When talking about platforms, open API:s and cooperation between rivals – have you ever wondered how that might be possible? How does it even make business sense to let others use your systems and resources for their business? This is the long form answer, mostly focusing on the situation that banks are facing right now.
TL:DR Regulations and new business models force banks to open up to competitors, but done right everyone can profit.
Most large banks benefit from a heritage and trust capital that makes their proposal far more attractive to customers compared to new players. Typically, they have an enormous reach and during years of operation built an ecosystem that is deeply ingrained in the fabric of society and business.
They have built this during years of competitive struggles and fighting to fend of newcomers, stimulating price fights on suppliers and making substitutes unnecessary by continuing to expand its own offering. Basically doing all the things that is anticipated in Porter’s five forces model.
Startups and new players have a disadvantage compared to the incumbents in this area. As a customer-facing (B2C) startup you obviously lack these things that you desperately need. No story, no recognition, no reach and physical presence, to top that of, they don’t have the integration with partners, competitors and customers as an organisation of hundreds of years have.
Even though banks have faced strong competition in certain areas (and to be truthful has left for instance, individual stock trading to players like Avanza and Nordnet on the Swedish market), basically, it has been due to above reasons, quite an easy task to keep newcomers at bay.
Although, at this point in time, banks are facing an increasing difficulty to fend of competitors, and to act as market dominant due to the regulations that are being forced upon banks.
The scenarios for financial actors
Given two major driving forces in the market – regulations and digitalisation, we can derive probable market scenarios and responses from incumbent actors.
Due to the digitalisation, customers will be increasingly automated and because of the regulations, the financial services industry will be increasingly fragmented with a growing number of actors willing and able to serve the needs of financial clients.
In the most extreme scenario, you have a vast choice of market players who are highly digitised and the customer relations are to a large extent digital and impersonal. This is the scenario in which PSD2 and to some extent MIFID II has had the intended implications in the market.
A likely response from actors on the market is to consolidate and acquire smaller players to regain market power and to absorb competence and resources, as well as attracting customers. A development we have already started seeing.
Another probable response is that the parts of the market that are not willing to be automated and digitized to the same extent, will find small IFA-like actors serving their need for individual advice and personal service. A very likely long-term market outcome is that these two positions will certain variations, will be available to enter if you’re a financial institution.
Going from battlefield to ecosystem
Actually, how to address these changes in the market dynamic described above is probably one of the most fundamentally important decisions to be made by financial institutions in the coming years. Not just for the neo-banks.
The regulations on the financial markets take aim at creating transparency and openness that in the end will benefit the customer. To be compliant with these regulations, banks have to undergo dramatic changes. For many years, the prospect of this radical transparency that for example PSD2 is enforcing upon banks has been frightening but more and more, it is starting to look like the greatest business opportunity in a long time. If done right.
Lets go back in time. Old school business models are based on harsh competition between rivals. The most successful business creates high entry barriers for entrants, price pressure on suppliers and aggressively acquiring customers with mass marketing and low prices (and not necessarily with a great customer experience or service).
Theses businesses create and control a linear occurrence of activities that usually is described as the value chain. You typically have a commodity or suppliers in one end, and a finalised value added product in the other. Many successful businesses today function like this. But now, what the most fast paced companies has in common is that they essentially have become a platform and an ecosystem for other business to build upon. In the process they are reaping the benefits of being the orchestrator of this platform and at the same time creating benefits for others.
Simplified, the shift that we are seeing now is that we are moving from a competitive landscape to a collaborative one. The new paradigm has more similarities with ecosystems rather than the battlefields of past times.
Apple, Facebook and Google are the best and most well know examples of this phenomenon. The semi-modern companies who grew rapidly during the 70:s and 80:s, are now trying to catch up by introducing platforms and ecosystems to their business – like Nike is doing with Nike+.
How did we end up here – why isn’t the war metaphor sustainable?
In the traditional business model, discussed above, putting pressure on suppliers and creating more output and volumes at a lower cost lead to competitors being forced out of the market and ideally, a monopoly is created. This is what in fancy business terms is called supply side economics. In these businesses you will find what Mr. Warren Buffett is looking for – a moat – something that will create enough distance to the competitor so that you as an investor can feel confident that they will never really be able to catch up.
