As the finance industry grapples with what the next generation of banks and payment systems will look like, it’s clear that partnerships are a linchpin for riding the wave of change successfully, whether you’re a multibillion-dollar traditional bank or a startup looking to bring cutting-edge technology into the mainstream.
“The rails that these payment systems are built on date back 20-30 years – people are not starting to reinvent that alone; it isn’t an overnight thing – it’s incremental innovation adding up to something massive,” said Jennifer Lee, vice president focused on fintech at growth equity firm Edison Partners during the recent Fearless in Fintech conference at Wharton San Francisco.
At the conference, which was co-sponsored by Knowledge@Wharton and Wharton Executive Education and organized by Momentum Event Group, Denise Leonhard, head of global credit expansion, business development and expansion at Paypal, used her company’s online payments system as an example of the challenges ahead.
“We’ve built our infrastructure with all these different partners – payment networks, bank issuers … we’re all playing in a very messy soup,” she said. “What we’ve been building in the last 20 years has brought all of those partners together to make the infrastructure as seamless as possible and we’re still relying on that infrastructure.”
As financial services companies begin to explore the possibilities of technology like cryptocurrency and the blockchain, “I don’t think anybody is going to be able to do it alone…. Cryptocurrency is reliant on old-school rails to extract value,” Leonhard added. “To get to the next evolution of payments, it’s going to be really partnership driven.”
Traditional banks value startups for their speed and the opportunity to stay on top of potentially disruptive innovations. Start-ups can benefit from the scale and resources offered by larger established firms. But what are businesses doing to make sure the partnerships are valuable and viable?
“Startups and big companies live in very different world: They hire people differently, they operate differently,” noted Serguei Netessine, Wharton professor of operations, information and decisions. In 2016, Netessine co-authored a report that examined how the world’s largest companies were dealing with “the startup revolution.”
“Going into this exercise, our expectation was that big companies and startups don’t do much together,” Netessine said in an interview with Knowledge@Wharton. “But the reality was very different. What we found was that the majority of Global 500 companies have a variety of ways of partnering with startups.”
That engagement took the shape of M&A, investment funds, spin-offs, accelerators and incubators, events, support services, startup programs and offering co-working spaces – or a combination of several of these.
“You have to qualify your own goals [for partnering]: What is it you’re trying to achieve?” Netessine said. “Some companies just want to make money through investing in innovation – for example, Yahoo made a ton of money purely by investing in Alibaba. That’s fine, but sometimes the goal is very different – you want to keep an eye on what’s happening in your industry, emerging technologies, and usually those are commercialized by startups.”
“The rails that these payment systems are built on date back 20-30 years.”–Jennifer Lee
Added Wharton operations, information and decisions professor Gad Allon: “Legacy firms are really good at mitigating risks. They do excessive testing and are generally very slow to adopt tech that hasn’t previously been tested and adopted by other organizations. Startups are the exact opposite. Their only advantage is speed; they move very, very fast, they undertest, they usually underdevelop… this is a partnership between two vastly different culture and value systems.”
At the Fearless in Fintech conference, leaders from established companies and relatively young startups discussed how they have navigated the path to successful partnerships.
Beyond the ‘Walled Garden’
Leonhard noted that Paypal’s approach to partnership has changed significantly since it became an independent company four years ago. “When we were part of eBay it was all about running payments for the mothership,” she said. “As a public company and really thinking how to be successful, one of our big strategic decisions was to move away from being a walled garden to much more of an open platform enabling all financial institutions to drive that ecosystem.”
When the company thinks about partnering on products today, “we always start with the need of the customer, whether that is the merchant or the consumer,” she said. “Then we look to see if we have the right building blocks internally to meet that need. Sometimes we do, but we see that it’s going to be really difficult to do, or we do but it’s not hitting the right prioritization.”
