What Alice Gets Right About Aligning Incentives

I came across Alice recently and love it. It isn’t only what the product claims to do, it’s how their business model aligns so well with their users and customers.

(FYI – I’m not involved with this company in any way. I don’t know the team or invested…although I wish I was an early investor!)

First, what it does.

It’s an app that employees connect to their credit cards which monitors their spending. When it identifies charges eligible to be reimbursed with pre-tax w2 dollars, Alice submits the deduction to the employer’s payroll system automatically.

This is ingenious because it requires no behavior change from anybody and makes money for everybody at the same time, including Alice.

  • Employees – It’s simple to connect an app to your credit card and you’re more than happy to find out that bus pass you bought is now being paid for with pre-tax dollars. That’s money in your pocket.
  • Employers – It wires into the payroll system to automatically submit deductions. Simple. Every dollar deducted pre-tax reduces the employer’s payroll tax burden (Medicare, Social Security, etc…). That’s keeps more money in company’s bank account.
  • Alice – This is where incentive alignment comes in. They save the employer money and the employer pays Alice back a portion of the savings. That’s money in Alice’s bank.

The last part may seem obvious, Alice takes a cut of the savings. But consider how powerful that is when compared to a service that negotiates on a patient’s behalf to lower their medical bill. The patient received a $10k medical bill. The company negotiates it to $2k and charges the customer 5% of what they saved them, $400.

Sounds great in theory, unfortunately the patient didn’t have the $10k to start with and probably doesn’t have the $400 to pay the service provider. Even if they are relieved the bill amount was reduced, the business model isn’t fully aligned with the customer.

In Alice’s case, the employer does have the money and is happy to pay a percentage to Alice. They were going to spend it anyway! And now they get to pay less.

It’s interesting to think why this product has emerged now. What makes it possible today versus 5 years ago? A combination of things:

  • Fintech Infrastructure – APIs to monitoring card transactions (thanks Plaid!) have made this 10x easier.
  • API Economy – Of course, the payroll providers all have an API. Try having done this even 5 years ago. Remove the benefit of auto-submitting the deduction and now you have to ask the employer to do work or change their processes. Much harder sell.
  • Consumer Habits – That fintech infra has made services that tap into your financial accounts so much more prevalent, resulting in more apps that do so. People have gotten used to it and are more willing to try.

Two Important Acquisitions

Cost of capital is the driver of recent headline M&A

Two huge M&A announcements this week that sound very different and under the covers are driven by the same goals.

  1. LendingClub buys Radius Bank – Fintech OG buys a bank with $1.4B in deposits. Price Tag: $185M
  2. Morgan Stanley buys E-Trade – Wall Street OG buys discount broker with $39B in deposits. Price Tag: $13B

They may sound very different, yet are driven by the same need for the lowest possible cost of capital. The cheapest money comes from you and I depositing our cash into the bank. From there, the bank lends it out and invests it, earning revenue from the deposits.

The E-Trade numbers are particularly interesting. Trading commissions are approaching zero, a trend started by RobinHood and accelerated by Schwab. In reality though, E-Trade doesn’t make the bulk of their money from that trading fee.

They make ~18% from commissions and over 60% from net interest over deposits (from an excellent post by Charley Ma that you should read).

As Morgan Stanley offers a fuller suite of retail finance products, those deposits are the zero cost capital they can use to finance them.

As LendingClub expands their product lineup, the Radius deposits offer them the same benefit.

Would you want to be a fintech carrying capital at 3% trying to compete with others who have an almost zero cost? Easy question. With almost no bank charters being created, expect to see more and more of these deals.

A Neobank That’s A Bank

How Varo’s bank charter will help prove or disprove the Neobank thesis.

Varo, a Neobank, announced this week that the FDIC approved their banking charter. This is a first for Neobanks, enabling them now to hold customer deposits and lend that money out.

You know, like a regular bank.

This will be a fascinating experiment, one that could make or break the thesis on the potential value of Neobanks.

To understand why, it’s worthwhile to explore the challenges Neobanks (Chime, Stash, etc…) face and how this charter potentially differentiates Varo.

The Problem With Neobanks

First, let’s understand what a Neobank actually is. You don’t deposit your money with a Neobank. Your money is actually held (and subsequently lent out) by a traditional bank.

It looks a little something like this.

That API between what the Neobank controls and the deposit holding bank introduces a set of challenges. It means the Neobank:

  • Can’t earn money by using the deposited funds to lend out at a near-zero cost of capital
  • Is limited in their product development by the API’s available from the underlying bank (or infrastructure provider that sits in the middle).

The bear argument for Neobanks is that they are novel UX layers and marketing channels, which can easily be replaced, to bring deposits in for the underlying bank.

On the bright side, Neobanks do not have the compliance overhead of holding customer’s money. The bull case treats Neobanks as modern finance companies with incentives aligned to their customers.

