Case Assignment #2 Cutting Through the Fog: Finding a Future with Fintech

1. What is fintech, and how has it evolved over time? Who are the major players? What

conditions have contributed to the emergence of fintech?

FinTech is the financial technology that has developed in the past few decades and has

allowed our financial management services to transform the way they have done business and

serviced customers. They are limiting human processes and increasing automation, enabling

firms to reduce their physical footprint.

Fintech starting with simply using the internet and start taking advantage of the power of

technology by developing and using online banking and online brokerage services. With the

emergence of smartphones, mobile banking and mobile payments became prevalent. Apps on

your phone can be used to administer payments directly from your bank or through services such

as Venmo or CashApp. Today, social media and AI are revolutionizing the fintech industry.

Fintech startups are the reason many of the other players in the fintech world have been

able to use this technology to grow their business and stay current with the times. They have

driven the innovations used by government agencies, financial customers, and other traditional

financial institutions such as banks, insurance companies, wealth management firms,

stockbrokers, etc., and technology developers.

As mentioned with the evolution of fintech above, the major conditions that contributed

to the emergence of fintech can center around the .com boom in the 90s and 2000s. This

transformed further in the mid-2000s when smartphones started to gain popularity that allowed

for a greater customer base to have access to their information on the go. Shortly after, this was

followed up by the 2008 financial crisis, where fintech firms started to really focus on their
diversification from traditional finance firms by combining past innovations and focusing on new

ones.

2. What are the four options that Costa could share with her client? What are the pros and

cons of each choice? Which one should she recommend and why?

Option 1: Do Nothing

Pros: This would be the simplest and easiest option to perform.

Cons: There have been studies showing that 95% of financial transactions are not

performed at a branch location - thus, doing nothing would render the bank behind in

sticking with its current business model. Costa was also aware the history had shown that

adaptation was necessary.

Option 2: Acquire FinTech Firms

Pros: Both firms that focused on technology and financial services could be potentially

acquired. They often had the resources already in place and would require little

maintenance in terms of the existing firm to hire, train and maintain employees and the

products offered. Smaller firms are easier to acquire and assimilate into the banking

industry. There can also be more opportunities to acquire multiple smaller firms to

develop in the different areas they are focusing on.

Cons: Pure technology driven companies such as Google, Amazon, Facebook, Apple, and

Samsung were too big to be acquired and had already started their own endeavors in the

Fintech world. Costs and regulations associated with acquiring a company can also be

cumbersome. Also, with any acquisition, both companies face challenges with

assimilation into the new environment and combining company cultures. A question to
 think about here is how would a technology-driven company transfer to the culture of the

traditional banking environment?

Option 3: Convert Current IT and Strategy to Become a FinTech Company

Pros: Many banks have already realized in the past that IT was an important factor in

continuing to conduct business in the 21st century and have a significant amount of IT

professionals on staff. Banks are showing a willingness to be “nimble”.

In converting the business model, the bank would also have full control of the process,

employees, and final product being delivered.

Cons: The culture that surrounds many tech startups is vastly different than the culture in

the banking industry. Retaining staff to help develop the programs that are already seen in

Silicon Valley might be difficult unless the banking industry shifts its traditional way of

doing business to a more entrepreneurial setup. Starting from scratch could be costly in

terms of time and money. If there weren't people on staff available and had the

knowledge to take the bank into the fintech industry - the bank would have to spend time

searching and hiring a team that could develop, execute and maintain its services and

platforms. This process could also take away from other projects in place if using existing

talent.

Option 4: Partner with Fintech Firms to Serve Customers

Pros: Outsourcing this meant that the firm could partner with many different start ups and

offer more services to its customers and quicker than if it had to develop it themselves or

work through an acquisition. This would save money by having a partnership and help

build competitive advantages and generate revenue for both companies. This would also

be the quickest option as they could evaluate different companies, what services they
 provide and get a contract in place much quicker than the red tape with acquiring a

company or the time needed for developing a brand new system.

Cons: Systems would need to be reoriented to be able to integrate one or multiple firms

into the existing firm’s platform. There would also be less direct oversight and control of

the systems being used. The bank would have to rely on the partnership and trust that

their end of the service is being properly maintained.

