Amidst all the excitement and sometimes overinflation of financial technology startups’ disruptive potential, entrepreneurs often can't zoom out a bit out and see a bigger picture. While it is understandable when your startup rapidly gains traction and there are no visible barriers, yet the market is not infinitely stretchable. At some point, a strategic decision will be required and every entrepreneur will have to find an answer to the important question: what's the endgame?
The answer highly depends on the niche and AI startups that most likely have a different life cycle and final destination than, for example, RegTech startups. The different results of startups’ years of work depends on the role and place of that work in the general ecosystem.
Let's roughly divide startups into two big categories – an element and a unit:
- the ones whose product is an element in other companies' infrastructure (like AI startups, big data analytics startups, banking technology startups, open-source platforms, machine learning startups, authentication startups, fraud detection software, etc.), and,
- the ones that can be considered a fairly independent unit (companies dealing with customers directly and offering proprietary services, like InsurTech startups, RegTech startups, remittance services, licensed challenger banks, etc.).
The first set of companies tends to be on the back end – they are on the technology side of any business. Meanwhile, the second set is a service-oriented company working on advanced technology (possibly offered by the first set or in-house built).
To be fair, further inclination towards ‘element’ startups does not take into account industry giants such as Alipay, WeChat, ZhongAn and other truly massive and powerful non-traditional Asian players. Their success carries different hallmarks due to specifics of the region they have been growing in and other factors as well.
When a startup is an element of core infrastructure
Startups that offer products enhancing institutional infrastructure are probably the ones having the best chances for success on their own in the market because they are not really competing with the most powerful players. Instead, they are helping the existing ecosystem to evolve, to boost operational efficiency, cut the costs and better serve customers.
Those startups are especially ‘dangerous’ for the rest of the startup ecosystem when they are acqui-hired by institutional players because they become an Ace up that institutions’ sleeve against disruptors.
Blockcypher, a cloud-optimized blockchain platform powering cryptocurrency applications reliably and at scale, is another example. The company counts very interesting partners and clients among which are BitPesa, Volabit, BitX, Coinify, Coinprism and many others.
The AI startup ecosystem is an example in itself. Startups working on AI technology are multifunctional by nature because AI is a cross-industry and highly adjustable technology. Machine learning has no barriers and limitations in terms of application, which puts AI-focused startups in a sweet spot of cross-industry presence. The very same AI company can ‘teach’ its product to be helpful in the transportation industry, healthcare, education and a range of other industries.
Backbase Omnichannel Banking Platform is not a very sound name for casual consumers. It is a software company on a mission to help financial institutions create, manage, and optimize secure omnichannel customer interactions. The list of clients of Backbase is very impressive: Barclays, CheBanca!, Sberbank, Nationwide Bank, First Data, Westpac, Touch Bank, KeyBank, Intuit, Phillips, ABN AMRO Bank, Deutsche Bank, CertusBank and much more.
Temenos is worth mentioning, which counts such clients as Bank of Shanghai, UBS, Techcombank, Metro Bank, BlueShore Credit Union, Commercial Bank of Africa M-Shwari, EQ Bank and Equitas Microfinance among others.
The mentioned companies do not comprise a complete list but do provide an idea of their place and role in the financial services industry. These companies are seen as enablers for financial institutions and allow them to operate on a different level. Hence, financial institutions are extremely eager to invest in companies of that sort, enable their growth so that in return, they can help banks achieve higher performance in the future.
Among such examples are Ayasdi, which attracted financial attention of Credit Suisse and Citi, Digital Reasoning (Goldman Sachs, Credit Suisse, etc.), Digital Asset Holdings (Goldman Sachs, JPMorgan, Citi, BNP Paribas, Santander InnoVentures, IBM, etc.), Context Relevant (Goldman Sachs, Bank of America Merrill Lynch, etc.), Symphony (Bank of America Merrill Lynch, BNY Mellon, BlackRock, Citadel, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, Jefferies, JP Morgan, Maverick, Morgan Stanley, Nomura and Wells Fargo) and others.
When a startup is an independent unit
There are wealth management apps, licensed challenger banks, InsurTech startups competing against traditional industry leaders, RegTech startups, etc.; they are not looking to improve institutional infrastructure, but competing with elements of institutions’ value chains or even with institutions themselves.
Watson is ‘eating’ RegTech
Let's take an example of RegTech startups that in recent years were believed to become the next big thing and revolutionize compliance. An interesting event happened recently that has been largely overlooked by professionals (except our MD, Amit Goel), but which does signify a very important process in motion. At the end of September, IBM acqui-hired Promontory’s 600 employees – many of whom are former government regulators – to bolster its artificial-intelligence program, known as Watson.
