FinTech Innovation: China Lab

The only way for financial executives or the banking industry to move forward is to ‘disrupt themselves’. The term ‘disruptive innovation’, as it relates to business, was first coined by innovation guru Clayton Christensen in a Harvard Business Review article in 1995, followed by his 1997 book, “The Innovator’s Dilemma” and many subsequent works.

While Christensen was not without detractors or valid challenges to his theory, but his writings as a ‘lesson plan’ to help provide guidance to financial institutions struggling with change or innovation. Just as importantly, he often argued about the difference between ‘radical sustained innovation’ and ‘disruptive innovation’. While many refer to disruption as a departure from business as usual, Christensen argued that established companies have challenges innovating because they focus too much on what had made them successful in the past. He further surmised that start-ups benefited because they didn’t have that legacy, therefore allowing them to view the future without holding on to the past. His theory described how innovation can transform a business or industry. Nevertheless, there are some questions that can only be answered on a massive scale and in an unorthodox way. In physics, this is called Big Science, a trend that emerged after WWII as governments started funding large-scale projects focused on generating empirical evidence of theoretical scientific theories. Technologies like the Large Hadron Collider (LHC) — a 17 mile-long circular tube buried more than 500 feet below the border of France and Switzerland — have only been made possible by Big Science. And despite the cost (more than $5 billion and counting for the LHC), such technologies have allowed scientists to definitively answer hugely important questions that would otherwise be impossible to answer (like ‘why do particles have mass?’).

The questions that we wrestle with financial services aren’t nearly as weighty or maddeningly-hypothetical as those plaguing scientists. That said, we do have plenty of theories that have historically been difficult to prove. Thankfully, in the same way, that scientists have the LHC, FinTech enthusiasts have China — a massive, technologically-advanced financial services market dominated by large incumbent banks and innovative technology companies competing within a comparatively permissive regulatory environment. Put simply, China is an enormous FinTech laboratory, where answers to the big questions in FinTech are constantly (and sometimes disturbingly) being sought.

The foundation for disruptive innovation is a marketplace that is currently served by incumbent organizations that are making ongoing, incremental product innovations to serve their customers. The business continues to be strong, they are less likely to take risks that will disrupt the status quo and because of this relative complacency to the changes in the marketplace, new firms enter the market. As opposed to replicating the incumbent model across product lines, the new firm selects a single or few product lines that often have narrow margins. The margins are low, the incumbent usually determines that defending the turf is not a viable strategy. The result is that the new firm captures a significant portion of the market share for the product by offering a new product, a new technology to produce the product, new ways to distribute the product or a new way to provide the service. Many times this is achieved by offering services much more efficiently than was possible in the past. In financial services, this would be what happened in payments, where fintech firms found new products, new distribution methods and brand new ways to serve the consumer. From this foundation, the new entrant expands its offering across a broader array of similar services or ancillary services. By the time the incumbent stages a defense, consumers may have already changed their buying or usage patterns and developed new loyalties. The foundation established by the new entrant provides the leverage to go after a larger share of the incumbent business.

Between January and October of 2017, $49.3 billion in mobile payment transactions were processed in the U.S. During that same period in China, $12.8 trillion in mobile payment transactions were processed. 90%+ of those Chinese transactions were processed by Alipay (owned by Alibaba) and WeChat Pay (owned by Tencent). Put another way, according to Brett King (@BrettKing) “Alipay and WeChat Pay now annually process more mobile payments than the world’s plastic cards”. Despite their success, Alipay and WeChat Pay aren’t resting on their laurels. Building on the growing ubiquity of facial recognition in China (which is being used for everything from government surveillance to dispensing toilet paper in public restrooms), both companies have introduced facial recognition technology that allows consumers to pay in stores with just their face. Alipay is especially bullish on the potential of the technology. It is planning to spend more than $400 million to subsidize merchants’ installation of the technology and provide rebates to shoppers who make purchases with it. The companies’ intense focus on facial recognition payment technology appears warranted. And maybe even necessary in order to keep up with the expectations of Chinese consumers, whose appetites for convenience (like consumers’ everywhere) appear insatiable.

Here’s a fun thought experiment. Try to guess how many different apps from U.S. companies you would need to mash together in order to approximate the functionality built into Alipay. By my quick calculation, you would need approximately ten. (let’s count them up) With Alipay, Chinese consumers can make payments in-store and online (Apple Pay), place and track orders in Taobao and TMall (Amazon), view discounts and offers from thousands of retailers (Honey), send and receive money from friends (Venmo), pay bills (Prism), invest spare money in wealth management products (Robinhood), book air, rail, and movie tickets (Expedia & Fandango), order food from local restaurants (DoorDash), and summon a taxi (Uber). And that’s underselling it because Alipay is one of several apps within the broader ecosystem created by Ant Financial (the parent company for all of Alibaba’s financial services offerings); which also includes online lending (Marcus), insurance (Oscar Health), small business lending (Kabbage), and credit score monitoring (Credit Karma…kind of…it’s a long story). Along with a range of other services that don’t have obvious equivalents in the U.S. yet (like a recently announced blockchain initiative that will enable donors to track how their donations are used by charities). The playbook for Alipay (and WeChat and other aspiring super apps), as CB Insights helpfully outlined, is to create an ecosystem of interconnected services that is so comprehensive and convenient for its users that it continually attracts more users and third-party providers that want to serve them in a virtuous cycle. As recently reported by the Wall Street Journal, Ant Financial’s flywheel is really beginning to spin — eight out of every ten Ant Financial customers use at least three of its five primary services and four out of every ten customers use all five.

Only about a fifth of China’s population has credit cards (according to data from 2017). To address this problem (and further lock users into its ecosystem), Ant Financial created a micro-lending service called Huabei. 20% of Chinese consumers don’t have a basic bank account and 28% have to borrow from friends or family if they need emergency funds. To address these problems (and pull more users into its ecosystem) Tencent created a digital-only bank called WeBank, which has grown to serve over 100 million customers at an exceedingly low cost per account, as Chris Skinner (@Chris_Skinner) notes. These initiatives obviously have a beneficial impact on financial inclusion, especially for younger and less wealthy Chinese consumers. However, there are also signs that the availability and convenience of these digital services may also be contributing to a new, more permissive attitude towards debt accumulation by Chinese consumers under the age of 30.

The results from these ‘FinTech experiments’ in China are fascinating and absolutely something that every financial services executive in North America and Europe should be paying attention to. That said, as any scientist will tell you, the precise conditions of an experiment matter a great deal. And, to put it mildly, conditions in China are quite different than in the U.S., U.K., or other western countries with respect to privacy, regulation, and cultural norms.