After reviewing all four options, Costa should recommend Option 4. This is the quickest

option to employ without staying complacent in its current business model. The bank can use

multiple services through different partnerships it will have the opportunity to create. Option 1 of

Doing nothing will only keep the company in the past and will not work to generate new

customers. Option 2 and Option 3 are viable options, but both would take significant time and

capital to execute - something that the banks might not have time for. Option 4 is the best for the

start up companies by allowing them to stick with the entrepreneurial feel of their industry, the

banks get to use and harness that power without delay and the customers see the benefit of the

technology quicker than the other two options and these partnerships could also help to attract

new customers.

3. What do the historical M&A data tell us about the fintech landscape? Which other

alternatives could this bank focus on to create value in the fintech space?

The fintech landscape has been evolving over time and has been brought to the forefront;

it is the way of the future. The internet revolution in the 1990s played a significant role in the

emergence of fintech by significantly lowering the cost of financial transactions. With

millennials becoming substantial financial services consumers, there is a considerable demand

for financial transactions to be completely virtual; smartphones also helped grow the fintech

landscape. Many consumers started doing financial transactions on their mobile devices. “Due

to fintech companies already having a significant impact on the financial industry, every

financial firm needs to build capabilities to leverage and/or invest in fintech in order to stay

competitive.” (Lee & Shin, 2018). Traditional financial companies are increasingly investing in

fintech ventures as they realize this is the way of the future and the only way to stay competitive.

These standard financial companies invest in fintech startups by collaborating with them or

building fintech from within their companies.

This bank can collaborate and integrate with an existing fintech startup to help stay

competitive and meet their consumers’ demand. By collaborating with a current fintech startup,

the bank can gain insights into customer transactions to see what the consumer wants and help

develop new products. To grow in the fintech landscape, the bank will need to understand the

fintech ecosystem. The fintech ecosystem comprises fintech startups, technology developers,

government, financial consumers, and, themselves, the traditional financial institutions. The bank

will need to understand all aspects of the fintech ecosystem to grow and create value in the

fintech space; it will be critical to their survival and maintain a competitive advantage.

The bank will also need to understand the various fintech business models and which

model(s) they will provide to their customer base. The fintech business models comprise

payment, wealth management, crowdfunding, lending, capital market, and insurance. Each of

these fintech business models provides consumers with something different. Currently, many

consumers are getting these services from different companies; the bank will need to decide

which fintech business model best fits their company structure and which one they will be able to

grow and expand in.

4. How are fintech companies valued in comparison to the broader market? What are

typical multiples, and why are fintech companies priced as such?

It is hard to value fintech companies because there is limited historical data on them.

Some can be highly uncertain and risky; new technology and products are surfacing all the time.

The methods used to value companies in the traditional industries cannot be used for fintech

companies because they are not the same. “Traditionally, net present value (NPV) without real

options thinking has been widely used, but it ignores the flexibility in investment such as

deferment and expansion in the investment horizon” (Lee & Shin, 2018). Fintech companies are

valued using real options instead of NPV like most other companies because NPV typically

undervalues the fintech companies’ valuation. “Fintech companies are generally priced at a

premium to the broader markets with the median S&P 500 company priced at 19.6X forward

earnings at year-end 2014” (Cartwright & Allayannis, 2016).

There are several real options applicable to Fintech companies; option to defer, option to

expand, option to abandon, and option to contract. By having these real options available,

management can be flexible with what they do with the fintech projects as there is significant

uncertainty surrounding the future of a fintech endeavor. If a project is not profitable,

management can use their option to abandon the project and not incur any future additional

losses. If a fintech project is being fruitful and data is pointing to future success for this project,

management can use their option to expand to bring in additional revenues.

Decision trees can be used to calculate the value of fintech projects and are used when

evaluating real options; this way, management can assess a fintech project and simulate the

future of these real options based on data they have gathered so far. “Decision trees are more

intuitive to decision-makers, and solutions can be framed flexibly and realistically without
confined assumptions of other real option pricing models” (Lee & Shin, 2018). Decision trees

give management a better view and often a better estimate of the valuation of fintech projects.

Because of the many factors at play with fintech projects, real options with decision tree models

are used to determine fintech projects’ valuation. Unlike traditional industries like manufacturing

or banking, the NPV cannot be used because of the ever-changing landscape of the fintech

industry.

5. What is the financial outlook for legacy banks in vide of new entrants into the financial

institutions' space? Is panic from big banks justified or is fintech just a trend of the

moment?

