Your Margin Is My Opportunity
A pragmatic approach to reinventing banking
When I was a boy, perhaps 10 years old, my father took me to the big city for a business meeting. As we idled through downtown Houston in Dad’s pickup, I marveled at the soaring office towers and the “rich people” scurrying about in three piece suits. My father, a man of few words, chose that moment to drop some knowledge:
“Visit any downtown area in any city. Which companies have the nicest buildings? The banks. Who do you think pays for those buildings? We do.”
Three decades later I have more appreciation for the nuance in Dad’s words. The undertone of animosity toward banks is just as pervasive today. Banks are perennial bottom-dwellers in NPS rankings, known for nickel-and-dime fees and an eagerness to say “no”. We bail them out, but they don’t bail us out.
If you look up “nickel-and-diming” in the Cambridge Dictionary, the example sentence is “The banks nickel and dime you to death with all the little fees they charge you.” So banks are quite literally the definition of nickel-and-dimers!
Like it or not, banks occupy a unique position in the business world. They are granted superpowers by the government and can do things that would be illegal for other businesses. Banks have the money, and thus wield considerable power in our society. But as countless business and political leaders throughout history have learned, both money and power can be fleeting.
The recent pandemic has reminded us of both the importance of banks and the increasingly strained relationship between banks and their customers. Protected by a regulatory moat, banks have resisted change for decades but a day of reckoning may be near.
Feel The Power of the Dark Side
I’ve spent most of my 25 working years in startups and fintech. I love this stuff and have been lucky enough to nearly “hit for the cycle”, with one home run (an IPO), a couple singles and doubles (small acquisitions), and of course some spectacular strike-outs (where the real learning happens). More importantly I’ve worked on things I care about with lots of smart people.
So in January when I told my friends that I had joined a bank many of them reacted with dismay. After all, I’ve been a vocal critic of the industry for years. The DMs I received could roughly be summarized as “WTF?”.
But I remained unfazed. I’ve thought about banking more than most and am acutely aware of the industry’s well-deserved reputation. But for an entrepreneur, problems equal opportunities. As a fighter pilot might say, “it’s a target rich environment”. (It also didn’t hurt that the bank I joined, Central Pacific Bank, is headquartered on a tropical island 🏝.)
Armed with a keen eye for the obvious and a distaste for complexity, I developed a simple thesis:
- Few banks are admired as companies. Books about banking are typically tales of scandal and greed, not out-of-the-box thinking or brand building. “PayPal mafia” is a term of respect but “Wells Fargo mafia” rings true in a more literal sense. But banks have business superpowers: access to cheap (essentially free) capital, the ability to hold and redeploy government-secured deposits, and the right to lend money with broad discretion on fees and terms.
- People generally dislike and distrust (and sometimes despise) their bank. And for good reason: Banks have demonstrated that they value profits over the needs of customers and often can’t be trusted to do the right thing. Backlash against banks — especially big banks — is at an all-time high.
- Banks are protected by a regulatory moat but the very moat that protects the banking oligarchy is also a cage, limiting evolution and diversity (in the Darwinian sense). Silicon Valley has taken notice and has aimed its formidable guns directly at banks. If fintech has its way, banks will be relegated to the role of a back-end utility.
- That said, the practical reality is that fintech companies are hamstrung by the very banks they seek to displace. To do anything interesting, fintechs must partner with a “bank sponsor”, which largely limits product innovation to the data and UX layers. Not to mention that banks are typically bad partners; slow, bureaucratic, and hyper risk-averse. Put simply, the current fintech model is quite limiting.
- If banking is going to be reinvented then at least some of the innovation needs to happen within the system. This must happen by definition because there are layers of the stack that can only be changed by banks (more on this later).
To summarize: There has never been a better time to offer banking customers something completely different, with a blockbuster value proposition. As Jeff Bezos famously said, “Your margin is my opportunity”, and few industries have more margin (or lower customer satisfaction) than banking.
