The Evolution of Massive Tech Spending by FSIs and How to Stay Sane
Including proprietary analysis and insights from the industry foremost benchmarking expert, Howard Rubin.
The Evolution of Massive Tech Spending by FSIs and How to Stay Sane
For those of us old enough to have witnessed FSIs since the 2001 recession, their behavior toward investing in digital capabilities in recent years has been perplexing. Despite the lessons learned from the last two downturns, FSIs have now placed technology and data on a pedestal with around a trillion dollars in annual spending. Disregarding well-publicized cases of massive waste, the industry keeps increasing technology budgets without a tight, business-driven rationale. Some FSI CEOs seem to be in a competition to outspend each other, with business lines allocating up to 20% of their revenue to technology spending.
Not even a global pandemic or fears of a recession have altered FSI executives' desire to emulate cool startups within their traditional firms. The foremost expert on FSI technology spending, Howard Rubin, analyzed data since the late 90s and identified a first-of-a-kind phenomenon: a decline in GDP is not followed by a decline in FSI IT spending:
How did the FSI industry reach this point, and what is the sane approach in such an environment? Since the 2008 financial crisis, the industry has passed five milestones in fueling its appetite for technology spending.
1st milestone: Garages, accelerators, and refineries
It began innocently about a decade ago. FSIs started to worry a bit about whether local bright minds all move to Silicon Valley, so they launched the first act of innovation theatre, a cool-looking off-site facility. I visited many of those places, and they were almost always semi-empty. In one case with a large payments company, I asked for a tour of the facility and was reluctantly shown a completely empty space.
The craziest example in my experience was MetLife erecting a dedicated 7-story building for 'innovation'. It had nice coffee machines, modern furniture, Play Stations, etc., yet remained empty for two years, as I went there in disbelief several times. The logic was to house some startups there, who, via some osmosis, would infect core employees in nearby buildings with innovation vibes.
2nd milestone: Richard Fairbank and Jamie Dimon
At the same time, some FSIs were starting to get it. Capital One was one of the first FSIs that embraced the concept of becoming a technology company, correctly driven by desired business outcomes. Even two decades ago, when I first worked with Capital One's IT leadership, it was unusual to see how much more they cared about business outcomes rather than launching a big IT program. What made Capital One unique vs. traditional FSIs was that their business executives didn’t view IT as a separate faraway function. Already in 2014, Capital One CEO, Richard Fairbank, understood that being a technology company means much more than digitization:
"Ultimately the winners in banking will have the capabilities of a world-class software company. Most of the leverage and most of our investment is in building the foundational underpinnings and talent model of a great digital company. To succeed in a digital world the company can't just bolt digital capabilities onto the side of an analog business. At Capital One, we're embedding technology, data and software development deeply into our business model and how we work. "
By that time, Capital One had also made a groundbreaking cloud-first decision, well before it became a common talking point among FSI executives. Richard Fairbank was the driving force behind it and personally delved into technical details. While intense curiosity about technology is standard among fintech CEOs, there might be less than a dozen traditional FSI CEOs in the country who exhibit that same level of hands-on involvement.
Another example is JPMorgan and its CEO, Jamie Dimon, who is probably the most respected FSI executive in the US among his peers, considered both a very effective manager and a visionary leader. By 2016, Jamie raised JPMorgan’s technology spending to almost $10 billion, an unheard-of 10% of the revenue. At the same time, Jamie made technology the key feature of his annual letter to shareholders:
Notice a pragmatic business outcome focus and lack of consulting jargon. Jamie understood then what many FSI executives still don’t get today - modernization, digitization, and time to market are just means to an end, and should not be the focus of digital transformation.
3rd milestone: Blockchain and partnerships with digital natives
“The President told us to sign 10 partnerships and get them to a pilot stage, so it ended there,” explained a former head of partnership of a large credit card business. Around 2017-2018, I remembered seeing announcements of her signing up digital natives and fintechs. The press releases felt random, and there seemed to be too many to scale, so I asked her a few years later about the outcomes. In a traditional sense, there were no concrete results, as the innovation theatre's North Star metric is media mentions.
In another example, a large payments network had even more money to spend than a credit card company, so they put $50 million into creating 'AWS for payments' while signing up a few cool partners in Silicon Valley. A couple of years later, they called me for quick ideas on how to improve the usage. I asked what problem this platform was trying to address. 'Our primary goal was to be the first in making this platform available, but the cost proved to be too high for just a pilot, so we need to make it really work now.'
