I wrote this article for the Rady Business School at the University of California, San Diego. The original can be read here.
When Mike, a character in Earnest Hemingway’s “The Sun Also Rises”, is asked how he went bankrupt he famously replied: “Two ways, gradually and then suddenly”.
The “gradually then suddenly” line has been used in countless ways in the years since Hemingway wrote it, but lately it has become a popular way to describe the seismic shift in industries in the 21stcentury. The newspaper world was long rumored to be ripe for digital transformation and disruption, and for a few years the predicted changes to that industry were only gradual – perhaps your paper was a bit thinner, perhaps there were more ads – but it essentially was the same paper you always received.
Until it wasn’t. Suddenly, newspapers began to cut back their issues, many sold out to larger publishers, and others simply closed their doors. Today’s newspaper business – even the inclusion of the word “paper” is a clue how much news delivery has changed – would be unrecognizable to a newspaper executive from even 25 years ago. Similar changes have occurred in many industries such as entertainment, retail, and insurance as they continue to experience astounding and fundamental change.
It might be easy to suggest banking has gone through a similar degree of significant change over the past decade, but I think that the industry change we’ve seen in banking falls more into the “gradual” category, with the “suddenly” category fast approaching.
First, let’s acknowledge the tremendous change that has occurred in virtually all phases of banking. You’re ability to monitor your account balance went from interactive voice response to online banking, to mobile banking, to voice-enabled assistants and so forth. You can pay your bills online, get low balance alerts on your mobile device, access budgeting tools, and transfer funds with little effort.
But these interactive tools rest upon technical platforms and organizational structures that are largely unchanged from decades ago. You might love your bank’s mobile app, but you still fundamentally have a transactional account (“checking”) held with your primary bank. The changes you’ve seen have been more visual than foundational.
But true digital transformation in any industry is always foundational. Success requires existing industry participants to completely re-think and re-organize, or the market will replace them with new participants who think differently.
These aren’t just the usual bromides you might read about digital disruption. This change has industry shifting agility and economic impact. Consider an Oliver Wyman report that shows how “digital banks” – that is, new banks built from the ground-up on digital technologies – experience a cost per acquisition of $30 versus traditional banks’ cost per acquisition of $150. Digital banks can also configure new product in weeks, while the traditional banks would require months to do the same thing.
The banks themselves have been consolidating rapidly. The number of U.S. banks have declinedfrom more than 18,000 to 5,800 (and dropping) in just three decades, and the five largest US banks hold more than 40% of all deposits. Credit Unions are consolidating even faster.
Branches have declined as well, largely as a result of big banks gobbling up small banks and then shuttering the redundant branch across the street. But there is another factor that will play an even bigger role in reducing bank branches: your mobile device.
If you’re looking for a leading indicator when the industry is going to transition from “gradually” to “suddenly”, look no further than the chart below in which survey respondents suddenly changed their minds about the importance of branch location in determining a bank’s convenience. Focus on the third category from the top (“Branches Near Me”) and see the rapid change. This is a big deal.
Banks are in the data and service business. Your money is not kept on pallets in a bank’s warehouse (thankfully), and there’s nothing for a bank to “manufacture” unless you use the term as a metaphor for financial product design. The challenge banks face is they were never contemplated as digital entities, and so have many years of legacy technology and siloed organizational design to overcome.
Marketers in industries like this tend to adopt the hopeful view that a long corporate history matters to their customers. I was at a digital money conference recently where a venerable east coast bank was boasting that they had a “200-year head start” on the future, much to the amusement of conference attendees.
But efforts to use corporate age as an enticement for new customers ignores the fact that when you look at a list of the brands millennials loveand trust, you won’t find a lot of “old” brands. The millennial brand preferences include exactly the names you’d expect – Amazon, Uber, Instagram, Apple, Netflix, etc. And while a bank might (correctly) point out that delivering financial services in a highly-regulated environment is harder than posting pictures on the internet, the fact that millennials view their preferred digital providers as potential financial services providers should be a worrying trend to bankers.
Source: cg42 “Retail Banking Vulnerability”
An equal challenge banks have in this era of disruption is that their technology infrastructure is tied to an outsource model that itself has consolidated and is based upon technology that is old and inflexible. I was in the office of a bank executive once and in the middle of our conversation he mused “you know what bugs me about this industry Mike? – it’s that anything I create will be at my competitor across the street within six months”.
There’s a reason for that, and it has to do with the industry’s shared technical infrastructure. It’s hard to differentiate when both you and your competitor use the exact same technical platforms from the same provider. Your bank might implement a new feature somewhat before your competitor, but they’ll have that same feature soon enough and their customers are unlikely to notice the delay.
