Despite fintech’s rise over the past couple of decades, legacy banks still handle the majority of financial transactions worldwide. Yet legacy banks face a number of shortcomings and challenges of their own.
For a fintech startup, competing with legacy institutions isn’t a matter of having more money. Rather, it’s a matter of understanding the opportunities and challenges available and then responding effectively.
The State of Digital-First Banking
Much of the conversations around fintech-bank competition focuses on the need for established banks to compete or cooperate with these companies, not the other way around. A common prevailing view is that it is fintech companies who have the competitive advantage.
Where Are Customers Going?
“Fintech’s place in the public consciousness has really taken off in the past three years,” writes finance expert Alex Graham. Fintech startups have technological knowledge, regulatory flexibility and customer interest that legacy banks may lack.
While interest is increasing, however, adoption of digital-first or digital-only banking has been slow among consumers. More than a decade after the first digital banking options became available in the U.S., only 3 percent of millennials house their primary checking accounts in a digital bank, writes Ron Shevlin, managing director of fintech research at Cornerstone Advisors. For older generations, the percentages are even lower.
“In contrast, more than four in 10 Millennials have their primary checking accounts at just three banks--Bank of America, JPMorgan Chase, and Wells Fargo,” Shevlin writes.
Finding the Funds to Survive
Meanwhile, the COVID-19 pandemic dealt a blow to fintech funding.
Between December 2019 and May 2020, global venture capital funding dropped 20 percent across all ventures, Dean Takahashi writes at VentureBeat. A March 2020 survey of fintech startups found that more than 40 percent of respondents said their startup didn’t have the funding to survive past June 2020; about two-thirds couldn’t make it till September 2020.
These numbers indicate that “now may be the most opportune time for banks and fintechs to address their respective weaknesses through greater collaboration,” writes Paul Schaus, CEO of CCG Catalyst. Fintech companies can benefit from access to banks’ customer relationships, while banks can benefit from fintech companies’ agility.
Opportunities and Challenges for Fintech Startups
Both fintech startups and legacy banks have certain strengths and weaknesses. Within this terrain lie several opportunities — and challenges, as well.
A fintech startup with a lean budget faces certain challenges. Yet a lean budget requires these companies to prioritize and plan before building and launching digital offerings, potentially placing them at a competitive advantage.
Many legacy banks have IT budgets that dwarf the budgets of fintech startups. This money, however, has not resulted in legacy leadership in the tech innovation sphere. Rather, “the lion’s share is spent on the maintenance of existing legacy systems,” writes Christian Hugo Hoffmann, assistant professor for finance, cryptocurrencies and fintech at the University of Liechtenstein.
“It’s often not the lack of smart and driven people or initiatives that hold traditional banks back,” writes Adrian Klee, a partner at Ross Republic. “It’s the legacy IT systems.”
Fintech startups do not have decades-old legacy systems to maintain. Neither do they tend to have the same loyalty to tradition that established banks have, Hoffmannn writes. As a result, these organizations are able to spend what funds they do have on the development of new technologies and systems, rather than on keeping old systems on life support.
Choosing the Right Audience
Changes in customer lifestyles and expectations are placing pressure on legacy banks to offer seamless, always-available digital service. Yet some of these changes also weigh in favor of legacy banks.
The unique demands of the gig economy, coupled with increasing student loan debt, mean that many consumers have more complex financial lives and needs than previous generations had, writes Veronique Bergeron, director of verbal identity at FutureBrand.
Legacy banks have been developing a lifetime big-picture view of banking customers for centuries. Fintech startups, however, may struggle to understand the same perspective.
“If there’s one metric that’s often overlooked in the pitch decks we see for early-stage fintech companies, it’s customer lifetime growth,” writes Amee Parbhoo, director of investments at Accion Venture Lab. Focusing too heavily on customer acquisition can drive fintech startups to neglect customer retention, despite the fact that customers are often more expensive to acquire than to retain.
Since dealing with individual customers comes with major challenges, many fintech companies have pivoted to working with established banks, rather than attempting to compete with these banks for customers. “It is not rare for a fintech business with a business-to-consumer model to transfer completely to a business-to-business approach,” writes Julija Andjelic at Fortunly. Making this transition allows fintech companies to access a larger, more robust customer base.
Growing Through 2021 and Beyond
The biggest challenge for lean fintech startups in the near future may not come from legacy banks. Rather, it may come from tech giants like Apple, Amazon and Uber, writes Andy Chan, cofounder of Hubblic.
“With a volume of users the same size as some countries’ populations, these companies are poised to entrap consumers even further into their own ecosystem” through fintech, Chan writes. Companies like Google and Amazon, for example, are exploring ways to offer digital checking accounts to users. Facebook’s money-transfer app, Facebook Pay, competes alongside companies like PayPal and Venmo.
Fintech startups and legacy banks may find value in uniting against this common challenger. To succeed, however, both organizations will need to embrace change and maintain a keen understanding of their own resources and limitations, says Matt Hatch, partner and Americas fintech leader at EY.
By design, fintech startups tend to focus on one particular problem customers may face in the financial sphere. Banks tend to have a more expansive view of customers, yet they can find themselves losing those customers piece by piece, as customers turn to startups for help with various financial tasks.
Legacy banks with a strong digital strategy, who have committed staff members to digital transformation, are more likely to partner with fintech startups, Lars Hornuf and fellow researchers write in a 2020 article in Small Business Economics. These banks may help fund small fintech startups, but they are most likely to collaborate with larger fintech organizations.
Here, a focus on building and maintaining customer relationships is essential as well, writes Erin Bankaitis, strategic business consultant at Braze.
“Investing in truly knowing your customer in a holistic, up-to-date way can support an intuitive messaging strategy and result in significant uplift in each customer’s likelihood to convert,” Bankaitis writes. When it comes to using data to glean these insights, fintech startups can lead the way by analyzing information they’re already collecting.
For fintech startups, striking the right balance between competition and collaboration with legacy banks can lead to success. Understanding the startup’s strengths and the challenges it faces are key to planning any strategy for success.
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