Banks face the stark reality that they may not be part of banking’s future. Their customers have an increasing range of options both for their banking services and in other areas of their lives such as housing, health care, education, travel and entertainment. This is not only a threat but also a real opportunity for banks if they start to think innovatively about how they can support their customers with what they really need. This is clear in the difference between how customers and banks see decisions about housing. For banks, what is important is the mortgage, but for customers, the mortgage is only a small (though significant) part of their desire to find, finance and settle in their dream home. Today’s homebuyers spend a great deal of time on housing portals; they ask Alexa which mortgage they should be getting and use comparison sites and brokers to search for financial products. That means the relationship with their bank is diminished and ends up commoditised, leading to reduced margins and an unsustainable business. Banks need to respond to this new world by unlocking new sources of value, recognising that this will be not just in banking, but also in the broader ecosystems centred around customer needs. This is where platform business models excel, but the transition to these kinds of models will not be easy for banks. It will require a clear vision and strategy, and new, hyper-personalised digital propositions that truly meet the needs of users (consumers and producers). Banks will need to identify partners that can support them in that broader ecosystem. All this will require banks to make choices about their technology and smart use of data.
PARADIGM SHIFT IN THE MARKET
Customer needs and behaviour are changing rapidly.
Today’s customers are used to the seamless, personalised experiences they get from the likes of Google, Amazon, Facebook, Apple, Airbnb, Uber, etc.
They now expect to have the same experience and level of service from financial institutions, and the banking sector has begun to respond to these changes. Incumbent banks have gradually adopted customer-centric approaches, simplifying and improving their processes to provide a better experience. Meanwhile, FinTechs such as Monzo and Revolut, which provide a more personal service that responds to customer needs, have succeeded in attracting large numbers of clients.
It is also clear, however, that with better access to products and services, and with more information about what is available, customers have become much more focused on choosing companies that give them the best deal. They want speed, convenience, simplicity and cost effectiveness and will look for providers that meet these expectations rather than sticking with traditional brands or firms with significant assets. Customers are looking for partners that will empower them to achieve the outcomes they desire.
This means that the competitive landscape is changing, and banks’ biggest competitors in the future are likely to be not other banks but technology companies.
A real shift is taking place away from banks to non-banks as people look in different places for financial products. It used to be very common for people to use only one bank for all their needs. Today, however, even if people just have one bank account, they will search for better products online when they are looking for mortgages, loans or credit cards. Comparison sites and search engines have now become much more important in driving business and offering consumers a much wider choice of providers.
Banking is just catching up with other industries that have gone through similar changes. The travel sector is just one business that has seen a dramatic shift in the way people buy products. We have moved from using travel agents to book flights, hotels, events and excursions and holiday packages to using Booking.com, Expedia and Airbnb. All these provide a very different customer experience and a challenge for incumbents, and a similar transformation is likely to be seen in banking.
Regulation is changing to accommodate technological advances
Another development that is enabling change in the banking sector is the increasing willingness of regulators to create new regulatory regimes that support innovation. The recent implementation of the second Payment Services Directive (PSD2) and General Data Protection Regulation (GDPR) are just some examples of where regulatory requirements will mean
that the financial institutions will have to make consumer data available to nonfinancial institutions, opening up the market further.
While regulations will continue to differ in different geographies, and their full implications are yet to be seen, it seems clear that these changes will give banking consumers more choice and enable new providers to enter the market. In particular, this is giving rise to multi-bank propositions (instead of propositions from banks that offer only their own products and services) and intensifying competition.
Moreover, regulatory changes are likely to work to the advantage of large platforms (Google, Alibaba, Facebook, Tencent, Amazon), all of which hold e-money licences and have already started to compete with banks in payments. It is very likely that they will continue to expand their offerings and offer strong competition to banks in the PSD2/open banking payment space. Given the breadth and depth of insight they have on consumers, it is also highly likely that they will do well in these areas.
IMPLICATIONS FOR BANKS
One of the most far-reaching changes for banks is the way customers are increasingly thinking about the goods and services they want before they think about the financial services products that will enable them to make the purchase.
Although this has always been the case to some extent, banks will be more affected by the change because of the way new technology can now make the role of the bank invisible to the end user.
