Monthly Research
& Market Commentary

Jaws 2018 – The Digerati Bite the Banks

21st Century / 17 Jul 2017 / By Bill Murray

The great fish moved silently through the night water …

The digerati are taking bites out of the banking sector offering business loans, credit and savings products to the under-banked.  Amazon Cash allows users to deposit to their balance by showing a barcode when paying cash in at bricks-and-mortar checkout locations in the US, so they can shop at Amazon without a bank card.  Amazon Loans offers its online sellers loans to cover working capital at rates that are typically less than for a credit card.  Amazon Reload now has features that challenge credit cards.  Amazon is offering Finance-as-a-Feature.

This rapidly growing phenomenon of ‘techbanking’, where eCommerce giants provide financial services, was born of three effects.  First, the financial crisis, which had an adverse impact on trust in the banking system.  Second, the spread of mobile devices, which reduced the advantages of physical distribution that banks previously enjoyed.  Third, the demographic shift to millennials, who are more open than the older generation to financial services from non-traditional financial services firms.

Established banks make small or negative margins on serving most small businesses, so they cherry-pick customers, creating an under-banked market.  Now sophisticated analytics is mainstream, lending and payment opportunities are moving to the firms that have the best data on customers.  That used to be banks, but now it is eCommerce companies like Amazon, Alibaba and PayPal, whose payment processing capabilities can underpin techbanking.  Their customer data is more relevant, granular and timely.  They can see minute-by-minute metrics, cash flows, shipping profiles, product accuracy and customer satisfaction.  Best of all, clients who have credit lines with these firms spend more than those who don’t, so even low-margin techbanking is worth it.

Amazon Business goes further.  It offers companies VAT-free pricing, VAT invoices plus reporting and analytics to track, approve and limit spending.  It will even provide a broad range of business supplies and free one-day delivery on orders of £30 or more.  The rich data these services generate gives Amazon even deeper insights into a customer’s creditworthiness, so it can construct a profitable, durable loan book healthier than that of a bank.

So, a LOT more customer information will pass through Amazon than any bank.

“That’s a 20 footer.”
“25!  And three tons of him!”

The digerati are eating into the traditional banking market at a scale any fintech organization would die for.  Net interest income constitutes the majority of revenues in the banking sector, and this is where Amazon and Alibaba stand out compared to their tech counterparts.  Amazon Loans has enabled SMEs to grow sales by an estimated $4 billion having lent out $1 billion in small loans in the past year.  More than 20,000 small businesses have received a loan and more than half of those have taken a second loan from the company.  Loans range from $1,000 to $750,000 with interest rates between 6 and 14 percent.  Amazon Payments, with 33 million users in 170 countries, is catching up to credit cards and PayPal and is already ahead of Apple Pay, Google Wallet and the rest.  Patents indicate that Amazon is thinking about the future of payments in terms of facial identity and selfies as a means of quickly paying.  Payments is an efficiently served market, but not to a challenger with Amazon’s superior levels of efficiency, product integration and customer engagement.

Asian digerati are far ahead of Amazon.  Ant Financial, the finance arm of Alibaba (and formerly known as Alipay), is valued at around $60 billion.  It offers payments, personal lending, banking products, savings products, and peer-to-peer lending.  It also owns 30 percent of MYbank, the two-year-old Chinese online lender that already has 3.5 million small-business customers.

Alibaba’s four year old Yu’e Bao fund, a repository for leftover cash from online spending, is the world’s largest, with $165.6bn under management.  Alibaba’s Ant Financial moved into fund management when it spotted the growing piles of cash in its customer’s accounts that are used to pay for everything from coffee to taxis to fridges.  By sweeping the money into a money market fund, Ant Financial is able to offer a return on surplus funds better than the banks.  Customers have responded by taking their money out of bank accounts and placing it in their Alipay digital wallets.

“What kind of a shark did you say it was?”
“Carcharodon carcharias.  A great white!”

The digerati providing tech banking have some advantages over conventional banks:

  • They can acquire customers more quickly and less expensively by cross-selling financial services to existing eCommerce customers (who tend to rate them more highly than banks), enabling their financial lines of business to grow with decreasing customer-acquisition costs and increasing gross margins. 
  • Their cost-to-serve can be up to four percent less than banks because they have little or no physical distribution costs.
  • The more advanced analytics of these technology companies, plus their superior views of customer data, enable them to understand customer needs better and predict ‘next best actions’.
  • They can focus on specific propositions for small businesses and millennials, addressing those segments’ sensitivity to cost and familiarity with remote financial services. 
  • They can leverage their existing infrastructure – some digerati fintech firms can offer administration support via Software-as-a-Service tools developed internally, or provide cheap business supplies from their other B2B partners.
  • Their IT organizations are 21st Century IT organizations; much better at analyzing customer behaviour and faster at releasing new and evolved services.

Crucially, they know they do not need to be ‘banks’ to steal the ‘banking relationship’ of their customers.  These tech firms are now serious financial services businesses.  They are looking more and more like banks, but they are not banks.  Yet. 

“Boys, oh boys!  I think he’s come back for his noon feeding.”

What if the techbankers want to take a giant bite out of the market?  Should they buy a bank?  They could then offer full banking services to all of the retailers and consumers in their ecosystems.  They would be buying a customer base that could bring a significant credit card portfolio.  Owning more of the card payment’s value chain would provide them with an opportunity for cost reduction and even more data about customer behaviour – a vertical integration play in card payments.  They would also get the capability to manage the deposit base they have already accumulated.

And, crucially, it may be the fastest way to address the biggest blocker to becoming a bank: getting a banking licence.

“This fish doesn't run from anything.  He doesn't fear.”

Banks have significant advantages over would-be competitors.  A bank is highly regulated; it holds a grip on credit issuance and risk taking; banks are by far the biggest repository for deposits (which customers still mostly identify with their primary financial relationship); they are still the gateways to the world’s largest payment systems; and they still attract the bulk of requests for credit.

But what digerati such as Amazon and Alibaba have that banks do not are ‘flywheels’ like Amazon Prime with its 66 million members.  This is a cross-selling machine, powered by network effects, made even stronger through the application of machine learning.  Prime subscribers spend at least three times as much as non-Prime shoppers.  If it chose to do so, Amazon could make huge inroads into the consumer banking market by adding no-frills banking and payment services to Amazon Prime.  How long before they help business and consumer account holders manage their money once it is in Amazon?

You knew it was dangerous, but you let people go swimming anyway

The techbankers and their ilk are 21st century organizations.  As Dave Aron says, “They know how to win in a digital world”.  So, if you’re a bank with legacy loan books, branch networks and systems, how do you win in their 21st century digital world?  You’ve done your analysis.  You’re going to build and buy fintechs and disrupt yourselves?

Stop.  You might harm yourself.  If you understand the real landscape, or Wardley Value Map, of your customers, systems, processes, data, ecosystems and relationships, you may be able to outmanoeuvre the techbankers with your existing assets alongside advanced digital capabilities from the ecosystems you did not know you had.  Product innovation, technology innovation, relationship change, incubate, partner, venture, acquire.  These are all possibilities, but only a value map will tease out the valuable, durable, affordable combinations … quickly and economically.

There are two ways to deal with this problem:  you're either going to kill this animal or you're gonna cut off its food supply.  Which one?


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