The Fintechs Are Coming! The Fintechs Are Coming!

Welcome back for part II in this series on Michael Porter's Five Forces for community banking. This article will cover the second of five forces: the threat of new entrants. When I worked in consulting for Michael Porter, a question that often came up was “What is the difference between Force 2 (the threat of new entrants) and Force 3 (the threat of substitutes)?” The way I like to frame it is that a new entrant delivers substantially the same product in substantially the same way while a substitute achieves a similar result but it accomplishes that in a different way.

At the risk of treading into a religious war, I have a more concrete example: the Android phone and the Google Play marketplace is a new entrant following the iPhone, whereas the messenger app on your phone is actually a substitute for your old school pager. Android and Google Play mimic the product and delivery of the iPhone’s iTunes marketplace. The messenger app on your phone allows people to get in touch with you; however, the delivery of that service looks quite a bit different than the pager you used to clip to your belt.

The Threat of Traditional New Entrants is Rare….

Let’s look at how this plays out in the banking world. The community bank (and even a credit union) that opens up across the street is actually a new entrant. Don’t fall into the trap of considering a credit union a substitute rather than a new entrant; the truth is, both of those examples are offering the same products in the same way. Truth be told, traditional entrants are actually increasingly rare when we look at today’s competitive landscape. Despite the FDIC trying to make it easier for banks to open up, de novo banks have hit all-time lows; only 15 applications were approved in 2018 and just nine were approved in 2019.

...But, Banking is No Longer a Traditional World

By contrast, there is a rush of Direct-to-Consumer banking startups. We’ve seen a flurry of activity on the transaction accounts side with players like Chime, N26, Monzo, and Revolut. Dozens of others are serving more niche-focused markets where they think that there is a specific need that they can solve. Uber Cash facilitates a way to pay across all of Uber’s offerings while saving up to 5% when Uber Cash is purchased in advance. Honeyfi caters to couples with an app that helps couples save, pay down debt, and keep tabs on finances. Greenlight offers a debit card for kids with built-in controls for parents, enabling them to teach financial responsibility in a safe, secure way. Each of these is serving very specific segments. Community banks are well-advised to avoid writing off these startups as docile, non-competing entities.

Non-Banks are Stealing Your Customers

It’s easy to look at hyper-focused non-banks as a mere footnote in the competitive landscape. That’s a mistake. Consider the growth of the lending sector; LendingClub (now owner of a bank after the purchase of Radius Bank), OnDeck, and Prosper have quickly become household names. Those three are just the tip of the iceberg when you consider that there are hundreds, if not close to a thousand, other microlenders that are non-banking institutions. Each is siphoning off relevance, viability, and customers from traditional institutions.

Here’s where it gets interesting. The resounding chorus from community banks is

“Well, they're not stealing my customers.”

I’ve watched the denial unfold in some of my larger talks. I always ask “By show of hands, who here competes with Rocket Mortgage?” The response? A few, hesitant hands in an audience of hundreds raise up to say they compete with Rocket Mortgage.

Well, I can tell you somebody is competing with Rocket Mortgage because they are now the largest mortgage originator in the United States.

We see a similar attitude towards neobanks. Chime purports to have millions of customers. It’s easy to pick apart their definition of a “customer” versus an “account” or to look at whether those customers or accounts are active or inactive. Granular definitions aside, they are still growing by leaps and bounds. What are the implications if you’re a community bank? You probably aren't seeing a total loss of customers — at least at the moment. However, these new accounts are taking up mindshare, or a portion of an account, or behavior from your existing customers.

Death by a Thousand Cuts

Many community banks have blinders on to the way non-banks and neobanks are chiseling away at business. While community banks maintain vigilant guard against traditional new entrants, the fintech wolves in sheep’s clothing are picking off customers. Since the funneling of customers is more piecemeal, it draws less attention. In reality, community banks are bleeding customers. It may be a slow bleed, but death by a thousand cuts is still death.

What does it look like? It looks like one of your customers who frequents the EU opening an account with N26, leveraging it as a specialized transaction account for travel. It looks like another one of your customers — a mom of three — opening a Greenlight account to easily manage her kids’ allowance and spending. It looks like two of your recently engaged customers opening a honeyfi or honeydue account to seamlessly marry their finances. It looks like one of your technologically-curious employees reading about Chime’s use of AI for predictive personalization and finding it so effective they end up signing up for an account, even if just for a subset of spending.

The examples above are a handful of customers that are looking for unique and personalized solutions to very specific needs. It’s not enough to create a large dent in community bank or credit union business at this moment in time — but it is changing expectations. These non-traditional new entrants are changing user expectations around the experience of banking. Rocket Mortgage has dramatically impacted the expectation around how quickly a customer can get a mortgage and what decisioning looks like. Online lenders can do pre-approvals within a span of minutes and finalize approvals in days while banks are still proud of their ability to finalize loan approvals in weeks. Here’s the kicker: customers are willing to pay a premium for the faster, more personalized service.

A Rocket Mortgage customer pays, on average, 35 basis points more than she would for a mortgage through another institution. They’ve wrapped up convenience with a pretty pink bow and customers are chomping at the bit to pay more for that experience. A person buying a home is more than willing to shoulder that incremental cost (which is bundled and spread over the long-term) rather than trudging through the mountains of paperwork and delays that often accompany the traditional lending experience. What Rocket Mortgage understands is that a customer isn’t looking to get a mortgage; they are looking to get settled in their new home as quickly as possible while enjoying some degree of certainty in the process on the way there.

It’s a similar value proposition for small business owners looking for a small business loan. If the customer is playing by bank rules, they have to find (scarce) free time away from running their business to head into a branch and fill out a loan application. It would not be unheard of for that hypothetical small business customer to pay a higher cost (considering how highly they value their time) for a more relevant, convenient loan experience.

Time and convenience are big factors, but capabilities and features are making a dent, too. Customers relish the small things, like the ability to turn a debit card on and off or being able to categorize and track spend. Take Venmo, for example, which allows users to share transactions socially as a part of the base functionality. Niche fintechs are baking these features into core functionality, enticing customers with convenience and all of the “small things” they crave in a financial services provider.

Obviously, cost matters. Non-traditional new entrants have put a kink in traditional cost structures, changing customer expectations here, too. Robinhood managed to drive trading costs down with zero trading fees and commissions. Betterment and Wealthfront dramatically lowered the cost of tailored wealth management services. Even the costs associated with transaction accounts are shifting; TransferWise and Currencycloud are able to efficiently manage foreign exchange costs, passing those savings on to customers.

It’s easy to look at each of these examples individually and say “That doesn’t impact me today.” And that might be true...today. Tim Ramza of Liveoak Technologies (disclosure: they are a personal investment of mine and I'm a big fan) says it best with his analogy to global warming. If you think about global warming today, it’s easy to say that the oceans rising one-sixteenth of an inch is not really a big deal. When you zoom out, however, and consider exactly how much water one-sixteenth of an inch entails across global waters, suddenly you’re facing a much bigger problem.

It’s tempting for some to look at that significance and shrug it off. It’s still “that iceberg over there” that’s melting. But when it’s your iceberg that starts to melt — or is on the verge of completely disappearing — it suddenly becomes a lot more relevant. This is the nature of global warming and the transformation of the competitive landscape. The shift takes place very slowly at first, but with time, it builds to a precipitous change that can be shocking for the unprepared.

Stay tuned. My next article will cover Porter’s third of the Five forces: the threat of substitutes. That article will focus less on fintech startups and other direct competitors and more on the subversive players that are materializing in the market in a unique way. These insidious threats often start out as non-competitors but may begin to morph into true competition over time.