It’s been fascinating to watch. Since I came to London a year ago to work for a startup there, I’ve seen all these digital banks taking momentum and trying to penetrate the market as much as possible.
Our company was being offered more and more generous deals if we promoted their banking apps - all funded by venture capital, of course. Today, while opening my Revolut app, I was being offered 10$ for every friend I would refer, and those friends would get 10$ too! It’s starting to look a lot like the Paypal story, only this time, the reward is more uncertain.
Comparing Paypal to N26, Monzo, ...
When Paypal arrived, it brought a fundamentally new technology to the world: the ability to exchange money without a bank being involved. Similarly to Visa/Mastercard for the physical world, they knew that there was a massive monopoly situation waiting for them. If they managed to gain a critical mass, merchants would switch to them, customers too and the more they would grow, the more solid their business would become. That's why they could spend a blasting 60 million on referral rewards : because the reward was going be absolutely huge.
But nowadays, our new challenger banks are not introducing a new technology like Paypal. Instead, they're only promising us to be cheaper and more convenient than Paypal. And while Paypal never intended to be free, these 2.0 banks promise to be, so how will they make money?
How will “winning” look like
Right now, Starling, Revolut, Monzo and so on all have the same pitch: "we will help you save money". But this is not a profitable business model (simply look at airlines). Similarly to Paypal when it started, the goal of these new banks is to become an unbeatable monopoly that becomes stronger the more it grows. But is that actually possible?
Monopolies are companies that become stronger as they grow, making it nearly impossible for competitors to enter the market. Usually, this is done through network effects. Here are a few examples of monopolies:
Facebook: the more users join the social media, the more people will be pulled in, thus becoming more attractive to advertisers and growing even more.
Amazon: the more people buy on Amazon, the more vendors will join the platform, making it even more popular for people to go shopping. Amazon will also be able to save through economies of scale, making its products cheaper than the competition.
Paypal, Visa & Mastercard: The more vendors accept this payment method, the more people will sign up, and the more they will earn through their fees.
For comparison purpose, let's look at a few examples of non-monopolies:
Airlines: Anyone can start a new airline if they have the cash, the main decision factor for buying a ticket being its price.
Physical shops(Starbucks, McDonald’s,…): Physical shops are limited by their physical location, anyone can start a new successful coffee shop somewhere.
Banks: Anyone can start a bank that addresses a specific market.
Of course, none of those ventures are easy and you can be a non-monopoly business and still make tons of money through high margins, economies of scales and so on. But you don’t have a significant advantage over new market entrants.
Why banks don't become monopolies
Banks are basically just a cost factor. They all offer the same features and every time a bank comes up with a new feature it gets copied by the competition at some point. Let's see why banks don't become monopolies:
There is no network effect
If my friend uses Revolut, Monzo or Startling, it's not a big issue. there is nothing pulling us to use that same bank. Of course, I'll be able to send money for free to my friend who uses the same bank and lives oversea but that’s not an everyday situation.
Price war to the bottom
"We’re cheaper than the competition" only works for so long. For example, Monese has recently lowered its pricing to stay competitive but once the VC cash runs out, they’ll have to raise fees again to say afloat. Making it super easy for a new competitor to enter the market with “ultra-low fees”.
So what are the options, how to win?
While I expect a lot of investors to see a new Paypal in these banks, they are absolutely not. Still, here are a few options through which one of these new banks could still become a monopoly:
The WeChat path
Revolut has started it, starting to offer a large range of different products (travel insurance, stock trading, airport lounge passes) for a monthly fee. A solution for a banking app would be to take over more and more products, become a one-does-it-all kind of app, challenge Google/Facebook from a data perspective and start to use this data in some financially effective way. This would be a way towards a huge monopoly.
I don’t know the technical details of how a transaction actually works but if they could compete with Paypal/Visa/Mastercard, they could become a payment platform of their own. That could be a game-changer and they could become a huge nearly unkillable monopoly. Of course, they would need to bypass Visa/Mastercard first...
Simply being a profitable bank
Maybe there is no monopoly solution in this market (like the banking sector). Maybe we've made a too big deal of these cheap banks. The best players will be the one who manages to capture a part of the value they create for their customers. Be it through a fremium business model or generally a Saas model.
Excited to see the future unfold...