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![Responding to the Fragmentation of Finance
June 2018 12
Banks become a driver of change, rather than a victim of change through collaborating
with FinTechs and other non-traditional service providers.
Banks must retire legacy systems and reimagine their business model beyond that of a
product-based approach
The banking industry must now compete on innovation; start-ups can innovate faster, more
frequently and more creatively than a few old and rigid bankers
Financial firms need to modify the DNA of the company to compete in new ways with
thousands of start-ups and Google, Amazon and Facebook, rather than compete on fortified
positions and market stability
“And this is where it’s so important […] that you
either disrupt or you get disrupted. Probably 40
percent of enterprise customers around the
world will not exist in a meaningful way ten
years from now.”
John Chambers, Cisco Executive Chairman
Cisco is known for opportunistically acquiring technologies rather than
building in-house. Since the 1980s, Cisco has completed over 200
acquisitions. The majority have offered only moderate advancement;
however, 10% have been instrumental in catching technology
transitions. This relentless pursuit for innovation is how banks and
insurance companies need to act to survive in the digital era.
TheStreet Cisco CEO: Here is Our Acquisition Strategy
Banks that choose to embrace innovation will compete across a variety of elements;
collaborating with adjacent business models will consistently expand their capabilities to
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Beyond Banking: New Business Models for the Digital Era
The banking and financial services industry is undergoing significant disruption due to advancements in technology, the rise of fintech companies, and shifting consumer expectations. This period of transformation is prompting banks to reevaluate their traditional business models and embrace innovation through collaboration with fintech partners. To remain competitive, banks must adapt to digital pressures and focus on creating seamless, customer-centric experiences while overcoming challenges posed by legacy systems.
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Similar to Beyond Banking: New Business Models for the Digital Era
Beyond Banking: New Business Models for the Digital Era
- 1. Beyond Banking New BusinessModels for the Digital Era June 2018
- 2. June 2018 2 Unlockinga New Era for Banks & Financial Services Section I: Welcome to the Future Highlighting the unrelenting & unprecedented disruption in the financial services industry. We consider how the competitive landscape is shifting and how banks are embracing FinTechs by playing to their strengths. Section II: The Disintegration of Finance Exploring the disintegration of the financial industry and the unyielding forces of disruptive innovation and hyper-competition that are fragmenting the traditional value chain – and creating opportunity. Section III: Re-Defining the Banking Model Exploring a comprehensive re-design of the traditional banking model to chart a path forward in a digital future. We leverage the crumbling effect of digital pressures on vertically integration and highlight three refreshed models enabling banks to compete in a landscape of constant disruption. The banking and financial services industry is undergoing a period of unprecedented disruption, which is re-shaping the competitive landscape. Criterium Group believes we’re experiencing a fundamental change in how people manage, save and spend their money – which means banks and credit unions will need to re-imagine how they deliver value to customers and members. We’re experiencing a disintegration of the financial industry. But disruption is exciting, not scary. As our relationship with money evolves, there are endless opportunities to delight customers and deliver value. However, competing in a digital age takes a completely different approach. Criterium Group has considered the changing landscape from a competitive, financial, technological and operational perspective to re-design the traditional banking business model to win in a digital world.
