Banks That Don’t Open, Will Close
For 400 years, banks have been operating as niche, specialty retailers selling their own brand of financial products, despite most all those being commodity products. Face it, Bank A’s 4% 30-year fixed mortgage is not materially differentiated from the 4% 30-year fixed offering by Bank B.
What is different is the user experience. And, that is what actually matters.
As much as customers will shop around for the best rate, what they really want is the best experience at a competitive rate. Convenience is a key driver of that. Witness the success of Amazon’s one-click checkout. In banking, Fidor Bank (Germany) excels with its “60-second banking” where most products and services (yes, even loans) can be transacted, start to finish, in a matter of seconds because most of the bank’s processes are fully automated. Its this speed and convenience that keeps the customer from shopping around for a lower rate. And, the net interest margins that are double the industry norm, thanks to non-discounted pricing and low cost operations, keep bank shareholders happy.
To understand what is happening and going to happen, retail bank executives can look at the overall retail sector as an analog. Specifically, where is the best valuation multiple? Is it specialty retailers driving people to their branches to buy their branded products? The Gap Stores, for example, has an enterprise valuation of six times EBITDA. Meanwhile, Amazon’s valuation is 45x EBITDA. Other specialty retailers like Border Books and Barnes & Noble either closed or no longer have earnings to multiply.
What happened? The basis of competition changed.
Now, perhaps its not fair to compare banking to the retailing of physical products like books and jeans. After all, banks sell complex products & services. Perhaps a better analogy would be the purchase of vacation travel, a once-a-year purchase that amounts to a sizable chunk of a customer’s annual disposable income. I like the analogy because the service is now digital, just like financial products. Retail bankers should take heed from the experience of the travel agency industry. Twenty years ago there were 34,000 travel agency locations in the USA that sold appreciably all travel product. Today, the numbers and the market share are one-third of what they used to be. In the late nineties, before the bottom fell out, branch-centric travel agencies were selling for a high of 3x EBITDA; today digital-only agencies, such as Expedia, trade at over 14x EBITDA.
What happened in speciality retail and in travel retail is starting to happen in bank retail because, again, the basis of competition has changed. Not only is the buyer now fully in charge (we no longer “sell” basic banking, it is a “bought” good) but what the buyer values has also changed. More precisely, while they still want the same “things”, they now recognize them in different ways. Yes, it still matters to be convenient and to be secure. Historically, that might have meant a nearby branch in a thick-walled building. Now though, it is increasingly associated with an intuitive digital experience available 24/7 on a smartphone. The good news is you don’t need to be big and old to win anymore. The bad news is that if you are big and old, it requires a massive investment and massive change in orientation to compete with ‘digitally native’ competitors (from neo banks to FinTechs to Amazon, Alibaba and others).
People have grown accustomed to great digital experiences, be it from Amazon or Expedia or even Dominos. More and more, they want their bank to provide that level of customer experience. And, your branch simply cannot do it. Convenience is king and convenience is not about real estate anymore, its about the digital experience. Digital-only banks can operate at the cost of a just a few branches and yet still open thousands of accounts per week. And, those accounts are profitable because the operation of the bank is so highly automated.
So, how’s it possible, and what do you do? The key is to be “open”. This means not just open dialogue with your customers to enable true engagement and viral growth, it means open architecture systems so you can plug in and offer whatever products your customers want. Amazon sells a lot more than books now. Small Fidor Bank offers 2x or 3x the number of products offered by large banks — but the vast majority of those products are from third party fintechs which can integrate to the bank’s API in a matter of days.
Face it: Your customer will find and buy what she wants. If she wants a robo-advisor, she can find and fund one in a matter of minutes. So, offer her one that she can find and use in a matter of seconds. Not by building a robo-advisor but by plugging in one or two best-in-class ones for the customer to select.
Of course, the open architecture is powered by modern APIs. These are to become ubiquitous in Europe thanks to PSD2 and they are going to become popular throughout the world. Banks with APIs will partner faster, better and cheaper than banks without. Why? Because partners, regulators, customers, and shareholders like APIs! Product partners like them because they can sell more product via the bank distribution channel without the undue cost of integrating to a core banking system or legacy enterprise service bus; process partners like APIs because they can integrate best-of-breed solution in days rather than months; regulators like them because they empower the consumer and bring greater security to a world rife with screen-scraping; customers like them because it opens up a whole new world of choice and allows them more one-stop-shopping (convenience!) from a trusted provider; and shareholders like them because they enable more efficient innovation than either build or one-off integrations ever have.
So, who uses APIs and how? Big banks have tons of customers and tons of data. For them, its obvious: you become the platform — you become the Amazon. They’ve already got the scale on the buy side, now they just need to offer the selection on the sell-side. For smaller banks, becoming a platform may be a stretch — not enough scale to compete on the margin that mega banks will dictate on their platform. Similarly to how few online retailers can compete with Amazon on breadth of selection and pricing. For mid-size and small banks, the choice becomes one of integrating into the customer’s lifestyle — becoming an integral part of their daily routine.
In the open social forum at Fidor Bank, users give each other advice on how to save money, and its as often about store coupons as it is about certificate of deposit accounts. The customers use the bank, and its customer base, as a resource of information and they rely on the various products and services to make their life more convenient. They top up their mobile phone accounts, do P2P lending, invest in gold, buy foreign currency, even trade crypto-currencies (at an external exchange that is integrated to the bank). If they want to do it with their money, and its legal, the bank wants to help them do it. What choice is there? Tell them they cannot get financial advice from a outside financial advisor? Tell them they cannot open a retirement account elsewhere? Tell them they cannot use PayPal or Venmo or Transferwise? You cannot dictate to the consumer what to do; ultimately you don’t actually manage their money, they do.
One thing is for sure: we don’t know exactly what the future consumer will want from their bank. Therefore, the only reliable strategy is not to hard-code proprietary commodity products but, rather, to invest in open systems so to be able to quickly adapt and offer what will be wanted. Ultimately, it’s about offering convenient choice to the customer and developing strategic options for the bank.
Banks that open their minds, processes and systems to offer a broad selection of best-of-breed options via an intuitive digital experience will win and keep customers and grow. Customer will inexorably march their digits to those “open banks”. And, banks that aren’t “open”? Well, they’ll be closed.