A platform play
- Banking as a Service
From Uber to AirBnb, platforms have become an ubiquitous method for connecting users to providers quickly through an easy-to-use app interface. Platforms have brought ease for customers and disrupted traditional, direct business models. This blog will explore why platforms will be the future of banking.
The creation of value
First, let’s agree that all enterprises; for-profits, non-profits or any kind of charitable foundation will always try to create some kind of value, be it in the traditional sense of monetary or perhaps social value. As Danco states in his theory of Emergent Layers all value comes from points of friction. In the case of monetary value, if I decide to sell a product for €50 that cost me €20 to purchase, I need to have removed some friction for the buyer.
Test this idea by imagining a frictionless world, where nobody had any need or wants. In this environment the sale price would converge to a price of €20, as everyone could just make or create whatever they needed, exactly when they needed it. Introduce needs or wants into this world and points of friction start to emerge. Add in a need or a want: let’s take food, a basic need which grows on a scale with hunger and with taste. Then consider the desire not to expend effort in satisfying that need, and you emerge in the modern world, where food delivery apps are some of the hottest property (and not just because everyone is forced to stay at home right now).
In the case of money, being profitable in the long run means that a person or company is able to sit at a point of friction that is defensible and unavoidable. This is not likely to change before 2030, or ever.
Scarce elements abstracted to abundance
Taking this further, the same friction that creates value has to come from somewhere. Let’s examine what happens when friction is removed by a resource becoming more abundant. To illustrate that point, Taleb tells the story of Giaccomo - a 19th century musician - in his work Black Swans. Giaccomo is living in a small town in Italy, just before the advent of recorded music. Musical performance for him is not scalable. Anyone wishing to listen to music must be physically present - so Giaccomo cannot export his work, and neither can any of the biggest singers in Milan or further afield, who might otherwise compete with him. The points of friction that allow Giaccomo to create value are geography and physical proximity.
When those scarce elements (physical proximity to Giaccomo’s voice and the voices of his fellow musicians) become abundant, the friction that was once present, allowing Giaccomo to make a living from his performances, quickly disappears. Imagine Giaccomo’s wonder when the first recording devices allowed the distribution of his music to thousands of people simultaneously. The recording of his music had removed the friction arising from geography and physical proximity. Then imagine his consternation when he realised the removal of that friction meant a radical change in the amount he could charge for his performances. If his audience could choose between his recordings and those of the very best singers in Milan, they would surely choose only to listen to the very best. The barrier of physical proximity had been entirely removed. This fundamental shift didn’t instantly mean Giaccomo was done-for, but it meant he would need to do a hell of a lot of adapting and improving to continue to be successful in the ‘new world’.
Importantly, even if Giaccomo was the first musician to be recorded, the abstraction of the scarce element of physical musical performance meant he would be just as likely as others to succeed. Any other musician who came after him, who was better than him, or even more effective at distributing their recordings, could blow him out of the water. This phenomenon is known as levelling up.
Levelling up banking
In the context of banking, the scarce elements of physical proximity in the example of Giaccomo could be replaced by a number of once-scarce elements. The obvious resource is technology. However, technology has always been an abundant resource for banks, with billions of dollars at their disposal to buy in the latest technology.
Instead, the most interesting element which was once scarce and is now abundant is regulation - or specifically banking licences. In recent years, as part of efforts to open up the banking industry, regulators across Europe have opened up the process of becoming a bank to new entrants. Alongside that, e-money institutions have emerged as a new form of regulated financial institution, with reduced capital requirements as they do not lend customers’ deposits. The reduction of barriers to entry has led to an unprecedented amount of challengers entering the financial services industry. In the UK, there is even a New Bank Start-up unit run by the Bank of England, designed to support new financial institutions on the journey to acquiring a banking licence. This was unheard of, even a decade ago.
The relative abundance of this previously scarce resource (banking licences) has allowed new entrants to thrive in a market previously dominated by the same players.
Levelled up, but still in the sandbox
More importantly, while regulatory easing has allowed a once-scarce resource to become abundant, the story does not end there. The rapid rise of challengers is still countered by the dominance of the big banks - partly due to customer apathy and the sheer size of the market (every single person in a given jurisdiction is a potential banking customer). This is because the products and services that many challengers offer are not a fundamentally different proposition to those offered by the banks. With a far lower cost base and a captive audience desperate for an alternative to the old drudging efforts and perceived shady operations of the big banks, it’s been enough for most challengers to pay lip service to the idea of disrupting the banking industry, without fundamentally shifting the playing field. There are exceptions to this, of course,
Let’s take day-to-day business banking as an example. The challengers in this space predominantly target smaller businesses. There is a huge market for financial services targeting the smallest businesses and it’s easier to adapt an app designed for consumers to work for the smallest businesses. So, while several players are playing in the sandbox, seeking to create a one-stop platform for all businesses’ financial needs, none have succeeded yet. Banking might have levelled up, but they’re still playing in the sandbox.Indeed, the Fintechs queuing up to be ‘the Uber of banking’ have formed a steady queue since the crisis, so that the market is now crowded with banking ‘platforms’ which promise a new way to do banking. Starling in the UK positions its business banking services as a platform, offering users the opportunity to plug into accountancy applications and other financial services. Others are partnering with like-minded digital businesses to build bolt-on services, or recommend like-minded digital businesses are preferred suppliers.
The platform play
That’s not to say Fintechs and banks are ignoring the benefits of a platform play. As a key component of Open Banking, banks are falling over themselves to release developer APIs, build sandboxes and offer customer propositions that link data from multiple sources. APIs bring together more than one interface to make it smooth and easy to interact with multiple propositions or services at once. Under Open Banking regulations, APIs are being used to present a customer’s data in the interface of a rival provider, or to initiate and authenticate payments in a separate interface. But there is a broader opportunity than this. The real power of banking platforms has yet to be unlocked.
That means that business owners are still using multiple service providers for the jobs they need to do. As a business owner, I want to be able to manage my company’s finances in the same slick way I manage everything else about my business. A company that takes payments online might use one provider as its payment gateway, another to issue company cards and deal with expenses, a separate accounting platform for its financial returns and yet another again for its main business account to store its money.
That’s where the platform approach comes in. A provider that can provide all of those things in the same place stands to win - and win big. In the new levelled up banking world, the Uber of banking is still waiting to emerge.
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