Around 2017-2018, the blockchain gained popularity, leading many FSIs to allocate some budget to it. For larger FSIs, it was around $1 million per year, for mid-size ones - around $250K. Drawing from my cross-border startup experience and blockchain knowledge, I naively offered assistance to identify profitable use cases. But again it wasn't their primary goal.
4th milestone: Fintech attempts - in-house and via acquisitions
Dissatisfied with the digital transformation velocity of its core business, even with partnerships, large FSIs began creating fintechs, in-house and via acquisitions. Billions were wasted as a result (see this newsletter for more).
However, the persistent failures didn’t lead to a reflection on whether a top-down digital transformation is effective; rather, FSIs concluded that they should focus on their core business. And even that lesson is not heeded by some FSIs. Every few months, there is another financial services or insurance player launching a digital subsidiary, often under a different brand name and with a host of other, at-this-point textbook mistakes. 'Those who do not learn history are doomed to repeat it.'
5th milestone: FSI as a “technology company” goes mainstream
By 2021, Fintech valuations hit the moon. A typical revenue multiple for financial services and insurance companies is 2-3X, 5X is the best case. Temporarily, fintechs seemed so different in their business, operating, and technology models that they couldn’t possibly be compared to traditional FSIs, which they were going to disrupt anyway. C-Suite executives of traditional FSIs were puzzled by such attitude from investors. “Why are they viewing these tiny fintechs as a threat akin to Amazon and Netflix for other industries?”
Executives’ compensation and bragging rights are tightly tied to the company valuation, so once Revolut’s valuation reached a 40X revenue multiple, more FSIs felt compelled to join a technology spending parade.
Just three months later, Bank of America's CEO famously articulated that becoming a technology company largely meant investing billions in technology.
The arms race was on! To the delight of vendors and consultants, more FSIs began pouring money into technology investments while making pronouncements about major modernization and digitization initiatives. These days, there are dozens of FSIs spending billions annually on technology, reaching a 20% share of revenue.
What makes the current state of technology spending especially unusual is that FSIs are not only spending massive amounts, but they are also allocating a larger portion of it, up to 50%, on investments rather than maintaining existing technology. For example, JPMorgan spends $7+ billion annually on technology investments. Even if half of that is a waste, shouldn’t a regular FSI be concerned about the remaining billions invested by their larger competitors?
What should FSIs do in such an environment?
The conclusion of this arms race of tech spending is uncertain. Even the industry's most enlightened CEOs, such as Richard Fairbank and Jamie Dimon, are likely to continue viewing digital transformation as a combination of massive top-down initiatives, albeit business-driven. One day, FSI CEOs will realize that being a technology company requires a different approach: empowering small teams of 10X employees to act as mini-CEOs or addressing tech debt through a small team chipping away at the monolith. But that day might be a few years away. Unless investors start demanding explanations for low ROI instead of glorifying the arms race, the era of roaring 20s in technology spending will persist.
A more pertinent question is how other FSIs should approach their technology spending in this environment. Howard Rubin understands this topic better than anyone else:
'No sense to participate in the arms race with companies like JPMorgan. This approach is creating chaos to a degree that would be wise to avoid. Instead, the benchmarking focus should be on the scalability of already deployed IT assets ("run" spend). Has the digitization made you more efficient?'
According to Howard's analysis, IT spending as a portion of OpEx has returned to the levels of the go-go days in 2007 while reaching unprecedented heights as a portion of Revenue. Benchmarking technology investments, as opposed to "run" spending, against the top players in this environment, is akin to the Soviet Union attempting to compete with the US in Star Wars during the 80s. FSIs could later discover that the expected impact is merely a phantom while the investments made were ultimately detrimental to their survival.
Howard identifies a couple of technology investment areas that might be ongoing waste:
'If you don't have measurable business outcomes, it is likely a waste of money. My primary concern is FSIs pursuing a cloud-first strategy. I refer to Cloud as the crypto currency of technology investment - a revolutionary technology that tends to upset customers and regulators. Another concern is around generative AI. With vendors and consultants pouring billions, the promises will get more grandiose, while the impact on customers could lead to even more confusion.'
Assuming the 'run' spend benchmark looks favorable, an FSI should focus its investments in technology on a very targeted approach, as recommended by Howard:
'Focus on the few areas that could provide the economic leverage against your top competitor, which might not necessarily be the largest FSI. Use digital capabilities to become better than a competitor to address rising attrition, which is reaching 20% across the industry. If your customer base is younger, selectively introduce the most popular fintech features from leading firms like CashApp, Revolut, and Chime.'
Let sanity prevail because every 1999 and 2007 is followed by 2001 and 2009.
Great analysis per usual and very eye opening. Mr Rubins analysis is also extremely interesting and makes you think....or at least it should