On the other hand, a fairly well known concept in the digital world is what is known as the network effect, which in schoolbook terms could be described as demand side economics. You can use the rise of Facebook to explain the network effect. The value I can derive from Facebook increases with every participant in the network. If Facebook had 100k users, the value to each and every one of these users would be higher if there was 100 million users, or even more so, a billion. This leads to a winner takes all situation, because everybody wants to spend time where everybody is. When the network effect is working against you, call someone from MySpace and ask for advice.
In a “software will eat the world-world”, a platform with 100 million users and no real business model can be worth quite a lot. Instagram at that size was bought for $1B and, WhatsApp’s 600M users for $19B – for that price they also got $10-20M in sales. This is also why (with a caveat for lofty valuations) why Uber is worth more than GM.
This platform-thinking have led Google (and others) to aggressively move into new, seemingly unrelated business ventures. From an old-school perspective, going from “search” to self-driving cars, thermostats etc. seem far-fetched. With a platform perspective, it makes perfect sense. This also means that incumbent business owners can be blind-sided by competition from an unexpected place.
In seminars and presentations I have sometimes described this as the driving force for what we in Sweden call “branschglidning”. The best translation is probably “industrial transformation”. Essentially it means that media companies is becoming services in which they can monetize their audiences (and vice versa). Gas stations become fast food-joints and convenience stores, and supermarkets, entertainment hubs and meeting places. The true value lies in how many participants you can gather around a specific event or service – and from that you can derive business opportunities and value.
What we ended up with is something like this:
The bank as a platform
Let’s conclude these ramblings with a banking perspective.
Going from creating moats to effectuating openness is driven both by regulations and a shift in how markets and business models are modelled today. This means that no matter what financial institutions think of this – the winner will be the one who within its market position best can leverage the possibilities that will come.
As late as last week – Nordea made the not very surprising announcement (at least for us finance nerds that follow these issues) that it would launch a financial app-store.
What Gunnar Berger from Nordea could have said, but did’nt, was something like; “We are not able ourselves to create services that can fulfil all of our customers needs and wants. We want to cooperate with developers and users to create an ecosystem.”
As a financial institution, already deeply ingrained in society and business (basically a unorganized ecosystem and one that to a large extent is analogue and physical/geographical) the opportunities of owning and managing an online platform is vast. If you think of banks as the plumbing and central nervous system of the economic world, all services related to my business and my personal finances can be built on top of this.
As a service provider to businesses or individuals your service could gain tremendously by having a tight integration with “the bank”. One example, which is already a reality on the corporate side, is external accounting services and payments integration with other banks. Most of these ‘software as a service-systems’ are integrated with the customer’s bank today. Doing accounting, paying out salaries etc. is simple and effortless. Going from this type of integration to an ecosystem similar to what you can find to enhance your iPhone-experience on App-Store there is a lot of value to be gained. Both from the one who orchestrates the platform, to the one developing apps to the end customer.
What are the challenges?
Of course, there are plenty of challenges. To achieve this, the ones supplying and orchestrating the platform needs to understand the different challenges that comes with it, compared to managing a value chain-business.
A couple of immediate challenges rise above others. One is the inherent struggle between participant (developer) and owner of the platform. On the one hand, the platform owner must create enough value for the participant for it to be interesting and worth it’s while. However, if the participant grows a dominant position, it can be tempted to deviate and create a platform of its own, or move to someone else. In either case they are deducting value from the end customer and platform owner.
Owning a platform is also about cultivating it to be a valuable place for all participants. You need the right mix of freedom, possibilities and rules to thrive.
If it is a freewheeling, do whatever platform; its value will diminish as soon as the experience deteriorates. On the flipside, too strict governance will create a closed and non-growing platform, with less creative output making it less interesting for both developers and customers. These two scenarios aptly describe Android and Apples ecosystem approaches respectively. Android have had lot of problems with bad apps and Apple, with its really strict rules gets criticized from time to time.
By wisely using a set of rules and governance structure, and by being flexible, constantly analysing what’s is going on your platform, you can make sure to foster a great culture and community.
Obviously, the hardest part of this, given its uncertain nature, to navigate towards a solution that is both profitable and valuable to the bank, as well as something that is appreciated and used by the end customer. The difficulties moving into a new paradigm is that no real benchmark is available, and innovation and research, trial and error needs to take place. That implies that banks will be forced to undergo some cultural and most likely infrastructural changes to adopt new ways of working.
PSD2 will come into effect on the 1st of January 2018. We’ll see what we have by then.
EBA:s (European Banking Authority) technical recommendations here (PSD 2 RTS).