If there’s a niche in financial services, it’s likely been filled at this point. A slew of financial technology startups have stripped off subsets of services typically provided by banks and brokerages, unbundling everything from payments and lending to advisory services and stock trading.
But history has taught us it won’t always be this way. The startups that become mainstream in this space will have to follow that path taken by virtually every other incumbent before them: They must start to consolidate, offer more services and expand into different verticals.
Catalysts for The Great Financial Services Unbundling
Former Netscape CEO Jim Barksdale has said there are “only two ways to make money in business: One is to bundle; the other is unbundle.” In financial services, the “other” option has only recently become possible.
One key reason why unbundling in this sector has taken so long is that the technology to seamlessly onboard financial customers at scale has only recently become available. Opening a financial account involves complicated processes such as know-your-customer (KYC) and bank account linkage/verification — processes with many edge cases that are handled manually (and often in person) by large teams of people at incumbent financial institutions.
In addition, banks historically have had a huge advantage in distributing ancillary products due to being a customer’s first financial services relationship. This advantage has naturally led to successful companies in the space expanding to offer a full suite of financial services — banks offering brokerage services and discount brokerages offering checking/savings accounts.
At the same time, however, their massive footprint became a disadvantage that made these institutions slow to innovate. Legacy infrastructure and processes, once implemented across multiple product lines, become next to impossible to replace. As Marc Andreessen, Barksdale’s Netscape colleague and the venture capitalist whose latest project is upending finance (disclosure: Andreessen Horowitz is a Robinhood investor), put it: “You shouldn’t need 100,000 people and prime Manhattan real estate and giant data centers full of mainframe computers from the 1970s to give you the ability to do an online payment. You would not today, starting from scratch, invent any of these financial businesses in the same way.”
That’s exactly the approach we at Robinhood and many other startups have taken. By running infrastructure in the cloud and operating purpose-built platforms, we have dramatically cut the costs of operating and distributing our products. By leveraging modern APIs and technologies, we have dramatically improved customer onboarding, in a space where most incumbents still onboard customers in person.
Banks have also inadvertently contributed to this unbundling after their misdeeds resulted in stricter regulation. Because banks are now under more stringent constraints, this provided a framework for innovation to startups, which have also benefitted from a distrust of “the establishment” that emerged after the financial crisis.
The Advantages of Consolidation
One downside to unbundling is friction. It’s a simple fact that integrating products and services within the same company allows money and information to flow more freely. In addition, using multiple products for similar tasks introduces stress on the customer, who has multiple user interfaces and relationships to manage.
For consumers, there are clear advantages to using services offered by a company with which you have an existing relationship. For example, in financial services, using a checking account offered by the same company that you have a brokerage account with is a real convenience, all other things being equal.
For service providers, the advantage goes beyond convenience. If the provider already has a profile of the consumer, it can leverage its profiles for banking to improve their KYC experience in checking. It can also replace external bank-to-bank transfers via ACH, which are susceptible to chargeback risk, with internal bookkeeping. In addition, having a customer sign up for a new offering by the same provider locks the customer into that company’s ecosystem, making it more difficult for the customer to leave.
The Cyclical Nature of Unbundling
Given the inherent advantages of a diversified offering, it makes sense that fintech startups will head in this direction — a path that parallels the cycles we see time and time again, in industry after industry.
Take the web portal unbundling in the late ’90s. Similar to banks often being the first financial services relationship, portals such as AOL, Yahoo, Excite and InfoSeek were consumers’ first relationship with the Web. It presented a huge advantage in the early days of the Internet, and these portals tended to own a large part of a customer’s web experience (e.g., news, chat, email, games, basic search).
The lack of focus on any specific product line, however, led to them being outcompeted by Google, who nailed search. The vastly improved search experience made it easier for companies who wanted to build superior news, chat and game services to get discovered. Before these portals could blink, there were improved versions of everything they offered, rendering them obsolete.
I see these young financial companies following in the consolidation footsteps of Google, which expanded from its core offering into email, maps and so on. How will this strategy play out in finance? One example is the way robo-advisors are beginning to offer checking accounts and debit cards, or lenders introducing advisory services.
It goes back to the innovator’s dilemma. Startups in the finance space are exceeding expectations when it comes to meeting their customers’ needs, but they need to branch out beyond their existing specialized services in order to grow — especially as their younger customers come of age and want a consolidated view of their financial situation.
The current sprawl of financial services will inevitably shrink. Only a few finance startups will survive and become mainstream — and that’s because they will have transformed themselves to become almost unrecognizable from how they look today.
A first-generation immigrant from Bulgaria, Tenev earned his B.S. in Math and Physics at Stanford University before starting two finance companies in New York City, selling trading software to hedge funds. In 2013, Tenev created Robinhood, the fastest-growing brokerage aimed at making financial tools more accessible. The company has raised $66 million from NEA, Index Ventures, Google Ventures, and Andreessen Horowitz.