Legacy banks have the advantage of notoriety when it comes to banking, but they have to

start implementing change if they want to survive. People trust the names they know like

Goldman Sachs, Wells Fargo, J.P. Morgan, and so on. The issue is that they have to either come

up with new technology on their own or partner with fintech companies if they want to be

relevant in the future. Considering that more and more people are switching over to using the

Internet as their primary source for anything dealing with money transactions and banking, a

partnership would be profitable for both banks and fintech companies.

Fintech is the newest and most popular trend at the moment, but it is not just going to

phase out and go away. Over time, fintech companies will become more reputable. It is not

something that big banks should be worried about though. They should view it more as an

opportunity. Likewise, the panic that banks are causing is not justified because fintech only has a

“0.7% penetration rate…in the U.S. financial-services market” (Cartwright & Allayannis, 2016).

Banks should start to be concerned if they decide not to partner with fintech companies. While

the penetration rate looks to only be less than 1%, it is expected that banks profits will decrease
by a substantial amount within the next five years if they do not incorporate any sort of fintech

into their services.

With all that being said, if legacy banks are open and willing to adapt to the changing

industry, they should not be too concerned with how their financial outlook will be impacted by

fintech companies being introduced and more prevalent. Fintech is only just getting started and

the possibilities are endless when it comes to the technological capabilities it is able to provide

for banks and financial institutions in general.

6. What is the impact of fintech on banks and the financial services industry at large? How

might the future look for banks and fintech companies? -Madison

Fintech has been able to reshape and improve the financial industry as a whole. It has

improved the quality of financial services offered and made them more accessible than they were

before. With everything being so digital, users are always only a several clicks away from

finishing tasks that would normally require them to leave the house and go into an actual bank to

solve. Having fintech as accessible as it is, it has also helped with the efficiency of how

operations are running for banks. Online services that are offered are then able to be improved by

machine learning, thus helping them run more smoothly. Making operations more digital has also

cut costs for banks which allows them to reinvest that money back into fintech companies to help

them create more products to benefit banks. It is an ongoing cycle that has an abundance of

potential if they are willing to work for it.

The future is going to look very different. We will either see a lot of competition or a lot

of collaboration and cooperation. Some banks are trying to fight it and come up with their own

products to put out into the market, but the most logical thing to do would be to partner with

fintech companies. J.P. Morgan already understood the value in collaboration with fintech
startups. They decided back in 2016 to work alongside them “in order to develop innovations

that enable banks to operate faster, safer, and at a lower cost” (Lee & Shin, 2018). It is essential

that bigger name companies are seen working with fintech because it shows fintech is a reliable

source for helping improve the quality of services offered.

For both banks and fintech companies to be sustainable in the future they will have to aid

each other. Banks have the ability to really help out fintech if they choose to. They can provide

funding and promote the business so the smaller fintech companies can gain some momentum. In

return, fintech will be able to provide banks with more digital and AI compatible technologies to

help them keep up with the quickly changing market we see today.

7. How will the orientation of Costa's client bank need to change over time in terms of its

approach to fintech and products? How are banks currently "dealing" with fintech?

Over time, the bank needs to adopt a clear digital strategy to grow and adapt to

fast-changing customers' needs, a market that reinvents itself continually and to react to the

growing market share of fintechs. It is evident that the approach of wait and see is no longer

viable because the bank risks being caught unprepared when the threat to its business becomes

imminent. It risks the loss of data, customers, and revenue. The bank must assess and adopt an

approach of partnership and collaborations with fintech companies without losing sight of its

core business. However, it has to have a clear understanding of what is needed to make it an

effective relationship. To be successful, the bank should position itself at the center of the fintech

ecosystem (Cartwright & Allayannis, 2016), use its positions of trust with the customers, its

access to customer data, and its knowledge of the regulatory environment to find the financial

technologies or products that can be made available to its customers. As part of that process, the

bank would need to learn about different fintechs, what customers and segments are being
served, what products are being offered, be sure that they fit its customers' needs, or have the

potential to capture additional market share. This working relationship would require capital

investment and system integrations that can take time if not managed efficiently. The bank would

also need to understand that timing would be critical to avoid other institutions taking the lead in

the market.