- 3. Section One: Welcome tothe Future
- 4. Unrelenting & UnprecedentedDisruption: The New Normal June 2018 4 Competitive disruption, financial challenges & operational pressures: banks and credit unions are feeling the heat from all angles. The ‘status quo’ is officially dead and banks need to re-imagine how they add value for customers. • Constant disruption from FinTechs, technology giants & other non- traditional competitors • Digital transformations are changing customer expectations for intuitive, seamless and customized experiences • Immense regulatory burden with increasingly strict capital & liquidity requirements • High-cost legacy systems and infrastructure • Low interest rates and economic growth • Shrinking margins from increased competition • Responding to the upgrade of payments infrastructure in many jurisdictions, including Canada • Constantly evolving technology that needs to integrate with stubbornly inflexible legacy systems Operational
- 5. The Competitive Landscapeis Shifting June 2018 5 We’re in a period of unprecedented innovation, which is re-shaping the competitive landscape. Banks must compete with FinTechs and traditional financial services players, digital companies and platform entities like Apple, Google and Amazon. Unencumbered by legacy systems and structures – FinTechs can move faster and are better at leveraging data analytics and integrating with innovative platforms. • Google, Apple, Facebook, Amazon and Alibaba (collectively known as GAFAA) are leveraging highly responsive and personalized platforms, data capabilities and global reach to attract people to banking alternatives • Connecting value chains of multiple sectors create intuitive “ecosystems” - platforms become the touchpoint and own the customer relationship • Nearly 75% of U.S. millennials would be more excited about new financial services from Google, Amazon, PayPal or Square than from their banks2 FinTech Digital Banking Platforms1 Danske Bank: MobileLife, Open Banking 2 McKinsey Annual Global Banking Review, 2017 3 Forbes: Banking’s Paypal Nightmare a Customer’s Dream 4Economist: China’s Digital Payments Giants Keeps Bank Chiefs Up at Night FinTechs remove “friction” (through driving out costs) from the customer experience in specific components of the value chain (e.g.,. peer-to-peer lending) Example: Paypal3 • Paypal’s extensive reach positions it to be an enormous threat; with 17 million merchants worldwide Paypal receives fee income from Uber, Netflix, Pinterest, Airbnb and Facebook Messenger Example: Ant Financial4 • The most valuable Fintech firm ($100+ billion) has 520 million customers in China and 112 million abroad • Ant Financial taps into China’s internet-payments market ($11 trillion) with a direct-to-customer model Example: Danske Bank1 Banks around the world are embarking on digital transformations that leverage technology and data to completely re-imagine the customer experience • Established MobileLife, an independent unit that only focuses on customer needs • Leverages a start-up mentality to quickly launch new products; recipient of many innovation awards • Only 40% staff have a banking background; they follow a different governance model • Embraced open banking in the UK – allows third-party providers to access customer data and initiate payments on their behalf
- 6. Don’t Compete; Collaborate:How Banks are Embracing FinTech June 2018 6 KPMG Pulse of FinTech Report 2017 PwC Global FinTech Report 2017 PwC Global FinTech Report 2017 FinTech continues to disrupt traditional financial services; however, incumbents are embracing the change Investments in FinTech have grown exponentially - reaching US$31 billion in 2017 and bringing total global investment to US$122 billion over the past three years Banks are ramping up investments in innovative and digital technology – over 75% of financial institutions have reported an increase in internal efforts to innovate More than 50% of banks report they are actively searching for acquisitions, partnerships, and accelerators to access exciting technology More than 80% of incumbents expect to increase FinTech partnerships within the next five years, with high expectations - projecting an annual ROI of 20% for FinTech related projects The digital revolution and FinTech are fundamentally changing the financial services industry, and banks are trying to embrace the change. The exact future state is difficult to predict, and will constantly change. To win, banks must be able to rapidly adopt new innovations as they happen.
- 7. Playing to ourStrengths: Banks vs. FinTechs June 2018 7 EY 2016 Consumer Banking Survey Banks and FinTechs have different strengths – and weaknesses. Both need to become strong collaborators, or neither will realize the full value of innovation. • High level of trust – over 95% of customers trust banks to keep money safe • Access to valuable customer data • Strong subject matter expertise and access to talent • Navigating complex regulatory environments • Access to capital • Legacy systems and vast size make innovation difficult for incumbents • Often driven by short-term performance measures, like quarterly results • Nimble, focused efforts on specific components of the banking sector • Excel at removing “friction” between customers and banks • Strong understanding of the customer journey • Unburdened by legacy systems • Inability to clearly articulate value proposition • Inability to achieve scale by connecting with customers • Inability to meet complex regulatory requirements • Underestimating integration challenges and/or costs Banks FinTech Strengths Weaknesses Strengths Weaknesses
- 8. Section Two: The Disintegrationof Finance
