Research conducted by the World Economic Forum and led by Deloitte Global demystifies the seeming randomness of disruptive innovations in the financial services industry.
For many executives, innovations aimed at disrupting their businesses often seem to emerge out of the blue. At present, established players in the financial services industry are scrambling to respond to a variety of technology-based innovations, including mobile payments, cryptocurrencies, crowdfunding platforms, and distributed ledger technology.
Yet these and other technology-fueled disruptions in financial services are neither random nor unpredictable. Bob Contri, Global Financial Services Industry leader with Deloitte Touche Tohmatsu Limited (Deloitte Global), describes the business and regulatory environment that paved the way for many of these disruptive innovations. “Financial firms took a reactionary stance toward innovation in the aftermath of the financial crisis, due to heightened regulatory scrutiny and the need to regain public trust,” he says. “Against this backdrop, much of the disruption that we see today in financial services emerged. With the awareness that disruption is predictable, financial companies now have an opportunity to stay ahead of encroaching technologies.”
The predictability of innovation in financial services is one of several high-level insights uncovered through research conducted by a World Economic Forum (WEF) working group comprising a diverse range of industry stakeholders, with Deloitte Global acting in the role of exclusive advisor. The working group published its findings in “The Future of Financial Services: How disruptive innovations are reshaping the way financial services are structured, provisioned, and consumed.”
In researching various financial technology (fintech) innovations, the group found that disruptive innovations frequently target processes that are inefficient or painful for customers, yet highly profitable for service providers. International money transfer provides an apt example. In 2011, TransferWise, a peer-to-peer money transfer service, set out to expedite and lower the cost of transferring money across borders. TransferWise claims to save consumers up to 90 percent of the cost of a traditional money transfer and to have captured 2 percent of the U.K.’s share of the international money transfer business, while moving £500 million ($720 million) a month on its platform.
“Past innovators often tried to replicate the whole bank, resulting in business models that appealed only to either the most tech-savvy customers or more price-conscious ones,” observes Rob Galaski, a partner with Deloitte Canada and leader of Deloitte’s Financial Services Disruption team. “Today’s innovators take a diagnostic approach to financial services—meaning, they seek out large, poorly defended profit pools, then attack with surgical precision.”
Thus, financial services executives seeking to stay on top of disruptive innovations can start by watching for encroachment into profitable areas of their businesses.
Other insights revealed through the research effort include:
Innovations with the greatest impact employ business models that are platform-based, data intensive, and capital light. According to Galaski, the startups whose innovative products and services pose significant threats to incumbent financial institutions share several characteristics that allow them to gain market share very quickly: They design business models that require little capital, they scale rapidly because they forgo traditional infrastructure, and they employ data-driven systems that meet or exceed human capabilities.
Those characteristics are notable because they may herald the rise of the “virtual organization,” according to Galaski. “Think about technology companies that are increasingly positioning themselves as platforms,” he says. “By creating and enabling ecosystems of third parties, they allow customers and external experts to more directly shape their businesses through hackathons, developer environments, incubators, and startup-focused venture funds. As financial institutions explore those techniques for expanding their ‘virtual organizations’ and tapping into external insight and talent, traditional notions of which functions reside inside and outside their organizations could change radically. Financial institutions can take inspiration from data-heavy, platform-based models.”
Incumbent institutions will employ parallel strategies—aggressively competing with new entrants while also providing these upstart competitors with access to their infrastructure and services. New entrants are simultaneously competing with incumbents in the areas of their choosing while taking advantage of incumbents’ scale and infrastructure. For their part, a growing number of incumbent financial institutions are realizing that collaborating with new entrants can give them a fresh perspective on their industry and ameliorate their understanding of their own strategic advantages. “It is important that incumbents do not instinctively go on the defensive and view all innovators as threats,” says Galaski. “We are seeing a new wave of companies emerging, whose goal is to partner with traditional financial institutions to supercharge their efficiency and sophistication.”
Regulators, incumbents, and new entrants will have to work collaboratively to understand the effect of new innovations on the industry’s risk profile. Regulators play a significant role shaping the playing field inside the financial services industry, yet the accelerated pace of innovation has made their job much harder. To stay in step with emerging technologies and prepare appropriate responses to them, regulators will need incumbent and new entrant perspectives. These discussions will be of interest to both established players and startups, as those parties seek to leverage and commercialize new technologies that less-informed regulators may otherwise opt to restrict.
The universal banking model will become unbundled as niche entrants develop attractive point solutions that address unmet customer needs. For years, large institutions have reaped the benefits of being one-stop shops for their customers’ financial services needs. But that business model is under threat as increasing numbers of startups offer their own compelling financial products and services and as consumer preferences shift. As a result, notes Deloitte Canada’s Christine Robson, who leads a key project stream with the World Economic Forum, the financial services industry is beginning to specialize, with players falling into four distinct categories that characterize their specific value proposition: customer experience leaders, distribution platforms, product “manufacturers,” and infrastructure providers.
“Consumers, especially millennials, are beginning to gravitate to customer experience leaders because their offerings are designed first and foremost with the customer in mind,” she says. “In that manner, customer experience leaders either fulfill a need that large institutions have overlooked, or they provide a better user experience on top of an existing process.”