The internet, digitalisation and other major changes brought about from technology are rapidly transforming a host of industries, paving the way for new disruptive business models. In the financial services industry these trends are creating modulation on both the supply as the demand side. For customers, increased transparency and choice through a range of platforms allows them to shop around from a wide range of suppliers, while on the supply side, automation is creating room for increased competition, down the line reshaping the industry’s market structure. As a result, around $1 trillion in revenues within the financial services industry is expected to be on the move.
The financial services industry is undergoing considerable upheaval as technology opens up the industry to a range of new competitors and their offerings. FinTech startups are for instance developing a range of services to compete with traditional banking offers (the market is now assessed to be $19 billion globally), while tech giants are leveraging their brands and big data to create new payment offerings, with blockchain technologies earmarked as the main disruptor (assuming scalability issues can be overcome). Incumbents too are finding ways to better satisfy the growing demands of customers, a move which if not successful, may see banks lose billions in revenues.
In a recent report by Oliver Wyman, titled ‘Modular Financial Services: the new shape of the industry’, the consulting firm explores a number of way in which the development of technologies are pushing the financial service industry into an age of ‘modulatory’.
Modulating financial services
Modulatory can abide on both the demand and the supply side of the financial services industry. There is modular demand when customers can easily pick from a range of products or services, with no particular product provider owning a complete relationship with a customer. Modular demand is supported through, for instance, aggregated platforms or comparison websites. On the supply side, modular supply means that some aspect of the product value chain has been outsourced to a third party specialist supplier, with traditional players too able to outsource specialised offerings.
There report highlights a number of reasons why the relationship between customers and financial institutions is being transformed. Some have already taken place, for instance, changes in consumer loyalty to financial institution, which has been eroding since the 1990s, and further, with the development of the internet and its capacity to parse and disseminate a wide range of information, customers now have an effective means to quickly compare vendors. New entrants, such as supermarkets and price comparison sites provided additional means for customers and vendors to successfully enter markets, while a tightening of regulations on competition within financial markets has lowered the barriers to entry for new players.
Further digitalisation has seen consumers turn more than ever to digitalised offerings, placing increasing pressure on banks and their often outmoded forms of engaging customers – particularly FinTech and tech giants are finding ways of better serving customer expectations in various areas. Big data further provides entrants and incumbents deep insights into a variety of market segments allowing for ease of specialisation for targeted offerings, while tighter rules around leverage and capital mean that banks’ hands have become further constrained.
In the coming five to ten years, further changes are expected as consumers’ expectations and needs fail to be met by current providers alone. Consequently, the researchers forecast that the number of platforms offering a range of financial services that meet the needs of different market segments will rise strongly. The development of additional business models, often leveraged from the exploitation of data, is expected to heat up competition for traditional players, while price comparison between the wider ecosystem of players will too see revenue streams on the move as transparency kicks in. In parallel, consumer behaviour will remain in a state of flux, forcing client engagement models across a range of financial matters to adapt.
Many banks currently have ‘legacy systems’ that require considerable upkeep and are difficult to update or replace as they are built on a complex web of systems and interfaces, as well as the need to be constantly on the fly. From an efficiency perspective, the back office also tends to contain a considerable amount of potentially ineffective manual processing. As competition heats up, the need to be efficient and cost effective will increase, placing increased pressure on finance players to transform their back office operations. One way of transforming their operations is, according to Oliver Wyman, through outsourcing a range of activities to specialised suppliers operating business models that sidestep the often complex legacy requirements.
For large financial institutions the risks associated with external parties, from cyber-attacks and other data breaches, may be too high. They will instead need to create their own in-house platforms to compete in the new market, where that platform might itself become something outsourceable to other players. The cost of such developments at the largest institutions may be in the order of $4 billion or more. With returns currently subdued and average dividend payouts for the largest 100 universal banks at $1.7 billion, re-platforming may require banks to suspend dividend payments for one to three years.
On the supply side then, significant changes are expected to the way products are provisioned, becoming more modular as different vendors are engaged across the value chain of businesses to meet specialised demand from customers, while traditional banks create platforms that can be outsourced.
An analysis of the market forces reveals that the impact of modular demand and supply side changes could shift, if not erode, billions in profits from the financial services industry. For the current $2 trillion cost base of banks, a value shift in terms of savings could be achieved of up to $340 billion from re-platforming and up to $50 billion from outsourcing opportunities. In terms of revenues, increased transparency could erode between $150 billion and $300 billion from turnover, while between $150 billion and $250 billion in revenue opportunities could be diverted to new business models. The rise of third-party platforms could result in a value shift of up to $150 billion.