- 9. Introducing the Disintegrationof Finance June 2018 9 There are three core elements contributing to the overall disintegration of the financial sector. These forces are shaping the banking models of the future, and inform the overall approach to collaborating with FinTechs. The fragmenting effect of digitalization on financial services1 • Digitalization fragments the “polish” from production to the customer; essentially, dissolving the customer experience into components that can be individually disrupted • This drives innovation as the fundamental competitive differentiator The disruptive innovation and technological practices that fundamentally alter the structure of an industry 2 Hyper-competition which creates an industry dynamic of constant disruption 3 2. DISRUPTIVE INNOVATION 3. HYPER- COMPETITION Disintegration of Finance 1. FINANCIAL FRAGMENTATION Three forces are disintegrating the financial sector:
- 10. Element #1 –Financial Fragmentation June 2018 10 For decades, firms have “won” by building strong positions and defending them. They have entrenched themselves in specific product and geographical markets and operated within a business model where the competitor with the largest market share enjoys the best economies of scale and scope, and therefore, the highest profit. The Old In banking, geographic proximity has been the historic driver of customer reach and profitability. The number of physical branches and front offices has dictated how many customers can be reached. Customers were unlikely to change banks or insurance providers – it was difficult, and they went with whatever company was closest. Market share and profits have been generally stable, driven by sustained competitive advantage. Banks and insurance delivered essentially the same services, but incrementally better. The New The world has changed. Enter, digitalization. In the digital era, business models will rise and fall at tremendous speed. Continuous disruption is the new normal, and firms will either disrupt or be disrupted. Why is this happening? Digital products and services consist of layers of modules that, together, form the user experience and enable functionality. For example – the smartphone: 1. At the device layer, we have handsets with the screen, camera, fingerprint scanner, security measures. Each of these is a module, on which layers can be added. 2. At the network layer, we have the operating system of the phone (like the Android system or Apple's iOS) that provides the basic operation functionality 3. At the service layer, we have apps – games, social media, banking apps 4. At the content layer, we have individual articles on our news apps, or the messages we send through Facebook Together, these layers make up a digital stack - a structured collection of different modules in different layers, which are: • loosely connected through standardized interfaces, often through Application Programming Interfaces (APIs) • loosely connected to a defined interface which allows digital stacks to be customized, and easily changed • able to change one module without having to change all the related elements. • able to create innovations by connecting different modules to each other in new ways. For example, a banking app that uses the camera to scan invoices, or the fingerprint scanner to log-in or send payments. These are simply re-combinations of the digital stack. The fragmented nature of the digital stack fosters rapid change and innovation. The digital stack was designed with innovation in mind; the “physical world” (like a classic banking system) was not. McKinsey Overhauling Banks IT Systems Oracle the Future of Retail Banking – Legacy IT Transformation All banking technology is built on a basic technology stack. A simplified stack has four layers or modules: Content Service Network Device1 2 3 4
- 11. Element #1 –Financial Fragmentation June 2018 11 Legacy Banking Systems Compromise Performance With many of the legacy banking systems dating back to the 1970s, banks are burdened with aging systems that hinder performance and hamper technological innovation. Core Banking Systems sustain the software and infrastructure necessary to carry out day-to-day operations, and to link systems to customers. Furthermore, these systems serve as the launchpad for IT capabilities and growth. This reality presents a complex challenge, as many of these underperforming and antiquated legacy systems barely deliver on current tasks, with a dismal outlook on their ability to capitalize on future technological advancements. 1McKinsey Overhauling Banks IT Systems 2TechCrunch Ant Financial These banking systems have been tightly integrated and controlled. Back-office systems and the front-office systems are interconnected, making it hard to innovate. To adopt even the most basic change, everything must be changed simultaneously in a coordinated and synchronized way. By design, digitalization fragments these tightly integrated stacks into layers with modules that can be easily innovated without considering the whole or having to manage the cascading effects in the system. Modules can be combined in new and creative ways. Legacy systems can be leveraged for global expansion by FinTechs. Ant Financial is seeking to acquire local firms abroad with legacy systems, like MoneyGram, to gain access to licenses and pre-existing client base; although regulatory uncertainties have stymied this strategy thus far.2 Legacy banking systems essentially have three layers: 1. Product or service layer, the layer that most banking legacy systems are focused upon includes products such as accounts, mortgages, lines of credit and credit cards. Rapid development and delivery of new banking products and services is becoming business critical as a means of profitable growth for retail banks, however aging IT systems make enabling such products too complex. 2. Distribution layer, back-end legacy IT systems where customer data is secured and stored. Data is accessed by customer service representatives, and in some circumstances via apps. 3. Consumption layer, the customer-facing interface that traditionally consisted of customer service representatives and ATMs and has now grown to include online banking, phone services, and mobile apps, yet customer demand is significantly outpacing the flexible consumption offerings which banks provide.