For example, Neobanks protect you from overdraft fees with warnings and quick loans because they make their money from a monthly SaaS fee as opposed to the penalty fee itself. A traditional bank has no incentive to offer the same protection, it just hurts their bottom line.

The Varo Bull Case

With their charter, Varo is betting that owning the entire stack, from UX to deposits, will enable them to:

  • Build the tech stack that realizes the potential of relationship banking.
  • Better anticipate, qualify, cross-sell and serve customers than banks today and at a lower cost of capital and less friction than other Neobanks.
  • Offer API driven banking infrastructure that others can build on (note: this one is something I’d like to see, not what they’ve publicly stated)

Can Varo do this and challenge incumbent banks in scale and market cap? Maybe.

The charter gives them a unique weapon in their arsenal. Considering it has taken them almost 3 years to get the charter issued it doesn’t appear there will be any fast followers. And with it, we’ll finally see what the value of a fully digital bank is.

Software Is Relationship Banking

Software has replaced relationship banking as the best way to acquire customers and sell new financial products.

This bodes well for the land and expand strategies of tech companies and not so well for the mythical personal relationship banks have with customers.


  • Changing customer attitudes and bank’s antiquated tech stacks are killing relationship banking, leaving banks vulnerable to competition from tech companies.
  • Fintechs have built modern and integrated tech stacks to better serve customer segments more economically.
  • Others (Uber, Shopify, etc…) are leveraging their vertical solutions to sell financial products.

Relationship Banking Test

Relationship banking posits that customers select products from banks they already use and presumably trust. And that these banks are best positioned to understand and serve their customers because of their relationship.

This just isn’t true.

Consumers, particularly younger ones, don’t discover and choose financial products based on their bank relationship. In truth:

  • ~70% bank digitally because they don’t want to visit a branch
  • ~50% don’t think banks are that different from one another
  • 3x more likely to close accounts and switch than older cohorts

Let’s skip the “next generation changes everything” argument. Instead let’s use Frank Rotman’s excellent rubrik (highly encourage reading his full post for more detail).

  1. Is it easier or more economical for current customers to access other products from you? Are you able to qualify customers because of your current relationship that others can’t?
  2. Are you proactively suggesting and moving customers into the best products based on what you know about them?

Ever applied for a mortgage with a bank where you hold an account to find that you are filling out same information that a brand new customer would?

Ever gotten a maintenance charge on a checking account when the bank offers a free option that you also qualify for?

Then you know the answer to these questions is a resounding NO.

Banks are playing a tough hand. Their tech stacks are a mess, cobbled together over 30 years, making it difficult to serve customers across products. It also makes it expensive for them to support the niche segments that tech companies can profitably serve.

How Do Fintechs Stack Up?

Using modern tech stacks, low opex and a technology-driven mindset, fintechs focus on acquiring the best (i.e. most profitable) or underserved customers as wedge into the market. Solving one customer segment’s problem enables them to move into adjacent products and/or customer segments (‘land and expand’).

Their entire business plan is predicated on being able to answer yes to those questions. Let’s look at one of the test questions.

Is it easier or more economical for current customers to access other products from you? Are you able to qualify customers because of your current relationship that others can’t?

Remitly’s core product is an international money transfer service and many of their customers are thin file immigrants who have difficulty getting a bank account or many not have a SSN. No problem, they released a bank account that using international identification documents and no SSN to KYC a user.

How do you think these users will send money internationally from their new bank accounts? The virtuous cycle spins. It’s easy to imagine Remitly growing into loans and other products as well, all to an ignored customer segment deemed too expensive (i.e. risky) by the legacy bank tech stack.

What About “Regular” Tech Companies?

It’s not only Fintech companies the banks need to worry about.

Increasingly, tech companies that you don’t think about as finance businesses are leveraging their customer data to offer financial products more economically than a bank could. It makes sense, it’s getting easier to roll out a finance product and it’s a margin lift for their businesses.

Shopify helps anybody setup a storefront on the web and sell directly to consumers, who pay a monthly fee for the service. But, did you know that they offer loans to businesses or that this is ~50% of their revenue.

That’s a business loan, the same kind you can idealize is taken by a hopeful entrepreneur in the lobby of their local bank. Instead it’s delivered by a technology company that makes data-driven decisions based on the businesses use of their software platform.

Technology is the new relationship banking.

Everybody Becomes a Bank


You could imagine a Shopify competitor giving away the storefront for free to attract businesses and then earn money from loans and payment processing.

We are seeing this happening already in some verticals. Divvy is an expense management platform that is free for businesses. Completely free. They earn money from the interchange fee via use of their issued credit cards and soon through loans issued to business customers.

The permutations are endless depending on the market and pressure points. This is great for customer, not so great for banks.