Rebundling finance – the key to success of fintechs in the platform economy

One of the emerging themes of the platform economy is the shift from vertically integrated value chains to horizontally layered value stacks.

This is happening across industries but the financial services industry provides a great template of how to think about this shift. This edition of the newsletter conducts a deep-dive on this topic.

One of the most frequently asked questions we answer for companies relates to helping them understand their strategy in a world of horizontally layered ecosystems. A couple of months back, I co-authored a whitepaper with Standard Bank, which lays out this shift for the financial services industry. This newsletter carries an overview of the key points from that analysis. You can also access the full whitepaper at this link.

Let’s dive right in…

From vertical to horizontal

Banks have primarily performed the transformation function and served to collect deposits and pay interest on savings. Other core functions included payments, lending, and asset management. Through the 1990s and early 2000s, banks bundled financial services and acted as ‘one-stop shops’ for their customers. However, these bundled services were not structured around customer needs – they were optimised around the capabilities of a bank’s delivery channel.

As transaction costs fall with the emergence of new digital infrastructures and new mechanisms to organise the market for financial services, the vertically integrated value chain starts to unbundle. This is giving rise to new specialised competitors – agile and innovative ‘fintechs’ that focus on specific tasks in the value chain.

From the late 2000s to the mid-2010s, we saw the emergence of fintech challengers that specialise in particular activities across the financial services value chain. In doing so, they effectively ‘unbundle the bank’. Venmo and Square started by specialising in peer-to-peer (P2P) payments, Mint specialised in budgeting, and Lending Club helped consumers identify P2P loans with the best interest rates.

This unbundling of the vertically integrated industry architecture is creating a more modular, layered ecosystem where firms at every layer specialise in a particular value-creating activity.

Multiple competing firms can take up positions that were previously occupied by a single financial services firm, thus driving down margins and expanding consumer choice.

In these modular ecosystems, firms increasingly retain those activities where they possess superior capabilities. Over time, this has a positive reinforcement effect, as these firms increasingly develop competitive advantages by specialising in their niches, while letting go of activities in which they are less strong. Moreover, the low costs of API-based coordination with other firms further validates specialisation, since firms can invest in specific capabilities in a particular part of the value chain, while participating in larger business ecosystems that consist of firms across layers.

The emerging financial services stack

As the financial services industry reconfigures into ecosystems, and as value is directed towards new business models, the vertically integrated value chain of the financial services industry is being transformed into a layered financial services stack.

This stack has seven distinct layers that span the production and consumption ecosystems. The production ecosystem, further down the stack, comprises the underlying interbank network infrastructure, banking infrastructure, transformation functions, and product provisioning. Further up the stack, the consumption ecosystem spans consumer-focused decision-support systems and market aggregation platforms. Industry-wide integration infrastructures may play a role in the middle, linking the production and consumption ecosystems. We explore each layer in more detail below.

Value stack for your industry

This post lays out some of the core principles of value stack analysis.

If you’d like to learn more about our work here, check out our Advisory page or request our Advisory kit to get more details on our analysis and approach.

Interbank network infrastructure layer

Interbank network infrastructure provides direct links for banks to interact, enabling faster and secure communication and money transfer between banks on the same network.

The SWIFT payments network – and competitors like the Depository Trust & Clearing Corporation (DTCC) – provide clearing and settlement services to financial institutions.

Increasingly, distributed ledger technologies (DLT), like the Blockchain, enable more efficient record keeping for loans, investments, and even securities clearing. RippleNet, for instance, provides a DLT-based decentralized network for real-time settlement of international payments.

Inter-bank networks also include DLT-based trade finance infrastructure like Vakt and Contour. Multiple banks, often operating in consortia which include logistics and procurement companies, use a shared DLT-based infrastructure to seamlessly share documentation related to trade finance transactions.

Banking infrastructure layer

The banking infrastructure layer has traditionally been dominated by suppliers of core banking systems.

The monolithic technical architecture of traditional core banking systems discourages the modularity needed to participate in ecosystems. However, several firms, including Plaid, Tink, and TrueLayer, now enable banks to modularize banking products and services, making them accessible to external applications.

These firms open up core systems in corporate and retail banking as well as in treasury and capital markets through open APIs, allowing financial institutions to provision their products and services modularly and make them externally consumable as APIs on which external fintechs may develop new solutions.

Credit scoring is a key capability in the platform economy. Credit scoring enables access to credit, but can also serve as reputation scoring to determine access to other non-financial services.

While traditional credit access was collateral-based, emerging credit scoring models leverage other data sources. In the agricultural sector, Apollo Agriculture uses satellite imagery data to determine credit worthiness of farmers while APA Insurance uses similar data sets to inform risk. Companies like SyeComp gather geospatial data through a combination of satellite and drone based imagery. FarmDrive employs a blend of social, agronomic, environmental and satellite data to develop credit scores for farmers.

These capabilities, while traditionally bundled inside the bank, will increasingly be provided by independent firms. These firms, if successful, will provide these capabilities across multiple banks and learn from the data captured across activities across banks, further reinforcing their capabilities. In this manner, a bank’s ability to lend in the future will no longer be limited by its access to past lending and repayment data.