- 12. Responding to theFragmentation of Finance June 2018 12 Banks become a driver of change, rather than a victim of change through collaborating with FinTechs and other non-traditional service providers. Banks must retire legacy systems and reimagine their business model beyond that of a product-based approach The banking industry must now compete on innovation; start-ups can innovate faster, more frequently and more creatively than a few old and rigid bankers Financial firms need to modify the DNA of the company to compete in new ways with thousands of start-ups and Google, Amazon and Facebook, rather than compete on fortified positions and market stability “And this is where it’s so important […] that you either disrupt or you get disrupted. Probably 40 percent of enterprise customers around the world will not exist in a meaningful way ten years from now.” John Chambers, Cisco Executive Chairman Cisco is known for opportunistically acquiring technologies rather than building in-house. Since the 1980s, Cisco has completed over 200 acquisitions. The majority have offered only moderate advancement; however, 10% have been instrumental in catching technology transitions. This relentless pursuit for innovation is how banks and insurance companies need to act to survive in the digital era. TheStreet Cisco CEO: Here is Our Acquisition Strategy Banks that choose to embrace innovation will compete across a variety of elements; collaborating with adjacent business models will consistently expand their capabilities to enhance their customers’ lives
- 13. In the 1990s,Clayton Christensen wrote the book called The Innovator's Dilemma that argued decision-making and resource allocation processes are both key to success and reject disruptive technologies: “Successful companies want their resources to be focused on activities that address customers’ needs, that promise higher profits, that are technologically feasible, and that help them play in substantial markets. Yet, to expect the processes that accomplish those things also to do something like nurturing disruptive technologies – to focus resources on proposals that customers reject, that offer lower profit, that underperform existing technologies and can only be sold in insignificant markets– is akin to flapping one’s arms with wings strapped to them in an attempt to fly. Such expectations involve fighting some fundamental tendencies about the way successful organizations work and about how their performance is evaluated.” Element #2: Disruptive Innovation June 2018 13 No one wants to be disrupted; everyone wants to do the disrupting. Being the disruptor will lead to glory, and profits; being disrupted can mean death. But what is disruptive innovation? An incumbent or market leader is typically focused on the established high-end of the market, which is often associated with higher profitability, and tends to ignore simple, low-cost solutions. Small companies enter the market, and provide a simple, low-cost solution to the underserved customer base. These can be improved faster than incumbents’ products, until the new innovations become attractive to the high-end market. Incumbents often have the talent and resources to innovate, and they do create new products. However, they fail to value new innovations properly because they attempt to apply them to their existing customers and product architectures. They don’t hit the required hurdle rates, or the new market is viewed as too small to significantly add to the bottom line. There are elements of disruptive innovation in the FinTech revolution. Examples include peer-to-peer (P2P) lending services in Asia, or mobile payment solutions in Africa like M-Pesa that allow the “unbanked” to make purchases through their cellphone account. Mobile money services are an effective gateway for financial inclusion among this demographic, which has traditionally been underserved; it is estimated this could evolve into a US$3 trillion payments volume opportunity. However, FinTech is not solely driven by low-cost innovation. Start-ups are leveraging data analytics and technology to challenge the entire status quo of the industry. The challenge for incumbents is to spot disruption, and have the ability to quickly adapt. Spotting Disruption It is not easy to spot disruption. But all disruptive innovations have one thing in common - they leveraged yesterday’s success as a basis to define new ways of doing business. No single technology will disrupt the financial services industry. Some disruptive examples are: • Mobile payments that use advanced technologies and smartphones • P2P lending using digital networks and new risk estimation algorithms • On-demand car insurance that leverages improved connectivity and geographical tracking PwC Global FinTech Report 2017 Orbis Research: Next Generation Mobile Payments Market: Smartphones, Wearables and Implantable Technology 2018-2023
- 14. Element #2: DisruptiveInnovation June 2018 14 Phase II: Selection But, is it here to stay? Many innovations are heralded as disruptive, only to fade away once the novelty wears off or the niche market is saturated, without broadening adoption to the masses. To gain traction, the innovation must perform just as well as (or stronger than) existing alternatives, and then evolve faster. Mobile payments are in the selection phase now. To date, mobile payments have not necessarily proven to be much better or cheaper than credit cards – in fact, most leverage the existing credit card systems. We need to consider how quickly the alternatives are developing. Customers’ use of cash and credit cards has changed significantly over the past 10 years. Assuming mobile payments will continue to deliver safe and secure transactions, there is a case to be made for cost reduction. Digital beats physical when it comes to cost, and mobile payments would also piggyback on developments in smartphones and digital networks. What happens next? A few options will rise to the top as the dominating alternatives – much like Apple iOS and Google Android. Over time, quality will increase, cost will decrease, and capabilities will adapt as customers start to use such payment options for much larger purchases like buying a car. Phase III: Stability It is highly unlikely that mobile payments will completely replace cash, credit cards, and even checks. Not all disruptive innovation completely replaces what came before. If mobile payments enter the stability phase, it does not mean that what already exists gets completely rejected. Credit cards only partially disrupted cash; TV did not replace radio. This creates a significant burden for financial institutions. Maintaining legacy services while adding new, disruptive products is difficult and expensive. PwC Global FinTech Report 2017 Orbis Research: Next Generation Mobile Payments Market: Smartphones, Wearables and Implantable Technology 2018-2023 Disruptive innovations tend to develop over a three-stage cycle: 1. Initiation 2. Selection 3. Stability Disruptive Innovation Phase I: Initiation This is characterized by uncertainty. Many versions of the technology exist and many players are involved; they are all targeting a niche market. It is typically chaotic, and it is exceedingly difficult to predict which one of the many versions of a product will dominate in the end. “Cheap, but good” is a difficult mark to hit. Payments are a good example. Mobile payments originally began as SMS payments, which were admittedly a poor product. However, this evolved over time, and became the foundation for services like Apple Pay and Google Pay. Today, mobile payments represent a $600 billion global market. Banks are creating their own solutions (like CitiPay), and retailers are creating their own systems – Starbucks and Wal-Mart are outperforming Apple and Google in this space. Leveraging security measures like fingerprint scanning continues to make this an easier option.