For example, a customer who wants to buy a new camera could search online, go to a new e-commerce site that is particularly good for enthusiasts, look for options, read reviews and decide to buy a fixed lens and a full-frame camera. He would then go to the checkout and see several payment options. He could decide to get a credit card from the e-commerce site because they are offering a 10 per cent discount and complete the purchase with one click without ever having to deal directly with a bank.
Then three days later, he might notice that it is difficult to take portraits without a tripod. He could say, ‘Alexa, I’d like a tripod that should be about 1m high,’ and the tripod arrives the next day. Again, the financial institutions enabling his purchase are almost invisible.
Before the new millennium, Bill Gates said, ‘We need banking. We don’t need banks anymore.’ Fast forward to 2015, he still believes, ‘Banking is necessary, banks are not.’
The example of the camera purchase shows that, in some ways, this is true. There are an increasing number of daily activities where people need banking but do not need to interact directly with their banks to complete the task.
All this means that if banks focus only on traditional banking, they will prove Bill Gates right. If, however, they start to focus on how they can support their customers at the beginning of the process and meet the primary need, they will be able to create greater value and more sustainable business models.
CURRENT CONTEXT: ROLE OF BANKS IN NON-BANKING ECOSYSTEMS
The housing market illustrates how banks play a role in non-banking ecosystems. Similar thinking could be applied to other areas such as mobility, travel, healthcare, entertainment, education and others (see primary need spaces in Figure 2).
For most banks, housing equals mortgages. The mortgage business is a great driver of revenue and profit, which also helps to upsell and cross-sell, creating greater value down the line. In response, banks have made significant investments in digitising their internal mortgage processes. They have also enhanced their risk management capabilities and have improved their presence across their own and partner channels.
Banks tend to think that this means they are now providing mortgages better than ever before and that customers are more satisfied with the application process.
Yet if we take a more customer-centric view, a different picture emerges. This starts by recognising that for customers, the mortgage is only a small (albeit important) part of finding, financing and settling into their dream homes. Homebuyers spend a great deal of time on housing portals, ask Alexa which mortgage they should be getting, and use comparison sites and brokers to search for financial products. They use innovative propositions to apply for mortgages across multiple banks digitally.
While banks are working hard to improve their internal processes to meet customer needs, they risk missing what is happening in the external world. That is change, which is rapidly leading to the disintermediation of the customer relationship, the commoditisation of banking products and reduced margins. Citi estimates that banks may lose more than 30 per cent of their mortgage volumes to disruptive models by 2025.
Even banks that are doing well should be concerned about these threats and look beyond positive short-term numbers.
Banks face important strategic choices
These developments mean banks face some important strategic choices. For those focusing on managing their bottom line, targeting the core business, increasing efficiencies and cutting costs may help. Yet this will not be enough, as banks need to unlock new sources of value, not only in banking, but also in the broader ecosystems of customer need.
The answer to securing this value lies in platform business models that excel in meeting those broader needs.
Platform businesses are taking over
Airbnb has transformed the hotel industry. Uber has transformed mobility. Facebook has changed news. Wikipedia, Twitter, Apple and Microsoft have all transformed their industries. All these companies have one thing in common. They are platform business models that have challenged pipeline business models. Platforms are conquering and transforming traditional industries.
The top seven publicly listed companies by market capitalisation are platform business models, and some of these companies did not exist at the beginning of the millennium. It is not a matter of ‘if ’ but of ‘when’ platform business models will also disrupt financial services.
What are platforms, and why should banks be worried about them?
The value equation in a platform model is fundamentally different from that in a pipeline model (Figure 1). Even the idea of a ‘customer’ is different, and a whole range of new definitions are required to explain platforms:
Consumer: The entity that receives the core value in the interaction.
Producer: The entity that creates the core value.
Customer: The entity that pays the platform owner. Crucially, in platforms this could be the consumer, producer or a third party.
User: Consumer or producer on the platform.
If we take Uber as an example, the core value unit is the ‘ride’. The consumer is the rider, and the producer is the driver.
In Facebook, the core value unit is the post. The consumers are readers of the posts, and the producers are the entities that post. Interestingly, the consumer and producer can be the same person. The customer, however, is the advertiser (as well as a producer as they post).
In the pipeline business model, the user, consumer and customer are all the same. They pay the company, which is typically the producer of the product or service. In short, the company gives a product or service in exchange for money. As the number of customers grows, companies benefit from economies of scale.
