Digital disruption is a key theme in the financial services industry this year.
The volume of venture capital that is being injected into the industry at a global level is at an all-time high and high profile investments such as Westpac’s investment in the peer-to-peer lender SocietyOne has brought the story closer to home.
While historically there are countless examples of industries reinvented through innovation, the speed at which business models are being challenged is startling to some.
Clayton Christensen was the first to coin the terms "disruptive innovation" and “continuous innovation” and make a clear distinction between them.
Continuous innovations in financial services might include the iterative improving of existing products and services to meet the demands of a competitive marketplace. Consider the introduction of fee-free banking, enabling multi-channel support for customers and the plethora of mobile apps that have been implemented to improve customer convenience.
Disruptive innovation is a different story.
According to Christensen, disruptors redefine markets by introducing new products and services that, while not immediately as sophisticated as currently available product, offer other benefits such as simplicity, convenience and lower prices and that appeal to new, less demanding customers. Over time, these new products gain a foothold and improve in quality and eventually set a new benchmark for the minimum viable product that defines a category.
Examples include email superseding postal mail, digital downloads usurping CDs and DVDs and online payments replacing cheques.
There is no doubt that Christensen’s work has transformed our thinking on innovation in the last 15 years. There have been outliers in recent history however, that have led some theorists to question the relevance of Christensen’s line of thinking in today's business landscape.
Since 2007, he has repeatedly said that Apple would not succeed with the iPhone. The iPhone was an example of continuous innovation, he said, not disruptive in that it didn’t follow his model of starting as a low end challenger to an existing higher priced and higher quality incumbent product. He was convinced that a newer, cheaper product would eventually appear and overtake the iPhone.
I agree with those theorists that propose that the iPhone and subsequent tablets have certainly been disruptive innovations. While they have not challenged the phone market so much, they have disrupted the PC market and continue to do so.
While cheaper products have appeared, they have not substantially affected Apple’s growth. Apple is successful not just because it markets (arguably) the best products, and certainly not because it has the lowest prices. It is successful because of the way customers feel when they use Apple products.
Like Apple, today’s disruptors don’t systematically follow Christensen’s path to disruption. Challengers like Twitter, Facebook, Skype, Paypal and Amazon aren’t encumbered by traditional thinking. They look for opportunities to try new things quickly and then adapt as required.
Financial services in the new order.
The financial services industry is no stranger to the threat of new competition. Over the last two decades, the industry has faced challenges from startups, telcos and even supermarkets all trying to move into payments and insurance services.
To date I would argue the industry has proven to be robust and has not been materially affected.
The technological barriers to market entry have lowered to the point that disruptors can enter financial services at a lower cost with more convenient products. It is becoming increasingly likely that even with regulators on the prowl, new entrants will be able to attack the traditional territory of incumbent banks and insurance companies.
The most successful disruptors target existing pain points for customers, where there are opportunities to substantially improve the customer experience or reduce the cost of the service. Whether it be taking out a complex loan or insurance or paying for financial advice, if, like Apple a new entrant can change the way that the customer feels when they transact while still offering a competitive proposition, they will prove a threat.
Consider Amazon Lending. Loans provided by Amazon are meant to serve as an alternative source of funding for those merchants unable to secure funding through traditional lenders. While it seems to be only a niche play today, I can foresee a world where Amazon enters into retail lending.
Peer-to-peer lending uses the power of crowd and the cloud to offer better rates Watch for Funding Circle, SocietyOne and Zopa to pose a genuine challenge. Zopa already has more than a billion US dollars in loans on its books.
Consider Google's recent acquisition of the BeatThatQuote price comparison service for car insurance. Consider the impact should Coles, Woolworths, Google, Paypal and Apple take advantage of the financial data they hold on customers.
So how should the banks and insurers counter disruptive innovation? Read on for more...
While disruption is a serious threat for the financial services industry, here is some advice for how best to turn disruption into an advantage:
- First, acknowledge that every industry is prone to disruptive innovation and talk about it. Some executives in financial services feel that because we are so highly regulated we are safe. They feel that the new entrants will never go to the trouble of getting a banking licence or dealing with the regulators. I am confident the disruptors of tomorrow will find a way. Disruptive organisations don’t follow the “rules” of traditional organisations and have a different view of barriers to success. Keep abreast of your own market but also of peripheral markets should disruptors come from outside. Encourage conversations about this in the boardroom.
- Be prepared to break your business model. It's tough work breaking the cash cow, but when your traditional market is being disrupted around you, breaking or changing your business model may be the best way or only way for you to survive and thrive. You can choose to be a Kodak and pretend the change isn’t going to affect you, or you can be a Fuji, (which diversified into movie production). Think of new business models as an opportunity.
- Don’t give in to the disruptors without a fight. Think about creating your own disruptor. Not just to protect your own businesses but to challenge other businesses. Incumbent organisations need to be more creative in this regard. Look to create a combined business and technology team and be ready to look at acquisitions or investments that may not be your core business. Westpac’s Reinventure investment is a great example here, as is CommBank’s Pi payments platform and the Albert point of sale device.
- Implement a dual approach to innovation: continuous and disruptive. Survival requires you to embed innovative thinking into all parts of your organisation. Continuous innovation is simply a hygiene factor - you just have to do it to stay afloat. You need to make continuous innovation part of the culture.
Business leaders should start by ensuring that they keep abreast of what is happening in the market. Consider setting up a reverse mentoring program where new hires mentor seasoned professionals and keep them up to date with the latest trends.
Consider adding a continuous innovation test into the investment review process to ensure spend is adding value for customers and is keeping you at pace or ahead of your competitors.
Another play is to instigate an innovation planning space where you can bring together people from all over the organisation to challenge the status quo and come up with short to medium term innovation ideas.
While these strategies can get you started, they tend not to challenge the business model entirely and it will not protect you from disruptive innovation. Even with the best processes large organisations put in place to facilitate innovative thinking, I am convinced that most innovation happens at the fringe rather than the core. Innovation tends to happen less through structured facilitation and more from just letting it happen.
As such, you may also consider establishing a “start-up” within your organisation to be your own disruptor. I am not referring to an R&D unit, more so a businesses that is allowed free reign to break the traditional business model and try a new approach.
My experience suggests that innovation is extremely difficult within large organisations if the start-up has to follow the same processes for funding and risk assessment as the core business. To ensure quick outcomes, use a different business model and rules of engagement.
A great example of an organisation that decided to embrace innovation and created a separate entity to do so is Wal-Mart.
A few years ago it created @WalmartLabs, an idea incubator, as part of the company’s growing ecommerce division in Silicon Valley—far removed from the company’s head office. One of the new group’s innovations was a new unified company-wide ecommerce platform that helped Wal-Mart increase online revenues by 30 percent in 2013, outpacing Amazon’s rate of growth.
The key point with creating a new entity is to focus on disruptive innovation, not continuous innovation, which otherwise should be embedded in the core business and become part of the day to day culture.
Protect yourself by focusing on the customer experience.
No matter what new innovations appear to challenge you in the market, you can always protect yourself by following the Apple approach. Don’t just focus on price and quality, focus on the overall way that your customers feel when they do business with you. Use the power of your brand to fight off challengers.
At the very minimum you will buy yourself some time to develop your own response to the disruptive innovators.
Jeff Jacobs is a Sydney-based technology executive and IT consultant with over 25 years experience in senior IT positions with AMP, Zurich, CBA and most recently as the CTO of Westpac.