Disruption of the Financial Services Industry: A Case Study of British Fintech Startup Revolut Copenhagen Business School MSc Economics and Business Administration Applied Economics and Finance Master Thesis Authors: Tadas Vilkinis – 31634 Tomas Vasciula – 91323 Supervisor: Jens Marcus-Møller Date of Submission: 17th of September 2018 Number of Characters: 270.250 Number of Pages: 119 Abstract This thesis investigates the dynamics of financial services industry in the 21st century to answer the research question of why and how the industry disruption began and to suggest a response to disruption for incumbent financial institutions. To achieve this, the thesis takes a case-based approach, applying a combined theoretical framework to the case of British fintech startup company Revolut. The thesis challenges conventional strategy theories, such as Michael Poter’s Five Forces and SWOT, for being unable to explain emerging business phenomena, such as industry disruption, in the light of product and service digitalization. Instead, it utilizes more recent theories such as Clayton Christensen’s Theory of Disruptive Innovation, Lean Startup Method, and Rita McGrath’s Theory of Transient Advantage. The thesis finds that incumbent financial institutions historically focused on sustaining type of innovations that target the most profitable customers, overlooking the less demanding customer segments. By engaging in disruptive innovation, Revolut among other fintech startups targeted those overlooked segments, offering a more convenient service at no charge, eventually causing the industry disruption. The thesis finds that Revolut achieved this by advocating ideas associated to the lean startup method and engaging in continuous innovation. Given the findings, the thesis suggests a response to disruption for incumbent financial institutions. The key recommendation is to create a corporate culture where innovation is encouraged. The thesis argues that with the right corporate culture and values in place, incumbents will have three different options to successfully engage in disruptive innovation – via (i) a partnership with fintechs or large techs, (ii) an acquisition of fintech startups, or (iii) in-house innovation. The thesis also finds that large tech companies, such as Facebook and Google, may re-disrupt the financial services industry going forward due to general market shift towards “open-banking” caused by initiatives such as the European Union’s Second Payment Service Directive (PSD2). Page 1 of 137 Table of Contents 1. Introduction ................................................................................................................................................ 6 1.1. Motivation .......................................................................................................................................... 6 1.2. Research Question ............................................................................................................................. 7 1.3. Key Concepts ...................................................................................................................................... 7 1.4. Structure ............................................................................................................................................. 8 1.5. Delimitations .................................................................................................................................... 10 2. Methodology and Research Design .......................................................................................................... 12 2.1. Thesis Method .................................................................................................................................. 12 2.2. Research Design ............................................................................................................................... 13 3. Literature Review ..................................................................................................................................... 14 3.1. Porter’s Five Forces .......................................................................................................................... 14 3.2. SWOT and PESTLE ............................................................................................................................. 16 3.3. Critique of Conventional Theoretical Approaches ........................................................................... 18 4. Theoretical Framework ............................................................................................................................ 20 4.1. Clayton Christensen’s Theory of Disruptive Innovation ................................................................... 20 4.2. The Lean Startup Method ................................................................................................................ 25 4.3. Rita McGrath’s Theory of Transient Advantage ............................................................................... 29 4.4. Pricing and Concept of Free ............................................................................................................. 34 4.5. Network Effects ................................................................................................................................ 38 4.6. Switching Costs ................................................................................................................................. 42 4.7. Combined Theoretical Framework ................................................................................................... 45 5. Overview of Types of Financial Services ................................................................................................... 46 5.1. Payments .......................................................................................................................................... 46 5.2. Deposits and Lending ....................................................................................................................... 49 5.3. Investment Management ................................................................................................................. 52 5.4. Insurance .......................................................................................................................................... 54 5.5. Capital Raising .................................................................................................................................. 57 6. Past to Present.......................................................................................................................................... 60 6.1. Investments in Fintech ..................................................................................................................... 60 6.2. Overview of Main Digital Challenger Banks ..................................................................................... 63 6.3. Finance 2.0 – the Case of British Fintech Startup Revolut ............................................................... 70 6.3.1. Revolut and Disruption: Why and How? ................................................................................. 74 6.3.1.1. The Theory of Disruptive Innovation ............................................................................... 74 Page 2 of 137 6.3.1.2. The Lean Startup Method ................................................................................................ 79 6.3.1.3. The Theory of Transient Advantage ................................................................................ 82 6.3.1.4. Pricing and Concept of Free ............................................................................................. 84 6.3.1.5. Network Effects and Switching Costs .............................................................................. 88 6.4. Incumbent Financial Institutions’ Response to Disruption .............................................................. 90 6.5. Second Payment Service Directive (PSD2) ....................................................................................... 93 6.6. Sub-Conclusion of Past to Present Section ...................................................................................... 94 7. Near future ............................................................................................................................................... 96 7.1. Revolut ............................................................................................................................................. 96 7.1.1. European Banking License ....................................................................................................... 96 7.1.1.1. Benefits ............................................................................................................................ 96 7.1.1.2. Drawbacks ....................................................................................................................... 97 7.1.2. Features in the Pipeline ........................................................................................................... 97 7.1.2.1. Cryptocurrencies and Rationale for not Focusing on their Future Effect........................ 97 7.1.3. PSD2 ......................................................................................................................................... 98 7.1.3.1. Opportunities ..................................................................................................................