But as a practical matter, banks must participate in the revolution. Not because banks are full of revolutionaries or have the will to change, but because a bank is the very vehicle we’re trying to re-design.
Tesla wouldn’t be Tesla if the company had been limited to rethinking only certain parts of the car. This is what’s happening in banking today. We are creating incrementally better tires and windshields and transmissions, not fundamentally different cars. This is my argument in a nutshell: True disruption must happen across the whole product stack.
In this essay I hope to make a compelling case that a small-ish but forward-thinking bank that a) has the will to cannibalize the existing bank model, and b) can innovate across the whole banking stack, will be a massive winner. It’s a tall order but nobody said changing the world is easy.
A Billion Dollars Isn’t Cool. You know what’s cool? A trillion dollars.
It’s hard to overstate just how massive the banking industry is. In the US alone, banking generates $730 billion in annual revenue and the combined market cap of publicly traded banks is well over $2 trillion. The value of a bank is largely determined by the size of its assets, which in very rough terms is the total of loans outstanding, various securities, cash reserves, and a few other things.
The “Big 4” US banks (JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo) each have around $2 trillion in assets and together represent about half of all bank assets in the US. The other half is split among 10,000 smaller banks and credit unions. My company, Central Pacific Bank (Nasdaq:CPF), has about $6 billion in assets, making us just 0.2% the size of JPMorgan. Yet we’re a public company with over 800 employees. That’s how big the market is.
Let’s translate that into napkin-math opportunity. When you consider how vulnerable big banks are, it’s not hard to imagine that a different kind of bank with a clearly-better product could gain at least a tiny bit of market share from the big four.
By stealing just 0.6% of the big 4 banks’ business, a relatively small bank like Central Pacific would grow 10X, from $6 billion in assets to $60 billion in assets. We’d still only be 2% as big as the largest bank, JP Morgan, with a tiny 0.3% share of the overall market. Even assuming no premium for rapid growth or innovation, this would translate directly to a 10X increase in market cap— a venture-capital-esque return.
The key here is finding a “goldilocks” bank, one that is large enough to be a serious challenger, with a solid foundation and scalable infrastructure, but small enough to behave like a startup with an appetite to make radical moves.
How To Disrupt Banking (or WWAD — What Would Amazon Do?)
(Slide courtesy Alex Rampell, AndreesenHorowitz)
My Twitter friend Alex Rampell, a fintech veteran and partner at Andreesen Horowitz, has long predicted that “the Amazon moment is coming to banking.” Before Amazon, retailers (both online and bricks-and-mortar) optimized their business to drive transactions. The resulting consumer behavior, familiar to all of us, was “shopping around” for deals and selection (remember malls and price comparison websites?). With a few notable exceptions, consumers had little loyalty to individual retailers.
Amazon disrupted this model by playing the long game and optimizing around customer value. With unlimited selection and bundled value through Amazon Prime, behavior shifted from “shopping around” to “one stop shopping”, with much higher customer loyalty. The obvious-in-retrospect genius of focusing on customer value instead of transactions is that the value equation continually improves for both the customer and Amazon — sometimes in unexpected ways:
- Amazon spends $7 billion a year to produce content for Prime Video — and then gives it away for no extra cost to Prime subscribers. If a bank CEO were running Amazon, she would surely organize Prime Video as a stand-alone business unit with its own P&L goals. For Amazon, Prime Video is yet another compelling reason to become/remain an Amazon customer.
- Amazon allows other retailers to advertise alongside Amazon’s offerings (gasp). This is outright heresy for traditional retailers with a “bar the doors” mentality but Amazon embraces the reality that competitors are always one click away. Why not profit from those clicks (to the tune of $10 billion annually), earning trust and credibility along the way?
It’s worth noting that some large traditional retailers — most notably Walmart — have survived and even thrived in the Amazon era. In Walmart’s case, the company has always been maniacally focused on value (lowest prices, largest selection), enabled by massive scale. But there is no Walmart equivalent in banking. To the contrary, banks with the most scale tend to be the least focused on customer value, with higher prices, more fees, and cringe-worthy policies.
