The world’s getting more connected; nobody would argue with that. In this article we consider the macroeconomic impact of this trend, the shift of power that appears to be taking place away from the big organisations towards smaller firms and the implications for banks.
Work, money and utility
Traditionally, work has been closely linked to money – the “labour theory of value”, first coined by Adam Smith, argues that value of goods reflects the cost of labour needed to produce them, and has been espoused by economists in one form or another ever since. Other models argue that value is instead derived by usefulness and scarcity of products – the less there is of something, the more valuable it becomes. But what happens when people start working for no money, and there is an almost limitless proliferation of instances of a product? Or what happens when your extended identity starts operating autonomously and earning money without your direct control?
If there are theoretically close to infinite instances of a product, the value of each instance falls, and to use the example of itunes, the price you pay may mostly be covering the cost of processing the payment and profit to itunes, with a tiny fractional value going to the recording artist. And the cost of production is, to itunes, close to zero per unit, as the potential sales are limitless. Conversely, there is a growing number of people producing stuff for nothing – we’re doing it with these articles, but there is also the huge range of open source development software, wikipedia, all those useful videos you get on YouTube showing you how to change a recessed light bulb, build decking, prune roses or cut in a skirting board (thanks guys, these were really useful!) and many more. People all over the place are creating and distributing content for nothing.
Of course, everyone has an agenda, and in many cases will be distributing their content for nothing in the hope that it will further their profile, sell something else for them, etc. but in many cases, the agenda is more complex than that – it’s a genuine desire to share knowledge (and maybe show off a bit), develop skills, gain entry to a community, or some other such community based motivation. It’s about developing a network.
Conversely, the direct linkage of work to value is broken when your products do the work for you. The idea of a self-driving car dropping you off at work, then clocking into Uber to go off and earn money from passengers while you’re doing something else, may be relatively new, but effectively it’s an extension of the concept of viral marketing: rather than using “push” or “pull” sales – pushing out your content via broadcast, or waiting for a request to drive your provisioning, your social media content is out there on the network, building your reputation and selling units, without the need for either push from you or pull from your customers.
The value of network
Networks have value and a number of models have emerged to try to describe that value, but all agree that the value of a network increases exponentially with the number of nodes (people, companies, things) in the network. In our connected economy, it’s become easier than ever to build networks and consequently, more networks exist, and people and companies are more connected than they have ever been. Some of these networks will be more valuable than others, of course, because of their reach or target group. Individuals may be linked via work, interest groups, friendship groups and family groups, via telephone contacts, working groups, communities of practice, online via facebook, LinkedIn, twitter, whatsapp, newsgroups, dating websites, special interest sites catering to every conceivable interest, pursuit, political activity, you name it.
And these groups often intersect or overlap, meaning that they’re a part of a metanetwork, which again is more powerful because of the access to other networks. For example, the other day one of us mentioned something to a friend on Facebook, suggesting she join one of my LinkedIn groups because we have a common work-related goal. She then joined me to a related facebook group, and in response to a request for help from that group (unrelated to my friend), I reached out to a third network that I’m part of, which then identified someone to fulfil that need.
The important implication of this is that we no longer need formal intermediaries to manage distribution of knowledge, in much the same way we can now disintermediate financial transactions (as described elsewhere in this series). This changes the dynamics of information distribution significantly; what previously was the preserve of large organisations with deep pockets, is now open to anyone who has an interesting or valuable piece of information or product. We’re all familiar with viral marketing; we think the term is incredibly appropriate, not just because it describes the transmission mechanism, but because it can apply to something that’s infinitesimally small, in global terms, such as a small provider or a one-man-band with a paintbrush and a phone camera.
The huge revolution we’re all familiar with is the availability and rapid adoption of online shopping – which includes how companies shop, not just individuals. While this has changed consumer behaviour considerably, with more people buying directly from smaller producers, or from smaller, more conveniently located stores, it also means that specialised firms can sell their services to customers.
Shifting the value
As we discuss in the article on Branding, this means the balance of value is also shifting. The big organisations with the big budgets no longer have exclusive access to a global clientele; anyone with a web presence can do that today. Distribution opportunities, that would previously have been impossible to access, are now open equally to organisations via marketplace platforms and informally thanks to web searches, regardless of where the organisation is based or how big they are – profiles are built through quality of content, rather than scale of push. On the consumer side, people are free to find what they want, regardless of the size of producer or whether they’ve got a distribution network. So it’s easier than ever before to manage the marketing and distribution of your product or services. Even so, the fact that small businesses still maintain that marketing and distribution are two of the hardest things for them to handle, helps to illustrate that there is further potential to make it easier.
In response to this, there is a growing number of SMEs (mostly on the small to micro side) providing goods and services to relatively small numbers of customers, who have a specific need to fulfil. Ironically, the global downturn and related layoffs have also led to the growth of this sector, as individuals are either laid off or see opportunities with larger organisations disappearing, and choose to set up on their own. People who would in the past have bought most of their goods via larger stores, are now able to buy direct from exporters across the globe – and interact directly with them. Even locally, we shop more frequently than we did 15 years ago, and are more likely to visit smaller, local providers.
For supermarkets, the outcome is that the shift towards building out-of-town hypermarkets is in swift reverse, and this has attracted plenty of headlines. What’s less visible, is the parallel shift of customers away from larger providers and towards smaller providers, for specialist software and online services. The fintech revolution is a clear example of this, with small, lean groups of technical specialists and visionaries creating services and products that solve problems for end customers – and in many cases, as we explore elsewhere in this series, those are services traditionally provided by banks. In many other cases, they’re services that haven’t been provided at all, or which have required complicated, manual solutions, finding and exploiting new markets.
