By Rohit Arora. Source: Forbes.
Chris Myers of Bode Tree recently wrote in Forbes that “the bloom is finally coming off the rose” in FinTech and that the once hot sector has seen its fair share of failures of late. True, some online lenders, including OnDeck and Lending Club are experiencing heavy losses and some, including CAN Capital, stopped lending altogether.
However, what is currently happening in the FinTech industry is not unique in a new industry. In any sector, the market leaders jump out to an advantage. As the industry grow, players quickly enter into the marketplace. Some are run well and have a distinct competitive advantage. Others will flounder. That’s how capitalism works. Entrepreneurs take risks. Some succeed, and others fail.
FinTech is thriving because it greatly expanded access to capital to small business owners, including women, minorities and immigrants, who were under-served before technology leveled the playing field. Raising money for a growing business often could be intimidating for someone not born in this country and for whom language and culture could be a barrier. I know because I was one of these people before I co-founded Biz2Credit with my brother, Ramit.
In the high flying 1990s and early 2000s, one might have met a venture capitalist at a party and quickly struck a six-figure financing deal. That was surely not the case for minorities and immigrants — those of lesser economic means or who had not yet developed a strong credit history.
For lenders, they are able to make deals more quickly while lowering their risk because of the tremendous data available on potential borrowers. This reality is making them more efficient and profitable. FinTech is now taking hold in China where Alipay, Tencent and WeChat are revolutionizing the electronic payments industry.
Myers listed three reasons the industry is failing. While some of his thoughts are on target, others are not.
1) There is a fundamental strategic contradiction between technology and finance
Renowned investor J. Christopher Flowers remarked to the Wall Street Journal that “fintech” will mostly end in tears for entrepreneurs. I’ve seen Mr. Flowers’ observations play out in the market firsthand. The conflict is a direct result of how fintech companies are funded.
Investors of all kinds, from traditional venture groups to angel investors, are accustomed to the modern tech growth curve. Most funds, either institutional or private, have a three to five-year investment horizon. This means that investors inject capital into a business with the expectation of realizing a return on that capital within that investment horizon.
Myers rightly pointed out that the finance industry has traditionally been a very slow-moving sector and that it takes time for Fintech companies to break into the market. This happens whether they offer provide bank technology, offer small-business solutions, or act as a lender. Meanwhile, both existing and potential investors put pressure on these players for quick returns.
Banks are slow — and the bigger they are, the slower they are to adapt — and investors have short-term horizons. However, investors are often impatient no matter what the industry, and they want quarterly results. This is true for FinTech and other sectors.
The reality is that FinTech is going to be around for a long time.
Why do I believe this?
When traditional players adopt a new way of doing things, it shows long-term potential. If large banks are investing in technology to allow for digital loan applications and the ability to upload documents, it demonstrates that financial technology is becoming more and more mainstream. The industry has grown from the innovator stage to the early adoption stage. While we are not quite at the early majority stage, the industry will soon be there.
2) Market realities encourage short-term thinking
This growth-at-all-costs mentality is incredibly damaging for the industry. When fintech companies start using their investment dollars not for innovation, but for quick growth, problems arise. One need only look at Google AdWords prices to see what I mean. Over the past few years, the price per click (PPC) for keywords such as “small business loans” have risen to nearly $100 per click in some instances.
As competition increases, Fintech organizations begin making riskier and riskier decisions. For online lenders, it means riskier and less desirable loans.
What Myers described does not only apply to FinTech. Companies are rewarded quarterly and are indeed under pressure to keep earnings up. The businesses that are well run will survive. The innovators enter the marketplace and others follow. Those that do not have a significant differentiator or that cannot control their costs will go bust. Such is the nature of capitalism. Not too long ago, CAN Capital was the biggest player in the alternative lending space. Now the company is in rough waters.
Others will fill the void in the marketplace, just as alternative lenders pounced on opportunity when banks stopped lending in the “credit crunch” that followed the Great Recession. Companies that make high risk decisions may indeed earn high rewards, but high risk loans can be perilous.
3) Incumbents in the market are powerful and resistant to change
I work with banks and other incumbent financial institutions. Most have one thing in common: they hate change. Incumbents in the finance sector are incredibly powerful and complacent. Most don’t fear Fintech companies looking to take their business because, frankly, not a single one poses a real threat at this time. Banking, and Financial Services in general is highly regulated and therefore inherently conservative. It’s the one industry I can think of where a commitment to innovation and decisive action is detrimental to a career.
The large, slow moving financial institutions had no choice but to change the way they do business. The marketplace is demanding it. People are using smart phones and going online for everything they need. Millennials have grown up never having purchased a newspaper, written a check or conducted a transaction inside a bank. They use their phones. Technology has transformed banking, just as Amazon transformed retail through the use of the internet. At the time, experts claimed Amazon would fail, that it wasn’t making a profit fast enough. Now it is one of the most successful corporations in America. In fact, brick and mortar stores are failing because technology helped Amazon becomes so big.
Large banks are investing in the technology that enables online applications for small business loans. Further, APIs have been created that make it easier for people to conduct transactions via mobile. These changes in the marketplace are enabling FinTech to grow. FinTech is not going away.
Technology is transforming finance. The established, cautious institutions will indeed change how they do things. It cannot help but happen. FinTech firms are innovative, daring, and increasingly successful. They are thriving, and they represent the future of finance.