According to an analysis for The New York Time conducted by Mint, in 2019 people spent $640/year on digital subscriptions such as streaming video, music services, cloud storage, dating apps, and online productivity tools, up 7% from 2017.
West Monroe, a technology consulting firm published an article entitled America’s relationship with subscription services, where they conducted an analysis of 2,500 Americans’ budgets, spanning 21 categories of subscription service. When they first asked participants how much they spend / month on subscription expenses, the estimate was $79.74/month. After recording an initial answer, they prodded the participants to think about this more carefully & prompted them with specific examples of services & service categories, including “WiFi, mobile service, Netflix, Spotify, Birchbox, Dollar Shave Club, GoDaddy, PlayStation Now, iCloud, Fitbit, etc.”
· Average of first guesses (10 seconds): $79.74/month
· Average of second guesses (30 seconds): $111.61/month
A 40% increase in estimated spend between the two guesses. They then took participants through 21 different categories below:
· They calculated the actual spend to be $237.33/month or ~$2,847.96/year.
Subscriptions are eating the world. We wrote about this in our piece entitled Recurring Revenue: The Rise of an Asset Class where we highlighted the valuation re-rating of stocks like AAPL & ADBE after transitioning their business model to focus more on subscription revenue. Since that time Third Point & Dan Loeb have written a letter to DIS management pushing for them to double down on content & focus on their own bundle. Loeb writes:
As experienced public market investors, we have observed numerous precedents of successful non-linear business model transitions that paid off handsomely for shareholders. Among such business transformations, Adobe and Microsoft stand out as particularly relevant examples of companies which, in order to optimize their distribution models, had to forgo lucrative upfront license revenues in exchange for monthly subscriptions. Investors have learned that while these strategic shifts may depress near-term earnings, their patience will be rewarded with businesses many multiples the size of what they once were. Furthermore, the stocks were rewarded with significantly higher multiples reflecting the superior quality of their new recurring, subscription revenue streams (a significant improvement over their historic lumpy transactional model). Both companies’ shares have appreciated significantly since these transitions began.”
Whether it’s SaaS as the preferred delivery method for software products, monthly subscriptions for music / video streaming, newspapers, newsletters, podcasts, or physical products, subscriptions are infiltrating nearly every business model.
What’s notably missing from the existing subscription bundle is financial services. As Neo Banks look to compete with incumbents they have talked about their lower cost structure, and cheaper customer acquisition cost, leading to shorter payback period.
While this has largely held true, they don’t have a lower cost of capital, which is critical to a banks revenue potential under their existing business models. As some of these companies are looking to go public there will be enhanced scrutiny on monetization which, we believe requires innovation on the business model to a subscription model.
How do Banks Make Money?
Before diving into how Neo Banks should look to innovate on their business model it’s important to understand how traditional banks make money. In the most simplistic way they derive revenue from two main sources:
· Net Interest Margin
Fees are the better understood and more explicit of the two. Banks assess fees for a variety of checking / saving accounts, overdraft fees, card fees (which may include interchange), and ultimately try to cross sell other products such as financial planning, insurance, etc… which often have fees associated with them.
Net Interest Margin (“NIM”) is simply the difference between the interest a bank earns on loans, compared to the amount it is paying on deposits. The below chart shows the average NIM for all U.S. Banks which sits at 2.89% as of 2Q20.
This is why banks have such a high correlation with rates. As rates approach 0% it restricts the ability for banks to generate a higher NIM, as they are able to in a high interest rate environment all else equal. NIM has two components to it:
· What Banks earn on Loans (Mortgages, Personal Loans, Student Loans, etc…)
· Cost of Capital- What banks pay on deposits (also thought of as “cost of capital.”
We recently wrote a piece entitled Moats & Network Effects in Financial Services and highlighted that although there “are some 5,066 commercial banks & saving institutions and another 5,091 credit unions there are even moats / network effects in banking with the Top 15 Banks in the U.S. controlling in excess of 50% of total deposits.”
As a result of that size / scale of deposit base it’s almost impossible for Neobanks to compete on cost of capital which means they need to follow suit & implement a subscription bundle.
(Neo) Bank Subscription Bundle
We are starting to see some of the Neobanks experiment with a subscription model, most notably with Revolut reportedly generating 30% of their revenue as a result of the various subscription tiers. They have three tiers: (i) Standard- $0/month (ii) Premium- $9.99/month and (iii) Metal- $16.99/month
In the standard Revolut offering they allow for spot FX rates, no ATM withdrawal fees (up to $300), free card, 0.25% on savings, instant access to 2 cryptocurrencies & 1 junior account. In their Premium offering they allow for greater ATM withdrawal amount ($600), insurance such as overseas medical insurance, 0.50% on savings (double), LoungeKey Pass, Virtual Cards, Premium Designs, and a junior account for up to 2 participants. Finally, in the “Metal” offering, they allow up to $1,200/month in ATM withdrawals, baggage & flight insurance, a metal card, 1 free SWIFT transfer each month, and junior accounts for up to 5 kids.
