OBSERVATIONS FROM THE FINTECH SNARK TANK
2021: The Year of Value Chain Disruption
I’ve never been a big fan of “Year of the [fill-in-the-blank]” proclamations. Google the term “year of the customer” and you’ll find that every year for the past 15 years has been heralded as the year of the customer.
Hey, one year it might just really happen.
And past claims of “disruption” in financial services have centered on changes at the customer interaction level—i.e., digital account applications, user interfaces, etc.
That didn’t really result in much true disruption because there is a whole value chain of activities that occur leading up to the point of customer interaction—and little of that has changed to date.
Changes (or disruptions) to the value chain have certainly been in the works for a while now, but 2021 is going to shine a much brighter spotlight on those activities—making 2021 the year of value chain disruption in banking and fintech.
Click here for the list of the Hottest Technologies in Banking for 2021
#1: The Battle For Small Business Moves Up (and Down) the Value Chain
2020 saw three important developments in the battle for small business relationships:
1) PPP loans. The Paycheck Protection Program was important because it enabled many mid-size and small banks and credit unions to lend to small businesses overlooked or turned away by the bigger banks where those small businesses hold their deposit accounts.
2) Goldman Sachs/Amazon partnership. Amazon finally cracked open the door to third parties to directly lend to the platform’s merchants. It’s an important move because Amazon issued $1 billion in merchant cash advances to its merchants a couple of years ago.
3) Stripe’s announcement of Stripe Treasury. According to Stripe’s press release:
“Stripe Treasury will enable platforms like Shopify to offer merchants access to financial products. Platforms can offer users interest-earning accounts eligible for FDIC insurance and enable customers to have near-instant access to revenue earned through Stripe, and then: 1) spend it directly from their balance with a dedicated card, 2) transfer it via ACH or wire transfer, or 3) pay bills.”
Development #1 was important for many mid-sized financial institutions because it gave them direct access to a new set of potential customers. But to the extent that the small businesses involved are Amazon merchants or Stripe customers, that direct connection is meaningless.
Amazon’s and Stripe’s ability to embed banking services (deposit accounts and loans) into their existing services gives those firms (and their partners) a major advantage because they have ongoing access to data about those merchants and a near-zero cost of acquisition for those products.
Game over? Not quite.
From a small business value chain perspective, Amazon, Stripe, and even Square
Activities at the beginning of the value chain—production, inventory management, payroll, etc.—and after payments in the value chain like invoicing, accounts receivable, etc., are often invisible to Amazon, Stripe, and Square.
In addition, according to a study of small businesses by Cornerstone Advisors, small businesses accept, on average, 11 forms of payment—most of which are not supplied by Stripe or Square.
According to Cornerstone’s study, small businesses spend more than $500 billion on accounting/bookkeeping, invoicing, bill payment and payment acceptance services from third-party providers.
Many of these small businesses would consider obtaining accounting and payments services from a bank—as would many that don’t currently use third-party services and, instead, incur internal expenses for their accounting and payments functions.
To compete with Amazon, Stripe, and Square, financial institutions must be embedded into small businesses’ value chains.
Two fintech firms provide ways to do that:
1) Autobooks provides a turnkey service for financial institutions to white-label small accounting, invoicing, bill payment, and payment acceptance systems for small businesses.
2) Nav partners with retail POS (e.g., Fiserv’s Clover) and accounting systems that enable its partners to identify lending opportunities and access data about small businesses to make lending decisions.
#2 Payroll Fintech (Finally) Gets Some Attention
To date, the battle for consumers’ money has centered on payments—either in the form of the spending account (e.g., challenger banks) or the payment itself (e.g., P2P, mobile payments).
This battle, too, is going to move up the value chain to the point of payroll.
WhiteSight defines four categories in the payroll fintech space:
1) Salary On-demand. Fintechs in this category partner with corporations, HR software providers, and payroll systems to enable flexible access to earned wages.
2) Salary Advance. Fintechs in this category provide short-term credit to employees based on their salary and avoid the exorbitant rates charged by payday lenders.
3) Early Direct Deposit. This feature, largely provided by challenger banks, enables account holders to receive paychecks up to two days in advance from standard payday.
4) Crypto Payroll. This is the newest category which enables firms to make wage payments through multiple crypto-currencies.
Personally, I don’t think early direct deposit counts as “payroll tech” because the service is really a risk management decision—not a technology offering.
Advocates of payroll fintech often talk about these services from a financial wellness perspective, but, analogous to the small business battle, payroll fintech is really a battle to move up the deposits and payments value chain.
Payroll fintech firms offer the banks and fintechs an ability to redirect paychecks away from incumbents’ checking accounts (i.e., deposit displacement) and provide payment and lending services.
