The Daunting, If Insurmountable, Long Odds of the Financial Services Startup

I was struck after our Bank Innovation meetup this week by a singular thought: the online FI startup cannot win.

By "winning" I mean achieving real, lasting and deep scale, and by that measure there is not a financial services startup that can surmount the existing edifice built by this nation's largest financial institutions. Not Mint/Intuit. Not PayPal. Not WigetCoWhatever.com. They simply will not beat Bank of America, JPMorgan Chase, MasterCard, American Express -- or any number of the entrenched, TBTFs of these United States of America.

The issue is scale and brand. MasterCard had 1.6 billion (with a B) credit cards in circulation at the end of 2009. PayPal has 84 million accounts. Chase.com gets 24 million unique visitors a month. Mint gets 1.4 million. BofA offers a full suite of mobile banking applications, including location-based services. That's more functionality that UBank, the Bank of Australia's out-of-the-box "experiential" banking spinoff.

And this is all being done within the wicked confines of a rigid regulatory framework. I don't envy the compliance guys who had to shoehorn BofA's mobile apps into regulatory shape. To all those who say traditional FIs don't innovate, try building a whatever app with the FDIC looking over your shoulder.

But that's not what really tips the scales against the startup. Inertia does. As one meetup attendee said the other night, "Inertia is the greatest force in FI." A startup app can radically and obviously move the dial in terms of value and benefit to consumers -- PayPal comes to mind -- and still only the churn portion of the retail consumer base of this nation's banks will make the switch to that new enterprise or service. The vast, vast portion of every bank's deposit base will remain a part of that bank's deposit base, well, forever. In other words, until they die. No iPhone app is going to change that. This is not just my view; this was the consensus opinion at our meetup.

So if you are an entrepreneur out there, at this point you are thinking: a) I might as well burn my VCs' cash and flee to Mexico; and 2) I want to rip JJ a new one. Those are both fair conclusions (however unsettling that might be for me personally). But there is another side to this. While an FI startup cannot presume scale, it can presume an exit. After all, $120 million ain't bad for a few years of work. So what if Citigroup makes that amount of money in four days? As we were discussing here at Bank Innovation, the startup is the spur in the side of the mega banks. Visa and MasterCard are poised to wallop PayPal -- because there is a PayPal. Bank of America has such robust mobile apps -- because there is an Apple and an mFoundry. And if there's an exit for those "spurs," then it will make the effort worth it.

I'm trying to be realistic here. We're not going to tell you (like, ahem, some other blogs) that any dodateoo startup with a wacky name is going to overtake the FI world and scale to Bank of New York Mellon, because it never will. Or, rather, the odds of that happening are longer than the longest of long odds. I like the startups. Heck, I've worked on one or two. But I have no allusions. The big banks win.

Tags: american-express, apple, bank-of-america, bank-of-australia, bank-of-new-york-mellon, citigroup, iphone, jpmorganchase, mastercard, paypal

Comment by Jeffry Pilcher on July 16, 2010 at 12:36pm: I think the anticipated "win" for most financial industry startups is a buyout, like Mint. It's extremely unlikely (and equally rare) that any brand will transcend its challenger status to rise above established players.

Comment by JJ Hornblass on July 16, 2010 at 12:40pm: I'm in agreement, Jeffry.

Comment by Betsy Vavrin on July 16, 2010 at 12:59pm: The definition of 'win' includes varying degrees of attaining a goal. To the extent that 'smaller' FIs succeed in reaching a goal (e.g. having the number of customers they want, and are capable of supporting), I believe you could say they are winning as well.

Let's take this from another perspective. The customer's choice -- which is one all FIs value. The customer has a choice of selecting from a number of FIs that best meets his needs. Isn't this ultimately what the free enterprise system is all about? Many consumers will never be interested in mobile banking; many do not even trust ATMs (and I'm not just talking about the 60+ generation), so the 'big' banks will never be a considered choice.

In the end, the goals of the FI are met, as each individual selects the FI that best meets his or her needs. As a result, even the small FIs survive and excel. Wouldn't you agree that PayPal is a success story and continues to serve a specific niche, innovating as their customers' needs expand and/or change?