Many Americans would be shocked at how little banks actually do “in house”. Most banks outsource their data processing to a shrinking network of core processors. About their total reliance on outsourcing, one banker I was talking to said “I don’t even think we count our own money”.
Very large banks – for instance the top five banks with whom a majority of millennials keep their money – have the resources to innovate and operate technology platforms with less need for third-party support, giving them the ability to extend their innovation lead and gobble up more share.
And so, we can expect industry bifurcation between the large banks who have the resources to build their own technology and those who cannot. But to classify banks into these two categories based upon size alone is misleading. I expect we will see two types of banks emerge in the coming years that are more fundamentally different from one another.
The first type I will call the “Digitally Designed Bank”. Some of these banks might be banks today, some might be new banks you’ve never heard of, and some may be digital companies you know today but you don’t think of as banks. Today, companies like Square, PayPal, Google and others are pursuing regulatory approval to expand their services in ways that might look very different to an educated banker (e.g. lack of FDIC insurance) but might not look all that different to someone looking for a convenient way to pay for things with their mobile device.
The Digitally Designed Bank will understand that you won’t keep all of your financial assets with them. It will know that people with money will be more likely to spread it among multiple providers since keeping track of their complete financial picture is easy to aggregate into a single view on their mobile device. These banks will provide financial services through one of several “fintechs”, or digital entities that are highly focused on one aspect of financial services such as auto financing or small business lending. They will provision these services through Application Programming Interfaces (APIs) and will find it easy to create new offerings and terminate old ones based upon a rapid market feedback loop.
The second type of bank I will call the “Digitally Aware Bank”. These banks will likely be a consolidated version of the mid-size and smaller banks of today. They won’t lack digital sophistication – there won’t be room in the future for banks that ignore the digital world – but the word “digital” to them will refer to a layer that rests upon the traditional footprint of banking today. They will continue to depend upon legacy core processing and extensive physical branch networks to deliver their services – both of which imply commoditization and cost.
Banks are not insulated from big societal shifts, and it is concerning to consider how these two types of banks will play into the same forces of wealth concentration and the urban/rural divide we see today.
For years, banks who mass-mailed credit card offers understood the concept of “negative selection”, where consumers with the lowest credit scores disproportionately act on the bank’s credit card offer, thus increasing the bank’s risk of loss. Might a similar dynamic play out as those customers with less wealth and an aversion to digital banking negatively select the less digitally-sophisticated banks, thus increasing bank costs and limiting the services the customer is able to receive?
Of course, all is not doom and gloom for banks, although you might think otherwise if you read some of the more incendiary blog posts and tweets that portend the demise of traditional banking. The reality is that while a consumer might saythey’d trust a social media company with their money, it likely would be a different story when it comes time to transfer the funds.
Also, since I’ve been around banks for a long time, I can attest that their reputation for stodginess is often undeserved. Many of the digital technologies you use today in other industries were introduced or significantly advanced when your bank offered online banking, online bill payment, mobile check deposit and a host of other digital capabilities. Airline check-in kiosks might look new-age until you consider how long ATMs have been dispensing money (money!) error-free.
Successful banks, whether Digitally-Designed or Digitally-Aware, will look for ways to test and learn. Even the humble branch is undergoing something of a renaissance as banks test refreshed branch concepts that might be confused with your neighborhood coffee shop, or creating branches where financial advice is provided via video in a private room. These efforts are all part of banks’ efforts to sweep the mundane transactions to the digital channel – such as depositing your check with your mobile phone – while promoting higher-value conversations in the physical channel.
Additionally, banks will need to look outside of their network of core providers for technical solutions that enable them to differentiate. This will require new skillsets within the bank and – most difficultly – new organizational structures. Several banks have tried bolster their teams by hiring or acquiring digital hot-shots from outside the banking industry, but upgrading technology is easier than upgrading culture, and the typical bank culture rejects these new additions in fairly short order.
It’s often hard to see the sudden changes that are about to occur in an industry, even if that change is imminent and predicted. If you were to have made a prediction some years ago that “ecommerce is going to radically alter the retail landscape” you would have been right, but your understanding of that phenomenon would have been somewhat removed and academic. But now that we are well into the unfolding of that prediction, your experiences concerning local job loss, store closures, and magically appearing Amazon shipments on your doorstep make that change more real and visible.
A similar process will unfold with banking, as predictions of its imminent change are likely true but still miss the experiential impact of seeing banks around you consolidate their institutions, watch their services disintermediated by fintech attackers, unbundle traditional financial products into discrete APIs, and recede from your physical experience as they more deeply integrate into your digital world.
Michael Diamond is the GM, Payments for San Diego-based Mitek Systems, leaders in mobile capture and digital identity verification solutions and inventors of Mobile Deposit, used by 6,200+ US banks and credit unions. Mike also blogs at www.michaeldiamond.com