Banks vs Startups
Assuming that this is the endgame, this then means traditional banks and the likes of Monzo and Starling are already in a race.
As mentioned before, these newer challengers are already trying to build out marketplaces but what they realise (and what Monzo realised very quickly) was that a marketplace alone is not profitable without the lending activities to go along with it, which is where the traditional banks have the upper hand. Traditional banks have a low cost of funds and are able to lend these funds out at higher interest rates on their loans and mortgages than they offer on deposits. This is where the likes of Monzo and Starling are striving to get to as they convince people to move away from paying their salaries into their older, longstanding bank accounts so that they can use these deposits to build out their lending arms.
In short, having both the marketplace and the high margin lending activities is the holy grail and both startups and banks are closer to one than the other so it really becomes a question of who will be able to get their hands on both first?
It is worth addressing the elephant in the room though. Why would a bank want to build a marketplace if it involves recommending competitors’ products to customers?
We think there are a number of reasons:
- Jack of all trades, master of none:
It is impossible for any one player to be the market leader across all the possible offerings as different customers have different requirements whether it is the cheapest offering, specific product features or outstanding support.
It is best to acknowledge this from the outset and use this to one’s advantage. If customers are going to be using other offerings anyway, then why not provide value by making the discovery and application process for other offerings seamless and monetise this?
- Preserving a direct relationship with the customer:
A marketplace play means having a direct line to the customer with other players relegated to the periphery and needing to pay someone else to get access to this vast demand-side. The other argument is that this gives the marketplace the ability to surface their own products more often (obviously only when it makes sense to do because otherwise you risk losing the trust of the consumer) and to sell its benefits.
Simply put, it is better to be on the inside and in control than on the outside looking in. The nature of network effects means that once someone is on the inside, the relationship with the customer will be almost impossible for a competitor to break.
- A unique vantage point:
This model offers the opportunity to collect a vast amount of data on customers’ financial profiles via Open Banking, what demand for different products looks like over time and what product/services customers eventually end up opting for.
The beauty of this is that the owner of a marketplace effectively has a monopoly on this data and can use this to optimise their own portfolio of products or even to think about which new verticals to enter. If you know how many customers come through your marketplace and how many take out a particular type of product on a given day (on average) then you can forecast how many customers you could capture by producing a ‘better’ product. In other words, the ROI becomes clearer.
Another way to think about this is that you may start off with a ratio of 1:9 where 10% of traffic in the marketplace ends up taking your own product whether that is a mortgage or a personal loan. However, with the data, a marketplace can start to think about how to start shifting that ratio in their favour over time to 2:8, 3:7 and so on, whether that is through dynamically adjusting prices in response to demand or adjusting risk appetite at an individual customer level by leveraging Open Banking data and analysing their transaction history.
- Profitability at scale:
Banks can use their lending activities to subsidise the scaling of a marketplace whilst startups will likely need to rely on investors who understand the long game and are willing to provide the runway needed to realise this play.
We believe that once huge scale has been reached, the combination of revenues from own products as well as the take rate from marketplace transactions will be hugely profitable and even more so if the marketplace is successful in adjusting this ratio in their favour.