The Origins of Disruptive Innovation

While it is commonly believed that FinTech startups represent a substantial threat (or an opportunity?) to traditional financial institutions, the details on the inside story of FinTech are often lost in the hype. Not all financial technology startups are born equal and can even be considered disruptive.

What is disruptive innovation at all?

Probably one of the best explanations of disruptive innovation has been given by Clayton M. Christensen with two of his colleagues in the article What is disruptive innovation?:

‘Disruption’ describes a process whereby a smaller company with fewer resources is able to successfully challenge established incumbent businesses. Specifically, as incumbents focus on improving their products and services for their most demanding (and usually most profitable) customers, they exceed the needs of some segments and ignore the needs of others. Entrants that prove disruptive begin by successfully targeting those overlooked segments, gaining a foothold by delivering more-suitable functionality—frequently at a lower price.

After reserving a strong position among overlooked by incumbents segments, disruptive startups move towards serving the audience targeted by incumbents. And because incumbents do not see a threat in startups that don't target their primary audience at the entrance, they tend to postpone the responsive strategy.

At that moment, however, startups have already validated the idea in overlooked segments and can take up on the primary audiences with higher chances of success. That's when the threat becomes real and incumbents start evaluating the competitor. When mainstream customers start adopting the entrants’ offerings in volume, disruption has occurred.

How does the disruptive innovation occur?

As Christensen and his colleagues suggest, there are two types of markets that make disruptive innovation possible in the first place: low-end & new markets.

Low-end footholds exist because incumbents typically try to provide their most profitable and demanding customers with ever-improving products and services, and they pay less attention to less-demanding customers. <...> This opens the door to a disrupter focused (at first) on providing those low-end customers with a ‘good enough’ product.

As for the second foundation for disruptors, the new-market foothold, disrupters create a market where none existed. Put simply, they find a way to turn non-consumers into consumers. (Some call it financial inclusion.)

There are other hallmarks of what can be considered disruptive innovation, emphasized by Christensen: disruptive innovations don’t catch on with mainstream customers until quality catches up to their standards; disrupters often build business models that are very different from those of incumbents and more.

Are banks turning disruptive innovation into supportive to kill the threat?

The modern FinTech ecosystem cultivates the feeling of a disruptive force across industries and a threat to banks’ revenues. However, some would argue with that, fairly noticing that a large portion of FinTech startups seeks to optimize banks operations. In fact, some estimates suggest that in 2015, 44% of FinTech investments-funded solutions sought to partner with incumbents in reducing costs, managing risk and expanding in new digital businesses (these accounted for just 29% percent of investments in 2014).

The beautiful friendships emerging between banks and FinTech may, at the end, not be as much a desire to improve services for end-users, as to turn disruptive innovation into supportive – the one that would increase the internal efficiency of incumbents instead of stealing their business.

Given that the largest FinTech investors are banks, the idea doesn’t seem to be far from reality. Add to that the fact that banks comprise the foundation of FinTech growth and development with numerous labs, accelerators, incubators, and the ecosystem would appear to be in a perfect balance where traditional players found a way to turn a threat into an opportunity.