Digital disruption, or the use of digital technologies and business models to improve business performance, has the potential to overturn incumbents and reshape markets faster than perhaps any force in history. That may sound bold, but we’ve seen it before. In the mobile industry, Apple and Android devastated the pre-smartphone brands such as Nokia, Blackberry and Palm. Now, digital disruption is poised to have a tremendous impact on the financial services industry over the next five years. Yes, by 2020.
Recent research conducted by Cisco and IMD, one of the top-ranked business schools in the world, estimates that four out of today’s top 10 financial services incumbents (in terms of market share) will be displaced by digital disruption within the next five years. Forty-five percent of the financial services executives surveyed for the research believe that digital disruption “somewhat” or “significantly” increases their risk of going out of business altogether.
It’s clear that digital disruption will cause new leaders to emerge in the financial services industry and the institutions known as leaders today may become laggards or disappear altogether if they fail to evolve. Connected mobile, social, Internet of Things (IoT) and analytics technologies can be highly disruptive to all industries – especially when at the center of digital business models.
The difference between digital disruption and traditional competitive dynamics comes down to two main factors: the velocity of change and the high stakes involved. Digital disruptors innovate rapidly, and then use their innovations to gain market share and scale far faster than challengers who are still clinging to legacy business models. The smaller, more nimble FinTech startups that have all-digital business models are able to create value by unbundling bank services – without having to reproduce the conventional value chain. They can also avoid the capital investments, regulatory requirements and other impediments that incumbents and traditional banks must deal with. Examples include TransferWise (money transfers), Prosper (peer- to-peer lending), Privlo (mortgages) and Covestor (investing).
Incumbents’ strengths, such as advantage of scale, are no longer a compelling defense against the speed and high stakes of digital disruption – especially when the advantages are only applied to legacy models.
For traditional financial services firms to succeed in the digital era, they must adopt the characteristic advantages of start-ups, including innovation, agility, and experimentation. Yet, alarmingly, too many firms are reacting to the threat too slowly, or not at all, according to our recent research. In fact, one-third of financial services companies in our study either do not acknowledge the risk of digital disruption, or have not addressed it sufficiently. Forty-one percent are taking a “wait and see” approach, in hopes of emulating successful competitors. Only 27% have a plan and are willing to disrupt themselves in order to compete.
So, how can banks and financial services incumbents prepare for, and take full advantage of, this digital disruption? Digital business transformation can take many forms and smart transformation requires prioritization. Financial services firms should begin by identifying and prioritizing the areas of their business that are ripe for digital transformation. They can do this by questioning their posture in the following areas:
Business Model.What are our routes to market? Where does most of our revenue and profit come from today? How are we differentiated from our competition? What are our digital ambitions?
People.How digitally savvy are our leaders and employees across different parts of our organization? What new capabilities are required? How will we acquire them?
Processes.To what extent are our processes automated and digitized? Are they consistent across our organization? To what extent are our processes adaptable to change? What are the inhibitors?
Information Technology (IT) Capability.How effective is our IT infrastructure in terms of core systems, networks and databases? Is our IT infrastructure able to support our digital ambitions? How effective is our forward-facing IT, such as websites, mobile sites and social media? How effective is our customer relationship management system? Do we have a clear IT strategy linked to our corporate strategy? Are our “dark assets” connected so we have the data we need? Are we deriving value from our data? What shadow IT activity is going on today and in planning?
Offerings.How digitally enabled are our products and services?
Engagement Model.How strong is our relationship with customers? How many customer touch points do we have (i.e. website, mobile, mail, face-to-face)? How often do we engage with customers? How loyal are our customers? Have we mapped key customer journeys so we see their experience interacting with us?
By answering these questions, financial institutions can begin to develop a roadmap of transformation needs and evaluate which technologies and digital processes should be adopted. While the technologies associated with digital transformation are not fixed and can vary over time, the following technologies are currently most significantly associated with digital business transformation:
Analytics tools and applications, including “big data,” location-based services, video analytics and context-aware marketing offers;
Mobile tools and applications;
Secure platforms upon which to build shareable digital capabilities, such as internal, external and hybrid cloud solutions and app marketplaces;
Social media tools and applications;
The Internet of Things, including connected devices and “smart” networks.
Together these technologies form the Internet of Everything (IoE) and can be used to create profound performance improvements in businesses. Once an institution has a clear idea of where digital transformation is needed, what technologies are required and in what order it should be tackled, they must next identify how to enact this transformation.
Digital disruptors are dangerous to legacy market leaders because they create new business models that deliver greater value to customers at lower costs while delivering an exceptional customer experience. They can make the offerings from incumbents immediately appear less desirable or even obsolete in the eyes of consumers. Financial institutions can compete, and even thrive, in this new market by leveraging digital technologies to deliver greater value to customers in these two areas:
Cost Value. This is the area where the competitive effects of digital disruption are most acutely felt. Disruptors employ a multiplicity of strategies to lower the cost of a product or service for the end customer. For example, all-digital wealth management firms like Wealthfront and Betterment are able to offer lower cost services by leveraging big data analytics, robo-advisors and razor-thin cost margins. Betterment may have $2 billion in assets under management today and a growth rate of more than 100% year-over-year, but amazingly they are able do this with less than 100 people and cloud-based IT infrastructure. Where traditional firms may expect 1% to 3% fees on assets under management, Betterment can offer its services at a flat 0.15% annual rate!
Traditional wealth management firms must introduce new services that cut internal costs and consolidate, automate and modernize their IT infrastructure and applications so they can operate more nimbly and on a thinner cost structure.
Experience Value. Providing a better “experience value” – offering customers more convenience, context, and control – has been central to the rapid ascent of many of today’s most disruptive companies. As with cost value, experience value increases as offerings are digitized because what was solely physical and indivisible can now be partitioned into only the units that customers want, then delivered instantly to any device or location.
Disruptors that unbundle incumbents’ offerings give customers the power to select and pay for only the products or services they value, discarding the “bundled” elements they do not want (and that drive up the price). “Unbundlers” also attack incumbents, such as large financial institutions, by aggregating services. Virtualization allows niche players to provide these services through digital channels, with more personalization, and at a lower cost (even for free). This unbundling has banks scrambling to maintain the most profitable parts of their business, such as wealth management and mortgage banking, which are rapidly being attacked by disruptors.
By leveraging the disruptive power of the digital technologies listed above and transforming their business processes, financial institutions are in excellent position to create new opportunities for innovation and deliver greater value to customers. This will help financial institutions ensure that they do not become one of the four out of 10 institutions who are put out of business by digital disruption in the next five years – allowing them to not only compete with new digital disruptors but even thrive in this new market.
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