By Bernard Lunn
Banks are from Venus and Fintech are from Mars. Communication between these planets is improving, but too slowly. This will start to change in 2016, as we enter the Great Convergence when both Banks and Fintechs become judged on the same metric – CAC/LTV (Customer Acquisition Cost/Life Time Value).
We see three levels of maturity in the relationship between Fintech ventures and Banks:
- Level 1: Incomprehension. The other party just looks strange and it is hard to imagine a productive conversation. Whether the emotion is fear or disdain, the reaction is the same – inertia. Banks seek to overcome the incomprehension problem by funding Accelerators and Hackathons.
- Level 2: Funding. Banks take minority equity stakes in Fintech ventures through their Corporate Venture Capital (CVC) unit. This is the level that most relationships have reached. (Funding while still in Incomprehension mode is clearly dangerous).
- Level 3: Strategic. This is where the relationship drives needle-moving revenues and profits for both parties. This may or may not include an equity relationship; the strategic relationship comes first. Creating these win/win strategic relationships is one of our core skills at Daily Fintech Advisers because we understand enough about both parties to “know what makes them tick”.
Our thesis at Daily Fintech is that 2016 will see the start of the Great Convergence between Banks and Fintech. At the end of this Convergence, we won’t be able to tell the difference between:
- A Fintech upstart that matured, became regulated and added some people into the service delivery process (because that is what customers wanted).
- An incumbent Financial Institution that automated enough of the service delivery process to be cost competitive with Fintech upstarts and learned to deliver digital first.
This is as it should be. All the sturm und drang around disruption and conflict is great for getting media attention and selling conference tickets, but the reality is a more nuanced cooptition – some competition and some cooperation. And the competition is on a surprisingly level playing field. Banks have access to the same technology as the Fintechs and the Fintechs have to keep the same regulators happy with the same rules as the banks. May the best entity win – the customer benefits either way.
As the business model of Banks and Fintechs converge, their management teams, Board and investors will end up obsessing about the same metric – CAC/LTV.
CAC/LTV will be used to judge the financial health of both Incumbents and Upstarts. This normalization around a common metric is likely to have a significant effect on the valuation of both Upstarts and Incumbents as investors do comparables analysis across both Upstarts and Incumbents.
CAC/LTV = Customer Acquisition Cost/Life Time Value.
Both are complex in their own right, but it is the interaction between the two that is so often confusing or difficult.
Customer Acquisition Cost (CAC) on its own is the province of Sales and Marketing departments, armed with CRM and Marketing Automation systems. That is getting growth from existing products. Sell more of what you have now is the mantra. Low CAC is the metric for judging the efficiency of Sales and Marketing.
The biggest enemy of a low CAC is churn. Churn is the kryptonite of Superman Sales & Marketing. This chart from from a great 2009 vintage Slideshare tells the story of a 20% churn on recurring revenue (from Philippe Botteri of Bessemer Venture Partners at the time, he is now with Accel Partners).
The problem with Churn is that this is not directly under the control of Sales & Marketing. This is where Product is key. Another way of saying Churn is “customers think the product sucks despite all that expensive Sales & Marketing”. So they cancel the service and then Sales & Marketing have to win new customers, which is far more expensive than retaining them.
Life Time Value is not static. If Churn goes up, LTV goes down. If LTV goes down, you have to reduce CAC. Product strategy, pricing and Marketing have to be in alignment.
The story of Banking in the 20th century can be summed up as Low Churn. We are statistically more likely to get divorced than change banks. There was no point in changing Banks, because the difference between banks was marginal. The Fintech disruption changes that. Now customers have more real choice and regulation is seeking to protect consumers from lock-in strategies that make it hard for them to switch.
A great product – low cost and easy to use – reduces Churn. Great customer service reduces Churn.
With Churn a reality for Banks they will have to learn how to reduce CAC. Lots of vendors are ready to help with tools and techniques. Churn will be a level playing field for Banks and Fintech – playing to the same rules around data lock in and KYC. So both Banks and Fintech will be judged on the same metric – CAC/LTV.
Daily Fintech Advisers provide strategic consulting to organizations with business and investment interests in Fintech.