For Funds and Fintech, Savvy Middle-Market Companies Will Turn to Banks

October 9, 2017         By: Patrick Moore

Uber and Lyft are disrupting the taxi business, Netflix and Hulu the entertainment business, AirBnB and TripAdvisor, the travel business, but the impact of these high-profile companies is rivaled by the influence of the relatively obscure companies collectively known as Fintechs.

Driven by a convergence of dramatic technological advances—in areas like artificial intelligence, APIs, blockchain, and the Cloud—Fintechs are redefining the $1.4 trillion financial services industry. Among other innovations, Fintechs are threatening the primacy of traditional banks by using contextualized algorithms that allow independent investors to quickly extract research from millions of documents, creating robo-advisors to help consumers manage their retirement plans, and building stand-alone digital currency platforms that enable global financial settlements.

Capital One’s recent study, Disruption in the Middle Market, underscores the unprecedented challenge that the Fintechs represent for legacy financial firms, but it also details the surprisingly robust response of middle-market financial firms. Most importantly, it emphasizes the benefits that the new financial technology offers—when placed in the context of established relationships with financial institutions—to companies who are trying to navigate disruption in their own industries. Based on a survey of 301 senior executives from companies with annual revenues of between $100 million and $3 billion, Disruption in the Middle Market identifies steps that the most proactive middle-market companies have taken to flourish in this environment.

Banking and Insurance in the Throes of Disruption

The Fintechs have already made their presence felt in the middle market. Of the 10 broadly defined industry sectors used to segment the participants in the Capital One survey, the financial services and insurance sector was by far the most likely to have already encountered disruption. Half of the financial services and insurance executives reported that their companies have experienced disruption severe enough to have had a material impact on their finances. The response across all sectors was just 15 percent. Add to this the additional 27 percent of financial services and insurance respondents who expect to be disrupted in the next year, and the picture emerges of an industry in the midst of a dramatic sea change.

Confirming this view was industry executives’ sense of their vulnerability to disruption. Ninety percent of the respondents from financial services and insurance reported that their industry is vulnerable. To provide perspective, just 73 percent of executives from healthcare, a field whose future is the subject of national debate, said that their industry was similarly exposed. According to financial services and insurance executives, the Fintech technologies—big data analytics, blockchain, and mobile capabilities—are primarily responsible for their vulnerability.

Financial Technology Goes Mainstream

Given this sense of vulnerability to disruption, one of the most remarkable findings of Disruption in the Middle Market is that financial services and insurance industry executives uniformly view disruption as an opportunity and not a threat. This compares favorably to sectors like energy, resources, and chemicals where close to 60 percent of executives viewed disruption as a threat.

Why are financial services companies so optimistic in the face of Fintech disruption? It is because companies in financial services and insurance have embraced disruption themselves. Eighty-three percent declared that their firm is actively pursuing a disruptive strategy to create competitive advantage. For more than half, this specifically entails introducing new products incorporating the latest financial technology, especially in areas like online and mobile payments.

However, most middle-market financial services and insurance firms are not developing their own financial technology. Just 7 percent are devoting more than 10 percent of their R&D budget to creating disruptive products of their own. A likely scenario, therefore, is that rather than create their own products, middle-market financial companies are forming partnerships with Fintech startups.

The conclusion is straightforward – although the Fintechs have started a revolution in financial services, they will not be the only companies or even the primary companies finishing it. Disruptive products will be broadly available, not just from startups but also from middle-market financial services companies and even larger more established financial institutions.

For instance, through its commercial bank platform, Capital One has introduced a series of fintech-infused treasury management services that use application programming interfaces (APIs) to deliver real time data, from a variety of sources, to any device, facilitating appropriate decision making as well as timely action. Some of these features Capital One developed on its own. Others, like natural language search, it introduced in partnership with a Fintech.

An Opportunity for the Middle Market

The growing implementation of new financial technologies comes at an opportune moment for middle-market companies. Capital One’s research found that the middle market is, on the whole, unprepared for a disruptive event. Just 14 percent of survey respondents felt that their businesses are quite or extremely prepared for disruption.

To determine what steps they could take to bolster their defenses, we looked at the most proactive among them for guidance. This group, dubbed the disruptors, is composed of companies who are not only pursuing a disruptive strategy, but also quite or extremely prepared for disruption. Disruptors are enthusiastic about the potential of the new financial technology. Three-fifths of the executives from disruptive companies said that they are considerably or extremely interested in adopting fintech products for their businesses. They are three times as likely to take this position as survey participants as a whole. Disruptors are particularly interested in services for bills, transfers, and accounting; payroll and benefits; and merchant services.

Disruption in the Middle Market also revealed that disruptors have strong relationships with financial institutions. Almost all the disruptors—94 percent—said that they have a banking relationship that they could turn to for resources and guidance during a disruptive event. This is a significantly higher percentage than for respondents as a whole. A substantial portion of companies overall—nearly a third—lacked more than a casual relationship with traditional financial institutions.

The survey reveals that disruptors tend to rely on banks for traditional forms of finance such as asset securitization and asset-based lending, and it is likely that many have treasury management services and corporate card solutions from them as well. As we have seen, these same financial services companies are avid creators of products using the latest financial technology. As a result, disruptors will likely be turning to them for advanced treasury management and payments products in the course of securing financing.

If there is one lesson to be taken from Disruption in the Middle Market it is that for the average middle-market company strong financial relationships provide a foundation for any defense against a disruptive event, serving as a source not only of resources and guidance, but also of the financial technology that can help companies wrest efficiencies from their operations. These relationships will not necessarily shield middle-market companies from disruptive events, but they will markedly increase the likelihood that they will adapt to them and prevail.