OBSERVATIONS FROM THE FINTECH SNARK TANK
In nearly every conversation I’ve had with VCs over the past six months, they’ve talked about “moats” and whether or not fintech startups are creating them.
But what are moats, did banks ever have them, are fintech startups really building them, and are they even worth building in today’s environment?
“I look for economic castles protected by unbreachable moats.”
In a business strategy context, the use of the term “moat” is usually credited to Warren Buffett, who wrote in his 1996 letter to investors:
Buffett was simply giving a new name to something that strategy guru Michael Porter had written about in 1980, when he defined the “five forces” of strategy.
These forces—in particular, the threat of new entrants and the threat of substitute products—create barriers to entry and exit, switching costs, and economies of scale. All of which help to create the “moats” that Buffett talked about in 1996.
Scale Doesn’t Lead to Moats
An article by Ben Robinson of Aperture titled The new moat in financial services (and why Peter Thiel, not Warren Buffett, is the new investment wizard) argues that large banks like Wells Fargo and Bank of America had moats due to scale:
By spreading the fixed costs of expensive, non-transferable assets like a banking licence, as well as highly-geared operating expenses like brand marketing and regulatory compliance, over a larger revenue base than competitors, companies could be better known and cheaper.”
My take: Large banks have scale—but not moats.
The reason is lending. Lending is the profit driver in banking, but the wide range of credit worthiness among consumers makes its unpalatable for any single entity—regardless of its scale—to gain a significant share of the market.
While the megabanks have near-oligopoly levels of market share in deposits—50% and higher in markets like Dallas, Houston, Phoenix, and San Francisco—they have had single digit market share of auto loans and mortgages (with the exception of Wells Fargo, whose share of mortgages has reached double digits).
These low levels of share come nowhere close to the market share that Microsoft once had in the operating system market or that Google had in the search advertising market—two firms that truly had moats thanks to their scale (and network effects).
Trust Doesn’t Lead to Moats, Either
A recent Forbes article said:
“Incumbents have historically enjoyed a moat of consumer trust, said McKinsey, but that moat is eroding, driven by big tech players like Alibaba, Amazon and Apple.”
My take: This is wrong on a couple of levels. First, it might be true that banks enjoyed a certain level of consumer trust, but that trust was more about keeping consumers’ money safe than it was about providing advice.
Second, Big Tech players are not eroding consumers’ trust in banks. The 2019 Edelman Trust Barometer found that trust in the financial services sector is at its highest level since the barometer started in 2012.
The Erosion of Moats in Banking
Neither scale nor trust is at the root of the moat that banks have enjoyed. Instead, the moat has come from two sources: 1) Regulations, and 2) Poor user experience.
Requirements to have a banking license have certainly kept many potential bank wannabes out of banking.
But with the advent of rent-a-charter services (also known as banking-as-a-service), non-banks have been able to wade through the moat.
But that wasn’t enough to breach the moat.
Banks had the protection of a moat because, historically, the customer experience regarding account opening and money movement was cumbersome, untimely, and inconvenient.
Fintech startups have created simpler account opening experiences and have capitalized on easy money movement enabled by the internet.
Does Any Bank Have a Moat?
There is only one US-based institution that might be considered to have a moat: USAA.
It’s not scale that gives the firm its moat. And while it certainly enjoys very high levels of trust from its members, that’s not the root cause of the moat, either.
The credit for the moat goes to USAA’s: 1) superior knowledge of its target market (military members), and 2) ability to design and deliver products and services to meet the unique needs of those members.
Give Navy Federal Credit Union for serving its military-based members well, as well. But USAA comes closest to having built a moat around its castle—and having it without the benefit of regulatory protection.
Fintechs Breached The Moat—But Don’t Have One of Their Own
It’s certainly impressive that a fintech like Chime has opened a gazillion accounts in such a short period of time (OK, it’s not quite a gazillion, but give it a day or two).
But does Chime—and other fintech startups, for that matter—have a moat? No way.
Features like Chime’s early access to direct deposits are easily copied. And while many of the fintech startups like to say that they’re competing on the basis of their (self-proclaimed) superior user experience, that doesn’t fly. Today’s “superior” experience is tomorrow’s “average” experience.
Reality: Direct-to-consumer fintechs have been enabled by easy money movement, but will fall prey to the next round of challengers by the same capability.
B2B-focused fintech startups (those serving the banks) are in a better position to build moats by becoming embedded into the bank’s operations and infrastructure—much like the core providers have over the past 30 years.
The Key to Banking Success in the 2020s
Here are two losing strategies for banking in the 2020s:
- Provide generic products and expect superior marketing and customer service to create a competitive advantage.
- Expand your product set and expect existing customers to jump on the bandwagon.
Banks that pursue strategy #1 are doomed to fail. As are the fintech startups pursuing #2.
The key to banking success in the 2020s is: 1) focusing on a segment (or narrow set) of consumers; 2) being everywhere they are; and 3) giving them everything they want.
“Being everywhere they are” doesn’t mean advertising everywhere. It means integrating transaction and service capabilities where ever your target market is.
For example, want to sell banking services to Uber drivers? You’ve got to be in the Uber driver app. Want to serve gamers? Gotta be embedded in games. Want to focus on serving truckers and trucking companies? Then you have to be….well, I don’t know what apps and sites truckers use, but that’s where you have to be.
Can a bank become the destination, i.e., the “where” everybody is? Possibly. But it would take a lot of time and commitment. So…the real answer is no (I can’t count the number of banks who’ve said they want to be a “portal” and failed miserably).
And “giving them everything they want” doesn’t simply mean expanding the product list. It means: 1) personalizing the products and services offered, and 2) integrating ancillary and add-on products and services into the core products.
Bridges and Tunnels are the New Moats (i.e., Competitive Advantages)
Traditional moats—i.e., those created by barriers to entry and exit, switching costs, and economies of scale—aren’t worth trying to create anymore. You could do it—but it would take too long to create and it would be too expensive to maintain.
The rate of technology change is too fast today. How long could a company reap the benefits of a moat built to create entry/exit barriers and switching costs using today’s technology? Answer: Not very long.
Ironically, the winning banking (and fintech) strategy for the new decade isn’t walling off customers with “moats”—it’s creating service bridges and data tunnels to other providers of services (both financial and non-financial).
The winners will be the banks and fintechs that define identifiable segments of the market, figure out that segment’s unique needs, and serve them.
Don’t be lulled into thinking that because a handful of fintechs have gained a few million customers they have a winning strategy. They don’t.
Ron Shevlin is the Managing Director of Fintech Research at Cornerstone Advisors. Author of the book Smarter Bank and the Fintech Snark Tank on Forbes, Ron is ranked among the top fintech influencers globally, and is a frequent keynote speaker at banking and fintech industry events.