"The digital revolution will have a greater impact on us than the industrial revolution."
You might expect that statement from an executive of Google, Facebook or Twitter. But this was a statement made by Ashok Vaswani, Barclays CEO of Personal and Corporate banking, at a recent business school talk.
It's a bold prediction. In the retail banking space, we can see signs of it coming true. Mobile banking adoption is skyrocketing the world over. In the UK, 5.7 million transactions are initiated over handsets per day, whilst in Kenya more than 50% of the population use mobile money solution M-PESA to make payments.
But does the same hold true in the world of business banking? With over four million small and medium sized businesses in the UK, we've yet to see the same dramatic shift in behaviour. Are there indications of a seismic digital disruption just over the horizon? Or does it look like a more incremental transition to digitised business banking in the UK, driven by incumbent banking giants on the high street?
Will you go to a bank tomorrow?
Put yourself in the shoes of the owner of a small business selling books on Amazon. You've won a big contract to supply university libraries and need some working capital to stock up. You've asked your bank if they'd lend you money, and they've turned you down.
You could go to another big bank – a Barclays, a Lloyds, an HSBC or an RBS. But to open an account will range from at minimum a few weeks, to more realistically a few months. In fact getting to speak with someone will take luck or a feat of calendar scheduling. And you can expect that your signature will end up on anything up to 30 separate documents before the on-boarding ordeal is over.
Even after that there's no guarantee they will actually lend you the money.
Or you could go to UK lender iwoca, register within 10 minutes, click to share your Amazon and eBay sales history, and get the cash in your account within 60 minutes. EzBob will do the same. Kabbage will get you cash in your account within seven minutes, although they may use your UPS shipping history to better underwrite you.
Seven minutes to having cash in your account or a few months before getting an answer? As a small business owner it's a no brainer. As an incumbent bank, it's an easy way to be disintermediated.
Digital Financial Service Providers
Working capital isn't an isolated example. There is an emerging breed of digital financial service providers who excel at only one thing, but do it better than traditional banks. It's a David versus Goliath battle, and one with no shortage of Davids.
MarketInvoice is a great example of an innovative service provider, specialising in invoice finance. It takes 15 minutes to register online and list an invoice from a blue-chip firm. Professional investors will then bid for the invoice during a 24-hour window. It's all very quick, transparent and businesses only need to pay a single fee. The result? MarketInvoice grew 20% month on month in 2013 and has traded over £200m worth of invoices since its inception in 2011. They're also growing the addressable market: 75% of their customers haven't used invoice financing solutions before.
GoCardless on the other hand has applied a digital-first approach helping businesses set up payments. From a Y-combinator launched start-up in 2012, they're now the UK's largest online provider of direct debits; as a small business it would take your customer less than 60 seconds to set up a direct debit using their service.
Stripe is another start-up on a hot streak. They enable businesses to process payments on their website by cutting and pasting five lines of code. Started in 2010 by a pair of brothers in Dublin and now valued at $1.75bn by investors, they process payments in over 130 currencies. What's even more remarkable is due to a lack of competition in the UK, they've had a faster absolute rate of adoption than they did in the US.
The list of digital disruptors goes on: Accounting packages such as FreeAgent, Xero or Kashflow that suck data out of your bank and forecast cash-flow, adding value to the numbers; peer-to-peer lending solutions for small businesses such as Funding Circle, who will venture where banks will not; white-labelled payment & loyalty applications for retailers such as LevelUp in the US, who use data to enable next generation intelligent cash back campaigns based on customer spending.
If we take a step back, the view is clear. There's a growing ecosystem of disruptive start-ups. They offer fast, transparent and intelligent financial services to UK businesses. They are born-digital, offer a world-class customer experience and have a lower cost base with no legacy. And they're backed by an aggressive breed of venture capitalists who have seen their money pay dividends in retail and digital media, and are now turning their eye to financial services.
Whilst it seems unlikely that there will be a new 500lb digital gorilla in the banking sector soon, there's undoubtedly a pattern developing, where fast-moving start-ups begin devouring the best bits of the banking ecosystem, bite by bite. Left unchecked this disintermediation could lead to banks becoming utility providers, only ever differentiated on price and basis points.
It's certainly an interesting time to be a commercial banker…
Competing in the disruptive start-up ecosystem
Deutche Bank's head of cash management, Dean Sposito recently gave an interview about 'The sweet spot of transaction banking', comparing it to the aircraft business.
Like building a plane he says, it takes a huge amount of investment to build core banking systems. Like servicing a plane, it takes a huge amount of investment to maintain core banking systems. And like designing the next model Boeing or Airbus, it takes a huge amount of investment for banks to innovate and create a competitive edge.
This paradigm of colossal system investment – often hundreds of millions of pounds – has been the dominant logic for quite some time.
