Subprime is already a crowded market space in Fintech
A quick survey of the many consumer Fintech brands that have launched in the US and Europe shows the overwhelming focus on the young and credit challenged especially those who have the ambition to reach mass proportions. A few are focused on the retiree community. A small group is focused on bringing very specific investments to a broader but still limited affluent audiences e.g. T-Bills, cryptocurrencies, art and racing cars.
When looking for potential market entry strategies its natural to gravitate towards the white space in the market. It’s where the competitive pressure is the least and likely reaction from incumbents the most muted. For subprime consumers, this has led to the widest volume and greatest diversity of services in access to financial services in history.
Why ignore the customer segment with the most money?
Many in the industry consider affluent consumers needs to be fully served by traditional companies. How could they not be given that this group provides such a substantial proportion of their profits? As such the affluent market segment is considered saturated and highly competitive vs the relative white space and lower competitive pressure amongst subprime consumers.
Additionally, many consider traditional banks dominance to be unassailable in the affluent sector. Who could compete with Chases’ $2bn+ annual marketing expense? Banks are paying on average $200 per new credit card customer — far more for more affluent cards. Chase Sapphire is a formidable and very successful credit card no doubt, why would a consumer give that up for an alternative from Amex let alone an unknown Fintech firm?
The problem though is more structural, we are so used to the current model that it feels natural and unchangeable and that makes it very difficult to see the problem and how to change it. This is driving banks’ profits to the detriment of consumers and preventing effective competition.
2019 smartphone enabling a 1980’s bank product — innovation in approach not product
Technology, especially mobile, has been applied by Fintech companies to enable a new channel to market (the mobile phone) which carries a substantially lower cost base than the traditional banking model making it more economical to serve low value segments with better pricing.
Innovation has also been applied in how consumers and transactions are judged from a risk perspective (e.g. Affirm) broadening market scope and creating the potential for greater financial inclusion. User experience, design and big data has been deployed to help anticipate and serve consumers better with predictive models, data presentment and notifications to help consumers better manage their financial lives and prevent negative events.
However, the underlying product constructs used are largely the same that the industry has been using for decades. Separate current/checking accounts, savings accounts, credit and debit/pre-paid cards, investment platforms all remain largely the same as they were in the early 1980’s — before the internet and smartphones were even a thing let alone enjoying the ubiquity of the almost 2020’s.
These products are the result of decades of slow pre-internet evolution by the very companies Fintech needs to compete with. They are not designed for the modern digital world and the consumers immersed in it. They create a degree of complexity, cost and fragmentation that itself creates barriers for consumers to better manage their financial lives and outcomes.
The secret to financial security is not a secret
Ask anyone about the importance of money and financial security in their lives and for most people it’s right up there in the most import spot along with love. Look at the amount of time spent searching Google for financial management information vs the amount of time spent looking for love (in any form — no judgments here) and it’s pretty clear that where financial education and advice is concerned people do not put their money where their mouth is.
The information is there though and its really very simple:
1. Spend less than you earn
2. Save money into the highest interest savings account
3. Invest as early as you can, put a little in often, over the long term in the lowest cost diversified portfolio
That’s it — how hard could that really be? In the current market environment — pretty much impossible.
Consider what the financial profile of the average professional with a decade or more of corporate working experience is likely to have accumulated:
· Current account with a top 10 bank — maybe a second from the bank they first used
· Debit card with their current account(s)
· Savings account — if any, potentially but not necessarily with the same bank as their current a/c
· Credit cards — on average almost 4 of them (US)
· Work pension — 401K with one or more platforms including previous companies
· Stock options — with one or more platforms
· Personal investment account — if any
This is an ad hoc accumulation over time and not a planned portfolio, it’s also just the stuff concerned with everyday financial management — not including those rare and infrequent events like a mortgage or car purchase. No doubt at the time each account or card was applied for there were compelling reasons — 50K airmiles/points or 1.75% APR interest. Are these rates and incentives still relevant or competitive? It’s not a surprise financial services companies use special introductory rates and promotions and market their best rates and offers even when these vary from month to month. This is not designed to increase consumers net wealth but rather promote breakage.
