The Total Disruption of Retail Banking - Part 1

There’s a philosophy I characterize as “Lucky to be a customer” within banking today. A customer comes to the bank, we make him jump through hoops we often call risk assessment, customer profiling or KYC, and then maybe, if they are not too risky a proposition, we might let them be our customer.

This philosophy comes not from a monopoly play as a brand, but an exclusive club we call “banking” where the barrier to entry has been so significant in the past that there has been limited pressure to change on the traditional modes of banking.  This is evidenced by the fact that although in rapid decline, much of the world still sees cheques lingering as a popular form of payment, despite being roughly two thousand years old and hopelessly antiquated in form and function. The basics of branch banking haven’t changed in the last millennia either. It is very rare for a physical artifact like cheques or a distribution model to retain such dominance over such a long period of time. The normal process of iteration, competitiveness and technology improvement results in more frequent change at the front-end for other industries.

It is not difficult to understand then why bankers, when faced with talk of the threat of ‘disintermediation’ or rapidly changing distribution models, meet such with practiced skepticism. There's still bankers today who doubt the future of NFC mobile payments, of social media's impact and of a fundamental and dramatic reduction in support for physical branch network.

So what evidence is there that we face a fundamental shift in the way we do our banking, the way we handle payments, or deal with financial services and will this significantly affect the way the business functions moving forward? Or is it more realistic to posit that we are simply seeing a change in mix, with the fundamentals of banking too embedded into our day-to-day life to really change in a major way?

I’d like to propose the following lines of evidence for a major and disruptive shift in modality when it comes to bank distribution models:

1. History shows incumbent players rarely win out
2. Rapid acceleration of technology adoption makes change easier
3. Massive spend in innovation at the front-end is occurring through disruptors
4. The increasing gap between behavior and capability, and
5. Transparency challenging revenue and friction

I will warn you that this is an extensive analysis as compared with my usual read-over-breakfast blog post, but given the importance of this debate I think it needs a thorough analysis and review. Over the next two weeks I will provide a detailed analysis on each of these lines evidence, starting with historical precedents. The impact of these changes will be a complete disruption in the distribution of retail financial services in the next 5-10 years. The following is the first component of the shift that is forever changing the retail financial services sector.

1. History shows traditional incumbents rarely win out

In industries where a virtual monopoly of infrastructure exists, change normally occurs over a long period of time, but when it does it is a typically through a tipping point scenario. Traditional players are not afforded any protection by means of their existing infrastructure or distribution model when a new and improved core technology emerges, or a massive change in consumption behavior takes place. Here are a few examples of massive, disruptive change in long-established, traditional industries:

Telegraph to Telephone to Mobile

To understand the disruptive nature of a massive shift in technology adoption, let’s look at Western Union. Western Union today is a financial services organization, but back in 1855 Western Union was a company that provided Telegraph services. Inflation adjusted, Western Union was capitalized at US$830 Million dollars ($41m actual) in 1876. By 1900 Western Union operated a million miles of telegraph lines and two international cables.

Western Union's greatest threat came from a new technology, the telephone. Alexander Graham Bell patented the telephone in 1876, initially referring to it as a "talking telegraph." Bell offered Western Union the patent for the telephone for $100,000, but the company declined to purchase it. Western Union could have easily gained control of AT&T in the 1890s, but management decided that higher dividends were more important than expansion. By 1900 the rise in telegraph traffic had slowed, and by 1930 the number of net messages was in decline. By 1909, AT&T had already gained control of Western Union by purchasing 30% of its stock.

Over the past decade, the impact that mobile phones have had on the use of landline telephones is equally as disruptive. In June of 2010, the National Center for Health statistics stated that one out of every four Americans has given up their landline phone and are now using their cell phone exclusively. AT&T reported a 7.4% decline in landline usage in 2007, and 9.7% in 2008. Verizon reported a decrease of 10.9% in 2009, while Qwest Communications had a 17% decrease in landline usage from March 2006 to March 2008. AT&T and Verizon dominate this industry, which brought in $340 billion in 2000. By 2016, revenue is projected to have fallen more than $200 billion in 16 years.

Who dominates the new space? Mobile operators. Not telegraph companies, or fixed line operators. Owning the wires or physical network infrastructure is not enough to save your business from changing behavior. Owning branches and payments infrastructure is the same thing. Consumer behavior trumps outdated networks.

In the midst of this you have defining moments around mobile platform too. You have Nokia usurping the #1 mobile player of the 90’s Motorola, and then iPhone doing the same to RIM and Nokia. Consumer behavior is the killer app – literally. It will kill your business every time unless you move with it.

Encyclopedia Britannica vs Encarta vs Wikipedia

In 1993 Microsoft launched the $99 Encarta encyclopedia. In 1991 Encyclopedia Britannica was doing sales of $450m a year (valuing the company somewhere north of US$1.5Bn), but the effect of Encarta on Britannica’s sales meant that the company was sold at a fire-sale event in January 1996 for just $136m to Jacqui Safra (a Swiss Billionaire financier).  In 1991, a bound volume of Britannica sold for around US$2,000 with a $600 commission component going to door-to-door sales professionals distributing the publication. Today that sales force does not exist.

In 2009 both Encarta and Britannica were offered online in a limited form, for free, due to the impact of Wikipedia and Google itself. Search and content curation has replaced the traditional Encyclopedia. Owning traditional distribution networks was of no value in the end due to the shift from physical to digital artifacts. Even owning the content is of marginal value in the end because the fungible value of the raw content versus the collective consciousness of the living, breathing stream is not comparable.

Media: Music, TV and Books

Today the biggest seller of books in the United States is Amazon. The biggest distributor of music is Apple. If I told you this 10 years ago it would have been unthinkable. A computer company selling Beatles Albums? Are you crazy??

"I think in five years, other than a few specialist booksellers in capital cities we will not see a bookstore, they will cease to exist," Australian Senator Nick Sherry
The Age (14th June, 2011)

This shift in distribution powerbase has resulted in a complete disruption of the traditional music and publishing industry. Record labels, movie studios, booksellers, video rental stores, and others who relied on physical distribution models have been decimated. Borders, Blockbuster, MGM, countless newspapers, video post-production companies, and photofinishing facilities have simply been hammered by changing consumer behavior. It turns out that in 2010 65% of young people under 30 have turned to getting their news from the big bad Internet. No amount of wishing it isn’t so, lobbying congress, or trying to beef up regulations to protect existing businesses is going to save these dinosaurs.

IBIS World recently reported on dying business models and in respect to video rental and distribution it was quoted as saying, "price- based competition and ease of access has transformed the once-a-week Sunday night family movie session into an everyday possibility." It’s not just Netflix either. We are downloading more and more content and abandoning the old habits of watching a show on a specific channel at a specific time. We watch content, not channels or networks.

So what does this do for TV?

Free-to-air TV itself is unlikely to survive, because the Ad revenue based model no longer works if you aren’t watching Ads as you fast forward through recorded content via your DVR or TiVo. While content might be able to make the shift to digital distribution, increasingly the model of 15 mins of TVCs every 1 hour of programming no longer works. How will you acquire customers and build brand when these broadcast methods of advertising no longer deliver ROI?

Coming Next ... The Rapid Acceleration of Technology Adoption