Ben Soppitt

A blueprint for scaling a Challenger Bank in America and hitting a $25bn+ valuation

It’s getting easier to launch a Challenger Bank but harder to scale one — it’s not enough to be new, you have got to be different too

There are 11,652 financial institutions in the US as of April 2018 a number that has dropped significantly from 1984 when FDIC-insured financial institutions reached their peak of 17,900, while the number of credit unions apexed in 1969 at 23,866. Mergers and failures has been reshaping the market for decades. During this time the largest banks have grown in their share of the market from 16% in 1994 to 59% in 2018.

Competition is fierce with 7 banks spending near or over $1bn in marketing annually, with 2 (Chase and Amex) spending in excess of $2bn

There is a lot to play for, the 10 largest retail banks in the US make an estimated $110 billion in net income and new Challenger Banks are launching at a furious pace to take a slice of it.

Challenger Banks have a significant arsenal with which to compete against incumbents:

  1. Lower operational costs — relatively simple business models with limited product complexity, lack of legacy infrastructure (technical as well as branches etc.) and beneficial regulatory changes
  2. New Capabilities — whether in-house or bought via bank as a service or other providers, Challenger Banks can deploy sophisticated new capabilities and value propositions at speed to the market that traditional banks simply cannot match

But Challenger Banks also face substantial challenges:

  1. Traditional banks have the customers today and consumers are very reluctant to move their primary banking relationships — there are not enough new customers in the market to sustain Challenger Banks so new entrants have to take share from incumbents
  2. Marketing budgets from major banks far outweigh new entrants even with their substantial funding
  3. Traditional banks are not sitting by while they get out-innovated

A question asked a lot is which of these many different offerings will break out of the pack and truly threaten the Big Banks. Which ones will scale? In this context scale would mean 5–10m customers or approximately 0.68% to 1.3% of the market by customer numbers and $264B in assets (at 1% share) — in comparison Bank of America has 66m customers and around 9% share by assets ($2.74 trillion).

Using rough benchmarks in the market any Challenger Bank that achieves this will be valued at $25–30bn plus a likely substantial premium for market leadership.

What sort of a Challenger Bank are you? At it broadest Challenger Banks and FinTech companies as a whole can be segmented by their primary customer bases’ wealth orientation— are they focussing on people with money/likely to have money or people without.

Those focussing on consumers with money are rapidly converging to serve 3 core and complementary consumer needs — Saving, Spending and Investments.

Convergence towards this triumvirate has been rapid. Wealth managers like Wealthsimple have launched cash access cards, lenders like Sofi have launched savings and card products and new full service new entrants are rapidly propagating.

Those likely to win the race to scale will need to not only win in each of these categories independently but also achieve a high proportion of success in securing customers who do all 3. Of course it’s not necessary to scale, it is perfectly viable to remain within a specific niche and profitably so. But for those who’s ambition is to take on the establishment banks at their own game, its a game that is played at scale.

4 Principles and a possible blueprint to achieving scale as a Challenger Bank

Those Challenger Banks likely to really achieve mass scale will need to meet 4 key principles:

  1. Winning in each of the core products to support Saving, Spending and Investments
  2. Capable of serving all of a customer’s wealth lifecycle adaptively not a single niche
  3. Bringing best practice in behavioural science to product design
  4. Creating holistic value propositions that capture total customer value

Winning in Saving It really does not matter how great your app is if you are not giving people value, conversely if you are offering better value than the market you can get away with a terrible app/UX — look at Vanguard if you need evidence of that.

Saving has become a very active space recently with a number of Fintech firms launching in this space the most high profile of which is Marcus from Goldman Sachs but includes Sofi as well as others. Wealthfront just announced an increase in their cash account to 2.51% sparking what could become a savings APR war.

The most interesting product enhancement is the emergence of Hybrid Checking/Savings account — with the account carrying a high APR but with instant access linked to a payment card. This simplifies the product set from a minimum of 2, a checking and saving to 1. Betterment, Sofi, Radius and Zero are all hybrid cash management accounts.

So a Challenger Bank blueprint would be to have a simple single hybrid cash management account with a market leading APR. In addition the value of helping consumers to save and meet their goals cannot be understated both for the benefit of the consumer as well as their bank. Making it as easy as possible for the consumer to initiate and continue saving requires the application of Behavioural Science led insights and understanding the psychology of consumer bahaviour. Which such nudges are used and how is part of integral differentiation between players in the market.