According to the official statement, Promontory will begin to accelerate IBM’s development and machine training of cognitive solutions for risk and compliance. This includes solutions for tracking constantly changing regulatory obligations, expectations and control requirements, as well as solutions that address specific compliance needs, such as financial risk modeling, surveillance, anti-money laundering (AML) and Know Your Customer (KYC). In addition, Promontory professionals will extend IBM’s consulting and services offerings to help clients dramatically reduce the cost of regulatory compliance.
“Promontory’s professionals will train Watson, which will learn by continuously ingesting regulatory information as it is created and through interaction in real-world applications,” IBM said in a statement.
And when Watson is smart enough to take over the RegTech business in a more efficient and cost-effective for clients, it will not leave much space for RegTech startups working to automate compliance.
Alternative lending will not be so alternative soon
Now, let's look at alternative lenders. There are companies like Prosper, Lending Club and LendUp, and there are companies like Viewpost. The first set of companies does not go hand in hand with banks (aside from fueling some of the loans with institutional money) and is considered to be dismembering banks value chain.
Prosper and Lending Club are some of the most remarkable alternative lenders stealing the deals, but a closer look would reveal that not everything is going smooth with an independent growth. Several months ago, Prosper has been reported to be slashing its workforce by 28%, joining rivals in signaling investors aren’t as eager to fund loans after years of rapid growth. As for Lending Club, the story has been molded a thousand times and does serve a sign of necessary changes in a free flight of alternative lenders' practices.
The second set of companies is choosing to merge efforts with FIs in mutually beneficial relationships – they have crossed that phase of independent growth and have decided to become a gear in banks' value chain and serve as a touchpoint between the banks’ funds and borrowers.
But that's a lucky case because banks have access to talent and enough funds to learn and implement technologies allowing them to step on FinTech’s turf. Like when Wells Fargo earlier this year was reported to launch a program to offer small businesses online loans in as soon as one day. The FastFlex program offers one-year loans of $10,000 to $35,000, with borrowers required to make weekly payments.
Banks are jumping into robo-advising
Wealth management apps and robo-advisors are on the same path, because despite their success and growth, they by no means can compete with traditional players. BofA, Morgan Stanley Wealth and JP Morgan altogether have $2.8 trillion AUM, while Betterment, Wealthfront and Personal Capital are happy with $7.6 billion. The most successful FinTech alternatives to institutional divisions are nowhere close to large players in terms of pure economics. They may be more advanced technologically, but that's a narrowing gap.
Bank of America Corp.’s Merrill Edge discount brokerage unit is one of the latest examples of a financial institution jumping into the fast-growing robo advisory business. The bank outlined plans for Merrill Edge Guided Investing, a new service meant to combine Merrill Edge’s online brokerage platform with Merrill Lynch’s human advisers’ wealth-management expertise. In starting its own robo service, Merrill is entering a market pioneered by startups including Betterment LLC and Wealthfront Inc. as a response to investors’ demand for low-cost advice in an era of low expected returns.
Payments are about to get very competitive for Venmo and PayPal
Apps like Venmo and PayPal have been long considered a benchmark of a seamless payment experience with banks always lagging in that regard. The industry, however, is about to see a makeover after the announcement that came out a couple of days ago.
Bank network operator Early Warning announced it has 19 US financial institutions signed up to a forthcoming payments network called Zelle, due for launch in early 2017.
As reported by Reuters, the consortium is taking a series of steps in its attempt to bring more than 100 million customers of banks and credit unions into Zelle without disrupting people who already use other ways to send money with phones and computers.
"This is about creating a wide, and inclusive, alternative to cash and checks for everyone," said Paul Finch, Chief Executive of the bank network operator, Early Warning Services, who was at the Money20/20 payments industry conference in Las Vegas to promote Zelle for its bank owners.
Yes, banks have relatively slow to present an answer to Venmo and the likes, giving them an opportunity for a head start. Nonetheless, it was only a matter of time when they come together to present something potentially more powerful since banks have larger bases of customers to connect as they try to make Zelle ubiquitous.
The above-mentioned niches are not exhaustive and there will certainly be more examples of situations when a bank can beat a service of a FinTech startup over time as it invests funds and learns about new opportunities. After all, with five largest banks controlling nearly $15 trillion, FinTech’s $12.4 billion in venture capital investment last year barely makes a dent. And even if there are successful FinTech startups reaching masses on their own, financial institutions do not stand in one place – they also evolve with help of technology startups that can enhance their operational efficiency.
A lot in the formal financial services is tied to a score and a financial footprint of a customer. Several years ago, it was one of the inhibitors of banks’ growth as they could not reach a massive un-/underbanked population. But startups offering new ways to identify and create a profile on previously invisible people have come into the scene and are creating opportunities for banks to step onto the ground where FinTech has previously been blooming alone.