Given the rapid growth of fintech, traditional banking institutions no longer have the

luxury of ignoring the impact this technology has on the market. By doing so, they risk losing

customers, expansion chances, and revenue reductions. Financial Institutions are dealing with

fintech in different ways. Based on a Global Financial Services Executives survey (Allayannis &

Cartwright, 2016), banks are dealing with fintech startups mainly by engaging in joint

partnerships. These collaborative partnerships help banks offer more personalized services that

otherwise could take them years to develop. They are beneficial for the fintech startups by

scaling distribution faster and more cheaply than they could do independently.

Surprisingly the second most common way to deal with fintech is not to deal with it.

Some traditional financial institutions seem to be taking a "wait and see" approach before

deciding to invest time and resources in financial technology. They are betting on continuing

with their current business models, assuming that their economies of scale and financial

resources provide them with enough competitive advantages over fintech startups.

In third place, banks are opting to set up venture funds to fund fintech services. This type

of investment allows the financial institutions to keep their current models while exploring some

of the opportunities fintech can provide. It seems to be an expensive but less risky way of

exploring this emerging technology.

 The fourth way in which banks are dealing with fintech is by launching their own fintech

subsidiaries. This is not a very popular approach because it means that the institutions would

have to overhaul their IT infrastructure to focus on being a technology-centered company. Some

banks risk losing focus and get away from their primary business. This approach would require a

high investment in technology and personnel, and banks may not have the resources or time to

make it happen.

The least popular way to deal with fintech is by acquiring existing fintech companies.

The lack of popularity of this tactic is due not only to the possible high cost but to the difficulty

of finding a fintech company that provides the products that are right for the market and the

bank's clients. It could also be difficult to foresee if the acquired fintech company can grow in

the same direction as the financial institution.

8. Where is capital currently being invested in fintech? Which niches are still ripe with

opportunity? What would be an appropriate strategy for large banks and fintech start-ups

moving forward? Why?

Most of the capital is currently being invested in personal banking and SMEs activities,

followed by asset management and wealth and investment banking (Allayannis & Cartwright,

2016). When analyzing personal banking, lending comes up as the product that received the most

significant investment. Lending is a perfect fit for fintech startups because these companies,

through the use of technology and/or artificial intelligence, have the ability to analyze large

amounts of a customer's data and decide on risk factors, default probabilities, etc. Also, lending

regulations for fintech companies are more relaxed than those that govern traditional banks. This

process saves banks time and resources and allows them to personalize loans to each client's
needs and possibilities. Another segment that has probably received a large portion of investment

lately is consumer and retail payment products due to the low cost in customer acquisition, the

rapid growth of new payment capabilities, and increased popularity.

One niche that has potential for additional investment and growth is the insurance

business model. Insurance companies can combine efforts with fintech companies to use

artificial intelligence and data analytics to collect different kinds of information to supplement

traditional models and calculate current and potential customer's risks. The resulting information

can be used to improve the relationship between the insurer and the clients and provide more

personalized products. Fintech also has investment potential in the business-to-business (B2B)

sector. Fintechs can use artificial intelligence (Moradi & Dass) to facilitate the business

relationship between two companies. Fintech can provide solutions for managing payments in

different currencies, assess risks for insurance and lending purposes, etc. Finally, an investment

in fintech companies that offer data breach and identity protection has a lot of potential. These

services are an essential component of financial health for both the banks and the customers

An appropriate strategy for large banks and fintech startups moving forward would be to

partner together to serve customers. This partnership yields advantages to both sides. Traditional

financial institutions have competitive advantages in economies of scale and financial resources,

name recognition, market and clients' trust, and knowledge of a highly regulated sector. Fintech

companies bring innovation, adaptability, technological knowledge (artificial intelligence and

data analysis), and different regulation levels. By working together, these companies can offer a

path of continuous innovation and support that is beyond what is needed now and looks into

what will be required in the future. By working with fintechs, banks can implement technology

services much faster and more cost-effective than if they decide to do it internally. Customers
would benefit from this relationship by having products customized to their needs, improved

services, and less bureaucracy.

References

Lee, I. & Shin, Y. J., 2018. "Fintech: Ecosystem, business models, investment decisions, and

challenges," Business Horizons, Elsevier, vol. 61(1), pages 35-46

Cartwright, K. & Allayannis, Y., 2016. “Cutting through the Fog: Finding a Future with

Fintech,” University of Virginia Darden School Foundation.

Moradi, M. & Dass M. “ Applications of Artificial Intelligence in B2B Marketing: Challenges

and Future Directions”.