Venture Capital as a Path to Innovation in Payments

21Venture capital as a path to innovation in payments

Financial institutions that include innova-tion as an integral part of strategy are sixtimes more likely to meet their financial ob-jectives, according to a May 2012 McKinseyGlobal Survey of 2,297 executives from arange of industries and regions. Eighty-sixpercent of executives also agreed that inno-vation is crucial to their organization’slong-term growth. Yet many financial insti-tutions struggle to find the resources andcommitment to compete with the diversityof innovative ideas emerging from start-upsand non-bank attackers like retailers andmobile operators.

McKinsey’s survey further found that, whilegenerally agreeing that innovation is funda-

mental to their organization’s long-termstrategy, 54 percent of executives believe thatfinancial institutions face greater obstaclesthan other industries do in their efforts to in-novate. They cite regulatory hurdles, lack offocus and an insufficient infrastructure asimpediments. One innovation executive at aleading global financial institution com-plained of a lack of talent available to gener-ate and execute new ideas; another said thatnew initiatives at his institution must passthrough a cumbersome product development“obstacle course.” Even for financial institu-tions committed to innovation, sourcing newideas is not that simple, since, as one execu-tive put it, “There are so many more ideascoming from outside than inside.”

Venture capital as a path toinnovation in paymentsAs rapid technology development, regulatory change and the proliferation

of non-bank entrants continue to transform the payments marketplace,

market share positions and competitive dynamics are shifting rapidly. If

today’s leaders are to grow their market share and earnings, substantial,

continuous innovation will be crucial. The industry is rich in examples of

new entrants altering existing business models and shifting market

leadership. A handful of mobile point-of-sale (POS) companies have quickly

expanded the reach of POS devices to thousands of small merchants,

putting data analysis, fraud management and loyalty at the forefront of

defining the customer experience.

Yran Bartolumeu Dias

Eric Rosenthal

Robert Schiff

One option for financial institutions strug-gling to bring innovative ideas to market isto take on an investor role. Investing venturecapital in new payments technologies, busi-ness models and adjacent players – while notwithout its challenges – is a way to make anend-run around typical obstacles and enterthe innovation flow quickly.

Why venture?

Financial institutions that take the ventureinvesting route are typically driven by one ormore of the following rationales:

• Exclusive, continuous insight. Venture in-vesting often allows financial institutionsto better understand the potential trade-offs involved in innovative ideas and todiscover strategic options that are un-available from traditional sources. “Evenwith external advisors and well-informedinternal strategy teams, the depth andbreadth of insight brought to the tablecannot be matched with what we gain byattending portfolio company board meet-ings,” said one participant in McKinsey’sexecutive interviews.

• A seat at the table. Venture capabilitiesenable incumbent players to detect andact upon changing dynamics as they are

happening. “Instead of seeing the shiftsand reacting to them, we hope to be defin-ing the movements,” a survey respondentstated. Jay Reinemann, the head ofBBVA’s venture group, told the New YorkTimes in September 2012, “We are in oneof the most regulated and risk-averse in-dustries in the world, so innovationdoesn’t come naturally to us. We want toavoid the video-rental model. We want toevolve alongside our consumers.”

• Enablement of offensive strategies. Ven-ture investing can open up new strategicoptions that would otherwise be unavail-able through partnerships or alliances.For example, in seeking to enter an al-ready crowded credit card market domi-nated by local players, a top-tier globalfinancial institution found that its equityinvestment in a leading lifestyle andcouponing platform provided access tomillions of targeted potential customers.“Although we would like to believe we al-ways have something to offer throughpartnerships, at times that is not thecase. Equity opens up a door otherwiseclosed to us,” noted an executive at the fi-nancial institution.

• Expanded options. Merger integration isinherently cumbersome, and synergy diffi-cult to achieve. Unlike an acquisition,venture investing makes technology ex-perimentation less risky and can give anorganization room to adapt and preparefor future business integration. “Despitebeing dead-on target, after two major ac-quisitions, more than $150 million, andtwo years, we still were just in the processof bringing our mobile financial solutionfully to market,” lamented a respondent.

22 McKinsey on Payments September 2013

Venture investing can allow financial institutions

to better understand the potentialtrade-offs involved in innovativeideas and to discover strategicoptions that are unavailable from

traditional sources.

• Maintaining focus on innovation. Internalincubation efforts and innovation teamsoften suffer from the fluctuating commit-ment and administrative hurdles commonto organizations whose cultures and met-rics are geared toward short-term returnsrather than longer-term experimentationwith new ideas, products and businessmodels. Creating a venture unit to test anddevelop innovative ideas is one way toavoid the complications of finding thetime, funding and resources within thecore business while still running everydayoperations. One major Asian financial in-stitution significantly enhanced its agilityby creating an independent entity with itsown reporting structure and objectives forexperimentation and venture investment.Alternatively, a venture approach and logiccan be applied to internal teams and ideasas if they were independent start-ups.