- 15. Responding to DisruptiveInnovation June 2018 15 Spotting future innovations that will disrupt finance is difficult – no one has a crystal ball, and changes come rapidly. Applying the following screens gives the best chance of success: Assess the advancement in digital technology that might enable disruption 1 Explore the many ideas and concepts that seek to create true innovation 2 Identify which one will develop the fastest (which may not necessarily be the best at this stage) 3 Follow the fastest innovations to understand whether the target is market segmentation or full replacement 4 Banks need to make some decisions. If an innovation is segmenting the market, the bank must decide if it wants to be a part of that new niche market. If it looks like a full replacement is on the horizon, the bank must develop a strategy to protect its market share. An early, and constant, assessment of the landscape is critical. When the winner is obvious, it is too late. Banks must assess a broad range of solutions and explore and cultivate potential solutions further to identify the “best fit” – from there, banks must follow these innovations. To remain competitive financial institutions must imbue a culture of curiosity and innovation, and continuously seek out opportunities in emerging technologies. Successful incumbents will develop a process to identify and adopt disruptive innovations based on data and strategic focus.
- 16. Element #3: Hyper-Competition June2018 16 “I love change, I can’t get enough of it! I eat change for breakfast, lunch and dinner.” – said no one, ever. In the digital age, speed is the name of the game. Incumbent banks need to be ready to seize opportunities when they emerge. Renowned strategist Richard D'Aveni characterizes fast-moving industries as ‘hyper- competitive’ – rapid and dynamic, characterized by unsustainable advantages. The finance industry has been quite opposite. However, changing factors like technology advancements or regulation changes propel stable industries into rapid periods of change and hyper-competition. One may think finance is in the awkward transition from one stable state to another; however, this view is limiting. Once an industry undergoes a digital transformation, the ‘new normal’ is not stable - normal is now a state of hyper-competition and constant disruption. For example, the transition to mobile payments is not a steady state endeavor and banking will constantly face new disruptions: blockchain, machine learning, artificial intelligence, quantum computing, wearable technology. Historically, banks have created sustained competitive advantage and defended it for decades; this view needs to go out the window – hyper-competition will not allow it. Banks need to accept that competitive advantages will now be short-lived. These ‘transient advantages’ may generate high returns in the short-term; however, they are hard to defend because they are typically technology-based. As soon as new technology emerges, there is room for others to define a new transient advantage. In the future, sources of banking revenue will change over time as consumer knowledge and preferences shift. Banks will sustain short-term advantages in terms of customer data and infrastructure, but no long-term right to exist without converting these strengths into services that solve emerging digital frustrations. Banks are narrowing this technology gap through partnerships and integration with nimble FinTechs; such key emerging technologies enable convergence, with 30% of large financial institutions investing in artificial intelligence and 77% expecting to adopt blockchain as part of a system or process by 2020. A transient strategy focuses on cultivating the next opportunity, as even the current advantage has peaked. The only way to compete in a hypercompetitive industry is to move beyond sporadic innovation to create an organization that cultivates an advantage pipeline, while continuously retiring dated assets and capitalizing upon advantages: Accenture The Future of FinTech and Banking: Digitally disrupted or reimagined? PwC Global FinTech Report 2017 1 2 3 advantage pipeline continuous retiring of assets advantages
- 17. FinTechs vs. TechFins June2018 17 Financially-focused platforms that employ new technologies or programs to support existing banking and financial service functions. Broadly encompassing innovations in the area of finance, retail banking, cryptocurrency, lending and beyond. Technology-forward platforms leveraging technological advancements to solve and revolutionize current financial problems and provide financial services. New entrants into the financial sector are chiefly made up of technology and e- Commerce giants, with largely non-financial customer bases. TechFins FinTechs The increasing overlap between finance and emerging technologies is driven by technological innovations and prompted by customer desires. From this industry focus on data and technology first and finance second , the term “TechFin” was born. Financial institutions are moving toward technology, and technology firms are moving toward finance