Leonhard says Paypal does an internal pro/con exercise to see what a project would look like if it’s done internally vs. engaging with a partner, and whether there are potential partners outside Paypal who are already doing similar work. If the company decides to find a partner, Leonhard says it’s important that both sides are clear in the beginning what the expected outcomes are and how the partnership is expected to evolve over time.
“What we found was that the majority of Global 500 companies have a variety of ways of partnering with startups.”–Serguei Netessine
“That needs to be written down in detail and clear on the key performance metrics (KPIs),” she said. “Leadership can change or someone could get excited about another shiny object – there’s excitement, and being clear about what that excitement is going to deliver. You need alignment for partnerships to work and on both sides; you need leadership buy-in, that senior leaders are going to be held accountable for it.”
Leonhard, who worked for American Express prior to joining Paypal, noted that more established firms offer smaller fintechs a level of scale they wouldn’t be able to access otherwise. “They may have a great unique solution, but they can’t actually scale, and you need scale to drive forward,” she noted, adding that strong partnerships can pave the way for successful acquisitions down the line.
“When we think about partners, especially when we think about partnering with fintechs who may be really innovating in the space … partnership is the best due diligence you could ever do,” Leonhard said. “If you do a pilot with a partner, make sure you’re kicking the tires on the tech, kicking the tires on making sure you can work together.”
Anyone who has ever applied for a mortgage knows it’s a time consuming process. Mortgage loan company Fannie Mae has partnered with a San Francisco-based fintech called Plaid to try to take a little bit of pain out of a complicated system.
In 2017, the two companies launched a pilot to automate the asset verification step of the mortgage process. Fannie Mae lenders are able to connect with borrowers’ bank accounts in real time, meaning potential home buyers no longer have to go through the process of collecting paper documents to prove they have the capital necessary to afford a mortgage. The borrower controls who has access to his or her data, reviews data before it’s passed on to a new entity and has access to a history of each entity that had access to the information.
“It was good to have somebody to bounce ideas off of; it gave us the opportunity to improve our process. That’s what a good partnership is about – being open and honest.”–Natalie Hunt
Since its founding 2012, Plaid has formed a number of different relationships with banks – including some that are investors. “There is a lot we can gain from partnering with financial institutions…. Banks have scale, they have brand alignment,” said Kate Adamson, head of mortgage for Plaid. “So for fintechs trying to build the next generation of financial services, there’s a lot to be gained…. There’s a lot of common ground and frankly, having the best partnerships helps you get to that common ground in terms of values as fast as possible.”
For Fannie Mae, the partnership with Plaid has allowed customers to save 7-10 days in the closing process, said Natalie Hunt, Fannie Mae’s director of digital alliances and technology integration.
When the two companies began the partnership, one of the early challenges was getting past cultural differences between Plaid, which was founded in 2012 and has roughly 300 employees, and Fannie Mae, which has existed in some form since 1938 and was number 21 on the 2018 Fortune 500 rankings of top U.S. companies by total revenue.
“You’ve got to figure out how to get everyone comfortable,” Hunt said. “From Fannie Mae’s position, we’re a large financial institution and we’re trying to drive innovation, but we also have to do it in a safe and sound manner and demonstrate that we’ve got the right checks and balances in place.” One of the lessons that Fannie has learned from partnering with fintechs is to think about its established processes in a different way.
“They said, ‘Think about this this way and this way,’ and we said, ‘No, this is our checklist,’” Hunt said. “But it was good to have somebody to bounce ideas off of; it gave us the opportunity to improve our process. That’s what a good partnership is about – being open and honest.”
Adamson noted that the viability of Plaid’s product depends on creating stable relationships with banks. The company has taken a systematic approach to building those relationships, including making sure it has multiple points of contact within the banks and keeping track of different bank holidays that might create hiccups in the system.
“[Fintechs are] not thinking about regulatory policy, but it’s a fact of life if you’re playing in the finance system in the U.S.”–Susan French
“If we get Fannie Mae’s blessing, we’re on the map as a credible data source, we’re ingrained in the system,” she noted. “If it says in Fannie Mae’s guidebook that loans have assets verified by Plaid, there’s so much credibility to be gained. But that doesn’t happen overnight; that’s why you fight for it.”
