Growth at all costs vs. profitability
Digital banks continue to add users and raise eyewatering sums of money. But do they have a path to profitability?
Back in July of 2019, following a fresh round of investment, N26 co-founder Maximilian Tayenthal told the Financial Times that “In all honesty, profitability is not one of our core metrics. We want to build a global financial services company… in the years to come we won’t see profitability, we’re not aiming to reach profitability.” It is difficult to imagine that type of statement coming from other banking executives. Profitability is a core, not to mention necessary, metric for any bank.
At risk of stating the obvious, companies must turn a profit in order to be self-sustainable. Yet, that business maxim doesn’t appear to apply to N26 or any one of a host of neobanks cropping up all over the world. Instead of delivering steady, consistent profits, these digital banks are following a well-trodden startup path: “Growth at all costs, worry about profits later.” Uber, Lyft, Lime, WeWork, Casper. These ubiquitous startups, which have spawned many imitators, base their entire strategy around user growth. They raise gobs of money and then plough that money into acquiring users of their service, whether it be e-scooters or temporary office space. Once they reach a certain “scale”, the thinking goes, they will then be able to begin making a profit. How? Crowding out competitors, raising prices, and creating new lines of revenue.
Digital banks are following the same template. They are raising huge amounts of money, as evidenced by Revolut’s announcement just last week of another $500 million round of financing that valued the UK-based neobank at $5.5 billion. But that valuation is merely what Revolut’s private investors believe it to be worth. It is not a firm valuation that is validated by the market (see WeWork). Investors, and founders, are counting on continued user growth and scaling. These banks are spending the bulk of their raised funds on user acquisition. Revolut claims 10m global users. N26 just announced they hit 5m customers. With a large user base accumulated thanks to “hyper-growth”, the idea is that at some undetermined point in the future, the bank will start to turn a profit.
As it stands, these digital banks, just like their forerunners in the startup world, are not turning profits. They continue to report sustained losses years after their founding. Amsterdam-based Fintech Consultancy Group analyzed more than 150 challenger banks worldwide. Every digital bank they observed has negative profitability, losing money on every customer. The only way they sustain their losses is by continually raising more money from private investors. This is not sustainable. At some point, venture capitalists will want a return on their investment.
In that same report from FinCog, there was a hint as to what it might take for a digital bank to become profitable. One bank is close to breaking even in terms of net profit per customer: Nubank from Brazil. While still making a loss of $2 per customer, the bank offers a certain product that is absent from any European challenger bank: credit cards. By offering credit cards to its customers, Nubank has created a new line of revenue that accounts for the bulk of its income. Digital banks will need to increase and diversify their product offerings to bring in more revenue per customer.
Another major challenge neobanks still face is becoming the primary bank for their customers. A study conducted by advertising technology company Ogury analyzing the banking behavior of 688,000 people in the UK last year was illuminating in this regard. It found that very few users of digital-only banking apps in the UK, like Monzo, Revolut, and Starling Bank, were using those banks exclusively. The chart below shows their numbers compared to traditional banks in the UK:
It is clear that reported user numbers are not people who use challenger banks as their primary accounts. If digital banks want to become big, global banks, they will need to convince millions of people that they are more than just a no-foreign-fee card to use on holiday. Until those millions of reported users are actually purchasing products from these banks, they will continue to lose money per customer.
Even the darling of this startup moment recognizes the reality of the situation. Uber’s Dara Khosrowshahi said in an earnings call last month: “The era of growth at all costs is over.” That is easier to say when you have already completed the bulk of your user acquisition, as Uber has. But the quote speaks to a growing sentiment among investors in the startup world: no longer will mere user growth suffice. These companies will soon have to play by the same business rules as everyone else, where losses cannot be sustained in perpetuity. The primary challenge for all digital banks will be to establish a foundational, profitable user base before investors lose patience.