And it’s happening in corporations, too. IBM tells us that 80% of employees download their own apps, with or without the company’s permission, creating massive shadow IT. We regularly take our personal devices to work, so that we can do work for that company which our locked-down and outdated company-issued apparatus won’t support, often via smaller, niche providers.
But there’s still a gap between these small providers and their customers – normally, the customer is currently required to find the providers individually, which, with viral marketing, is happening, but it’s still complicated. There is a growing number of marketplace platforms aimed at the general public, such as App stores, Amazon, etc, and to specialist customers, and we think the evolution of the multi-sided platform marketplace will be the next big change to the connected economy, providing both producers and consumers with faster access to each other.
As discussed in the branding article, this connectedness means that customers can reach each other immediately, taking the power of the brand away from your control and into the hands of the customer. And this is shifting control from companies, and in particular big companies, to individuals.
Doing it all
We can’t do everything well. As we discuss in What’s the point of banks? and elsewhere, banks have traditionally provided a wide range of services ranging from insurance to corporate finance, and managed all the supporting capabilities from sales to technology infrastructure. This model is typical of large companies throughout the 20th century – with few exceptions, such as advertising and specialist software, larger organisations have preferred to insource services, maintaining control within the organisation. While that looks sensible from a control perspective, it presents firms with two problems: finding the best people to do everything in your organisation, and putting your best people on the most important things your organisation does. As Jim Crace discusses in Good to Great, organisations struggle to be good at lots of things simultaneously; he argues that they need to find what he calls their “hedgehog concept” – what is the single thing they can be great at, and focus on being the best at that.
As we discuss in New Standard Models for Banking, we haven’t been able to identify a single universal bank which does everything well, despite extensive research and experience working within many of the world’s largest banks. In fact, echoing Jim Crace’s research, the less a bank does, on the whole, the better it does it. Fintechs, which largely do only one thing, tend to do that one thing excellently. There are exceptions, of course; as with every industry, some players perform better than others, and some have flawed models. Surprisingly, historically there’s been little direct correlation between provision of excellent services and profit for large organisations, and in particular banks – in fact, a much closer correlation exists between positive corporate culture and profit, but we will cover this elsewhere. So this historical lack of impact of poor service to poor performance has meant that banks and other large organisations haven’t been punished for poor customer service – until now.
The combination of ease of access to alternatives and wide distribution of customer-to-customer information, shifts the power from the brand to the service. Customers, individually and collectively, are voting with their wallets and taking their business to the providers who can give them the service they need in the format that suits them the best. Smaller and startup banks, offering more focused and more customer friendly products, have started to change customer expectations and demands. While some of these challengers will need to pivot to sustain their business models, the impact of their service approach on banks’ customers will be to change what customers demand.
So how can today’s universal banks address this? There seem to be two basic approaches being taken today by universal banks: strip down the operating model but keep the universal banking paradigm, or keep the universal banking paradigm and the operating model, but bolt on some cool features via fintech partnerships. In the first model, banks have recognised that outsourcing supporting services to organisations that do these things best will reduce their risk and operational costs. However they’re still running massively complicated service models and may miss the cost reduction opportunity by outsourcing complex and poorly designed services wholesale, complete with bad KPIs and a proliferation of over-customised processes. In the second model, by failing to address structural challenges, banks aren’t really going to be able to transform at all, and are likely to lose customers to emerging competition because their core services are complex, slow and unreliable.
Scale vs networks
Banks have traditionally survived and thrived because of their scale, and because of their access to scale services such as payments schemes and central banks. Scale provides them with strong capital base, reputation and brand awareness, all of which are important, especially in financial services. What scale doesn’t provide for banks, however, is economies of scale; unit costs for customer acquisition and management have grown in line with banks’ increasing size, due to the ever increasing complexity of their operations, and the increasing regulatory demands for information to try to understand and monitor this complexity.
Meanwhile, global networks powered by internet, disruptive technologies and the shift in distribution are creating a new, connected economy where smaller, more agile organisations with greater focus and innovative service approaches are siphoning business off the older, larger organisations. This has profound implications for large organisations, including banks, that still exist in the paradigm where the industry and large organisations own and control the network. With that network shifting out of their hands, banks, like other industries, are struggling to address how they will overcome the challenge and maintain their strong position and customer share in the connected economy.
We think the answer is for banks to become active participants in the connected economy; not by bolting on Fintechs or service providers, but by changing their operating models so that they continue to benefit customers with the central expertise they possess thanks to experience, knowledge and scale, but becoming full participants in the network by truly partnering with, and giving shared ownership to, other organisations, including Fintechs, who can offer truly differentiated services to their customers. We’re starting to see this model emerge with the concept of Banking as a Platform (BaaP) and, rather than competing, we believe that incumbent banks should be participating in this movement, to benefit from the network opportunities and build their future as full service providers, via the network, to their customers.
In this article, we’ve argued that because of the rise of the connected economy, banks are losing their monopoly as sole providers of financial services to customers; customers are increasingly voting with their wallets and with the rise of new companies providing viable options, the threat to the traditional bank is growing. Operating model changes need to address the fundamentals of how a bank’s business is run, and need to take advantage of networks rather than trying to compete with them or buy them out.
See other articles in this series for details of how to conceptualise and build a service model which can exploit the connected economy through ecosystem based services.