At its core the Challenger or Neo-Bank offering is built around the customer experience. In recent years innovative product design and distribution have won new entrants an increasing number of converts, now numbering in the millions, and, despite the best efforts of incumbents to update their digital offerings, Challengers continue to expand their product range and grab market share.
COVID-19 and changing priorities
In a sector that stands or falls on its ability to provide not just an alternative to traditional banks but a great alternative that reflects the needs and preferences of the consumer, Neo-Banks have prioritised investments in customer experience and enabling technology. When the sector was in its seed and early growth phases the priority was to generate sufficient new customer acquisitions to justify follow on (venture capital) VC funding rounds, underpinned by a mentality of growth at all costs. To date this has proved to be a meritorious cycle, with Challengers pouring their newly raised funds back into expanding and improving the user experience. As the sector matures and looks towards profitability the focus has, inevitably, been shifting towards metrics such as customer contribution margins and demonstrating that growth can be achieved in a cost effective manner.
The emergence of COVID-19 has magnified the cost side of this equation, impacting Challengers’ business and creating a less hospitable environment in which to fundraise. UK Challengers are heavily reliant on revenue derived from transactions and payments, both of which have been severely depressed as a result of the lockdown restrictions. Central bank action to support the economy through lower interest rates has put further pressure on revenue by reducing the interest earned on cash deposits. In such circumstances Challengers need more capital just to stand still and maintain their position. Unfortunately, at precisely when it is needed most, VC funding may be harder to come by, as funds and their LPs face liquidity issues of their own. Even where funding is available it is likely to come with more onerous terms attached.
Consequently, cost management will play an important role in helping Challengers to weather COVID-19. In the immediate term delayed or scaled back growth ambitions, particularly those related to international expansion which would likely introduce additional regulatory burdens, can help avoid incurring extra cost. Meanwhile, the existing cost base should be scrutinised and many banks have looked to headcount reductions and staff furloughs as an easy to implement solution. The impetus for these decisions is largely to delay the need to raise additional funds. One need only look at recent sizeable down rounds in order to see stark examples of the pressure that the pandemic is placing on valuations in the sector. We believe that such down rounds are a reflection of the unique circumstances introduced by COVID-19 rather than a judgement on the underlying businesses and their long term potential. However, the message for Challengers is clear: where possible, delay fundraising until the worst of the pandemic has passed and tap investors from a position of strength at a later date.
Nevertheless, cost reduction must be about more than tough decisions concerning temporary headcount reduction. As a result of attempts to keep pace with breakneck growth, many Neo-Banks have not scaled their operations effectively and should review their cost bases with a view to making their businesses leaner and more disciplined. The cost pressures facing incumbents are well rehearsed – including complex legacy technology architecture and large physical branch networks - but what opportunities are present amongst the Challengers? We see three priority areas:
1. Digital workforce solutions: the UK fintech industry relies on an international talent pool but one that, historically, tended to be physically located in London. The response to COVID-19 has demonstrated the viability of truly remote, digital workforces and we anticipate that this will enable Challengers to access the best talent from across the world and regions within the UK, at the same time as benefiting from the cost advantages of not having an entirely London- and office-based workforce.
2. Transformation cost rationalisation: as each Neo-Bank has expanded its product offering so too have the number of teams within the bank responsible for creating and maintaining customer experiences. Rationalising customer journey ownership under a more effective support model not only provides an opportunity to streamline the business but, perhaps more importantly, enables a cohesive and consistent experience to be provided to the user regardless of the product or service they access.
3. Process excellence: Challenger Banks have started to set up regional UK and near-shore European operational centres, following a tried and tested approach amongst their established peers to leverage local wage differentials in order to deliver services at a cheaper price point. This has largely focused on customer service and compliance processes, particularly those that are highly manual in nature. However, the ambition should be to mirror the digital-first service offered to consumers and to leverage intelligent automation where possible across the organisation. Successfully deploying digital tooling solutions will enable Challengers to effectively scale their operations, almost independent of headcount.
Capitalising on long term trends
Looking to the longer term, the momentum remains with the Neo-Banks. While the concentration of their business in transactions and payments has hit Challengers hard, the relative absence of large loan portfolios means that they will not face the same difficulties as incumbents with regards to loss provisions. Once the economy returns to a version of normality, whatever that may look like, Neo Banks will be able to put the pandemic behind them with relative ease. In contrast, high street banks face the prospect of complex and protracted tailwinds surrounding their loan book. COVID-19 has also hastened pre-existing market trends, particularly the growing use of digital channels amongst consumers, and has normalised the use of digital-only services. This will only provide yet more momentum to the Challengers and open up new customer groups for their products and services.
The economic impact of COVID-19 has forced a unique set of problems upon the Challenger Banks. Immediate responses have necessitated difficult decisions about headcount and forced growth plans to be reconsidered. However, this temporary slowdown also presents an opportunity to strengthen and prepare for the future. Efforts to streamline the business will not only release cost in a sustainable manner, which may prove increasingly important should revenue remain subdued due to a stuttering economic recovery or advent of a second wave of infections, but enable Challengers to capitalise on the opportunities that lie before them.