While it’s working for them they can clearly do better.
Robinhood has also dipped their toes into the subscription business with their Robinhood “Gold” offering. The main selling point of Robinhood Gold is the ability to invest on margin. In addition to that they provide access to “professional research”, Level II market data, instant transfers “up to your portfolio value” for $5.00/month. This does not include the interest charged for margin.
These are a far cry from what the ideal bundle should look like.
There has been much written about the “rebundling” of financial products & services across the FinTech landscape with nearly every B2C FinTech company expanding into adjacent product offerings from their initial beachhead. CB Insights has written about this for the past 2+ years and we’re still in the middle innings of watching this trend evolve. We wrote about this in our post entitled, FinTech: The 2020’s discussing the re-bundling trend in conjunction with “Autonomous Finance” or “Self-Driving Money.”
We took the core CB Insight diagram and have added “next pillars” that we think you’ll see many if not all of these FinTech firms provide in addition to the core product offerings that permeate the industry today:
The Optimal (Neo) Bank Bundle
As we look at what would be included in an “optimal” neo bank bundle we’ll break it down into two camps (i) Table Stakes & (ii) Innovation. It will take time to be able to offer everything in the innovation bundle, and some of the product offerings won’t be for everyone, however these can serve as the building blocks from which to build various tiers of service offerings.
Table Stakes: This is what we consider to be a bare minimum to be in market today with a competitive product offering.
· ATM Withdrawals- Free ATM withdrawals up to a certain threshold e.g., $500-$1,000/month.
· Brokerage (Self-Directed)- Following in the steps of Robinhood, Monzo, Revolut, and Square a competitive neo bank will need to offer “commission free” equity investing. This product should allow users to invest in single stocks & ETF’s in fractional form.
o Companies such as APEX, Alpaca, & DriveWealth currently enable this.
· Card Issuance- Physical & virtual card offering
· Crypto- While this felt “innovative” 2–3 years ago, now that Cash App & PYPL both offer the ability to buy / sell BTC (and in PYPL’s case other cryptocurrencies) this too has become “table stakes.”
o Paxos is currently powering PYPL & Revolut
· Hybrid Checking / Savings Account- Consumers think about money by purpose (e.g., spending, monthly bills, student loans, travel, retirement, savings goals) but the industry is structured via regulated silos (Checking Accounts, Savings Account, Brokerage, IRA, HSA, 529, etc…). They want their funds to be interoperable and at a bare minimum that should exist between checking / savings.
· Loans- In order for any of these Neobanks to make money in excess of interchange fees they need to start rolling out their own loan product offerings. They’ll likely start with personal / consumer loans, student loans, home loans, etc…
· Personal Financial Management (“PFM”) Tools- While 10 years ago companies such as MINT & Yodlee built entire products on this one feature, after the creation of companies like Plaid, this too is table stakes, and the incumbents are innovating (e.g., Marcus by Goldman Sachs, BAML, JPM, etc…)
· P2P Payments- With apps such as Venmo, Cash App, Zelle, etc… all offering free P2P payments this too has become table stakes.
Innovation: These are areas that we believe, if added to a subscription bundle can start to see meaningful economics on behalf of the (Neo) banks that offer them. Given the amount of B2B API enabled infrastructure that’s been built these bundled offers don’t have to be limited to Neobanks but could & should be offered by legacy financial institutions, credit unions, etc… as a way to modernize their own business models in a 0% interest world.
· Alternative Assets- We think Alternative Assets will be one of the next areas added to the Neobank bundle. We wrote about this in our post entitled The Financialization of Everything, but believe there’s no reason investors shouldn’t have their Square Stock, next to their Bitcoin, next to their Michael Jordan rookie card all in their Cash App.
o Art- Companies like Masterworks offer curated access to blue-chip art in fractional form with a comprehensive price database. They are structured as securities allowing individuals to participate in the “IPO” and sell in the secondary market, or participate in M&A off the platform.
o Collectibles- Companies like Rally offer access to Cars, Memorabilia, Watches / Luxury Goods, Comics + Literature, & Wine / Whisky all structured as securities, with a secondary market, and M&A optionality.
o Limited Partnership Interests- Companies like CAIS & iCapital have taken investment minimums down from $1-$5M to $100K-$500K to invest in LP interests of blue chip funds. This is definitely a higher end product offering but an attractive offering for RIA’s / Credit Unions where clients have higher balances and are under-allocated towards alternative investments.
