Why the Traditional Business Model for Banks Is Dead

By Michael Goodman

In 2016, leaders in the financial services industry felt pretty good about their future. While digital forces roiled other industries, life in financial services seemed well protected against the chaos. Incumbents had cemented relationships with large customers over decades, vertically integrated business models insulated them from external shocks and banking regulations erected difficult-to-overcome barriers for new competitors.

In a 2016 survey of bankers, only 7 percent saw fintechs as a definite threat and just 15 percent thought they would invest in a modernization effort over the next three years. Three years later, banking and financial services executives are no longer feeling comfortable, as the results of new research reveals.

The digital tide they thought they were escaping is now rolling onto the beach in the form of rising customer expectations, unexpected competition and the evolution of the platform economy — all driven by digital technology.

This new level of industry competition hasn’t been spearheaded by established financial giants, but rather by retail and technology innovators such as Amazon, Apple, Facebook and Google. Their strategic weapon of choice is the Digital Business Platform (DBP).

Inside a friction-free, easy-to-use, mobile-accessible environment, a DBP can introduce consumers to a wide range of personalized goods and services, many of which are not even created by the platform owner. Platform businesses are anything but the traditional banking model of vertically integrated, full-service products sold through branch offices. Instead, platform participants and partners operate in concert to provide consumers with unique value 24×7.

The industry is at an inflection point for change, and the stakes have never been higher for traditional financial services institutions to evolve their business models to engage customers and partners to maintain clients and generate new business.

Market forces driving change

In the recently released research, the top three market forces global respondents identified — new technologies, increasing competition and changing customer behavior — each have a digital component, and are impacting the way the industry must operate. To compete effectively in the changing market and keep up with rising customer expectations, 53 percent of respondents indicated they must better leverage new technology. Artificial intelligence, machine learning, blockchain and the internet of things are making new agile business models possible.

Financial services institutions must adopt and integrate digital technologies with their legacy core systems in order to work with partners both inside and outside the financial services industry.

These technologies also enable new, more agile business models, lower the cost of prediction, create more data-driven insights, support quick hyper-segmentation and hyper-personalization, and inform a strategy around hyper-customization of products.

In addition to new digital technologies, 46 percent of executives are concerned about the competitive threat from new entrants: fintechs and technology giants. For a long time, the industry believed tech startups couldn’t challenge traditional financial institutions. The incumbents were too big, too entrenched with their customers and the industry too regulated. But over the last three years we have seen a major shift in attitude, as the industry has been forced to respond to the success of their new tech competitors.

While better leveraging new technologies and staying ahead of competitors is of high concern for executives, another 44 percent indicated shifting customer behaviors and demands are of paramount importance. Consumers are on the go more than ever — but they aren’t going to bank branches or brokerage offices. Instead, they want to interact with financial services providers in the same way they do business with retailers and other businesses: via the internet and, increasingly, using smartphones. Consumers now expect the same level of ease of use, personalization and guidance they encounter from other platform-based businesses. They are already accustomed to using mobile apps to get a ride from Uber, booking a flight through Expedia and ordering flowers for same-day delivery with ProFlowers.

Comfortable or not, leading financial services institutions are beginning to respond to these disruptive forces from platform competitors. A full 61 percent of respondents said their institution is moving away from the traditional business model of being a full-service provider that serves customers only their own products.

With a traditional business model, banks own and operate a vertically integrated value chain that includes manufacturing and distribution as well as sales and service and holds a fixed cost structure. Fintech firms, on the other hand, have brand new business models that avoid the expenses associated with physical buildings and layers of technology infrastructure. This allows them to build financial products and services that cater to mobile-first customers who demand self-service offerings at competitive prices.

The path forward

For decades, banks have been wedded to complex, outdated legacy core systems. Replacing these systems is not only costly but high-risk for the business, much riskier than simply maintaining old iron. That’s why many banks and carriers have not even considered wholesale replacement of core systems, and as if they needed further encouragement to patch rather than replace, numerous case studies demonstrate lengthy replacement projects that failed to launch.

However, the research shows nine in 10 survey respondents said the time is now for transformational digital change — fundamental change, not just investing in digital bits and pieces. But the less than good news is that these companies feel locked into legacy core technology that is not platform friendly.

How can FIs compete effectively in this dynamic market and keep up with rising customer expectations? Enter Digital Business Platforms and partner ecosystems. A DBP is a business framework that allows multiple business models to be built and supported on a single technical framework. A digital partner ecosystem is a set of businesses interacting in a shared market for products and/or services.

The Digital Business Platform is the holy grail — the solution to leverage core and distribution systems for success in a digital world. DBPs enable the financial services industry to keep pace with how customers and partners want to interact, increasing business demand for newer products and services. By creating a DBP and participating in digital partner ecosystems, banks and financial services organizations can work with fintechs to incorporate new digital technologies, leverage application programming interfaces (APIs) and share customer data.

DBPs can give firms the ability to adapt and launch new products quickly, while also keeping up with customer demand for better service and customization. Additionally, the DBP infrastructure manages the secure exchange of customer data, oversees authentication and authorization and ensures compliance with regulations. The best part is DBPs allow institutions to shift their business models without having to undergo risky, wholesale replacement of their legacy IT systems. DBPs also provide more sophisticated capabilities required to manage the data flowing between partners so that privacy and security are maintained. Executives are acutely aware of the need to maintain the trust and the business of their existing clients while they grow market share.  These days, privacy and security are core requirements of that strategy.

Maintaining relevance

The industry recognizes it is at an inflection point for fundamental digital change. The results of the research also suggest a powerful opportunity for the industry to improve its business strategy in the face of intensifying competition and ever-increasing customer expectations. However, the opportunity for incumbents to go on offense and commit to profound and powerful transformation has a limited window before technology giants choose to enter the financial services industry — as they have already begun with Apple’s new credit card and Facebook’s cryptocurrency Libra.

The results of a DBP benefit all stakeholders: fintechs would gain better access to the mass market; customers would enjoy a transformed, personalized experience under the protection of the regulated industry; and traditional institutions would have access to new revenue streams while maintaining their relevance in this era of digital disruption. The alternative scenario for the financial services industry is attempting to maintain their vertically integrated businesses on aging technology, which in this dynamic environment is becoming less appealing and less profitable by the day. Leaders of the past who will not change will be in decline; new leaders will be on the upswing, and the strongest brands of all will be those with the strongest partners. Which side will you be on?

Michael Goodman has spent his career devoted to understanding, managing and advancing the components of modern corporate infrastructures, including data, analytics, organization, process and technology. As vice president, Goodman leads both the Data & Analytics and the FSI Technology Advisory Practices at NTT DATA Services, a top 10 global IT services provider, focusing on Financial Services and Insurance where professionals bring a mix of analytics, data, technology, process, financial institution, vendor, and consulting experiences to each client in our effort optimize value. He also defines the key focus areas for each practice and leads related R&D and thought leadership efforts.

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