The path to profit for digital banks (The Business Times)

Of the approximately 200 digital banks of all forms, both startups and within incumbent banks, I found only 4 that were profitable in 2019: Kakao Bank, WeBank, MYbank and Tinkoff Bank. My research showed that the first 3 had a huge benefit in the form of low cost of acquisition and activation due to their association with their parent companies, which had lots of potential customers and data on which the banks could leverage.

When I asked Kakao Bank during a visit in February 2020 what factors were most responsible for its success, it named 2: its unique shareholding; and its timing, citing that when it launched in 2016, there was no truly credible Korean mobile banking app. In its first month of operation, it signed up a million customers. As at March 2020, it boasted 12 million users (23 per cent of the population of South Korea), of whom 10 million are active.

Kakao Bank was listed, and debuted with a valuation of 25.5 trillion won (S$29.7 billion) at the opening bell on Aug 6 this year. The country’s largest banking group, KB Financial, is valued around 22 trillion won.

From its inception, Kakao leveraged the immense popularity and trust factor of its parent KakaoTalk, the mobile messaging app used by over 90 per cent of Koreans, and thus they were able to attract a wide spectrum of customers. Featuring Kakao Friends characters on the bank’s app and debit cards helped immensely in attracting customers in the early stage. While Kakao has stated that it targets 30 to 50-year-olds as they are more profitable, Maeil Business News Korea reported that as at June 2019, “32.1 per cent of Kakao Bank customers were in their 20s, 31.2 per cent in their 30s, and 21 per cent in their 40s”. It added: “When looking at Korea’s entire population, this means 46.4 per cent of all 20s and 42.8 per cent of all 30s are using Kakao Bank.”

In my view, most digital banks will not have Kakao Bank’s good fortune. They will not become profitable so fast as the incumbent banks in their countries have digital banking that perform reasonably well, and there is no platform like KakaoTalk to help rapidly accelerate customer capture.

At the margin

Instead, for most digital banks, the key to profitability starts with understanding marginal and fixed cost accounting. Businesses lose money if their marginal profitability is negative.

The easiest way to think about this is to do the maths on the next customer you acquire. If that customer’s current annual revenue is less than his cost to acquire and his annual servicing costs, then the marginal profitability of the business is negative. This means that as the business expands and acquires more customers, it incurs more and more losses. In a traditional bank, new product profitability is mixed with the profitability of the bank’s existing cash cows, so one rarely has to think about marginal profitability the way a start-up has to go about it.

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The Business Times

8 November 2021