The original neobank proposition was to take one aspect of a consumer’s financial services needs and deliver transformational, rather than incremental, improvement, but what happens as the sector matures? How do neobanks continue to scale effectively as their product set becomes more complex, how should they manage their internal organisation to set themselves up for enduring success, and how will they balance increased regulatory demands whilst maintaining speed to market?
In a previous blog post we explored the measures that the UK’s neobanks, broadly defined as digital-only providers of financial services, had taken in response to the first wave of COVID-19. Rather than simply being a knee-jerk reaction to short term disruption, we proposed that a new found focus on operational efficiencies could help make neobanks leaner and more disciplined. Not only would this help them weather any subsequent disruption, but also ensure that their operations were ready to scale effectively in support of future growth.
The focus on unit economics
COVID-19 has only served to reinforce the neobank proposition. In a world dominated by virtual interactions, digital-only services truly became the norm for the first time and neobanks continued to add users at a pace. We also saw continued efforts to build a direct deposit relationship with customers and the expansion of product offerings, including the introduction of paid premium accounts, in an attempt to gain greater wallet share. The introduction of paid-for-offerings, in particular, is a departure from the traditional model of mass market banking in the UK where everyday banking services have historically been free (penalty fees aside). The early success of such products suggests that neobanks are serving a previously unmet demand; consumers are willing to pay for a bundle of services that includes not just basic banking products like current accounts, but also insurance perks, airport lounge passes and more.
Underpinning these moves is an increased focus on unit economics. A frequent comment made about the sector is the relatively low number of customers who use neobanks as their primary financial services provider. Contribution margins of customers who use them for day-to-day card transactions only are lower than those of customers who have been cross-sold additional services. An expanded set of products and bundling together of new services represent an attempt to open up new revenue streams and increase the value derived per customer. Similarly, while the current environment of low interest rates may limit its profitability, having a direct deposit relationship with the customer puts neobanks in a stronger position to convert themselves into their primary financial services provider in the future.
The desire to improve unit economics is also borne out in the introduction of fees for things like replacement cards and charges on ATM withdrawals (for non-premium customers). However, for neobanks that originally attracted converts with the promise of fairer, simpler, and transparent banking such moves risk tarnishing their brand amongst millennial consumers in return for marginal incremental revenue.
A better handle on operations
Increasing revenue is, of course, only one way through which to improve unit economics. The alternative is to improve the cost of acquiring, retaining and servicing users. Initially neobanks had low customer acquisition cost (CAC), owing to their ability to attract customers with novel mobile-based apps and millennial-friendly marketing. CAC tends to increase as a start-up scales but it seems that this will be particularly true in consumer financial services. As neobanks move into more traditional areas of banking, particularly deposits and loans, their product set looks set to converge with that of incumbents. There is also now greater competition with incumbents having spent heavily on their digital offerings. Consequently, as neobanks move up the maturity scale we do not believe that CAC will be the differentiator. Instead, it is internal operations and servicing of users where incumbents really struggle to compete.
We see two main areas of focus for neobanks:
- Servicing consumers: Neobanks were established with a simplified model and product set. As customer and product bases expand, they should be actively looking to understand the end-to-end customer journey for a diverse number of consumer types in order to ensure that the right operational capabilities are in place to be able to service them effectively, now and in the future.
- Scaling digital operations: As they continue to grow neobanks should ensure that the digital-first approach offered to customers is mirrored internally. This will require them to define what, and how, services are delivered to internal customers and balance the benefits of flexibility with increased demands from regulators.
We will dive deeper into each over the coming weeks and discuss what will be required for neobanks to continue to scale effectively.
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