Like retailers of years past, today’s banks are organized around products, not customers. Each financial product is treated as a stand-alone profit center to the degree that it’s not unusual for business units within a bank to fiercely compete with each other.
This model has been a profit bonanza for banks but an expensive mess for customers:
- Almost every financial move requires underwriting and approval, which means paperwork and hassle.
- It’s painful and costly to move money between different financial products. For example, if I want to tap home equity to pay off a high interest credit card, it’s a 4–8 week process with lots of paperwork and fees. This friction traps money in the wrong places and eats away at customers’ hard-earned money.
- Because banks force us to organize our money into silos, customers can only optimize individual products and don’t get the benefit of bundling (remember Amazon Prime?). For example, the Apple Card is a great credit card product — a triumph of design — but it’s still just a credit card. It works just like any other card and doesn’t play particularly well with other financial products.
Most of us have simply accepted the status quo as the way things work (“banks gonna be banks”). But as a thought experiment, consider this question: What Would Amazon Do?
By channeling our inner Jeff Bezos we can make a few educated guesses:
- Optimize around customers, not product silos. What if financial products were built and marketed based on customer needs, not the needs of the bank? What if customers were approved just once for everything they might need lead to live their financial life? What if the pricing was fair and transparent, with no nickel-and-diming?
- Eliminate friction so that money flows freely and doesn’t get trapped. What if you could move money between all of your financial products with one click (or automatically) and at no cost?
- Bundle to reduce cost and build lasting relationships. What if your bank provided more services and value to you over time without charging more for it? What if they became a true partner in your financial life?
I have spent years conducting primary customer research across a multitude of financial products and I can tell you conclusively that the vast majority of banking customers don’t understand financial products at all. They don’t even want to understand. Only a small segment of consumers use budgeting tools or PFM to actively manage their money.
What mainstream consumers want is the Amazon of banking: Easy, one-stop shopping, and great value. More than ever, folks are willing to hand over their paycheck to a trusted financial partner.
Re-imaging the Banking Stack
The good news is it’s possible to create the Amazon of banking today. And it’s not hard to imagine that a bank (or any company) that did so could be wildly successful. But there’s a catch: To pull it off, the entire banking stack needs to be re-imagined. What does this mean?
Recent years have seen lots of innovation — mostly by fintech companies — at the UX and data layers. Companies like Chime and Mercury have created beautiful apps that make banking simple and turn data into actionable insights. They’ve also nipped at the edges of the old bank model by eliminating the most egregious fees and policies.
But let’s be honest, a Chime account is fundamentally no different from a Wells Fargo account. Chime is subject to the same underlying rules and economics as every bank (and in fact, Chime is dependent on its sponsor bank, The Bancorp Bank, for underlying banking services). Chime and its contemporaries may be 10% better, but they’re certainly not 10X better.
It’s worth mentioning that Stripe is one example of a company that has innovated deeper into the banking stack, in this case for payment processing. But as Stripe expands into lending and credit cards, it must do so through a bank partnership with all the associated limitations.
To truly disrupt banking, we need to change the rules of the game and break the silos that are hard-coded into the underwriting and financial instrument layers of the banking stack. This isn’t as sexy as building a slick app but it’s much more transformative.
To further explain, let’s revisit our “trapped money” example. Why should I wait weeks and pay thousands of dollars in fees to move money from home equity to a credit card? We accept this as the status quo but it doesn’t have to work this way.
With clever mixing and matching of existing financial instruments and changes to bank policies and fees the experience can be dramatically improved. Imagine this experience:
- When you opened your bank account (or when you bought your home), you e-signed a bundle of documents all at once, putting in place a number of financial instruments, including a HELOC, that you may not need immediately.
- Your idle HELOC is automatically adjusted/re-underwritten based on changes in your home value (as determined by an AVM) and principal remaining. The HELOC is priced at your mortgage rate.
