The financial services industry is in the middle of a seismic shift. In order for banks to remain successful, they will need to embrace platform theory.
Paolo Sironi, global research leader in banking and financial markets at IBM Consulting and seasoned FinTech author, recently launched his fifth title. ‘Banks and Fintech on Platform Economies: Contextual and Conscious Banking’ explores how platform theory has taken hold of the financial market.
The core message of the new book is that the way firms have handled digital transformation has not been good enough.
Speaking with FinTech Global, Sironi explained the world is in the middle of its Fourth Industrial Revolution. This is both a data and a platform revolution. The evidence of this is simply the Wall Street Index’s S&P 500. The top companies are all platform companies. However, Sironi explained the digital world brings platform economies to a different level as it allows people to be more engaged and with reduced friction.
Spending on digital transformation has consistently grown each year. Data from Statista claims global spending reached $1.31trn in 2020 and will reach $2.8trn by the end of 2025. While a lot of money has been pushed into this initiative, Sironi believes “a lot of digital chrysalises were born, but not many butterflies.”
To become that butterfly, banks need to address one main element. This is the realisation that the platform revolution in the digital economy is a transformation from output economies, which focus on products, to outcome economies where engagement experiences are at the centre.
This shift is happening because the margin contributions of most financial services products are reducing continuously, he explained. Interest rates are low and high costs of capital are stopping credit functions generating value for shareholders. Similarly, there are problems across the payments, wealth management and insurance functions that are reducing margins. Each of these functions currently follow the linear value chain in the output economy, which causes monetisation to be found elsewhere. To find better value they need to move to outcome economies. Sironi added, “In the outcome economy, the product is not the core element that generates the revenue for the institution, but the revenue comes from somewhere else, which is through engagement.”
To better express how the two economies work, he offered a parallel between the automotive and banking worlds. The automotive market operates in a linear value chain on the output economy. Each year a manufacturer will establish their sales targets. Instead, if they wished to operate in an outcome economy, they would change the focus from selling a specific number of cars to the desire of helping people commute to their office.
Sironi said, “The core is not selling the asset, instead it is allowing people to do what they want to do with a car, which is go from A to B. Now since the asset is still there but is not the centre in the creation of a sticky relationship with a client, if the experience is not good, the client can shift to another. Whereas, if they had bought a car and didn’t like its performance, they could not just change it a week later.”
So why is this shift to outcome economies important for financial services? It reduces the dependence on the product and forces the financial service providers to fight for quality of the engagement experiences. For example, a wealth manager would no longer aim to increase their total assets under management, but instead aim to help clients meet their financial goals. “In the output economy the product is the product, but in the outcome economy the relationship is the product.”
As mentioned, this shift is happening because margins are shrinking for financial services and banks. If their existing products, which are based on the output economy, are no longer working, they need to find other ways to earn profits. The way to do this is by transforming the mindset of how to generate value for clients.
“Everyone that thinks digitising a bank just means to sell products on a digital medium, however streamlined, optimised or fancy the experience is, will not succeed. It can only survive with huge venture capital money or a potential abuse of clients’ relationships by leveraging a strong fear of missing out, such as often seen in the world of cryptos.
“Those who understand the value comes from somewhere else in the banking relationship, where operating as a platform allows this value to be unlocked, will be capable of succeeding. However, there needs to be a huge cultural shift that involves the whole organisation, because it requires a transformation of the organisation, so its data and systems become open to allow clients and advisors to interact in more valuable ways.”
Demand Vs. Offer
The second element of the platform economy is the push versus pull mechanism, or the demand versus offer.
One of the challenges of the digital ecosystem is that it operates on the demand side, while the financial services are largely working on the offer side as products are pushed to clients. Making it even more complex for banks is their divisions – lending, payments, wealth management and insurance – are all dissimilar in their ability to pull in clients.
Sironi explained that payments are the simplest products for clients to understand the value proposition. Having the ability to make a payment via your phone is convenient. This is why some of the biggest and earliest winners in FinTech have been payments companies, such as Stripe which is one of the biggest in the world. Similarly, lending is easy for customers to see the value in. However, with payments being very competitive and credit functions having low interest rates, it is still hard for businesses to generate value in these domains.
It gets progressively harder to see the value proposition for wealth management and insurance. These last two are more on the offer side of banking. Investing requires a lot of trust on the customer side that the firm will not lose their money, while a product like life insurance must engage an awkward conversation about the customer dying. These are issues banks need to resolve to allow each of their functions to work online.
“Banks still have to resolve their tech for this pull and push gap. They can resolve it, but they need to allow people to be capable of self-directing themselves. So, there’s something important that precedes data-driven banking or data-driven FinTech, which is absolutely relevant. It is data-enabling the client. This is making the effort to enable the client through an advisory process to make a conscious financial decision. This will enable reconciliation of the push and pull and motivation.”
Conscious banking and contextual banking
Another core aspect Sironi explores through the new book, is how contextual and conscious banking is underpinning the new forms of digital transformation strategies.
A recent report from the European Central Bank exclaimed successful financial institutions excel in information and communication, which Sironi sees as the names of the two axes on his Bank Innovation Quadrant. To intensify on the information axis would mean to open the bank to an ecosystem. This would include operating on a cloud, using blockchain and having trusted data that go beyond its borders.
To intensify the communication portion, the bank would need to implement AI to transform the distribution of products into a mechanism that augments the capability of clients to self-direct themselves or augment the human relationship in the advisor model.
“If you imagine this quadrant, on the bottom left side you would have traditional banking or digital banking. These are constrained because banks don’t have the capability to move higher in the information portion or move further in the communication portion. In order to do that, they need to apply new strategies which operate on a platform economy, which are named the context of banking and conscious banking.” Contextual banking is more emphatic on the intensity of the information portion, while conscious banking is more towards the communication side.
To engage in contextualised banking, Sironi stated that as banks struggle to remunerate their core banking operations, they need to pivot into a banking-as-a-service model, which would help them position their data and insight outside of the banking parameter. This enables them to contextualise themselves in a non-banking ecosystem by becoming embedded in a different ecosystem and remove frictions in customer engagements. This shift is already happening today. For example, State Bank of India recently launched its You Only Need One app, a mobile banking and lifestyle service, and China’s insurance giant Ping An, which helps people find a doctor and transition the relationship into an analogue discussion.
“The new value comes from the fact that the transaction is not the key element anymore, it is the new way people can engage in the frictionless economy and digital interaction. This allows them to monetise a new value that wasn’t there before because they can now orchestrate interactions that you could not before.”
This alone is not enough. Regulations are increasingly putting pressures on banks to become more transparent and ethical. With this, banks need to operate through conscious banking, which means they are more transparent and can justify the price of their services to clients.
How to succeed
The banking sector is becoming increasingly more competitive. FinTech companies are taking larger shares of the markets and the margins of banks are declining. But there is a bigger problem. Sironi said, “You cannot break the bank for the simple reason that they are already broken.” This means they function as giant organisms that are divided into different business units that are organised around product channels and are consistently building silos for their data and customers.
“I tell them that only by re-bundling everything you do on an open organisation interplay, where barriers are down, will they be able to generate value that enables them to win on the platform economy.”
This is a problem that is not only facing banks, but also FinTech companies. Neither can afford to be a marketplace of different product channels. It needs to be bundled into one mechanism with a pricing system that makes sense. “Without that they are destined to always express muted financial performance and eventually, if not taken out by mergers and acquisitions, they will be destined to disappear.”
To learn more about the transition towards platform economies in the banking ecosystem, check out ‘Banks and Fintech on Platform Economies: Contextual and Conscious Banking.’ Find it here.
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