- 18. Responding to Hyper-Competition June2018 18 A FinTech strategy cannot focus on safeguarding against disruption; it needs to create the next disruption. Banks searching for the financial technology that will revitalize legacy systems and propel technological capacity to meet current trends will be disappointed, as no such all-encompassing solution exists. Instead, banks must base their competitive advantages on the strength of their advantage pipeline, and on their proprietary ability to assess, explore, identify and follow new technologies to create new capabilities in their business. Maintaining a competitive advantage will be a continuous process of sourcing and replacing emerging technologies within their portfolio as they become available and retiring those which the market has not selected. More than defending a longstanding advantage, banks must welcome the practice of cultivating transient advantages, and being consistently hungry for new gamechangers. Moreover, financial institutions will be required to address slow capacity for change and restructure legacy processes to enable decision-makers to act once potential transient advantages are identified, to seize opportunities in the rapidly-evolving FinTech space. Key Takeaways: Develop an underlying advantage pipeline Continuously source and replace emerging technologies Develop a mindset of continuous innovation to cultivate ‘transient advantages’ Shorten prolonged decision-making processes to seize opportunities
- 19. Section Three: Re-Defining theBanking Model
- 20. Banks Face aStructural Shift to Stacks as Value Chains Disintegrate June 2018 20 Source: BCG Analysis Vertically integrated banks, with organizational units dedicated to each step of the value chain, compete against one another Individual business models evolve as value chains break up. Integrated business models are increasingly challenged. Competition The 1990s: Value Chains The Future: Stacks Competition Competition Competition At every stage of the value chain banks are being disrupted; banks feel the pressure of continuous competition at each business unit layer, not just as a vertically-integrated whole.
- 21. Breaking the Chains:Vertical Integration Crumbles Under Digital Pressures June 2018 21 Historically, banks won by mastering the end-to-end value chain – strength in some areas compensated for weaknesses in others. In a “stacked” reality, incumbents are attacked by new entrants at every layer. Banks must critically assess their capabilities and strengths across these layers and determine a competitive response. Competitive advantage used to come from low transaction costs due to economies of scale, achieved through vertical integration, and controlled access to data Cloud computing, advanced data analytics revolutionized economies of scale Digital transformations in other industries and the rise of platform companies have changed customer expectations; customers want an intuitive, customized, seamless experience BANKS HAVE THREE OPTIONS: 1. Be excellent at all layers 2. Limit focus to layers in which a competitive advantage already exists 3. Win in layers of strength, and partner with the winners in the layers where the bank is weak
- 22. From Vertical Integrationto Horizontal Landscape June 2018 22 Production (Banking Incumbents) Distribution Create financial products and services for specific customer segments, including other banks › Threat of new entrants is relatively low › Producers require a banking license and are subject to complex regulatory requirements › Opening banking initiatives do not focus on reducing the barriers to entry for producers › Access to existing infrastructure (i.e. core banking systems and payments infrastructure) is a competitive advantage Key success factors: › Achieving economies of scale to cover high fixed costs › Access to best-in-class technologies › Ability to incorporate advanced analytics, AI and machine learning, to gain efficiencies Provide products and services through managed channels to deliver an excellent customer experience › Threat of new entrants is high › Goal of open banking is to reduce the barrier to entry for distributors › Established trusted relationships with existing customers give banks a competitive advantage › Distributors may have diluted relationship with customers › Ability to constantly adjust product and service offering through rapid adoption and integration of new partners Key success factors: › Achieving economies of scale; distributors with access to a large network will gain competitive advantage and improved costs › Ability to deploy advanced analytics and AI to delight customers and provide a customized, intuitive experience Open banking (and initiatives like payments modernization) separates banking into distinct components: production and distribution. Banks have been distributors for a long time through credit cards, mutual funds, and other financial products. The new novelty is that banks could focus extensively on distribution as the main business model. Owning and managing the customer relationship is the largest driver of profitability for banks. The “distribution” side of banking (activities linked with origination and sales) contributes about 65% of profits, with an ROE of 20%; core “production” activities (financing and lending) deliver an ROE of less than 5%2 The In-Between 1McKinsey: Remaking the Bank for an Ecosystem World 2Accenture: Beyond Digital: How Can Banks Meet Customer Demands 3Accenture: FinTech and the Evolving Strategy
