When your stock in trade evolves from paper notes to ones-and-zeroes on a computer screen, how vulnerable is the finance sector to digital disruption? We looked at education in last week’s case study of industries on the verge of digital disruption.
This time around, I want to dig a bit deeper into the challenges facing incumbents – and, more importantly, the opportunities for innovators – in a sector that according to Deloitte has the potential for an even greater impact and not so long until the big shakeout comes…
Put the words “disruption” and “finance” together, and some would have you believe that Bitcoin is the only game in town. Maybe BTC is the future of currency, maybe it is our best hope to improve the payments industry, but what interests me most is Bitcoin as an enabler of disruptive change. The same is true of many innovations though, and Bitcoin has been discussed brilliantly elsewhere so I don’t want to spend too much time thinking about it here. Instead, I would recommend you check out The Umlaut‘s dissection of Bitcoin as the internet of money and Marc Andreessen’s brilliant piece for the New York Times on why Bitcoin matters.
Now, before we go thinking about what the future of finance might look like, let’s have a quick think about financial services as we know them today…
In Australia alone, the banking industry reaped $29b in profits last year – that is more than $1,000 for every man, women and child in the country! So, how do they make money?
First and foremost, the job of a bank is to keep your money safe. Rather than hiding their cash in the back garden or under the bed, your grandparents deposited it, in person, at their local branch. Keeping your money safe is still a vital function nowadays, but given that the vast majority of modern money is digital would you say that the role of banks as guardians of your cash has evolved to the same extent?
At its most basic, money is (i) a store of wealth; and (ii) a means of exchange. It is from that second limb that banks derive their second key role, facilitating transactions. Going back to your grandparents in the pre-digital world, they paid large bills using cheques (remember those?), which are essentially a promise from one bank to another bank to honour financial commitments on behalf of their account holders. We can all see why cheques have gone the way of the dodo when modern transactions are simply debiting a bunch of ones-and-zeroes in one account and crediting them in another. But why should it take more than matter of seconds, and cost more than a fraction of a cent, to complete a transaction when all the processing is done electronically? And how has all that changed in an increasingly-globalised world, where physical and digital goods and services can be sold across currency borders, why is it still so hard (and expensive) to get paid?
Even more than transactions fees, a key element of the banking business model is to take that money which they so graciously keep safe and allow us to transact with, and lend it to others. By more efficiently allocating capital, financiers make a profit margin between what they pay us for our deposits and the rate at which they lend those funds to others. Again, though, we are seeing challenges to this key plank of banks’ profitability, with peer-to-peer lenders like SocietyOne and crowdfunding platforms like Kickstarter, Pozible and Indiegogo helping people to fund projects that the banks might not have touched with a ten foot pole.
That a creative gets their latest work commissioned without the finance industry’s support is hardly going to keep bankers awake at night, but what if these alternative funding approaches are only chipping away at the margins for now? Could this be just the beginning of technology and the connected world eating into finance’s role as efficient allocators of capital?
Barriers to Entry vs Handcuffs of Incumbency
There are a couple of factors that some, particularly incumbents, argue makes it nigh on impossible for new challengers to come in and disrupt the finance industry: (i) regulation; and (ii) established branch networks.
I am all for encouraging direct interactions with your customers, but maintaining and staffing a huge network of branches doesn’t come cheap. It is a massive fixed (sometimes semi-fixed) cost which banks carry on their P&L each year, and which is only sustainable when the volume of capital flows that you facilitate (read “make margin on”) is as huge as it is today.
However, as the founder of Box (and must-follow tweeter) Aaron Levie, explains:
Could it be that the same barriers to entry which banks see as their defensive moats – those expansive branch networks, back-office systems and processes which are designed to simplify and mitigate risk – are actually holding them back from innovating in a digital world?
Celebrated entrepreneur-turned-VC Marc Andressen has a really interesting perspective on this:
Is that the kind of banking future you can imagine too?
The change it is a-coming
It’s not like the finance industry hasn’t been responsive to technology… We have seen ATMs replace bank tellers; Paypal move money around the world electronically; online trading platforms make the sharemarket more accessible for Mum-and-Dad investors (forcing stockbrokers to evolve and focus their energies on HNWIs); and, more recently, “innovations” like high-frequency trading allow them to skim tiny profits on huge volumes of stock (albeit arguably at the expense of their traditional customers) thanks to warp-speed internet connections and smart algorithms.
But what if the next generation of technological challenges come from outside the industry, rather than within?
Do we need mortgage brokers and financial planners, with their complex products and fine print that none of us understand, when we can manage our money in the palm of our hands? How will the vertically-integrated wealth management divisions and superannuation providers customise their mass market products to suit the needs of individual customers? Will banks continue to be the trusted place where we keep our digital money secure, and if so, could they take responsibility for the security of other elements of our digital lives?