I wanted to start this blog with a thought-provoking quote from venture capital firm Andreessen Horowitz which states the following:
“The battle between every Start-up and Incumbent comes down to whether the Start-up gets distribution before the Incumbent gets innovation”
If we start to think about the statement in the context that every industry eventually gets disrupted with the focus and pace within financial services, no-where is that battle going to be harder fought than in the FinTech arena.
COVID-19 is without doubt the greatest challenge the world has faced in decades. It has transformed people’s lives at unprecedented scale. The adoption of new technological behaviours in response to the pandemic, from videoconferencing to online shopping, means the use of tech has reached levels that were not expected for many more years.
The current environment has motivated customers to embrace digital interactions and contactless payments in Banking. For example, Visa saw more than 13 million customers in Latin America make their first-ever online transaction in the heights of the pandemic, in March 2020. Even branch-loving customers and older generations are now digitally interacting with their banks these days. In Banking, as in most other industries, the pandemic has accelerated the urgency of digital transformation.
This new world intensified the challenges banks were already facing and sped up the race for innovation and scale among key market players. In addition to this, the ongoing rise of open banking dissolves Banks’ monopoly on consumer financial data, bringing flexibility and creating a more competitive environment for digital banks.
By focusing on independent Digital Banking brands, Challenger banks (with a full banking licence) and Neo-banks (firms that partner with a bank licence holder or hold other than a full banking licence), aim to compete with traditional institutions. They differentiate themselves by being largely based on mobile-centric technology along with more consumer-friendly solutions that operate at a fraction of the marginal and unit cost of their incumbent competitors. For this reason, Digital Banking has become a truly global phenomenon.
In such a context, what are the success factors of independent digital bank models?
In our recent report “Ins and Outs of Digital Banks”, we analysed 80 different Banking brands globally, among which some are independent whilst others are corporate backed. Whilst there exist many ways to measure success for Digital Banks, we focused on various elements that would expose the achievements and the potential of each Start-up. These include the growth in number of customers, the company’s ability to raise funding, current valuation, revenue growth and of course, whether or not the bank is profitable. A mix of these and other factors may determine the interest future investors display towards each business model.
We evaluated four main elements of digital banks’ go-to-market strategy. These are value proposition, target segment, user acquisition, and product strategy. We found that despite the many differences in the way Digital Banks approach the market, one common trait is shared by successful brands.
Digital Bank business models start with the customer. Alternatively, the traditional Banking approach tends to start at the business model, to take deposits and lend, only after focusing on reducing costs of technology distribution - however, customer problems may or may not be solved. Research from 11FS on Banking business models that shows how traditional banks' core business model is broken suggests that the customer should come first.
FinTechs base their business model on finding the solution to customer dissatisfaction.
In addition to a business model that revolves around the customer, we found that Start-ups which were able to rapidly grow their customer base, raise large amounts in funding, reach high valuation and profitability, have some of 12 distinct aspects.
Here we look at the three most relevant traits:
1. Quickly setting-up and tapping into consumer needs first.
Rather than pursuing a full banking licence from the beginning, successful FinTechs were able to launch their product through partnerships and other simple licences. This allowed them to avoid the immediate application for a full banking licence in initial stages, a time-consuming process.
This gave them more time to focus on how to rapidly scale and increase customer awareness before expanding their offering. Examples of this approach include Chime, Revolut, Nubank and Monzo. From those Chimes has not a banking licence yet.
2. Niche market focus and creating a strong and unique banking proposition.
These banks focused initially on a single and easy-to-understand product, such as a debit card, credit card, or international transfers. On top of this, they identified segments which were underserved by traditional players. Monzo and Revolut serve the international customer segment, whilst Nubank focuses on low income individuals, and OakNorth and Qonto provide for SMEs. With a unique proposition, these firms quickly differentiated themselves.
Similar to UK Start-up Wise, Revolut addressed a major problem that incumbents were overlooking; sending and spending money abroad. On top of this, Revolut continued to diversify its services to distinguish itself from early competitors.
For NuBank, credit cards were a key factor of differentiation and helped to build the brand, as well as encourage confidence among prospective users. Confidence is key because customers tend to struggle to trust a new company that holds their money, and during this period acquisition costs are higher. For Oak North, SME lending was the key factor that led to the success of the brand.
3. Successful FinTech banks evolved from offering a sole product to offering a wider proposition.
Once successful FinTech banks have positioned their initial product, they continue to build their offering. The partnerships allowed them to quickly build relevant services that answer customer needs, and serve not only as a powerful driver of customer acquisition and loyalty among key untapped audiences, but also diversify streams of revenue.
Monzo, for example, teamed up with several companies to offer users a variety of products and services such as saving pots and FX transfers. Since 2020, it has introduced new products with the aim to monetise users and generate new income streams. 25% of Monzo’s revenue now comes from products launched during the pandemic, and it was the first major UK bank to launch its By Now Pay Later (BNPL) offering later last year: Monzo Flex.
