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In my last piece, I shared some high-level thoughts on the financial technology (“fintech”) industry and what its increasing relevance means for traditional financial services. Beyond the fast-growing digital payments space, I identified two broad categories of fintech “disruptors” that will present opportunities going forward:
How legacy financial services players (particularly banks) tap into the new infrastructure providers and respond to competitive threats from the emerging set of product companies will go a long way toward determining their fate long term.
For the entire modern history of banking, there were “rails” that moved money (or messages about money) and customers that were trying to solve a financial problem. In between those two layers, banks did pretty much all of the problem-solving facilitation. The products banks sold sat on top of a vast, complex orchestration of technology infrastructure and business processes.
Modern technology, namely cloud computing and the proliferation of application programming interfaces (APIs), has enabled the “unbundling” of this complex orchestration:
This modularization of the various components enables new modes of competition for existing services along the product layer in the above scheme. New infrastructure technology allows for the delivery of high-quality service to these new product fintechs, as well as new offerings to other types of companies that otherwise would have difficulty connecting into the bank technology environment.
My last piece highlighted the massive amounts of venture capital pouring into the fintech market over the past year or so. Product and infrastructure fintechs have been recipients of much of this funding because:
The modularization of bank architecture presents challenges to incumbent industry leaders (i.e., banks):
“Can the incumbent get product innovation faster than the startup gets distribution?” is an old tech adage that seems appropriate here. Fintechs clearly pose a challenge to traditional banks, but not every incumbent is doomed. It will be hard for many fintechs to acquire customers at favorable enough unit economics to survive long term. Some of them are selling features (not products), and the addressable markets may not be as large as envisioned for some standalone products. And while the pace of fintech innovation is accelerating, not all of these companies are super impressive; some will fail.
While banks as a group probably have more to lose than gain, those that adapt and embrace fintech (particularly infrastructure companies) could be net beneficiaries. Fintech is ultimately not a zero-sum game for incumbent banks. At a minimum though, these new fintechs are forcing legacy players to up their game and reconsider their business strategy, including the products they offer and how those products are designed and delivered to customers.