Established incumbents and nimble start-ups are in a race to find new opportunities. While some will go it alone, collaboration and acquisition between incumbents and start-ups will increase across investing, banking, insurance and wealth management.

The most successful partnerships will tap into the established incumbents’ financial strength and consumer reach, combined with the start-ups’ agility and appetite for risk. When they join forces, ongoing innovation in financial services will grow at a pace never seen before. This digital disruption will continue to allow advisers to do more with less, to enhance the profitability of their practice — and the ultimate beneficiary will be the consumer.

DISRUPTION AGENDA
Most established incumbents recognize the importance of digital disruption and have started pursuing strategies to keep pace. To remain relevant and succeed in the face of growing competition, many incumbents have been moving to “verticalize” operations.

In the process, some are disrupting their industries. Others are disrupting their own business model. To succeed, incumbent firms must view disruption as an opportunity. According to a recent study from The Economist and Ernst & Young, 60% of established firms are now investing in a disruption strategy. Likewise, 60% have created, or are considering creating, a new leadership role to focus exclusively on disruption.

At the same time, a growing number of fintech start-ups have been taking the industry in entirely new directions by offering innovations such as crowdfunding, peer-to-peer payments and lending, robo advisers, crypto-currencies, artificial intelligence and predictive analytics.

These new players have been supported by an infusion of capital from by VCs, accelerators and angel investors. And fintech investments are strong. A recent study published by KPMG, estimates that global fintech funding spiked to a record $46.7 billion in 2015. While this slowed to $24.7 billion during 2016 — impacted by the Brexit vote, the U.S. presidential election, and other complex geopolitical factors — fintech investment is likely to rebound in coming years.

ESSENTIAL PARTNERSHIPS
Facing the rapid pace of change and insatiable demand to innovate, it has become clear that incumbents and start-ups each have their own unique strengths. But they also have their own challenges. This makes strategic partnerships and outright acquisitions beneficial — and essential.

To keep up with the rapid iteration of products and services, established incumbents have the financial horsepower to invest heavily in their own innovation. But innovating in-house is not without its challenges, given that so much is already invested in legacy systems, established distribution channels, and existing profit centers.

Meanwhile, start-ups have the freedom and flexibility to create new product categories and re-engineer new solutions from the ground up. But with finite resources, they often struggle to scale up quickly. Over time, the vast majority of start-ups are likely to be purchased — or perish.

Since the advent of the internet, digital disruption has been transforming our industry and your clients’ financial lives. The rapid pace of change awards winners with greater growth and renders losers obsolete. But one thing remains constant — the ongoing trend toward simplicity, transparency and greater value. There are many examples across all areas of our industry.

  • Traditional Stock Brokers vs. Online Brokers

Starting in the 80’s and gaining traction in the 90’s, the basics of buying and selling stocks became a fungible commodity when online platforms such as Schwab, Fidelity and E-Trade disrupted the high-cost commission-driven traditional brokerage model. Today, more than $9 trillion of individual investor assets are custodied on these three leading platforms, which also provide custody, clearing and low-cost transactions for a substantial portion of the $6.6 trillion of client assets managed by independent RIAs and fee-based advisers — the fastest growing channel in financial services according to Cerulli Associates.

Now, some incumbent wirehouses and broker dealers are disrupting their own model by launching low-cost online trading platforms as well. These include Merrill Lynch’s MerrillEdge and Wells Fargo’s WellsTrade. By cutting costs and shifting away from commissions, these platforms can help create more value for high net worth clients, while also attracting the assets of younger investors and mass affluent clients.

  • Bank Branches vs. Internet Banking

Traditional banks with a branch on every corner were the norm until the 90’s, when Internet-only banks disrupted the industry by cutting costs, paying clients higher interest rates and charging lower fees. Traditional banks still hold more than $16 trillion in assets. But Internet banks such as E-Trade Bank, Ally Bank and new entrant GS Bank from Goldman Sachs, are gaining traction — the only category to gain share among retail customers establishing or moving their primary banking relationships, according to global market research firm TNS research.

To capture more market share, especially among millennials, incumbents are innovating. Wells Fargo has partnered with several start-ups to launch six innovation labs, as well as its own start-up accelerator, exploring ways to enhance the customer experience through emerging technologies — including biometrics, augmented reality, virtual reality and Artificial Intelligence. Incumbents such as HSBC, UBS and Santander are adopting innovations such as blockchain to cut costs, accelerate transactions, eliminate the middleman and aggregate data in real-time. By 2020, IBM says that 66% of banks expect to have blockchain in commercial production and at scale.

  • Traditional Insurance vs. Online Insurance

Several companies have become household names by offering low-cost Instant-issue auto insurance. But overall, the traditional insurance industry still faces numerous roadblocks to innovation, such as legacy IT systems, complicated underwriting, and complex regulations. According to KPMG, incumbent insurers will drive change by focusing on two goals. First, by refining individual components of the value chain, such as distribution, underwriting, claims and customer service. Second, by responding to the changing demands of their customers, allowing them to do business in the manner they prefer.

The pent up demand is tremendous, as the insurance industry works to catch up with other areas of the financial services industry. And like fintech, insurtech is an area of opportunity that will grow exponentially. Over the past year, a number of early movers in insurtech have matured and attracted more funding, and a growing number of insurtech accelerators have emerged. Likewise, incumbent insurers also made significant fintech investments in 2016, acquiring or investing directly in innovative start-ups, as well as by establishing their own innovation labs.

  • Traditional Asset Managers vs. Robo Advisers

Offering lower fees and lower minimums for basic portfolio allocations, robo advisers such as Betterment, Wealthfront, and Personal Capital are gaining popularity and gathering assets— more than $200 billion in 2016 according to consulting firm A.T. Kearney. While the first robos were designed for the mass market, the newest generations of digital wealth advisory platforms are designed with RIAs, fee-based advisers and their HNW clients in mind. And just as robos are learning to play nice with advisers, many incumbent institutions are seeing the benefits of offering advisers these digital platforms. Today a number of traditional brokerages and asset managers are building their own robos — or buying these start-ups outright.

NO TURNING BACK
Digital disruption is creating new categories of products and services that never existed, and expanding access in ways that were never expected. It is leading the industry toward a more holistic unbiased approach to guided advice. This can help advisers differentiate their practice, improve their clients’ user experience, and ultimately serve their clients’ best interests. And today there is no turning back — educated clients have come to expect and demand this standard of care.

So innovation will continue to surge at an unprecedented pace to meet the demands of advisers and their clients, fueled by incumbents’ own investments, an infusion of outside capital for start-ups and partnerships between the two. Where incumbents and start-ups once viewed each other as competition, today they often see each other as allies in the race to stay ahead of today’s complex and rapidly changing environment. In the long run, it’s clear that incumbents and start-ups need each other to succeed. After all, if you can’t beat them, you should join them — or buy them.

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Mitchell H. Caplan

Mitchell H. Caplan

Mitchell H. Caplan is CEO of Jefferson National, now operating as Nationwide’s advisory solutions business.