In platforms, because the value equation is different, the monetisation mechanisms also vary greatly. Therefore, platform companies need to think about not only the traditional customer, but all users of the platform as well as other parties in the broader ecosystem. Crucially, successful platforms benefit from network effects.
Network effects — Be the first and move fast
Put simply, when a new user is added to a platform, the value of the platform grows for other users. This, in turn, leads to much more attractive economics, allowing the platform to grow with additional users instead of by buying new assets.
Figure 1: Platform business models versus traditional pipeline business. Source: Parker, G. G., Van Alstyne, M., Choudary, S. P. (2016) ‘Platform Revolution’, W. W. Norton & Company, New York, NY.
Because the number of participants increases the value of the platform, first mover advantage often leads to growth that is exponential relative to that of any competitors — any challenger would need to be as big as the first mover to give more value.
The ‘network effect’ is the reason why banks should strive to be first movers to develop their platforms. Even if the winner-takes-all theory does not apply to all Internet platforms, there is a great upside opportunity in being the first and moving fast.
The platform opportunity
The unbundling and re-bundling of financial services on the demand side, supply side as well as the intermediary layer creates complexity. Platforms can turn that complexity into opportunity in many ways depending on the strategic ambitions of banks.
There is already significant activity in the market around platform business models, focused on two routes: the process-centric route (focused on the intermediary layer in Figure 2) and the end-user-centric route (ie demand side in Figure 2).
In the first route, new players pursue the digitisation of banking processes and then serve them as application programming interfaces (APIs), often referred to as digital open banking platforms. Fidor and Solaris Bank are good examples of this approach. By replacing slow, often manual, processes with digital ones, they help incumbents to speed up their processes and circumvent the legacy issues, often leading to significant time and cost savings. They also help start-ups that are focused on managing customers but that may not have the capability or appetite to develop their banking processes. They stand to benefit from same-side network effects as more banks or start-ups use them. They will also benefit from cross-side network effects if they successfully move to a ‘banking as an operating system’ model, where they attract independent developers who will continue to develop new digital processes.
This route is an important one for incumbent banks to pursue — either organically or via partnerships — because in addition to cost-side benefits, the digitisation of their processes will help them to develop other routes and develop new propositions faster.
Figure 2: Banks and primary end-user-need spaces
For banks that choose to pursue the end-user-centric route, the opportunity lies in empowering users in the enduser ecosystems (primary need spaces in Figure 2).
Revisiting the housing example, what might the home buying journey look like from the users’ perspective?
Alex and Charlie are in the market for a house. They spend a considerable amount of time searching for their house on housing portals. After visits to several houses that fall outside their budget, they finally find a house they like, but they are not sure if they will be able to get a mortgage for it. They speak with their broker, look online and ultimately apply for a mortgage that takes them two to three weeks to secure as they needed to ensure they had physical copies of payslips. They endure a few nervous weeks, unsure if it will all work out…
What does this look like from the housing ecosystem participants’ perspective?
Housing portals, which are platform business models themselves, continue to enjoy great levels of traffic and have accumulated useful data on buyers, sellers, real estate agents, as well as houses. With the vast ecosystem data and insights they have, they have begun to expand their offerings across the journey; however, they are not able to monetise mortgages as well as other entities in their ecosystems.
Sellers and real estate agents make considerable efforts to showcase their property, often only to find that the prospective buyers will not be able to secure a mortgage.
Meanwhile, banks are competing to get applications in through various channels, and spend a great deal of effort processing applications, all at substantial cost.
All this means that for one property purchase, there are considerable transaction costs (time and money) for all parties involved. Imagine a scenario where homebuyers receive personalised advice, matching them with properties they can afford, and for which they are pre-approved to get mortgages and insurance that fit their needs. This scenario increases transparency and reduces transaction costs for all those involved, and, ultimately, supports the end users to achieve the outcomes they desire, a house and a mortgage.
In the housing ecosystem, there are some notable propositions emerging that aim to address the preceding issues. Danske Bank and Commonwealth Bank of Australia have housing portal propositions that integrate their products in the journey. It is yet to be seen if their single-bank product approach will be successful. Equally, there are emerging digital mortgage management propositions. Habito, Trussle and Interhyp are great examples from Europe, and Rocket Mortgage is increasingly popular in the United States. The opportunity for them is to be seamlessly integrated into the homebuyer’s journey from the very beginning.
