Incumbent Choices in Business Strategy

An assessment of new entrant banks using disruptive innovation theory

Seven months ago, in the depths of a London steakhouse, a debate raged amongst KAE colleagues. At question was the best strategy to take for an incumbent, legacy bank, to achieve growth.


Both sides agreed that the basis of competition in retail banking was changing. Smartphones, regulation and wider technology improvement was altering the financial services landscape. Customers’ expectations were in flux.

On one side of the table, intrapreneurship was advocated. The proposal pushed for sustaining, iterative investment in internal development. By modernising the bank’s infrastructure and services from within, existing customers could benefit. Innovation would work for the business in the same way as it always had.

The opposing view emphasised the need to look outside of the business for growth. This time, things were different. Investing in an ancillary proposition provided the benefit of starting anew. Such an effort would be kick started by partnering with or acquiring a new entrant. In fact, it was posited, this path may be the only way to shed the inhibiting processes and thinking of the legacy bank.


One month after that heated dinner there was a news beak. Royal Bank of Scotland (RBS), our working example for this debate, planned to launch a separate challenger bank[i]. Six months later further detail emerged. Starling Bank, the new entrant proposed within the debate’s opposing narrative, announced a major deal to support RBS develop and launch this offering[ii]. Why did RBS take this action, and could it relate to the view put forward that fateful evening in London?


Disruptive innovation theory provides guidance to assess how an industry may be affected by change[iii]. Change may be technological, or business model related, and is often a bit of both.

To simplify, the prognosis of disruptive innovation is bad for an incumbent. Here, new entrants benefit from having a business model or using a technology that makes it hard for an incumbent to compete. Think of word processing vs. the type writer, digital photography vs. film or streaming vs. physical media.

Often this disruption starts when an incumbent is focused on improving their proposition for their most demanding customers. They ignore the needs of others and this is where new entrants step in. Entrants may have better or simpler functionality for specific needs at a lower price point. Yet as these customers are overlooked by incumbents, so too are the new entrants servicing them. Overtime the new entrant moves up market, based on their new business model or technology.

Sometimes change occurs in a market in tandem with the customer needs of an incumbents’ existing model. This is where the incumbent’s significant resources and capabilities can be deployed to effectively meet these new challenges. Think of Pfizer’s continued development in medicine, or Toyota’s improvements in car production as sustaining innovations.

There are a lot of litmus tests to define disruptive vs. sustaining innovation. In banking, the disruptive assessment is mixed:

UK Retail Banking Innovation Test


1. The UK has some of the highest levels of financial inclusion, core retail products are widely available[v].

2. Historic measures of performance, e.g. branch and phone servicing are not part of new entrant’s mobile-only offering. New performance measures around integration of other financial services and global availability now exist. But the bulk of other measures around service, value and product remain the same.

3. Entrants have the potential for a lower cost base to arise when achieving economies of scale. For example, where mobile only, they lack the service expense of operating branches, estimated to be between 30-50% of incumbent’s total operating cost[vi]. Furthermore, entrants do not need to support legacy IT. Old systems can represent up to 80% of an incumbent bank’s IT budget[vii]. Yet the challenge for entrants is in gaining enough scale to cover the high fixed operating costs of running a bank in general. Despite Monzo ending the 2018 financial year with 750,000 customers, the new entrant bank lost £33.1m[viii]. The path to profitability is hard.

4. Arguably one of new-entrants’ main competitive advantages is in the ‘newness’ of their infrastructure. To generalise, incumbent’s infrastructure is hugely complex and costly to change. The benefit of infrastructure improvement becomes visible for the end user in the form of innovative new functionality built on top. A lot of this functionality though, is enabled by third parties via API[ix]. Such API partners are free to contract with incumbents, whilst the technology behind new infrastructure is mostly non-proprietary. It is conceivable then, that incumbents could, with concerted effort, modernise for technological parity.

5. Both new entrants and incumbents rely on Net Interest Income (NII). NII is the difference between the revenue that is generated from a bank’s assets and the expenses associated with paying out its liabilities[x]. *However, a marketplace model has the potential to be more disruptive. Monetising the connection of third party services e.g. credit or savings products directly competes with incumbents’ model of bundling services provided in-house. It would be very difficult for an incumbent to offer a wide-reaching marketplace. In-house products required large sunk costs to develop and have higher margins when sold. Cannibalisation and reducing margins are large disincentives for management and shareholders alike when considering strategic change.

6. New entrants compete with incumbents for customers. Mobile banks may attract a younger audience vs. incumbents, and whilst these are potentially less valuable, they are not a largely undeserved or under targeted segment.


This assessment of disruptive innovation in the banking sector is, well, mixed. Because of this, it could be fair to say RBS’s strategy to partner with Starling is as much a hedge against the disruptive potential of new entrants, as it is an existential strategic choice. In this light, an incumbent’s partnering or acquiring decision could be viewed as conservative or risk adverse, rather than adventurous or courageous. Be that as it may, RBS can indeed proclaim the wise words spoken in 1672 by George Villiers, the 2nd Duke of Buckingham, “Now, Criticks, do your worst, that here are met; For, like a Rook, I have hedg’d in my Bet”[xi].