Bain & Co: "Banking's Amazon Moment" (AMZN)

From Bain, March 5:

Amazon may be taking the plunge into banking, and by any estimation, it’s a game changer for the industry. News reports that it seeks a bank for a cobranded, mobile-friendly checking-account-like product initially targeted to young adults in the US follow earlier moves into financial products. The company has a cobranded credit card offered by Chase, and Amazon Cash allows customers to deposit cash directly to their Amazon accounts from more than 10,000 retail locations throughout the US. In addition, Amazon has loaned more than $1 billion in the past year to small merchants selling online.
Amazon is now talking with big banks, including JPMorgan Chase & Co. This latest move raises urgent questions for retail bank and other financial services executives—and not only in the US:

• Why is Amazon doing this, and what is likely to come next?
• Will Amazon succeed, and how concerned should banks and other financial services firms be?
• What should they do about it?

Why Amazon would bother
The checking and debit account components of a banking relationship are notoriously unprofitable, especially for a fee-free model aimed at younger customers who have little money to keep in the account. Most banks don’t relish serving this part of the market, but Amazon has several good reasons to do so.

Amazon has spotted a segment of customers that it can serve better, and the company can worry about making money later. Start with Amazon’s mission statement: “Our vision is to be Earth's most customer-centric company; to build a place where people can come to find and discover anything they might want to buy online.” It can afford to go after this previously unprofitable segment in part because it will be able to transform the economics of banking; Amazon does not have the burden of an expensive branch and contact center network, which we estimate comprises roughly 40% of a North American retail bank’s costs on average. Instead, Amazon could steer new customers to “just ask Alexa,” its voice assistant on the Echo device. The company can also avoid a lot of the customer acquisition costs borne by most direct banks because it already has digital relationships with so many Americans. Given these two advantages, Amazon’s incremental costs will be almost nil.

Amazon will not legally become a bank. Rather, the bank it partners with would probably hold deposits, while Amazon would design and manage the customer experience and distribution. The arrangement allows Amazon to avoid dealing with bank regulatory compliance and managing the balance sheet. Amazon might generate revenue through fees and royalties from the bank partner, though the more valuable financial benefit will likely be the savings Amazon realizes from direct access to customers’ checking accounts. Amazon could make it easy for customers to pay right from that account instead of with their credit cards, which impose an average 2% interchange fee for most transactions on Amazon or its third-party merchants. Bain & Company estimates that Amazon could avoid more than a quarter of a billion dollars in annual interchange fees in the US alone. This estimate is based on three assumptions: Amazon achieves the bank account penetration our consumer research suggests; 15% of its e-commerce customers pay directly from their Amazon bank account instead of through a credit card; and those customers spend at the same level as Amazon Prime customers.

Beyond that direct cost saving, we could imagine Amazon’s banking services growing to more than 70 million US consumer relationships over the next five years or so—the same as Wells Fargo, the third-largest bank in the US. The estimate assumes that slightly more than half of Amazon’s estimated US customer base chooses a financial relationship with the firm—the same share of people who said in our new global survey that they expect to buy a financial product from a major technology firm over the next five years. Of course, the pace of customer sign-up will hinge on competitive pricing and a distinctive experience so that positive reviews spread quickly.

Once Amazon has established a cobranded basic banking service, we expect the company to move steadily but surely into other financial products, including lending (both purchase financing and debt consolidation), mortgages, property and casualty insurance, wealth management (starting with a simple money market fund to hold larger balances), and term life insurance. Amazon would follow the typical order of needs for its target customers as they age and move through different life and family stages. Underpinning this all, Amazon has a massive data platform and continually refines its ability to personalize offers and communications. Online shopping patterns already tell Amazon what it needs to know about customers’ life events, from getting married to having children to buying a house, which will allow the company to offer relevant financial services products—and information from those products will further increase the depth of the data.

What chance of success?
Amazon stands a very good chance of succeeding in banking by disrupting the industry as it has in retailing. Customers indicate ample willingness to buy financial products from technology firms, and Amazon has earned their trust more than most other tech firms. It possesses all the essential ingredients: digital prowess, a large customer base, an organization skilled in improving the customer experience and ample leeway to extend the corporate brand into banking.

Although many retail bankers and observers have pegged the nimble fintech start-ups as the likely disrupters, it has become clear that established technology firms pose a bigger threat. Fintechs may have innovative products, but they struggle to build brand recognition or a distribution model that will attract many customers. Large technology firms already have established brands and access to customers, both of which provide a massive distribution advantage.

We already see this dynamic playing out in Asia. In China, e-commerce giant Alibaba has amassed the world’s largest money market fund, issued $96 billion of loans in five years and grown Ant Financial to a market capitalization roughly equivalent to the ninth-largest bank in the US. Alibaba also started online bank MYbank, which approves loans instantly using automated processes based on consumers’ financial history with Alibaba. Customers globally also sent $1.7 trillion in total payments through Alibaba’s Alipay service last year, roughly five times the global payment volume that flowed through PayPal—another sign of big tech’s edge over fintech. Japan’s main e-commerce giant, Rakuten, has also cultivated financial services and operates the country’s largest Internet bank and third-largest credit card company by transaction value. Financial services now account for nearly 40% of Rakuten’s revenue.

Among the major US technology firms, Amazon is best positioned to succeed in US banking. It has a high frequency of purchase and review interactions with customers; a full commercial relationship, including credit cards on file; integration into consumers’ computers, smartphones, tablets, TVs and home audio devices; excellent service, including a great returns policy; and no major security breaches so far. No other technology firm can claim all of these advantages.

Most people know Amazon for its core e-commerce activities. Here, Amazon offers unparalleled traffic and reach: Some estimates suggest that more than half of US e-commerce searches start on Amazon. Just as impressive is Amazon’s sizable and growing share in markets outside of its core as it expands across countries, product categories and businesses ranging from movie production to cloud computing to plumbing supplies. The successful brand extensions adhere to Amazon’s flywheel model, which maintains momentum on the strength of three pistons (see Figure 1):

• Offer “Earth’s biggest selection” to attract traffic in part by expanding the network of high-profit, third-party sellers.
• Use scale to lower the cost of goods and fulfillment, passing along the savings to customers through lower prices.
• Provide a superior customer experience to earn loyalty.

---

Can Amazon spin the flywheel in banking? Surely, bankers might think, this won’t be a profitable or attractive business. Yet Amazon has never worried about the profitability of individual products. It focuses on learning about customers’ needs through the copious data collected, gaining their repeat business and thereby expanding share of wallet over time....

...MUCH MORE