The evolution of digital banking models
We have already seen a change in Digital Banks’ priorities. More recent Start-ups are focusing on profitability to prove the sustainability of their business model, whilst the more mature players position themselves for a potential public market entry via IPO or SPAC.
As companies scale, goals change, and digital banks are diversifying their revenue sources beyond interchange fees, moving away from fee-free propositions and towards premium, paid banking features such as lending and banking for businesses.
Monzo began its journey with ambitions to create a financial marketplace whereby the main source of income was generated by affiliate fees on third-party products. Monzo’s business model was dependent on interchange fees, which constituted 77% of company revenue in the 2017 financial year (FY). Four years later, it realised that the marketplace model was not sufficient to reach sustainable profitability, and has since moved towards customer lending and income from subscriptions in a bid to reach profitability. Over the 2021 FY, interchange income represented only 51% of total revenues. Similarly, Revolut Card & Interchange fees represented 43% of total revenues in 2020, down from 97% back in 2017. Despite recent efforts, both Start-ups are yet to reach consistent profitability.
As Start-ups switch their focus towards profitability during a time where people expect personalised services and superior customer experiences, differentiation has become essential for the survival of each Digital Bank.
An advantage to tech-savvy firms is their copious amounts of customer data, which they can leverage in helpful ways. Knowledge of a customer’s life, financial goals and history, as well as his/her spending habits allow companies to better predict what the user will need in the future, and are able to prepare for this in advance. Customer data is invaluable when banks pay it proper attention.
An emerging trend of the last few years has been the Super App model. Within all industries, not limited to banking, companies are bundling services, from Apple, Google, PayPal and Amazon, to retailers, telecom companies, FinFech firms and traditional players like Goldman Sachs. All have begun to build propositions around customer lifestyle, bundling financial, shopping, restaurant and travel services (to name a few) with the aim to boost engagement and become a one-stop shop for customers.
In layman's terms, lifestyle banking uses technology and consumer data to identify new opportunities—ones that take a holistic view of a consumer’s lifestyle to solve timely pain points or create enjoyable experiences. Partnerships inside and outside financial services are leveraging established name recognition, trust, and timely niche offerings to meet the consumer’s lifestyle needs. Digital engagement is at the core of all Super App propositions.
One of the best examples is Tinkoff, the Russian digital bank that has been profitable for many years now. It has pioneered the Lifestyle Banking model in Russia by bundling value-added services like travel and entertainment bookings, and a mobile network into a Super App to cater to every need. This has attracted additional more engaged users to the bank, who may initially join for non-financial reasons, and now Tinkoff Lifestyle customers make twice as many monthly purchases than average (non-Lifestyle) Tinkoff customers.
Income generated from Tinkoff Lifestyle engagement is then reinvested into customer loyalty via cashback and promotions. Deeper relationships with consumers and earning loyalty is critical for banks, as it pays off with higher revenues, lower operating costs, and happier customers, the perfect cocktail to attract more customers.
Investing into hyper-personalised lifestyle offerings
Other digital banks are following a similar approach. Revolut’s self-described “global financial Super App” includes a travel booking service, which allows users to make flight reservations, rent cars, among others. The $33 billion fintech firm is aiming to offer multiple services through one interface. The move marked a challenge to travel industry giants like Booking Holdings, Expedia and TripAdvisor.
MoneyLion’s customers can activate financial solutions and purchase products while consuming hyper-personalised content that engages and educates them on a daily basis. Early this year it completed the acquisition of Even, the leading embedded finance marketplace of its category. The acquisition strengthens MoneyLion’s platform by improving consumers’ abilities to find and access the right financial products. Together with the company’s current capabilities, it is well positioned to evolve its hyper-personalised lifestyle content and financial recommendations.
Similarly, SoFi Technologies, Inc. has agreed to acquire Technisys, a leading cloud-native, digital, multi-product core banking platform. Technisys uses data-driven insights and integrates them with technology that allows financial institutions to create and tailor any financial product – in real time – to deliver a seamless digital experience to every customer touchpoint, whether online, on the phone, or at a branch. This gives banks and FinTechs the agility to tailor offerings that become integral to a customer’s lifestyle.
Today, financial institutions are laser-focused on digital transformation.
The convergence of digital banks towards lifestyle banking offerings is transforming the customer journey and leading to greater personalisation. It ensures that customers have access to their desired services when they actually need it, as well as allowing for further differentiation. The development of these offerings is both cause and effect of income diversification and increased revenues, which lead to increased sustainability of a customer-centric business model.
If you are interested in how the banking industry is changing and what everyone should know about digital banking, take a look at our latest research Monzo: The Evolution of a Marketplace Model