o Private Company Shares- As companies continue to stay private longer there is growing interest in “exchanges” that offer accredited investors access to private company shares (e.g., Forge / EquityZen) and those that aspire to do so (e.g., CartaX). We think this market starts to evolve with a bifurcation of “exchanges / “brokers” and they become routing destination accessible via a front end, such as a bank. This will require standardization of structure (e.g., removing forwards / swaps concept & putting in place SPV’s) across platforms. If you could create an SPV with a finite number of shares for your user base that they can freely trade amongst each other without ROFER’s or triggering regulatory thresholds such as 12(g) that would be worth paying for.
o Real Estate- Companies such as Cadre, Crowdstreet, PeerStreet, and YieldStreet all offer access to different parts of the RE market. This becomes an attractive part of a holistic portfolio particularly when individuals are worried about inflation with the ability to isolate debt, from equity, from rental income, etc…
· Autonomous Finance / Self-Driving Money- We believe the holy grail of a product such as this would be the ability to have a holistic understanding of one’s personal finances (the asset & liability side of the balance sheet) and put forth recommendations, or more critically directly move funds for optimization. During onboarding (and periodically) have users answer basic financial goal & risk tolerance questions. You then will have a paycheck deposited into this account with money set aside for recurring bills (which it knows), and to pay down any high interest rate debt (e.g., CC). Users will pre-define different savings & investing goals & money will be optimally allocated across the highest yield savings account, and investments across different strategies (e.g., long-term growth, blue chip, DCA broad market exposure, FICC, etc…)
o Liability Optimization- This is something few companies have targeted but the ability to constantly look for the cheapest loan, credit card, etc… is critical. While asset optimization is intellectually more interesting the vast majority of Americans have a difficult time dealing with the liability side of their personal balance sheet.
· Bill Pay- Allow users to set up one-time payments or recurring payments for various bills. This is already a common feature (and in fact offered by some of the legacy financial institutions) but poorly done. It becomes a critical component of the Autonomous Finance stack.
· Buy Now Pay Later (“BNPL”)- Native integration into payment options that allow for BNPL at checkout are becoming more and more common. If there is an option available that’s truly 0% APR, from a time value of money perspective it’s better to take that than not, and allow your bank to handle this on the back-end. Even if you can afford the Peloton today, if Affirm is going to give you 0% APR access to capital, you should be able to take it, while automatically investing the balance due in a segregated account with little-to-low risk (and having inflation as a tailwind as opposed to headwind).
· Cards- Expand the classic debit card offering to a credit card, while also allowing for private virtual cards that can be autogenerated during the checkout period.
· Cash Optimization- Excess cash should be invested depending upon risk tolerance & investment objectives. If your bank knows within a range of variables what your expected monthly spend should be, you should allocate excess cash across a range of yield based alternatives in an attempt to at least keep up with inflation.
· Content / Community- One of the most under-penetrated areas within financial services is the content / community around the “demystification” of financial services. There could be a variety of podcasts, newsletters, propriety research, and access to a like-minded community of both experts & peers to discuss the most basic or sophisticated questions as it pertains to personal and professional finances. This something there would likely be demand to pay for and be apart of.
· Enhanced Brokerage- In addition to the “table stakes” free & fractional equity trading a premium package should include:
o Fixed Income Investing- Allow users access to individual CUSIP’s / ETF’s such as the product offered by YieldX. This can offer incremental yield to a basic ‘High Yield Savings Account” and while you have some principal risk associated with it, that can be accounted for based on the need for the cash at any given moment and the riskiness of the allocation.
o IPO Allocations- As companies look to target retail investors as opposed to providing allocation to the Private Wealth groups of bulge bracket banks could they look to set aside 5–10% for “retail” to a platform that can aggregate enough demand across it’s user base? This would be a huge value unlock and something investors would be willing to pay for because today it’s inaccessible.
o Managed Account- While there has been a growing trend towards DIY investors that folks like Howard Lindzon have been talking about for years, playing out in the massive user growth for companies like Robinhood & eToro, there’s also a segment of the population that doesn’t want to have to think about their investments, as evidenced by the Betterment’s & Wealthfront’s of the world. Neobanks should offer their users the ability to have an algorithmically generated portfolio that matches to their risk tolerance offered by companies such as IQVestment. You should be able to allocate a % of investable assets towards this strategy ranging from 0%-100%.
o Margin- While margin investing is not for everyone, some active traders have shown the desire for it. Given the risk associated with margin investing we would separate this from any bundle and make this an isolated feature that users must pay for in addition to the bundled package.
o Options- For some, options like margin, carry a negative connotation as it’s another means through which investors are able to access leverage. By offering only covered options to start, where users are only able to buy calls or puts, or sell puts where they have the offsetting cash position this will enable users another way to (i) Hedge and (ii) Optimize for Yield; in a capital efficient manner.