Beyond housing, similar thinking applies to other end-user-need spaces (ie nonbanking ecosystems). And end users do not necessarily have to be retail bank customers; SMEs have similar challenges in achieving their business outcomes where banks have opportunities to develop platform propositions to support them.
CRITICAL SUCCESS FACTORS
So, what should banks do today to seize the opportunities of platform models?
Start from the top
Banks should be provided with a clear vision and strategy by their leaders. They should identify which areas they should play in (and where they should not), including working out which end-user ecosystems they should prioritise and where they should buy, build or partner. They should then carefully develop and establish their monetisation and revenue exchange approach and understand that, at first, the new business models may seem to be cannibalising the existing business.
This requires banks to relentlessly communicate their strategy internally and align the entire organisation to the vision and strategy.
Reinvent the business, fast
At the same time, they need to create an innovation culture that can move fast to provide the products and services that will delight customers while continuously learning and improving. That means being open to new business models and understanding that pipeline business models do not become platforms overnight. This means it is important to start small, experiment relentlessly and learn to scale up fast when an experiment works.
Rethink the demand side: Innovation is especially relevant on the demand side (Figure 3). Banks should pursue usercentric innovations that work well for both sides of their platform.
Banks should also expand their scope of innovation to the outside world. Activating the ecosystems that they choose to play in and fostering activity in these ecosystems may require partnerships and ventures. They should lay the foundations now.
Redefine the supply side: Banks should also make important choices on the supply side. Users want partners who will empower them to achieve the outcomes they desire. This means that the products and services they will ultimately need are not necessarily what their primary banks are currently offering. If banks really want to be user-centric, they need to be open to offering the products and services of others.
All this must be done fast. There will not be many winners. There may not be one eventual winner (there never is), but those who start fast will reap the benefits. As platforms drive network effects, the demand side economies of scale yield great advantages to first movers.
Think big. Be the disruptor, not the disrupted
The value exchange is fundamentally different with platform businesses.
Figure 3: Traditional bank versus future direction
This may initially lead managers to perceive platforms as cannibalising the existing business. Changes on the supply side can be particularly hard to digest and raise the question, ‘Are we going to sell the products of our competitors? Doesn’t that destroy my existing business?’
Yet cannibalisation is usually an internal and political challenge, not a strategic one. Banks need to recognise that disrupting and cannibalising themselves is the best way to remain relevant to users. Indeed, the lesson of history is that very few companies have cannibalised themselves out of business, and there are many who have very successfully cannibalised themselves, not least the Apple phone, which must have really hurt the sales of the iPod but was the right strategy. In contrast, there are many companies that have gone out of business because they did not cannibalise themselves, Kodak being the most obvious example.
Technology will be the main enabler for banks to achieve their vision, and it will underpin their propositions and partnerships. The difficulty is that many banks are hampered by legacy systems, which slow them down. Since replacing the bank’s IT infrastructure is costly, and there is no clear benefit to end users, many have been reluctant to invest in an overhaul of their technology. They will, however, need to make some tough choices soon, as API-based internal processes and external facing APIs will be crucial to realising their ambitions to become platform businesses (Figure 3). This will be possible only if they have the right technology.
They should also recognise that they will not become successful digital platforms with cosmetic changes to the chassis but will need to rethink the whole nature of the engine that drives their business.
It is about smart use of data
Perhaps the most important part of the whole equation is data. This is not about having more data but rather about how to capture relevant data and how to make good use of that data in their propositions.
Banks that know more about their users (their identity, behaviour, needs, motivations, their current state, the outcomes they want) will be able to offer relevant, personalised services that better meet the needs of their customers. Whether it is instant credit scoring and pre-approved loan applications or predictive support on invoices and working capital, banks can better support their users to achieve outcomes with smart use of data. Those individualised products will be integral to putting banks back in the centre of banking.
Banking is changing, and banks are at real risk of being excluded from its future. They could easily become commoditised, invisible providers, in low-margin unsustainable businesses.
Yet those that embrace change and understand that they can play a much more meaningful role in their customers’ lives, empowering them to achieve the outcomes they desire, will be able to develop and transform their businesses in exciting and profitable ways.
Adem Kader is a strategy and financial services expert at PA Consulting