OBSERVATIONS FROM THE FINTECH SNARK TANK
Fears of an Amazon “invasion” in financial services have reached a fever pitch. One Financial Brand article reported that banks and credit unions are “bracing for the Amazon doomsday.”
Does Amazon–and other big tech companies, for that matter–really have that much of an advantage coming into the banking market? A new report, titled Big Tech in Finance: Opportunities and Risks, from the Bank for International Settlements, addresses that very question.
Why Would Big Tech Get Into Banking?
The report points out that the business model of “big techs” (i.e., Alibaba, Amazon, Facebook, Google and Tencent) rest on attracting a large number of providers and consumers and that:
An essential by-product of their business is the large stock of user data which are utilised as input to offer a range of services that exploit natural network effects, generating further user activity. Increased user activity then completes the circle, as it generates yet more data.”
That’s the promise and benefit of a “platform” business model. The BIS report goes on to claim that:
As yet, financial services are only a small part of their business globally. But given their size and customer reach, big techs’ entry into finance has the potential to spark rapid change in the industry. Big techs’ low-cost structure business can easily be scaled up to provide basic financial services. Using big data and analysis of the network structure in their established platforms, big techs can assess the riskiness of borrowers, reducing the need for collateral to assure repayment.”
These statements deserve some scrutiny:
- Financial services may be a “small part” of Big Tech’s business, but their financial services businesses aren’t small. S&P Capital estimates that about 11% of the Big Techs’ revenue comes from financial services. A relatively small percentage, but not small businesses. Ant Financial Services Group, Alibaba’s financial affiliate, has more than 600 million users. Amazon claims 300 million customers use Amazon Pay and has reportedly issued more than $3 billion in merchant cash advances in the past few years.
- What “low-cost structure”? For how many years did Amazon fail to turn a profit? It certainly wasn’t because it wasn’t generating a lot of revenue. It’s because, in order to build an efficient platform business, the company had to make significant investments in distribution, logistics management, and integration infrastructure (i.e., AWS). A platform business is anything but a low-cost structure.
- It’s the “right” data–not big data–that gives Big Tech an advantage. Why was Amazon able to issue $3 billion in merchant cash advances over the past few years? Because it knew two things: 1) The inflows of revenue to borrower, and 2) The inflows of revenue to the borrower’s industry segment. Those are two pieces of information that a bank has to spend a lot of time and money to collect. The rest of the “big data” that the Big Tech firms have is nice, but not what gives them an advantage here.
Does Big Tech Have an Advantage Over Incumbent Banks?
BIS identified three factors impacting Big Techs’ invasion into banking, cleverly calling it the “DNA of big tech:” data analytics, network externalities, and interwoven activities.
According to BIS, Big Tech firms have both advantages and disadvantages relative to incumbent banks across the three factors:
- Data. On the plus side, Big Tech has data on a very large number of customers and the technology and business model built to collect and merge data. On the negative side, Big Tech has a mixture of verifiable and potentially less reliable data and a shorter history of customer data at that.
- Network externalities. On the plus side, Big Tech has significant network externalities due to their wide range of non-financial activities and a captive ecosystem with potential high exit costs. On other hand, they need to reach a large customer base in order to exploit network externalities.
- Interwoven activities. Big Tech’s advantage here is that commodity services can be provided at near-zero marginal costs and pre-existing commercial activities yield data that can be used to support new services (i.e., high economies of scope). The disadvantages are limited or no footprint in key financial services; funding limitations; and lack of regulatory and risk management experience and expertise.
Do the Big Banks Have Advantages Over Big Tech?
On the flip side, BIS identified the advantages and disadvantages incumbent banks have relative to Big Tech:
- Data. On the plus side, banks have a long history of verified and reliable customer data and “soft” information from personal interactions with customers. The down side is a small number of customers and limited range of non-financial activities to collect data from; one-sided transaction data; and limitations associated with legacy technology.
- Network externalities. Banks have the benefit of already providing a wide range of financial services. The disadvantages are the strict regulatory limits on activities and use of data and the higher marginal costs of serving additional customers.
- Interwoven activities. Advantages include high margin and complex products requiring personal interaction and access to large and relatively cheap funding sources. The disadvantages are legacy IT systems that prevent banks from using existing data to offer new services (i.e., low economies of scope).
BIS concludes from this weighing of the DNA, that Big Tech could benefit from their ability to: 1) better screen applicants; 2) expand financial inclusion; and 3) lend without requiring collateral. The downside, however, will be the regulatory issues their growing power is sure to attract.
Amazon’s DNA is Distribution, Logistics, and Integration
BIS’ analysis is interesting, but none of the advantages or disadvantages the reports lists–for either Big Tech or Big Banks–are insurmountable. What the report is missing, if I may borrow a term from the report, is an analysis of Amazon’s DNA.
Amazon’s DNA is to be a platform–which means attracting as many providers and consumers in a product or service category as possible and then taking a cut off each transaction and generating even more revenue by providing value-added services to the providers on the platform.
Amazon reportedly provided $3 billion in merchant cash advances to merchants over the past few years, but the key question to ask is this: Why was it only $3 billion? There are two possible answers:
- That’s all the money Amazon had to lend, and/or
- That’s all the money Amazon wanted to lend.
The potential demand for merchant cash advances among Amazon merchants could have been $25 billion. It’s in Amazon’s best interests as a platform to meet that demand by matching merchants with banks willing to lend the $22 billion that Amazon couldn’t or wouldn’t lend.
Amazon has no incentive to cut banks out of the lending (or deposit) business. The company will make more money taking a fee for “matching” merchants (and consumers, for that matter) with banks willing to meet the demand that Amazon can’t or won’t fulfill.
And then Amazon will make even more money by providing technology services to help financial institutions underwrite, process, and even service the loans. Banks will gladly pay for this, because Amazon will do it for a lower cost that what banks incur to do it today. That’s why it made the investment in distribution, logistics, and integration.
Amazon’s DNA is rooted in an old quote from its founder and CEO, Jeff Bezos, who said:
Your margin is my opportunity.”
The margin opportunity in banking is not with the banks–it’s with the technology companies that provide applications and systems to banks and credit unions today.
When Amazon is helping connect millions of consumers looking for various financial services–lending and deposit–from financial institutions, Amazon will not only help match those consumers and providers, they’ll vertically integrate their services by doing account opening, KYC, underwriting, processing, etc.
The margins at risk in the coming Amazon invasion are those of firms like FIS and Fiserv who provide core and ancillary applications to the banking industry.
So When Is the Amazon Invasion in Banking Coming?
So when will the Amazon invasion in banking arrive? As Mark Twain (or maybe it was F. Scott Fitzgerald) said, “First slowly, then all at once.”
Look for a relatively small acquisition by Amazon of some fintech-related provider. That will be the first signal.
But when the invasion comes full force, it won’t look like a lot of people think it will.