The thrill of discovery

Current events have placed this commercial, which premiered during Super Bowl XX in 1986, firmly front of mind…

The music is 80s gold and would fit happily into the opening credits of any one of a dozen sitcoms from the era. But it is the words that deserve our attention as investors.

“The Discover Card puts money in a whole new light,” they tell us. This, my friends, was the dawn not just of a new card, but of never-before-seen financial innovation. Specifically, Discover was innovation because it offered…

• No annual fee

• Cashback bonuses on all purchases and available immediately

• It could be coupled with a high-interest savings account

DaVinci’s Ghost must have wept a little that winter night in 1986.

Fast forward nearly four decades, and it is remarkable how close that list of features is to the promises made when the Apple Card was rolled out. Instant cash back! Paired with a savings account! Apple put its name on a Goldman Sachs credit card and Tim Cook declared that his company was “uniquely positioned to make the most significant change in the credit card experience in 50 years.”

The only thing Tim was missing was a catchy 80s-style jingle.

And while the Apple Card has hardly been a failure, it has just been, well, a credit card. 12 million users are nothing to sneeze at. But then again there are 135 million iPhone users in the U.S. And those who do use it, based on the data provided, use it like… a credit card.

Innovation indeed.

I pick on Apple because the launch was so huge, but there are countless examples. Back in 1999-2000 I remember being pitched Juniper Bank, a collection of credit card industry veterans from (now swallowed) titans like MBNA and First USA who were going to take their credit card expertise and reinvent the product with the Juniper Card. No less than Benchmark Capital put up the funds! By 2002 management was up in Canada begging for financial support. By 2004 it was folded into Barclays with a whimper.

The most important thing to understand about banking is that in the history of the sector 90% of what is called innovation is just repackaging.

So, what’s the takeaway for investors?

If there is any industry where you should run for the exits the first time you hear the words “paradigm shift,” it is banking. I’m probably being generous saying that 90% of the innovation is marketing. It is likely much higher.

There are good reasons for this. For one, banking at its heart is the purest form of business. You are buying and selling money. You remove the friction that comes with factories and actual products. Throwing new widgets or bells or whistles on top of that tends to make things less efficient, not more innovative.

Also, banking is highly regulated. Even when a rare mad scientist does exist in this industry, they are held back by the bureaucracy. This is a feature, not a flaw. Go slow and don’t break things is a pretty crummy recipe in Silicon Valley, but it helps savers sleep well at night. The global banking regime is designed to make innovation hard.

The inverse of the 90% of innovation is just repackaging is that the primary way financial services companies can innovate is marketing. That’s the thesis behind Lemonade and SoFi. And it might just be enough to give them a solid foothold in the insurance and banking industries, respectively. But building a long-term viable strategy on being hip and new and cool is a tough trick to pull off. And new ways of doing the stuff we were always doing, while not real innovation, has made the products easier to swap out and less sticky than they have ever been in their history.

Which is all to say that even if you don’t avoid these “innovators” completely, be careful what you pay for them. If they are as successful as you hope they will be, chances are they will inevitably regress towards the incumbent’s valuation.

The most unexpected part of the Discover story was how long it took to play out.

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