Breakage (the net between rewards and benefits issued and those actually used by consumers) is the basis underpinning the profitability of every such platform — typically anything between 30–50% of the value of rewards issued are never actually used by consumers. Consumer inertia is not only assumed it’s relied upon.
The majority of customers are only very rarely going to put in the necessary effort to maximize their benefits and rewards or move to a new provider to chase a marginally better rate on an ongoing basis. The compound effect of maximizing for return and minimizing cost is huge but the effort required, the frequency to do it and the individual incremental benefits are very small e.g. 1 month of 50 basis points even on a large deposit is not that much relative to monthly likely wage income in the many thousands.
Everyday financial management — Save, Spend and Invest
Even a consumer whether by sheer luck or brute effort has managed to consolidate and optimize their financial lives in each category it does not mean they are optimized to achieve financial stability overall.
They might have the best credit card for them (e.g. Chase Sapphire), the highest saving rate with the most flexibility (e.g. Wealthfront) and the lowest cost diversified investment (e.g. Vanguard). But if these are not managed holistically they are still not maximizing their potential to reach financial stability.
The fastest and most reliable route to financial stability is to manage everyday financial management — saving, spending and investing, in a dynamic, consistent and sustained basis. This is already a huge challenge given the effort required to switch and the fragmenting of most people’s financial lives. It’s made more challenging by the radically different psychology behind spending and saving and investing.
Most US adults spend every day either through necessity or desire. It’s easy and ubiquitous with an almost infinite number of ways to spend money 24 hours a day. The payoff is also immediate, no deferred satisfaction with that morning latte.
Saving and investing, by contrast, is complex, hard, requires work and the payoff is an almost imaginable distance in the future — for a 30-year-old man potentially 35 years in the future — longer than they have been alive.
Whilst people are very bad on the whole at doing repetitive boring tasks technology is very good at it. The application of innovation in product design and technology can radically alter the equation of effort vs reward in maximizing the return of everyday financial management for millions of consumers. Helping maximize their probability of achieving financial security and the reducing time in which to do so.
So, what if it works?
The first Fintech that manages to successfully help those with unintentionally complex, fragmented and poorly performing financial lives will be well placed to thrive and grow, helping more people as it scales.
This would be a direct threat to the hegemony of established banks — banks with vast marketing resources, huge technology teams, experience and capabilities.
The challenges of implementing digital innovation within a traditional financial services company are well known and widely documented. Even for those who can achieve this a significant additional barrier will be cannibalization, for a top 10 bank with 50–100m customers creating a competing service line which offers better economics for consumers but worse for themselves is a major internal hurdle to overcome, requiring the agreement of their shareholders, the classic Innovators Dilemma.
A second front of competition might naturally assume to come from the current Challenger Banks, many of which are now carrying significant capital raises based on Unicorn+ valuations. It’s hard but not impossible to pivot a brand, product and business plan from being a mass-market subprime focus to include more affluent audiences.
The hurdle for these established Challenger models will be as much around how they justify their valuations and keep their funders satisfied of their worth. For most they are using gross account acquisition as the KPI most indicative of success — its known revenues are low and costs high — $100–200 CAC is not unusual. No minimum deposits and the most inclusive possible account qualification ensure that these numbers of account acquisition are high.
Adopting a dual-stream approach — simultaneously driving open and qualified/premium account strategies will bring more operational complexity, possibly confuse the brand as well as increase costs. It carries a risk that account opening KPI will be repressed as premium accounts will by definition carry a far lower volume.
That is not to say that Challenger Brands will never work their way up the value chain, it’s the basis of the classic “S” curve of disruptive innovation. If it happens, it won’t be soon though.