In our previous blog post we explored the regulatory framework required to provide financial services. In this final blog in the series we look at how to run a digital bank, including how to use marketing to drive customer acquisition and managing the path to profitability.
Launching a digital bank is one thing - running and scaling it is another. Management of a digital bank (as with any organisation) entails ensuring smooth daily operations and sustainable business operations.
This involves four key areas:
Customer acquisition forms the backbone of any start-up. Depending on the value proposition, the MVP may be offered for free. In order to generate future revenue, the company first needs to establish a customer base that can be leveraged for up-sell and cross-sell into other revenue generating services.
Typical metrics to track customer acquisition along the sales funnel include the number of app downloads and registered users for baseline growth, user engagement for up- and cross-sell potential, customer satisfaction as a measure of the customer experience, activation and retention for measuring customer stickiness, and finally cost of customer acquisition to measure marketing spend efficiency.
Digital banking value propositions are typically based around a superior customer experience at competitive pricing. In order to deliver on this promise, you must focus on operational excellence right from the start. This includes providing a simple, smooth process as well as low cost operations. To track operational excellence, you should consider amongst other factors the success rate of straight through processing for key processes such as onboarding; time-to-market of products and (micro) services; the quality of the relationship management of your partnerships; and regulatory compliance to ensure business continuity.
Successful management of digital banking operations is not without its challenges. Most digital banking models require rapid scaling of the business and operations. However, many have struggled with the technological and operational challenges arising from hyper-growth.
On the operational side, it is vital to keep up with the pace of onboarding, client interaction and transactions as digital banking customers expect real time and on-demand services. In addition, there is the potential emergence of a technological crowd, with a large diversity in programming language, database types and architecture approaches arising through the reliance on partnerships and focus on microservices.
When establishing and growing the organisation, strong people management is also important to ensure quality and business continuity. In the early days of development, digital banks often make use of flexible staffing - in particular, a large share of development operations (dev ops) is often based around contract workers. Digital banks should therefore focus on staffing continuity of key functions.
In addition it is important to maintain employee engagement and the quality of human resource management. As start-up banks typically have limited funds and generate little revenue, financial management is also critical. The initial focus should be on the financial runway, which is the time available until new funding is required based on expenses versus available funding.
As start-up banks typically rely on external funding, they should also closely monitor their valuation and access to new funding. In the scale-up phase, the focus should move towards profitability.
Typical performance indicators are the number of paying customers, conversion rates to paying products, income, cost and profit per customer, income and net profit margins, and valuation per customer.
As mentioned above, customer acquisition is one of the key components for a start-up bank and has several dimensions.
Firstly, a robust MVP with strong customer experience and competitive pricing will act as a ‘carrot’ to attract customers. Secondly, the absence of any hurdles ensures there are ‘no excuses’ to become a customer (this includes, for example, offering a free account, having no requirements for sign-up (i.e. proof of address) and a simple onboarding process. Thirdly, marketing will provide a ‘stick’ to drive sign-up and usage.
Digital banks tend to heavily invest in marketing and apply innovative growth hacking strategies. The goal is to create hype around their brand, typically surfing on the negative sentiment surrounding incumbents and based around explicit values.
Specific communities may be targeted through influencers and ambassadors. Personalised social media campaigns aim to increase brand awareness by going viral and this not only consists of digital marketing - offline channels are also used, such as billboards.
These large marketing efforts come at a price though. While the most efficient digital banks have customer acquisition costs of around $10 per customer, there are those that spend up to $250 per customer sign up.
Referrals can play an important role in customer sign-up, especially in the early days. Word of mouth can be up to four times more effective than alternative methods. When Metro Bank launched in the UK in 2012 as the first new high street bank in over 100 years, it offered strong incentives (such as a £50-100 reward) to refer a friend and was able to secure more than 40% of its customer base via referrals.
Additionally, rewards, promotions and gamification can be useful instruments to stimulate use and cross-sell of other services after sign-up. These tools can be particularly helpful when the account is new and inactive, while competing with an existing banking relationship.
Rewards are most effective at signup, for example to reward the first fund top-up or transaction. At this point customers are most likely to welcome a reward and once they have made a transaction they are more likely to keep on using the service.
Neo banks typically excel in creating an outstanding customer experience and achieving high customer numbers. But despite these positive signs of growth, their revenue and profitability have generally not yet matched expectations. A path to profitability is key to survival in the long run.
There are structural reasons for their low profitability. However, with the right strategic choices and proper financial planning, digital banks should be able to overcome these challenges and achieve sustainability.
First, digital banks typically have a small product portfolio, which limits their revenue potential. This puts them in a difficult position, especially when their core product (i.e. current accounts) is not profitable.
Expanding into new, more profitable product segments and geographical markets is the biggest driver for revenue growth. This enables the bank to tap into high(er) margin products and enhance cross- sell opportunities. However, the profit potential may vary significantly across geographical markets so selecting and expanding into the right geographical markets is key to enhancing revenue potential.
Second, they often operate at rather thin margins. To attract customers, neo banks typically offer very competitive pricing and commonly provide core features for free. However, pricing that covers costs is a necessity for a sustainable business model and to have a lasting positive impact on customers.
Therefore, revenue can be further enhanced by optimising pricing. Developing a good pricing strategy requires an in-depth analysis of the customer and the competitive landscape to ensure that pricing is fair, competitive and aligned with the company’s vision.
Third, neo banks usually have a less active customer base – they normally compete with existing banking relationships for the primary relationship, while churn rates are low. Most challengers struggle to bypass the stage of being a secondary account, with a more active customer and a large share of the wallet.
The customer acquisition described above should thus also consider the activation strategy that drives the share of active customers and increases the share of wallet towards primary relationships.
Fourth, even when a challenger bank is active in the right segments, reaching the break-even point to profitability may take a considerable amount of time and investment. To safeguard the future growth path and be able to fund the journey in between, a strong business plan is required together with investors providing the funding.
A business plan should, for example, provide an overview of the target market, the strategy to succeed and a financial summary for the coming years.
To build a successful digital bank from scratch and then scale it to profitability is by no means an easy task. However, with the right strategic choices digital banks should be able to enhance their profitability, achieving a sustainable business model with a lasting positive impact on customers. This requires a structured approach as laid out above, thorough understanding of the market and a solid business plan.
This blog post is part of a special series around successfully building a digital bank. These are all the blog posts in the series for further reading.
|1||Digital banks that do it well|
|2||The evolution of digital banking|
|3||Neobank, keys to develop a winning business plan|
|4||How to build a digital bank|
|5||Regulatory framework: required to provide financial services|
|6||How to scale a neobank|
The content of these blog posts was written with our exclusive guide 'How to successfully build a digital bank' in mind.
This is a three-step guide that will take you through what kind of digital bank to build, including the value proposition and business plan; how to build a digital bank, with a detailed description of each of the key elements including the regulatory framework, organisation design, technology, and people capabilities; and finally how to scale a digital bank into a sufficiently large and sustainable business.