Don't believe the truth about disruption

'Silicon Valley is coming' says JP Morgan.

Banks are about to be 'disrupted' by fintech startups kicked off in California's fertile garage spaces as smaller, more agile companies defend consumers by bringing in cheap, improved customer experiences which banks can't or won't provide.

"Fintechs are just as subject to the costs of the regulators as the banks."
Ben Dunn, Executive director, divisional strategy institutional & international banking | ANZ

Incumbents in financial services will be wiped out like music publishers, newspapers, hotels and taxi firms before them.

It's a dire future for incumbent banks - or at least that seems to be all you hear. Any alternative view means you 'don't get it'.

Now I'm a big fan of this kind of innovation and 'creative destruction' but having worked for big banks and small start-ups, I think the doomsayers have got it wrong and I'm not alone.

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Just last week, the Financial Times published an article prompted by a blog post which broke down fintechs into seven core categories:

  • Reinventing past mistakes of the banking industry because you don't know about adverse selection.
  • Thinking a great big lump of transactions data is more valuable than it is.
  • Hoping a load of people who actively mistrust each other will trust you instead.
  • Trying to use someone else's network and only pay the marginal cost of doing so.
  • Assuming the regulators will be more inclined to listen to your whining than to the incumbents.
  • Giving customers a worse service for a lower price.
  • Getting your act together with respect to an industry standard where the industry has conspicuously failed to do so.

Ok, the FT article was one of those droll, tongue-in-cheek analyses the paper is so good at but it does ruthlessly take those categories and apply them to one of Richard Branson's recent investments, TransferWise, asking how innovative the model really is.

TransferWise is an FX monoline similar to OzForex. The TransferWise proposition is “money without borders" saving consumers up to 90 per cent of the “hidden fees" charged by the banks, sending money faster and simpler. It sounds exactly the sort of disruptive fintech startup banks should all fear.

However it seems those low rates are actually achieved by passing the exchange-rate risk onto the customer while they wait for the right rate to appear in the market, if it ever does.

The Economist ran a special report on fintech recently which assessed the different business models and the potential impact on the banking industry.

They concluded many of the fintech startups and their business models may falter but if they achieve nothing else, “the gulf that long isolated banks from competition is being bridged".

That means like competition in any industry, the startups are likely to prod banks to up their game.

“Banks still have a future but they will have to work harder to make it a profitable one," the piece says. Indeed we have seen this in Australia, most notably when the mortgage originators fractured the lucrative Australian home lending market in the 90s.

BlueNotes ran a piece on this here.

However slow and lumbering banks might feel from the inside, the fact is banks and other financial services incumbents do detect potentially fatal changes in the environment and adapt accordingly, the financial crisis not withstanding.

To prove the point, one of Silicon Valley's foremost news sites, Techcrunch, published an article recently on the payments industry.

They profiled the efforts of Paypal and Google to win the mobile payments space and concluded the winners were in fact Visa, Mastercard and Amex. Their strategy was to compete by doing what they do best: “…define standards and rules by which their existing network could be extended to operate in a world where the mobile phone replaced the physical bank card…".

So they understood their existing competencies and advantages and applied them to the new environment, just like companies should.

In another recent article Techcrunch pointed out “…if you believe regulation is no longer an issue for fintech startups, you're on the fast track to the deadpool… fintech entrepreneurs need to understand and embrace regulation as a critical pillar in building their startup".

So fintechs are just as subject to the costs of the regulators as the banks. That's not to say the regulators will protect the banks, but startups should regard regulation as important and a potential source of innovation, but they can't ignore it either.

I'm not arguing fintech can be ignored nor some of them may have very real commercial viability.

In the eighties, the Harvard Business Review published an article which cited the decline of IBM's market share of the PC market. According to the article, IBM were so focussed on their big competitors they ignored the increasing share of the pie chart labeled as 'Other' which represented the increasing number of smaller PC manufacturers who flooded the market with PCs based on IBM's standard.

Collectively these manufacturers represented a huge threat but because they weren't large enough for their own slice in the pie chart IBM didn't reaslise until it was too late.

There are similarities between the fintech threat and the launch of budget airlines. The budgets pared back the services to the very basics: you got a seat. Airlines like Ryanair have taken this to logical extremes charging for everything from baggage to toilet access.

At the time, this seemed to be the end for any airline except the budgets. However the competition forced the full service airlines to understand and focus upon the parts of their service which customers liked and for which they were prepared to pay a premium and started to communicate those differentiators and advantages.

Recently I registered with OzForex and received a KYC (know your customer) call. I asked the broker what would happen if OzForex went bust while my money was with them in transit.

After some silence he replied 'Well…you'd be a creditor'. So much for the segregation of funds. We should be shouting that from the rooftops.

So what does this mean for banks, for my company ANZ? There are three main conclusions:

  • Learn from this new competition: it was only when Roger Bannister first broke the four-minute mile we found out it was possible. Whether it's technological agility, speed to market, fast failure or talking to customers, there's nothing they can do banks can't.
  • Understand our assets and advantages: from millions of customers to regulator relationships, incumbent banks have a wide range of key assets which start-ups would sell their grandmothers to access. We should understand what they are, their value and resist selling ourselves short to our customers or potential fintech partners
  • Focus on the customer: a Marketing professor of mine defined marketing as “finding out what the customer wants and giving it to them". Whatever you think about fintech's sleight of hand or budget airlines charging for toilet access, they understand what their target customers value and will pay for. Perhaps the days of providing and charging customers for products and features they don't use and calling it 'bundling' are behind us.

Of course, there is any number of ways this could all play out but I believe the most likely scenario - as indeed it was with the mortgage origination revolution - is banks are likely to become more agile and genuinely customer-focussed organisations.

It may mean margins come out of some businesses, it may mean banks buy or partner disruptors. But that will make the banking industry a more exciting and motivating place to work and even better experiences for customers, which can't be a bad thing.

Ben Dunn is executive director, divisional strategy institutional & international banking.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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