Security and Compliance
When it comes to regulatory compliance issues and security, often “fintechs don’t speak bank and banks don’t speak fintech,” which creates an opportunity for both sides to educate each other, says Susan French, head of product for BBVA Open Platform, the Birmingham, Alabama-based bank holding company’s banking-as-a-service platform.
“One of the benefits fintechs get from working with us and our platform is that we operate within the compliance platform of a bank, which provides lots of benefits once they get over the initial shock,” French said. “There are a lot of us catering to that business need, to find ways to build tools to make compliance easier, to build tools to help with security and protection of data and tools to help manage policies and procedures.”
French noted that it is alien to a lot of fintechs “to see rigid language in a contract and be expected to accept it as is – there are ways to conduct that process in more collaborative ways.”
One of her top don’ts for legacy companies: Don’t immediately send a fintech partner a list of dozens of compliance documents to read. “Most of those documents have acronyms that most fintechs don’t even [understand],” French said.
A better approach is to have an initial discussion about what the bank hopes to accomplish with the partnership. “Are the two guys in the basement capable of actually building the product and delivering a product with a meaningful value proposition?” French said. “Once you get there, there’s a lot you can do to help them understand what compliance and regulatory requirements are for a bank and help them to draft the policies they need.”
She noted that fintechs are focused on building their product and getting it to market as quickly as possible. “They’re not thinking about regulatory policy, but it’s a fact of life if you’re playing in the finance system in the U.S.”
Another fact of life: Data security issues. Aisling MacRunnels is CMO of Synack, a Redwood City, Calif., crowdsourced cybersecurity company that employs ethical hackers to test the vulnerabilities of systems owned by the U.S. government, banks and Fortune 500 companies. She previously worked at Sun Microsystems and recalled a lesson learned as part of that company’s effort to build a cloud computing platform.
“We thought we had every box checked. We thought we knew what we were doing … and within a half hour we had a denial of service attack that took the whole system down. We went from talking about the future being the cloud to addressing this huge security issue,” MacRunnels said. “It’s just an example of whenever you’re collaborating or bringing products to market, you really have to look at the big picture.”
“We’re running at a faster pace, and the scale is greater so innovation has to come from all different places; you can’t survive in a vacuum.”–Aisling MacRunnels
She noted that digital transformation makes building a robust partnership ecosystem even more critical. “We’re running at a faster pace, and the scale is greater so innovation has to come from all different places; you can’t survive in a vacuum.” Also important is understanding what the partner needs to make the collaboration work.
“In the early days when we started working with the IRS we asked what we could be doing better. They said, ‘Please don’t find a vulnerability on a Friday,’” MacRunnels said. “They were joking, but … we put all the controls into the hands of the [corporate] customer to be able to make those decisions about what’s going to work for them. You need to think of everything in that ecosystem, the gray space – that’s where we get together to collaborate, and you need to figure out who owns which part of that gray space.”
MacRunnels noted that digital transformation has also made security and compliance an agile system – no longer is software updated quarterly; now it’s changing constantly. And both legacy banks and fintechs ignore it at their peril, particularly if they are partnering with each other.
“Thirty-five percent of all breaches are in the financial services space. It makes it the most breached space out there and of those, 59% of the companies are impacted due to a third party,” she said. “That stops lots of companies from wanting to work with fintech….”
She added that many business startups can’t survive once they’ve experienced a security breach. “We want you to check all the compliance boxes but what we really want to get at is, how is security part of the lifecycle of development? How are you working with your engineers so their code is strong from the start, so it’s integrated between the third party and the parent company?
“Never expect that something isn’t going to get out there,” MacRunnels continued. “You’ve got to know where you’re going to go and go fast because creativity happens elsewhere and ideas happen fast and it’s going to get out there whether it’s stolen or created. That’s why the execution is the most important.”