- 23. Examples of Producersand Distributors June 2018 23 Most traditional banks are both producers and distributors. Back offices produce banking products, like loans, wealth management solutions, and mortgages. These products are distributed through customer-facing channels, like physical branches, online banking or mobile apps. In France, Crédit Agricole allows third-parties to build distribution services on top of its new banking platform - essentially crowdsourcing ideas for innovative banking applications from customers and supporting their developers to bring these ideas to completion14. Other banks have followed - institutions from Goldman Sachs to BBVA are releasing proprietary code and launching competitions encouraging software developers to build new platforms and apps to create a stronger service offering. Saxo Bank is a good example of a producer. Saxo Bank is a financial trading platform that enables trades in thousands of financial instruments on a multitude of exchanges. Historically, Saxo Bank connected trading products to customers through its own distribution channels, including its SaxoTraderGo app. Now, Saxo Bank increasingly connects its trading platform to customers through partners – banks and brokers, family offices, fund managers, professional traders and money managers, private banks and other service providers. Saxo Bank expects that more than 50% of all trades will be generated by partners soon. A strong example is Leveris, an Irish FinTech that has built a full-stack, standalone core banking and lending platform that delivers a cloud-based, quick-to-market solution for traditional banks, challenger banks and consumer brands. Leveris is not encumbered by issues that arise with migrating a legacy core banking system to the cloud; its platform is built specifically for modern cloud-based infrastructure. The modular, ‘marketplace’ approach enables Leveris’ clients to partner with leading market innovators, as they come. Another way in which banks are becoming distributors is through the licensing of small business loan platforms, such as in the deal between Santander UK bank and the Kabbage platform. Santander has licensed Kabbage to power automated lending services to SMEs; this relationship enables Santander to accelerate the underwriting process for businesses looking for loans up to 100,000 GBP online – also reducing time required to process requests to as little as 24 hours15. 14 American Banker: Open API for Bank 15 KPMG Forging the Future Global Report 2017 Producer Distributor
- 24. Banking Business Models:Re-Defined for a Digital Future June 2018 24 The business model will drive your FinTech strategy. Banks have four options: Stay with a traditional, vertically-integrated integrator model that acts as both producer and distributor (the “do nothing” approach) Focus on production Adapted from Ben Robinson (Temanos) Profitability Scope of Activity Producer Distributor Integrator / Traditional Banking Platform Focus on distribution Transform to a platform model
- 25. Banking Models Re-Defined:Producer June 2018 25 Producers focus on establishing economies of scale through providing back-end services to distributors. Rather than providing services to address a single customer problem or augment an area of the banking business, producers develop a suite of “managed solutions” that span from payments processing to product servicing, settlement and reporting. Producers are connected via an extensive network or value web to end clients and third-party providers. Through this model, producers can host FinTechs and act as a consolidator of services. Producers leverage insights and management of channel relationships; they service a broad range of clients by carrying a full product suite and utilizing white-label solutions. API LAYER Settlement Reporting Payments Processing Products Servicing Hosting Infrastructure Adapted from Ben Robinson (Temanos)
- 26. Banking Models Re-Defined:Distributor June 2018 26 Success as a distributor depends on rapidly identifying, evaluating, adopting and integrating innovation from third-parties. This can take a few forms: › Enabling “plug & play” relationships with service providers › Forming strategic partnerships, in which there are shared risk and rewards › Acquiring third-party innovations or technologies to establish a competitive advantage As distributors, a bank leverages its existing customer relationships and re-position itself as a trusted advisor. The goal is to gain a larger share of an individuals’ wealth, which is necessary to mitigate the high customer acquisition and ‘Know Your Customer’ (KYC) costs. The bank acts as a concierge, bringing aboard new technologies to offer enhanced service offerings based on a deep understanding of customer needs. Banks expand beyond transactional advisory services to strengthen customer relationships. An example is providing a suite of value-added service offerings like partnerships with real estate agents, corporate finance advisors, insurance companies and philanthropy experts. This leverages existing service elements; for