Comment by Sarah Meyerrose on July 16, 2010 at 12:59pm: There's a great book called "Small Giants" that talks about what drives small businesses to either grow into big businesses or remain small to be able to fulfill their original mission (s). I think the same thought process is appropriate here. A small financial services player/startup (and I'm talking both virtual and traditional here) can, if well managed with the right people and the right strategic focus, be very profitable, serve their chosen market or client base, and provide a great work experience for employees. If the only goal is to grow big enough to sell, I completely agree with your premise. However, if the goal is to serve an underserved market (say other small to medium size businesses and their owners), enjoy life, and make a good return for investors, that can be done. Just my thoughts.

Comment by JJ Hornblass on July 16, 2010 at 1:07pm: Betsy,

You make great points, so thanks. Yes, I agree that PayPal is a "success," from the standpoint that it generates a healthy amount of free cashflow and has branded itself successfully. If I'm Elon Musk, I'm a proud man.

However, I hope you would agree that PayPal is not a "success" when measured against this nation's major payments purveyors. In fact, PayPal might not even register as a blip on their radar -- and that's my point. Put in perspective, PayPal and other FI startups don't deserve the glowing spotlight. A nice pat on the back, perhaps, but not unreserved adulation.

Comment by JJ Hornblass on July 16, 2010 at 1:09pm: Sarah, in full agreement. My goal was injecting some perspective into our view of the FI scene, not lambasting small-but-meaningful FI ventures. (Heck, I work at such a venture -- or at least I hope the "meaningful" part applies.) Thank you for correcting me.

Comment by Chris Duncan on July 16, 2010 at 1:16pm: Maybe the FI world is very different, but I don't think so.

On one hand you are correct, most won't succeed. I realize my examples aren't FI start-ups, but nevertheless, good examples of those who went for it. Your logic would have been the end of Apple, Google would have never existed, Facebook/MySpace would have run the other way.

So, if you have a dream, follow it. You may just be the next big thing. But be forewarned, and be prepared, you may not. You do draw that conclusion at the end, but overall, your post left me with an impression of why even bother.

Comment by JJ Hornblass on July 16, 2010 at 1:24pm: I hear you, Chris, and you are right on some level. I'm kind of feeling a bit pessimistic today. I'm allowed; I'm a blogger. ;)

I guess my response to your points are, sure, that is true that Apple, Google and Facebook/MySpace would never have existed, however: a) how many other whatever-the-name-was companies don't? Apple, Google and Facebook/MySpace hit the odds I am talking about; and b) Apple, Google and Facebook/MySpace don't have to deal with the compliance requirements of banking. Those requirements up the ante significantly in my opinion, particularly in the wake of Dodd-Frank, which amplifies the capital demands of large FIs.

In conclusion, I wouldn't say "why bother," but I would say, "be realistic." And I would also say that we -- in the blogosphere, in VC, in banking -- need to be realistic as well. These startups shouldn't be bestowed with unmitigated aggrandizement.

Comment by Betsy Vavrin on July 16, 2010 at 1:27pm: JJ, I would agree that PayPal (and others) do not compare well on some specific levels to major payment providers, and I don't extend adulation to them or the 'big guys', however they are defined.

That being said, I would ask what 'succeed' means. In another category comparison, an independent drug store may 'succeed' based on achieving their goals, while the mega-store also 'succeeds', based on theirs.

My comparison is not to knock the big players or the small. Simply to point out, as Sarah has mentioned, 'small giants' may be quite successful based on their own criteria. That's all it means.

Comment by Sarah Meyerrose on July 16, 2010 at 1:34pm: JJ, did you realize what you started? Actually, I find this an interesting and healthy discussion. Definitely try, definitely be realistic, and please have other success goals than beating the big guys or 99.99% of start-ups will feel they have 'failed'. Much more to life than that. And your point, JJ, about the aggrandizement? Be careful what you wish for and be careful about believing your own press. How many companies/CEOs have shown up on the cover of Fortune or Forbes only to go down in flames shortly thereafter.
On a related subject, surely I'm not the only one who has noted that the Financial Reform Bill will forever be referred to as the D-F Bill. Shades of school days and the threat of what will show up on your permanent record!! :)

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