- When you have a need for cash to pay off credit card debt (or a multitude of other reasons) the HELOC is already in place and can be tapped immediately with no transaction cost. You don’t even need to know that it’s a HELOC or how HELOCs work — to you, the customer, it’s just “pulling money from your home”. The UX makes it all feel simple.
This use case may seem like an easy change for a bank to implement, but that’s far from the case. It requires a major rebuild of the stack and the willingness to cannibalize the entrenched silo model. But it’s a game-changer for the customer, saving hundreds if not thousands of dollars and lots of hassle. This is the Amazon of banking but it’s only possible with vertical integration through the entire banking stack.
So what’s new here? Here are a few novel concepts introduced by this model:
- Putting financial instruments in place preemptively so that they are available for future needs.
- Removing friction by eliminating fees and changing bad policies. We explored one simple use case but there are many. Perhaps a forward-thinking bank would charge one flat subscription fee for this type of banking service.
- Mixing & matching existing financial instruments in clever ways but hiding the complexity with great UI/UX.
- Underwriting the whole customer and utilizing cross-collateralization among financial products to reduce risk and drive prices down.
- Money is money is money — Customers don’t understand most financial instruments, and for the most part they shouldn’t need to. A dollar is a dollar whether it resides in home equity, savings, or another vehicle.
Here’s why the “Amazon of banking” will probably be created within (or along-side) a bank.
Some really smart people in fintech believe that banking’s Amazon moment will happen via a “meta banking platform” such as digital wallet or PFM with “robo-optimizer” functionality. While these platforms will play an important role in the future of banking, they face major limitations:
- As noted previously, a meta banking platform can only optimize at the product level (e.g. a lower rate on a mortgage or a better credit card). Attempts to optimize across products (at the customer level) would be met by the friction, cost, and hassle I mentioned earlier.
- Fintech companies must partner with a bank (often referred to as a “bank sponsor”) to provide actual banking services. By law the bank must have ultimate control and approval over the entire program. Any fintech CEO will tell you that this structure is workable but suboptimal. Banks are notoriously difficult to work with and often serve multiple fintech companies so the services they offer are standardized to the lowest common denominator. Even the best bank partner is a hungry mouth to feed, which limits end user price flexibility.
This is the reality of banking, and the legal and regulatory framework that governs financial services is unlikely to change in the next decade. For better or worse, banks do have unique superpowers and it seems clear that banking’s Amazon moment is most likely to happen from within, or perhaps through a joint venture of some sort. One can imagine a winning “startup” consisting of three components, a bank unit, a fintech unit, and perhaps an external (venture) investor. This could also be accomplished through a joint venture between a fintech company and a bank, but it would need to be a committed, “all in” relationship or conflicting interests would re-create the problems I’ve outlined.
The most compelling argument of all.
Industry wonks like myself can pontificate about platforms and economics and regulation but here’s the most compelling argument of all:
A bank that does what I’m proposing will be able to provide unmatched customer value. Full stop.
Your margin is my opportunity and better, faster, and cheaper wins every time. Fintechs simply can’t pull this off (without a bank) and big banks will protect their margins at all costs.
When all is said and done, the mainstream American banking customer simply wants to live their life and feel confident that they are making smart financial moves. More than ever, consumers are willing to give the keys to their paycheck to a trusted partner who will look out for their best interest.
Yet products continue to be marketed from a bank’s point of view using industry jargon, confusing financial terms, and fine print. It’s like the early days of personal computers, when PC’s were marketed based on tech specs instead of use cases.
Why hasn’t this been done already? It’s an issue of will. To quote Marc Andreessen’s recent essay, which serves as a rallying cry for bigger thinking, more innovation, and BUILDING things:
“The problem is desire. We need to *want* these things. The problem is inertia. We need to want these things more than we want to prevent these things. The problem is regulatory capture. We need to want new companies to build these things, even if incumbents don’t like it, even if only to force the incumbents to build these things. And the problem is will. We need to build these things.”
Every word of this statement applies to banking. This is our wakeup call. It’s time to build something better.