatory mandates as unnecessarily expensive and time consuming.

The Other Incumbents Model
Another relatively new view is that fintech innovation will scale through other incumbents. This approach often arises as an alternative in conversations concerning the flaws inherent in the other two models. Three types of incumbents are mentioned:

• Retail: Proponents suggest that retailers or wholesalers will enter the financial services arena by partnering with fintechs and using a bank as a utility. These outlets have existing customer bases and some already offer various forms of financing. For specific niches it is easy to see the connection. If Home Depot offered financial tools to manage a contractor’s business, it would help their core business.
• Employers and Payroll Providers: One of the most successful savings programs of all time is employer sponsored 401(k) plans. Recent talk of rolling in student debt payoff plans and financial health programs through employers have some fintechs wondering if they can scale through employers. Earned wage management tools are advancing earned money to employees outside of a normal pay cycle to help employees avoid payday lenders. Saving tools for goals other than retirement could be offered by employers.
• Telecoms: Telecom providers are functioning as financial service providers in developing countries where there is limited financial infrastructure. Supporters argue that many fintechs are mobile-first technologies and data suggests that mobile is the preferred banking channel for a significant–and growing–percentage of consumers.

Most of the other incumbent models recognize that there has to be a bank involved but relegates its role to one of a utility. This position tends to spark another round of debate. Will banks become utilities if they don’t learn to be better partners?

Common to all of these conversations is the growing expectation that innovation will alter how we interact with financial service providers. Whether the provider is a bank, fintech or employer, all agree that consumers and businesses expect innovative solutions and that the best solutions will scale or be widely imitated. No matter how these innovations scale, there is little doubt that significant change is coming and much of the innovation will be driven by technology.