It's a completely different paradigm to the lean approach used by the disruptive start-up ecosystem – by the iwoca's, the Stripe's and the Square's of today.
And the start-up paradigm is working faster...
Even the most successful business banks of the future won't be characterised fundamentally by levels of investment; they'll be characterised by how well they can work with an emerging ecosystem of digital disruptors. Harnessing that disruption – what the economist Joseph Schumpeter called 'creative destruction' - will require some key changes.
Strategy functions within banks can no longer just benchmark against core competitors. They need to take a more holistic view of the market, looking at partnerships between banks, non-traditional players such as Paypal & Facebook (who both now offer international money transfer services) and emerging disruptors such as Stripe.
Technology functions will find it all the more imperative to standardise connectivity between core banking systems and external applications such as online accounting systems. A balanced portfolio of technologists is crucial too; architects who maintain core banking systems (keep the lights on) are very different from technologists used by entrepreneurs, who excel at rapid experimentation and deployment of new propositions.
Transformation functions will also need to redefine themselves. The difference between traditional processes and disruptive start-up processes are in some cases so extreme it's difficult to see how one function could morph into another. Take today's underwriting process in a bank, and compare it to underwriting at Zest Finance in the US where over 70,000 data points are employed. Developing experimental parallel capabilities is a wise option, establishing processes where learning is incrementally implemented into core functions on an ongoing basis.
Forge new partnerships & alliances
Whilst the emerging ecosystem of disruptive start-ups provide a threat of disintermediation, they also provide an exciting opportunity to gain competitive advantage. Some banks are capitalising on the opportunity this ecosystem provides.
RBS is a good example; they've sponsored Y-combinator start-up GoCardless to the BACS network since 2012. GoCardless are now the UK's largest provider of online direct debits, and with two-thirds of household bills paid in this way and a 2020 forecast of four billion transactions, it's a strategic partnership in a growing market.
Stripe is another: they initially pitched their full stack payment solution concept to banks in Ireland. But the brothers who founded it were rebuffed as naïve teenagers. When they later moved to Silicon Valley, Wells Fargo took them under their wing, and helped nurture them into the multi-billion dollar company they are today.
Other organisations are not only partnering but investing in their partnerships to secure competitive advantage. BBVA for example set up BBVA Ventures with $100m in seed funding to foster an ecosystem of innovation. They've since taken a stake in start-ups like Radius – who trawl through two billion data points to model SME behaviour in the US, and SumUp – a provider of mobile money solutions. They also bought Simple Bank for $117m in February 2014, showing they aren't afraid to make big bets.
VISA is another good example which has made numerous investments and acquisitions over the past few years. Their relationship with payment specialist Monitise is strategic, and they took a 7.5% stake in 2012. But they've also invested in Square, the company championing innovation for American SME's and founded by the CEO of Twitter, Jack Dorsey.
What is clear is that banks need a clear direction on how they work with the emergent start up ecosystem, and that direction requires ownership in the organisation. Is this the remit of the strategy director, individual divisional managing directors, or a new role entirely? Different organisations will have different answers. But what's absolutely crucial is to have a clear voice leading the way.
Don't be afraid of competing services
It's not uncommon to hear bank executives worry about cannibalising sales when discussing the launch of a new innovation. And it's easy to see why, as the disruptive start-up community are targeting the same customer needs, but often in a more accessible or engaging way. This type of protectionism can be short sighted, and will not only kill new ideas but stifle innovation.
If customer behaviours are changing, no bank can stop them from changing. We should serve customers in the way they wish to be served. There's no reason why a bank couldn't offer customers an invoice factoring facility and an invoice marketplace solution, and may the best product win. What we'd likely find is that different customers gravitate towards different solutions, and that's okay too.
As the digital revolution sweeps through financial services we're seeing many ways to pay, many ways to lend and many ways to gain insight into finances. Without the aid of a crystal ball to see which product or service will prevail, it's hard to see how to come out on top without maintaining a balanced portfolio of products and services.
From the view of the market we've explored thus far, it's clear that business banking is ripe for disruption from an ecosystem of disruptive digital start-ups. Whilst most provide singular services, the way they do so is world-class and far surpasses traditional service offerings. Harnessing innovation from this emerging ecosystem will form a cornerstone of competitive advantage in the next digital era of banking.
Developing this competitive advantage will firstly require everyone onboard. Strategy, processes and systems all need adapting to capitalise on new innovation in the market.
Secondly forging partnerships and strategic alliances with digital disruptors is key. No one can remain an island and keep ahead. Executives need to become comfortable with multiple competing products and services. With so much disruption on the horizon, you shouldn't be putting all your eggs in one basket.
About the authors:
Zaheer Jassat is lead for innovation at financial services provider Santander. Richard Poole is managing partner of innovation and business consultancy Fluxx.