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.
#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 enables 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 the 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 SQ -0.9% are involved at the point of sale or payment
activity—which are at the middle of the value chain.
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 and one I can’t name yet (its
announcement is still under embargo) 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 digital banks. For some
of these institutions, these are weak attempts to recreate the success of some
of the challenger banks. The smart institutions, 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.
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