The Bankwatch

Tracking the consumer evolution of financial services

A New Way to View Change | Interaction

Most of us here are of the mind that there is a consequential change going on, and that change is driven by internet. Part of the reason that Banks have issues dealing with internet is that it is viewed as an add-on … a new access channel that is additive to the others such as branches and telephone.

The change is more fundamental however. The way that a company acts, and implements online activities increasingly defines that company, and that includes Banks. In banking language we refer to self service however this is limiting and tends to place internet within the traditional context of banking.

McKinsey have reactivated a 1997 study that is even more pertinent for Banks today, and it reflects the belief that there is a larger more fundamental shift occurring, and it is consequential that it comes from them.

A revolution in interaction | McKinsey 1997

The modern world economy is in the early stages of a profound change in the shape of business activity. Two centuries ago, dramatic shifts in the economics of transformation—of production and transportation—precipitated the Industrial Revolution. An upheaval of equal proportions is about to be triggered by unprecedented changes in the economics of interaction.

Interactions—the searching, coordinating, and monitoring that people and firms do when they exchange goods, services, or ideas—pervade all economies, particularly those of modern developed nations. They account for over a third of economic activity in the United States, for example. More than that, interactions exert a potent but little understood influence on how industries are structured, how firms are organized, and how customers behave. Any major change in their level or nature would trigger a new dynamic in economic activity.

Interactivity is simply defined as the need for interaction between people in order for economic activity to take place.

The article makes the point that interactions account for a large part of economic activity and more than 50% of economic activity within financial services. The relative efficiency of managing interactivity therefore accounts for a significant proportion of the profitability of financial services.

The next step in the logic is that technology will revolutionize interactions, yet company’s have yet to lever that benefit.

The past couple of decades have brought remarkable innovations in these fields, but modern economies have yet to exploit opportunities to increase the quantity and quality of interactions and reduce their cost.

Until now, our ability to manipulate and process data has far outstripped our ability to communicate and interact. However, a number of converging factors are set to change this situation. New networking capabilities, technologies that enhance connectivity and bandwidth, and standards that drive new applications are coming together in an environment of spiraling processing power and deepening technological penetration. This potent combination heralds a new age of abundant interactive capability.

In other words computing power has been levered to transmit and manipulate data. It has not been levered to improve interactions. If we look at the typical bank employee desktop this is abundantly clear. Across the 10’s of thousands of employees at a typical bank it is no exaggeration to note they have limited interaction capability. Web mail and IM are frowned on or in some cases disallowed. MS Exchange / Outlook is available to some, but often only HQ staff, and management and not all front line personnel. In fact as an outcome of typical bank policies and management approach, employee interaction is viewed as a hindrance to customer service. Quite the antithesis of the conclusions in the this McKinsey piece.

There will be new ways to configure business.

New ways to configure business.

Vertical integration will become less valuable and disaggregation, outsourcing, and the use of external markets will increase. Whether a company makes or buys depends on the comparative costs of transformation (production and transportation) and interaction. While outsourcing or purchasing from a market allows buyers to benefit from the superior economics of specialized suppliers, it tends to involve substantial interaction costs. As these costs fall, the relative attractiveness of arm’s-length purchases will rise. ….

In textiles, for example, EDI has allowed players to disaggregate procurement, spinning, weaving, finishing, logistics, and retailing, and contract them out to specialists along the industry chain.

In contrast, horizontal integration and cooperation will become more economically attractive. Horizontal integration brings benefits when carrying out a set of activities jointly rather than separately yields economies of scope in the form of higher returns or lower costs. As falling interaction costs allow companies better to coordinate the marketing and distribution of a wider variety of products and services, the value of horizontal integration should increase.

In practical terms they suggest ways to lever a core competence of interaction:

The strategic value of scale is likely to decline in many industries, although it will rise for networked businesses. In businesses where distribution or logistics originally made scale essential, falling interaction costs will reduce its importance. Outsourcing, alternative delivery channels, and the ability to variablize inputs will grow, reducing fixed costs. As a result, smaller firms will proliferate in such industries as consumer goods manufacturing, applications software, specialty retailing, and design services.

By contrast, in networked businesses, where the number of possible interactions increases exponentially with the addition of each node, interaction efficiency is the key to competitive advantage. As recent acquisitions and mergers in telecommunications, transportation, banking, and mass retailing suggest, scale expansion is likely to take place in such businesses.

And at the most obvious level, it means less supervision necessary,. which means smaller HQ.

In general, there will be a shift toward more networked forms of business configuration. At its simplest, this means that companies will be able to devolve decision making from corporate headquarters as interactions become easier and cheaper.

The punch line. The ease of interaction that is available will produce players that are efficient, and online markets and connections will replace intermediaries. Banks are intermediaries.

Some businesses, like banking, are by definition intermediary in nature. In time, their foundations will be threatened. If electronic cash comes of age, it is difficult to imagine consumers being willing to pay for the high-cost infrastructure they currently have to use when they interact with banks. Similarly, if consumers could obtain information directly from content providers at low cost, many areas of information publishing might lose their distinctive value.

It finishes with predictions about how the direct to consumer model will win and “Digital and Internet-based approaches will provide the next leap forward in the sales and delivery of goods and services. Using the Internet as a transaction channel, customers will be able to obtain a range of goods from wine to winterwear … ”

Relevance to Bankwatch:
This is a refreshing piece and while it states the obvious to many of us it is not obvious to Banks. Banks are stuck in the conundrum of decreasing revenue growth patterns as consumers de-leverage alongside enormous cost infrastructures associated with personnel and physical locations. As has been evident recently there is a shift to close branches, but that is not the answer.

First the Bank must decide what its future business model looks like and it should be an ‘internet first’ model as opposed to a ‘branch first’ model. The design of that new model is crucial. Only then can strategies be designed to get there from the current state.

[update:  this actually fits nicely with the theme of a presentation I have for tomorrow night at Ignite Toronto]

a revolution in interaction.pdf

Written by Colin Henderson

August 24, 2009 at 11:53

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