Many entrepreneurs in Silicon Valley believe that the financial services industry in the United States is “ripe for disruption.” The basis of this argument is really two fold. First, they believe that the current offerings from the financial incumbents are lacking. They would argue that credit card fees are too high, that there is a lack of true competition amongst American financial institutions, and that the ACH process is borderline asinine. They also believe that today’s technologies, most notably the smartphone, should allow for remarkably simpler one-click paperless transactions that have transaction costs that are a fraction of the status quo. Consumers want faster, simpler, and cheaper transactions, and entrepreneurs want to give it to them. The problem is that this drumbeat has been going on for many, many years, yet little seems to change. The key questions are “why?” and “might we need a fresh approach?”
A quick look at the U.S. consumer financial landscape raises a number of questions. Here are just a few examples:
- Credit Card Fees. U.S. credit card transaction fees are some of the highest in the world. If you look at the graph below, U.S. fees can be as much as 4.5X those in Australia, and are clearly larger than the rest of the world. Shouldn’t our access to technology and scale lead to lower rates than say Bulgaria? And keep in mind that credit cards still work in these other lower fee regions. The same companies operate there and here.
- Checking Account Competition. Over the past four to five years, U.S. banks consumer checking offerings have become less favorable across the board. “Free Checking,” which was once a mainstay of U.S. bank competition is now all but gone. If we are in a true competitive market, and one where technology should make things easier and cheaper, why are the offerings becoming more expensive? There are now 61mm unbanked citizens in the United States, and that number is rising.
- ACH Payments. Perhaps the most ludicrous piece of the U.S. banking system is the Automated Clearing House network, broadly known as ACH. This supposedly “electronic” network enables people to transfer funds from one bank account to another. The pathetic thing is that this “electronic” network takes three earth days to settle. I can ping Madagascar from my desktop in California in 368ms, but it takes 72 hours for a U.S. bank transfer to happen. Why? Guess who controls ACH? It’s the large banks, and ACH is slow for the same reason Vegas Casinos have long cab lines – they don’t want you to leave. In July of 2009, the UK instituted a network known as Faster Payment Service with same day settlement to replace their equivalent of ACH. In 2013 there were 967 million FPS transactions. Interbank transfers all over China are also same day.
The point to understand is that the U.S. financial system does not operate as a perfect competition – in fact, it is far from it. One could argue over the cause, but a likely contender is the overt level of regulation. Regulation becomes the friend of the incumbent in highly regulated industries through a process known as regulatory capture. Many blame Dodd-Frank and the consolidation post 2009 for the loss of free checking. Banking may be naturally prone to this calcification, and it is worth noting that the low credit card fees in Australia/France, as well as the FPS in the UK were the result of government intervention. So these “achievements” were not the result of a competitive bank ecosystem.
This past spring, Benchmark spent a week in China meeting with the leading Chinese Internet companies. Like Google, Amazon, ebay, and Facebook, the leading Internet companies in China are interested in disrupting payments. Both Alibaba and Tencent have made huge strides on this point. Alipay now claims to be the world’s largest mobile payment solution, with 100 million users, and 2.78B transactions for a total volume of $150B. Tencent has also been ramping their own payment service known as Tenpay on top of WeChat, the company’s leading messaging service. Tencent now has 20% of the market. Both these companies are aided by the lack of a defunct service like ACH. As noted earlier, it is much easier to fund an online wallet from your bank account in China.
While in China, we learned about a radically new approach that opened our eyes to what it might take to truly disrupt banks. Alibaba, a very ambitious company, was perhaps unsatisfied with users transferring small amounts of money periodically into their Alipay accounts. So they had the bold idea to launch a savings account alternative called Yu’e Bao. Yu’e Bao isn’t just a savings alternative, it’s a highly disruptive one that offers almost 200 basis points more interest than the rate most banks are offering. In a little over 12 months, Yu’e Bao has gathered 100mm investors and over US$87B in assets. Alibaba may be willing to forgo profits on savings accounts in order to grow assets, and that is wonderful for consumers. Isn’t that the exact type of competition we would love to see in the U.S?
Of course, the Chinese banks are now doing what any well-captured regulated incumbent would do – they are encouraging lawmakers to stop Alibaba. They have also put limitations on online transfers (its doubtful they will be able to make it as bad as ACH, but who knows?). Learning about Yu’e Bao gave us an epiphany that Jack Ma likely had years ago. If you want to truly disrupt the financial services industry, perhaps you need to stop attacking the transactional experience and launch a competitive product on the asset gathering side. Once you have the assets, all the disruptive things that Silicon Valley types want to do will be easy. The hardest part has been getting access to the funds.
Thinking about this on our way back to the U.S., we immediately thought of Wealthfront, the automated investment service started by Benchmark founder Andy Rachleff. Wealthfront is at the cutting edge of wealth management. Whenever someone asks for personal advice on what to do with their savings, I have always recommend they read Burton Malkiel’s A Random Walk Down Wall Street. This book offers the most pragmatic advice for the long-term saver, and teaches the reader to avoid the get-rich-quick schemes that stymie most investors. Prior to Wealthfront, doing what Malkiel recommended was easier said than done. It was simply too complicated to remain fully invested and properly allocated all the time. Wealthfront leverages ETFs and modern technology to perform these actions for you. The Wealthfront model is quite disruptive to broad-based asset management in that it replaces the inherently inefficient national wealth management sales force and the active fund managers with automated algorithms that better meet the needs of the household or individual. Unsurprisingly, Malkiel has joined Wealthfront as Chief Investment Officer.
It may just be that “grabbing the assets” is more disruptive than trying to take control of the transactions. Visa, MasterCard, and all the large banks watch after the transactions like a hawk. More importantly, the banks make it very difficult or expensive to move funds out of your checking account, effectively stranding your assets in their system. Wealthfront just hit $1B in assets in a little over 2.5 years, and there are many reasons to believe that the path to $10B will be easier than the path to $1B. A longer track record and larger assets under managment will build increasing trust. Soon, you may see Americans directing their paychecks directly into Wealthfront. At this point they will have stepped above the banks in the food chain, and from there the options to be disruptive are endless.
With the benefit of our newfound perspective, Benchmark asked Andy and CEO Adam Nash if there might still be an opportunity to invest. We are thrilled to announce that they kindly obliged.