By Oliwia Berdak for the Amrican Banker. Oliwia Berdak is a senior analyst at Forrester Research.
These days most banks seem to have an innovation lab, accelerator or a venture capital fund to encourage tech experimentation. But these corporate startup programs are driven by either hope, fear or a herd effect. That is, if their banking competitors have a vehicle to promote innovation, they need one too.
Traditional banks battling against digital disruption openly admit that they’re willing to try just about anything to help them win and retain customers. They’ve heard the fairy-tale success stories of accelerators, both those that are started by incumbents or that launch independently. Famous disruptors, such as AirBnB and Dropbox, are graduates of the independent accelerator Y Combinator. They make the lab approach a tempting route to follow.
But to justify the cost of nurturing new startups, incubators cannot limit themselves by housing an insignificant number of new tech firms, particularly because many new businesses fail out of the gate. The success of a standalone accelerator like Y Combinator is in part because it has funded more than 500 startups since 2005. By comparison, the innovation labs at some of the biggest banks house no more than a handful of startups at any given time.
The energy and expense required to run a full-scale startup program are difficult to justify for most banks, especially if the outcomes are so uncertain. This struggle will ultimately cause banks to abandon their innovation labs and replace them with more sustainable approaches to nurturing innovation.
Before they do, savvy bankers should use their early forays into incubation to learn more about the startup process, which can lead to a more serious strategy for innovation within the financial institution itself. Startups have limited resources, and working with them will reveal any lack of focus or discipline. Banks can use this opportunity to identify and tackle obstacles to innovation, such as a lack of clear priorities and poor testing environments.
Accelerators are short-term programs, which usually run no longer than three months and provide startups with funding and other resources to develop their products and go-to-market strategies. For banks, the impetus to launch an accelerator is tied to the financial institution’s own ambitions. Bankers want to access cutting-edge technologies and innovate quickly. Many are also hoping to inject fresh energy into tired or complacent corporate cultures.
The agility, creativity and lack of constraints among startups are a breath of fresh air to banking executives wary of meetings, committees and red tape. Even if the direct benefits of launching a lab are disappointing, there are still welcome side effects. The publicity that accompanies each new accelerator launch positions the bank as an innovator. Digital reputation is important for attracting and retaining customers and software talent. At the very least, the bank might hire some of these entrepreneurs.
However, business incubation is notoriously difficult and accelerators gobble up resources. Good ones require a lot of work upfront to sift through applications and select the most promising startups to promote. Some accelerators may accept only 1% to 2% of all applicants.
Few bankers regularly meet with startup leaders, so banks often hire additional staff to connect them to entrepreneurs. However, being selective doesn’t guarantee success. Around half of all new businesses fail. In most cases, it’s because of a lack of demand for their products. This applies to startups with incubation support. In the case of financial technology, it may be that the technology doesn’t work, or it isn’t mature enough to avoid material kinks.
For startups both that succeed and fail, accelerators have to provide a lot of resources to nourish these young businesses, including space, seed funding, entrepreneurship training and ongoing mentoring. If the startup plans to test its solutions within the bank, employees will need to learn about regulation, compliance, and IT standards. In return for these services, banks might want to retain between 1% and 15% of a startup’s equity. But such a demand could force banks to lose out on some of the more promising startups. Entrepreneurs have so many accelerator options that the competition to house new innovators has stepped up. To look more attractive, some firms like MasterCard or UBS are forgoing equity shares.
If you can spare $1 million a year to support an innovator lab, and are willing to accept the risks and uncertain results, there is nothing stopping you. But I suspect many financial executives will struggle to justify this long-term investment, and corporate accelerators will disappear quietly in a few years.
Banks that take a long-term approach to developing and homing in on the right innovation process will be the best outcome of the recent growth in accelerators. Banks that go down this path will still work with startups, but in a more focused and successful way. They will partner with more mature startups to target new customer segments, or to use the young companies’ technology to offer more comprehensive, customized services to their customers.