How disruptive is today’s FinTech?

Over many years, the financial services industry could not be changed. While many businesses were disrupted in and since the dot-com bubble, finance stayed the same. But one may ask, if today’s FinTech players are different.

Financial services have been one of the industries that are most resident to change. Most banking products have been around for centuries and even when many businesses such as retail where disrupted by tech players, the banking industry has not changed much. 

According to McKinsey, in the eight year long period between the Netscape IPO and PayPal being acquired by eBay, more than 450 companies tried to attack the business models of financial service providers – with online currencies, wallets and many more. Only five of those firms survived as standalone entities. This history shows us one thing: Trying to disrupt banking is tough.

This resistant may now break. More and more companies enter the space of financial technology. While their number amounted to 800 in April 2015, says McKinsey in their article “Cutting through the noise around financial technology”, their number has grown to 2000. Those companies are supported heavily by investors. Globally, nearly $23 billion of venture capital and growth equity have been invested during the past five years.

One may ask now, whether the new FinTech players are just another hype or have the power to actually disrupt the financial industry. Answering the questions, if it is different this time, McKinsey says that “in many ways, the answer is no. But in some fundamental ways, the answer is yes. History is not repeating itself, but it is rhyming.”

On the banks score card remains, that due to their unique and systemically importance to the economy, they are highly regulated. They hold the monopoly on credit issuance and risk taking, are responsible for deposits and they are the gateway to the payment system. Most customers still prefer traditional banks over new start-ups.

Still, trust in the banking system has decreased significantly during the financial crisis. Moreover, new forms of distribution make the existing branch system obsolete. Those new systems are backed up by increasingly available computer systems that decrease development and operational costs, increase the speed of development and ease the scaling process. Finally, the demographics have changed. Many more consumers are now able to access the internet and are used to digital technologies.

Although the failure rate of financial technology companies is still likely to be high, some companies will be able to be successful on the retail market, says McKinsey, and build sustainable business cases. The report outlines that by 2025, 10 to 40 percent of bank revenues, depending on the banks business areas, could be at risk by 2025. New entrants will probably lower prices and margins in the industry.

Both, incumbent and entrants have distinctive assets: While established players have a customer base already, entrants may find it difficult to acquire customers cost-effectively. With scale, gross margins are likely to increase while acquisition costs decease - a key advantage of an established customer base.
FinTechs on the other hand have the advantage of lower costs. According to McKinsey, they can offer their services 400 basis points cheaper. This advantage comes for their digital infrastructure that does not rely on a branch model. Passing this advantage on to customer gives them an advantage when acquiring customers.

According to the report, both types of players can survive: For FinTech companies, advanced models for customer acquisition, lowering costs to serve customers, innovative data usage, segment-specific value propositions, partnering up and using existing infrastructure as well as managing risk and regulation are key success factors.
Banks on the other hand need to become more digital to compete. They need to use data-driven insights and analytics, improve their customer experience, build digital-marketing capabilities, counter cost-disadvantages through digitalisation and simplification, embrace and deploy new technologies such as cloud and mobile and need to rethink their organisational structures.