• Going where customers go. As customers’shift to digital technology and online in-teraction, the nature of financial productsand services they demand will evolve.With the growing capabilities of ad-vanced analytics to make sense of a diver-sity of data sources (e.g., financialtransactions, shopping patterns, geo-lo-cation data), keeping abreast of cus-tomers’ behavior and purchase decisionswill become increasingly important. Ven-

ture investing is about more than simplyoffering new technology to appear inno-vative; it is about gaining access to newbusiness models and technologiesthrough third parties and harnessingthose capabilities to offer new valuepropositions to customers. (For example,American Express invested in a digitalcoupon company.)

Making the leap

To determine whether venture investing fitsinto its overall innovation strategy, financialinstitutions should consider some funda-mental questions: What is our overall strate-gic aspiration? How does innovation (e.g., inproducts or business models) fit into that as-piration? Are we on track to fulfill that aspi-ration, or is there a gap between ouraspirations and capabilities that venture in-vesting might help us fill?

If the gap between a financial institution’scurrent capabilities and its desired state isdeep and wide, then venture capital investing– coupled with the abilities to experimentand to capture and act on proprietary insight– is a promising way to bridge that gap.

Even if venture investing seems interestingin theory, several practical questions need tobe addressed:

• Does our innovation strategy have a clearmechanism for engaging with externalnetworks? McKinsey research suggeststhat successful innovation strategies relyon both internal and external idea genera-tion. Venture investing can providesmaller players with financial resourcesand opportunities to scale, thereby pavingthe way for collective idea generation be-tween the two parties.


Creating a venture unit is one way to avoid the complications of findingthe time, funding and resources within the core business while still

running everyday operations.


Leading corporate venture units

Citi Ventures: Global corporate venturing arm chartered to collabo-rate with internal and external partners to conceive, partner, launch

and scale new ventures that have the potential to disrupt and trans-

form the financial services industry, drive client success and gener-

ate new value.

Sample portfolio companies: Jumio, payment and online ID verifi-cation company; DDWang, location-based offers platform; ShopKick,customer loyalty management.

Amex Ventures: American Express corporate venture fund chargedwith identifying and developing innovative technologies that will help

accelerate the company’s digital transformation, including loyalty and

rewards programs, mobile and online payments platforms, security,

fraud detection and data analysis.

Sample portfolio companies: Fancy, social fashion and style plat-form; SavingStar, mobile couponing; Radius Intelligence, system ofrecord for small and medium-sized enterprises.

BBVA Ventures: The corporate venture arm of BBVA Group. Itsmandate is to partner with and invest in teams with innovative ideas

that could change or disrupt the world of finance.

Sample portfolio companies: Social Point, social game develop-ment and distribution; Radius Intelligence, system of record forSMEs; SumUp, mobile POS.

Ping An Ventures: Corporate venture arm of Ping An InsuranceGroup, the world´s second-largest insurance group by market value,

with a broad focus on financial services, consumer products, health-

care, automobiles and tech, media and telecom.

Sample portfolio companies: Not publicly available.

Visa Ventures: Established in 2011, Visa Ventures is a non-dedi-cated venture unit complementing Visa´s corporate development and

innovation activities.

Sample portfolio companies: Square, mobile POS and customerloyalty; SecureKey, PaaS for authentication, payment and identity.

Notable payments start-ups, 2012-13

• Is the external ecosystem robust enough toserve as a source of new inspiration?Without a healthy deal flow, venture in-vesting is not possible. Sufficient deal flowis still concentrated in a relatively small,though growing, number of geographies.Emerging ecosystems ripe for venture in-vestment can be found in Brazil, Singa-pore and East Africa; establishedopportunities are abundant in the UnitedStates, China, Israel and Western Europe.Some institutions in regions where start-up activity is weak are maintaining a re-mote presence in more vibrant marketssuch as Silicon Valley.

• Are elements of our core business underthreat? Disruptions across the paymentsand overall financial services landscapeare becoming increasingly likely, as is thepotential threat to leading players. For ex-ample, over the past five years, more than40 percent of venture activity in financialtechnology in the U.S. has occurred in thepayments space. With so much moneypouring into innovation, many incumbentinstitutions feel threatened. As one indus-try executive suggested when asked aboutthe value of venture investing versus wait-ing and acquiring, “Investments in and ofthemselves are a tool not only to educateus about what the future will look like, butalso to help us realize that, well beyondthe confines of our venture unit, we may

not have the tools to deliver on a myriad ofother core daily challenges.” In otherwords, venture investing is one more toolin the effort to evaluate the health of apayments player’s core business.