Winning in spending Access to cash is relatively comoditised with many processors offering access to high utility branded cards linked to an account including Greendot and Marqeta. Linking a payment card to a hybrid account offers utility but not strategic differentiation — any more than a checkbook.

Similarly credit cards have achieved little in terms of innovation and differentiation.

We are however begining to see the emergence of new innovation with new entrants such as Brex and Zero offering payment cards that are niether traditional credit or debit but more of a hybrid card with the best features of each.

To add to our Hybrid Cash Managment Account we would therefore want to add a single Hybrid Card which can be attached to the Cash Management Account as an integrated feature or offered as a standalone product with credit offered on the basis of account linking financial accounts held elsewhere as well as the investment account — giving the ability to offer a dynamic and customised card product representing the specific circumstances and financial situation of that customer as well as the business objective of the company.

This also means that the card product is adaptive and can evolve with the changing circumstances of the customer. The customer is not forced to apply for orreceive a new card every time their circumstances change or they need a new credit limit. This overcomes the problem of having a very specific product aimed at a customers cicumstances in time e.g. just left college with student debt. Over specialisation with this speicfic situation will make it hard to retain that customer down the line when their circumstances change.

Winning in Investment Wealth management overall has undergone perhaps one of the most complete tech led transformations in financial services with the emergence of dedicated investment firms in the last 20 years like Vanguard, Schwab, Robinhood etc. and Robo advisory. In addition we have seen more creative solutions to the problem of access with fractional ownership from the likes of Stockpile and passive drip feeding with Acorns.

The multiplicity of models from pure Robo, hybrid models and traditional personal advisory services shows no sign of resolution as yet. Winning at scale in wealth management seems to point towards a broad approach and ensuring that there is an appropriate product for every lifestage and experience level as well as preference between active and passive as well as pure robo and personal service.

Again it’s worth remembering that scale is not necessary for success and niche plays such as United Income focussing on the retirement community exclusively are likely to be highly successful. However this article is concerned with the blueprint to scale and that means serving multiple niches in parrallel.

Winning in value proposition design It’s well understood in banking that the more products a customer buys from a single institution the higher the overall customer lifetime value is for the customer. For a Challenger bank to scale sustainably and profitably it will need to maximise the proportion of customers that are buying all 3 of the triumvirate across Saving, Spending and Investing.

Winning in each of these individually is great and provides multiple acquisition channels, winning in all 3 is greatest.

As an illustration a customer with $100k in investments at say 0.5% fees, $30K in savings at 2% and 20K in spend at 0.25% will generate a total fees of $1550 per year. A substantial step up from a customer with only one of these.

Getting consumers to move just one of their accounts is hard, getting them to consolidate all 3 primary accounts into a single new institution harder still. This is the role of the value proposition design. In addition given that Challenger Banks will be unable to compete on marketing investment anytime soon with the traditional banks, value proposition design will need to drive media coverage and word of mouth recommendations to reduce the marketing overhead.

Cross selling and incentives for multiple accounts could very quickly become complicated for the consumer and bank to manage. It can also lead to an inauthentic brand positioning where headline rates are promoted but inaccessible to the majority of customers — something most Challenger banks say they are reacting against.

It’s tempting to speculate what winning strategies in value proposition design might be to maximise multi product use. But this represents the newest frontier of innovation in FinTech. Up to this point focus has been more orientated toward product launch, building the product portfolio and UX, specifically mobile apps and the tools and widgets that accompany them. It will likely take a substantial amount of experimentation before the winning combinations and models become clear.

Ifthis blueprint to scale and the 4 principles underlying them are directionally correct a Challenger Bank would look something like this:

  • Hybrid Cash Management Account with market leading APR (no need for both a checking and saving account)
  • Hybrid Payment Card capable of being linked to Cash Management Account or Standalone with credit line that is adaptive to the changing socio economic and lifestyle choices of the customer (no need for a serperate Debit and Credit or multiple credit cards — unless they carry very specific benefits e.g. airlines)
  • Investment services including both pure robo, hybrid robo/personal and potential full service (an all in one investment shop)
  • A value proposition design that maximizes the proportion of customers with all 3 product lines as their primary accounts relative to Saving, Spending and Investments (providing simplicity for the consumer and profitability for the provider)

Of the 4 principles of scaling a Challenger Bank, value proposition design might just be the most important of all.

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