Large payroll providers like ADP have been struggling for years to broaden their relationships with the consumers who receive paychecks from them. I’m surprised that the Big Tech firms haven’t acquired one of the payroll providers yet.
Expect payroll fintech to get more attention in 2021—although a lot of the discussion will be couched in wellness terms. Don’t let that fool you.
As Anish Acharya, Seema Amble, and Rex Salisbury write in a blog post titled The Promise of Payroll APIs, the promises include: 1) Income and employment verification; 2) Direct deposit switching; 3) Payroll-attached lending; and 4) B2B HR and payroll access.
Payroll is the new battleground in 2021.
#3 Financial Health Gets Political
Speaking of wellness, “year of financial health” is to banking what “year of the customer” is to marketing.
Each year, financial health advocates exhort the industry to focus on consumers’ financial health, relying, however, on nonsense like “half of Americans can’t cover a $400 emergency expense.”
Financial health is going to take center stage in 2021 for a few reasons that have nothing to do with what the advocates talk about:
- Banks (and credit unions) will up their virtue signaling to unbearable decibel levels. Fintechs have been telling us (inaccurately, in many cases) about how much they’re concerned about consumers’ financial health. Incumbents have paid lip service to it, but with a new administration occupying the White House (probably), demonstrating their social conscience and contribution—to more than just low income consumers—will be a top priority for incumbents.
- Financial health scores are emerging. The topic of financial health is often dominated by discussions of financial literacy—which is virtually useless (not enough room here to explain why). Quantifying financial health has been a challenge because self-reported measures are unreliable. But some companies—like Financial Health Network and MX—have developed robust financial health scores that rely on actual account data.
- Financial health will be regulated. Look for the new administration to require banks to monitor and improve their customers’ level of financial health. What could this look like? Todd Baker and Corey Stone recently proposed some ideas. The first of their three-stage proposal would require providers to “make available to regulators data that regulators can use to analyze and measure changes in customer financial health.”
The combination of these three factors will spur innovation in the fintech community to build financial health platforms.
#4 Fintech-as-a-Service Platforms Emerge
And speaking of platforms…
There’s a supply and demand imbalance in the market today. Lots of fintechs want to partner with banks—but few banks are equipped to partner with the fintechs.
Enter fintech-as-a-service platforms.
Fintech-as-a-service isn’t a new term, but when I’ve seen it used, it’s usually by a fintech talking about how they can use an API to integrate their service into incumbents or other fintechs.
But that’s not a fintech-as-a-service platform.
Banking-as-a-service has become a popular term (and service) and refers to enabling a company—usually a platform—to embed banking services into their offerings.
But what about the hundreds of mid-sized banks and credit unions who want to partner with fintechs?
The path is difficult—resources to develop partnerships are limited, integrating into the core is a massive job, and developing other approaches from scrap is time-consuming.
Companies like Moov, Unit, and Synctera will enable banks to provide a range of services—e.g., ACH processing, transaction processing—to fintechs in a more modular way.
The result: Banks will find it easier and—more importantly—faster to partner with fintechs.
#5 Banks Step Up Fintech-Powered Core Workarounds
And speaking of the hassles of core integration…
A lot of bank and credit union CEOs think the biggest barrier to innovation is their core system. Hardly any, however, are planning to replace their core—too painful, slow, and expensive.
Finding core systems workarounds isn’t new. According to Cornerstone Advisors partner Quintin Sykes:
“There are banks and credit unions comfortable with integration with best-of-breed solutions that pursue this strategy. I call it ‘turning the core into a glorified adding machine.’ It’s a viable approach for institutions good at—and comfortable with— integration and managing a lot of vendors.”
What about those that aren’t? While a number of fintechs have emerged over the past few years to help financial institutions execute on this strategy, expect 2021 to see strong demand for three types of fintech providers in particular:
- Core integration providers. Companies like Constellation, Sherpa Technologies, and Sandbox Banking have been offering core integration platforms for the past few years enabling banks and credit unions to better integrate with—but potentially migrate away from—their core systems.
- Payment hubs. Fintechs like Payrailz and Finzly (which recently won two best-of-show awards at Finovate) not only enable financial institutions to intelligently route payments to the optimal payment mechanism, but allow them to offload transactions from core processing.
- Digital cores. Companies like Finxact, Q2, and NYMBUS have been helping financial institutions deploy digital banks. For some of these institutions, these are weak attempts to recreate the success of some of the challenger banks. The smart ones, however, recognize that the digital cores are good ways to create and deploy new products and services that would take years if they tried to do it with their existing core system.
Core workarounds may not be new, but in some respects, they are—like the first two trends—disruption of the value chain. In this case, banks’ and credit unions’ technology value chains.
Overall, however, this is going to be the banking and fintech story for 2021: The disruption of the value chain.