Getting into the flow

Financial institutions that choose to ventureneed a clear strategy, just as they would forany other business venture. Particular issuesto address include how the new unit will en-gage with external networks, the specific ra-tionales for investment, and the valueproposition for portfolio companies. Pru-dent venture investments usually take thefollowing steps:

Take time to understand the marketplace andhow current trends fit with your innovationstrategy. Financial institutions seeking to in-vest need a broad view of emerging trends,and then must determine how (and whether)those trends fit into their innovation strategy.Adjacent opportunities will surface that,while not tied to an institution’s core busi-ness, may be worth considering for the in-sights they provide into emerging trends oraccess to new customers. American Express,for example, has invested in a companycalled “Rent the Runway,” which allows con-sumers to rent designer clothing for specialoccasions. Such investments can enable fi-nancial institutions to continue to reach theircustomers in an increasingly diverse digitalmarketplace. “The payments industry is un-dergoing a fundamental change as the verynature of commerce is redefined,” saidHarshul Sanghi, managing director at Amer-ican Express.

Rather than trying to find “the next bigthing,” develop a diversified innovationportfolio. Venture investing is risky by na-


Financial institutions seeking to invest need a broad view of

emerging trends, and must determinehow (and whether) those trends fit into

their innovation strategy.


ture; many ventures will fail, and others willbring lackluster returns. Financial institu-tions seeking to invest must set realistic ex-pectations and manage their ventureinvestment portfolios as they do their overallinnovation portfolios; both should be simi-larly diversified in terms of risk profiles andthe timeline for expected return. Portfolio

companies should run the gamut fromyoung, risky start-ups to relatively stable andestablished concerns (with a minimum oftwo years’ track record), and from short-term investments with immediate benefits tolonger-term investments with less certainreturns. Without “quick wins” – investmentsthat can be immediately integrated into thecore business or begin generating value rightaway – institutions may lose support for themore disruptive ideas that take longer tobring returns.

Some of the companies in the portfolio willprovide insight and experimentation oppor-tunities, while others will be almost ready toscale to the investor’s business. Venture can-didates that can readily scale across the in-vesting institution’s entire enterprise are

rare, so financial institutions should nothold their breath for global, one-size-fits-allsolutions to invest in. Instead, they shouldlook for core markets with a healthy dealflow that will help them to gain a foothold inthat particular market.

Define communication channels andprocesses during strategy development.Gaining value from venture activities de-pends largely on the investing institution’sability to establish formal mechanisms forgathering insight and keeping executivesand staff informed at all levels. In particular,a process for communication – including aformal planning and review process – be-tween the venture unit and senior manage-ment should be established, as ventureemployees often struggle to explain their ac-tivities and goals to senior managers who areused to rigidly defined processes and timeframes. Good communication ensures thatthe investment portfolio informs strategy re-view and development. For example, the in-vestment team could participate in theannual strategic planning process, a memberof the investment committee could serve onthe corporate strategy team and the strategyteam could have input into product develop-ment roadmaps.

Prepare to enter the innovation flow. Portfo-lio companies will expect much more thanmoney from investing firms. For example,they will be excited to work with financialinstitutions that provide technical expertise,access to customers or support in navigatingregulatory questions. To manage expecta-tions on all sides, the investing organizationshould establish clear guidelines as to whatthey will and will not do for their portfoliocompanies. Mechanisms that facilitate ex-perimentation (e.g., a lower bar for offering

Financial institutions seeking to invest must set realistic

expectations and manage their venture investment portfolios

as they do their overall innovationportfolios; both should be similarly diversified in terms

of risk profiles and the timeline for expected return.

portfolio companies’ services to a small por-tion – less than 1 percent – of the investingcompany’s customers) will generate valuequickly for the investor and investee alike.Moreover, it is critical that financial institu-tions remove obstacles that could inhibit fu-ture opportunities to engage with thestart-up ecosystem.

* * *

As disruption becomes the new norm in pay-ments, it will become increasingly difficultto predict how market shares will swing and

who the long-term winners in the paymentsindustry will be. Venture investing will notbe for everyone, but for those who have setan ambitious vision for future growth andcannot meet it by internal means alone, ven-ture investing could become a critical com-ponent of the broader innovation agenda.

Yran Bartolumeu Dias is a principal in the Sao

Paulo office, Eric Rosenthal is a consultant in the

Mexico City office, and Robert Schiff is a principal

in the New York office.


Venture Capital as a Path to Innovation in Payments

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