example, credit card companies offering exclusive concert experiences or special rates for products, like flights, cars or vacations. Operational Tactics This business model must be strongly endorsed by executive leadership. Defined accountabilities and decision-making authorities are critical, as these supporting processes underpin the innovation sourcing role of the distributor. From a compliance standpoint, clear guidelines and back- end documentation should expedite decision cycles and ensure regulatory requirements are satisfied. The reliance on connections to third-parties mean distributors must have robust and responsive risk management and security practices. Non- Financial Products Fintech Products Banks Distributors API Layer Open Product Catalogue Decision Engine, CRM Engagement (Gamification, PFM, etc.) Digital Channels Data Customers IF Adapted from Ben Robinson (Temanos)
- 27. Banking Models Re-Defined:Platform June 2018 27 PLATFORM LEVERS CURRENT STATE BANKING-AS-A-PLATFORM (BAAP) BANK PLATFORM PARTNERS SCOPE OF FIRM Firm does everything Focused only on core activities Partners perform broad array of complementary activities PRODUCT Owns 100% of product stack Own core product stack Partners develop and offer ancillary products SERVICE Owns 100% of product stack Own core product stack Partners develop and offer ancillary services IP/DATA No sharing Information is shared Information is shared TECHNOLOGY Not modular, not opened, not open source, not open standards, sometimes proprietary, silo based Modular tech, open source and open standards use, API, interface openness Interoperability between partner interfaces and bank’s interfaces is key RELATIONS WITH PARTNERS Embryonic Based on collaborative-competitive continuum Collaboration with some partners, competition with others HR/ORG CHART Company-centric Articulated difference between focus on core, and focus on platform/partners Bank develops ability to “speak” same language as partners The Platform model offers a wide variety of technology solutions and capabilities to customers through rapid time-to-market development of proprietary technology, or aggressively sourcing third-party products and partnerships. The platform is vertically integrated, with banks taking advantage of strong customer service capabilities but strategically outsourcing activities and product lines that could be delivered more profitably by other providers or “platform partners”. The platform model addresses client needs by consistently keeping its innovation pipeline full, based on insights and abreast of new trends. The platform product suite is valued by customers and providers for performance and quality - tailored to customer needs. Table adapted from The Financial Brand
- 28. Bringing it allTogether June 2018 28 Banks continue in customer-facing role by rapidly adopting innovation and passing efficiencies on to customers BANKS HAVE FOUR OPTIONS: To create value in the digital era, banks must collaborate with TechFins and FinTechs in a way that complements their business model and strategy, whether that be as a distributor, producer, integrator or platform. Accenture: FinTech and the Evolving Landscape Banks relinquish some activities but retain end-to-end value chain activities by offering open and safe services integrated with customer solutions Banks make a drastic shift away from customer relevant activities; creating value by operating as a highly regulated core, integrating complex supply chain and service providers Status Quo; Banks continue as integrators in highly customer relevant role, yet with decreased ability to compete on innovation Banks must develop a FinTech strategy that delivers the corporate go-to market strategy & reinforces the supporting structures & processes. Integrator / Traditional Banking Platform Producer Distributor
- 29. What’s Next: TheFuture State of Banking June 2018 29 Banks should focus on moving toward “Ambient Banking” or Banking-as-a-Lifestyle by way of first being a Banking-as-a-Service provider. The current stage of innovation we are entering in the financial services industry is only one phase of evolution, and even our current reality is poised to change in the near-distant future. Banks must strategically look to the future to determine how our short-term transition will enable a long-term transformation. There is no rest for the innovative as the banking industry continues to experience widespread disruption and changing customer preferences. Everest Group Future of Banking – “Experience First”: Banking ITO Annual Report 2017
- 30. Bow Valley Square1, Suite 1120 202-6 Ave SW Calgary, AB T2P 2R9 [email protected] +1.403.668.1630 We Can Help Criterium Group can help your organization respond to disruption and emerge as a digital winner in this new age of finance. Our experienced consulting team works with banks and financial services clients to craft creative strategies, with an accompanying business model to deliver results. Our clients are poised to leverage innovation to emerge as digital winners in this new era of finance. Our expertise and services include: • Strategic Assessment & Development • Business / Operating Model Design & Execution • Framework for Collaborative & Value-Added Partnership