o Recurring Purchases- Academics & Practitioners alike have coalesced around the idea that Dollar Cost Averaging (“DCA”) is a prudent investment philosophy; however this is easier said than done. This should be automated on any investment app allowing users to invest the same dollar amount at whatever recurring interval they feel appropriate, in whatever instrument they desire (E.g., SPY, QQQ, IWM, BTC).
o Tax Loss Harvesting- Employing sophisticated tax investing techniques will have a significant impact on long-term returns. This is something few retail investors understand but brokers like Fidelity & Schwab offer this service, while Wealthfront highlights this as one of their key value props. Looking to manage capital gains, distributions, investing in municipal bonds, analyzing which account to take cash from, or put cash into, all have tax ramifications; that can & should be automated.
o Yield Optimization- As part of the “autonomous finance” yield solution & Fixed Income investing would be optimizing across the yield curve for a given risk tolerance. This can be done in a number of different ways by selecting bonds with higher yields but comparable risk parameters, off the run vs. on the run, etc… We can also envision new products such as recurring revenue bundles offered by companies like Pipe.
· Financial Advisor- While the allure of self-driving money appeals to many, others prefer talking to a financial advisor. It’s not uncommon to see a fee of $1,000-$2,000 for a full financial plan, 1.0% ongoing fee for AuM, and an hourly rate of $100-$500/hour thereafter. Within a certain tier users should be provided a detailed financial plan that their automated or suggested financial allocation will be based off of. They should also have access to a group of financial advisors to discuss what is being done with their finances, goals, changes in risk tolerance / life events, etc…
· Health Savings Account- The HSA market looks a lot like the 401(K) market did ~20+ years ago. At 17 years of age it’s still in its’ infancy but there are a number of macro tailwinds that make now a compelling time to bring this front & center. HSA accounts are triple tax advantaged allowing for 1) Pre-Tax Contributions 2) Tax-Free Earnings & 3) Tax-Free Withdrawals. HSA’s are portable & after the age of 65 you pay ordinary income but can use the capital for anything. They are able to roll over every year making it an ideal account for retirement growth / emergency healthcare spending needs.
o A widely cited Harvard Study found that 62.1% of all bankruptcies were a result of medical problems.
o $300K is required on average at retirement for HC expenses.
o Nearly 1/3 of Americans fear they won’t be able to pay for HC.
o The current annual contribution limit is $3,500.
· Insurance- There are a variety of insurance levers that should be offered through a product like this such as Auto, Home, Life, Travel, etc… Users should be able to purchase enhanced coverage (in addition to the basic coverage).
· Retirement Accounts- You can contribute $19,500 to a 401(K) (or $26,000 if you’re 50 or older), $6,000 to an IRA (or $7,000 if you’re 50 or older), and $3,500 for an HSA. If you are single & make >$139,000 you’re not eligible for a Roth IRA, (if you are married that number is $206,000). How should you think about allocation between those three accounts? You shouldn’t have to think about that, the contribution limits, and differences. This too should be automated to optimize tax benefits for your current & predicted life status, and maxed out before you take part in any taxable investing.
· Rewards- How often do reward points / miles degrade in value year over year, sit idle, or never used. When are you eligible for something but don’t realize it? In this hyper-connected world, where we have access to data from every corner of the web, we shouldn’t have to think about this. If you have excess Chase Reward points and at year-end you know they are going to be worth less, but you travel every year in mid-March, you should be prompted to buy that trip now with the points before they lose their buying power, etc…. If you are eligible for a discount this should applied at checkout. All of this could be automated as part of a financial assistant tool.
· Subscription Optimization- Companies like Snoop are looking to categorize spending, alert you when bills change, find discounts, provides spending summaries, looks for ways to save money, makes reminders on key insurance purchases, etc…In a world where subscriptions are eating the world, you want to ensure they don’t eat your personal finances.
· Tax Filing- If you have access to information on income & investments & spending, you should be able to expedite the tax filing process. There are a slew of features that are being built out for 1099 workers & solopreneurs from companies such as Catch.co which should also be part of this bundle. Saving receipts as write-offs, etc.. should all be part of this solution.
According to Northwestern there are Eight Dimensions of Wellness including (i) Physical (ii) Emotional (iii) Social (iv) Intellectual (v) Environmental (vi) Spiritual (vii) Vocational & (viii) Financial. While there’s a subscription for almost everything else, financial wellness remains a significant whitespace opportunity.
If you can justify $13.99/month for NFLX, $9.99/month for SPOT, $6.99/month for DIS+, $39/month for PTON, $14.99/month for Calm, $100/month for WiFi + Cable, $70/month for wireless, $50-$250/month for a gym membership, $12.99/month for AMZN Prime, etc… what would you be willing to pay to optimize your financial life with the suite of services offered above?
Our guess is more than the “interchange fees” that the Neobanks are earning on your spending today.