Build or buy... or build and die
Rather than trying to reinvent themselves as technology companies, banks should curate the best third-party solutions to support what is basically their core competency: client service.
Head of Fintech, Saxo Bank
Like many other sectors of the banking and finance industry, wealth management is facing a stiff challenge from fintech start–ups that are embedding new technology innovations into their services in the hope of usurping incumbents.
These new entrants – some of which are “robo–advisors” moving up the value chain from their roots in retail financial advisory services – offer a number of potential benefits. The APIs, algorithms and big data analytics that are integral to fintech firms’ highly automated value propositions can offer greater scale and improved customisation at lower cost than traditional wealth management models.
The question is do these companies represent a great leap forward to a new digital experience paradigm that could sweep away the old order? Or are they just bringing more commoditisation to an industry that is already suffering from compressed margins and profitability in the digital age?
If it is the latter and robo–advice brings about more commoditisation then incumbents can make defensive but strategic acquisitions and let the competition die out. If it is the former, the incumbents have an entirely different battle to face – which is the stacked versus platform business model dichotomy.
The full stack business is where the complete supply chain is owned from R&D to marketing, with a proprietary distribution system, as well as a complete sales vertical – these businesses are highly profitable but expensive to maintain and hard to scale. On the other hand, the platform business sits on top of a vast supply system, with its own digital relationship with the user. They can offer an exponential upside by avoiding vast supply costs and finding new ways to monetise their users’ attention. If we use examples from other industries as leading indicators to the future we believe the platform business model will win out in the end.
For some, it may be surprising that tech–savvy start–ups are targeting the high–touch, gilt–edged world of wealth management, where human relationships and highly personalised service levels have evolved over generations. But the digital revolution has impacted the daily lives – and customer service expectations – of high net worth individuals just as much as less affluent retail banking clients. Whether buying the week’s shopping or booking a night at the opera, digital technologies can be integral to the efficient delivery of high–touch experiences.
Across many industries, a key feature of this digital revolution has been the growth of business models that rely on service aggregation to build a superior user experience, rather than wringing more value from owned assets by offering an ever widening range of products and services. In short an enormous amount of value has been generated by companies that build the layer (i.e. the user experience or digital relationship) that sits on top of a vast system of suppliers (the products and services of others). This shift from owning assets to leveraging them has transformed large swathes of the entertainment, hotel and transport sectors; and is now finding an echo in banking.
The digitisation of banking is being driven by several technology innovations. In particular, the open banking architecture that is being developed through the increasing deployment of APIs enabling service providers – both incumbents and new entrants – to create “best of breed” value propositions that draw on the services of multiple third parties. APIs enable this to be done, creating better cost–effectiveness, greater agility and more flexibly than under previous forms of interoperability; equally important is that the end result is more seamless, personable and user–friendly from the user’s perspective.
How might open banking change wealth management? Like other financial services providers, wealth managers already augment their own expertise and skills with those of other firms, for example, performance analytics specialists, execution brokers and custodian banks. These supplementary services are typically subject to complex agreements that may take time to upgrade or replace, or may involve multiple suppliers across geographies and client segments.
Because APIs enable third parties to access each others’ systems and platforms more easily, wealth managers have new opportunities to select and regularly review the value derived from the various supporting building blocks on which they construct their own proposition to customers. This increasingly important form of unbundling and re–bundling is a critical differentiator between simply iteratively “improving” a product/service or fundamentally “changing” the establishment for the better with a completely new re–bundled proposition.
Smart use of APIs is a big part of the fintech challenge to incumbents, but is it enough to see wealth management clients shift their assets? Not yet it seems; there is little evidence to suggest a significant movement away from traditional providers. As such, wealth managers are not scrambling to defend their turf by bringing out new user–friendly apps, backed by a select roster of market–leading partners.
But technology–enabled competition from nimble fintechs is not the only factor encouraging wealth managers to adopt open banking. New regulations such as MiFID II are demanding greater levels of transparency in the interests of investor protection and value. Over time, inducements, cross–subsidisation and bundling will have to be replaced by clearly costed services that add value on a standalone basis.
In parallel, the margin compression being experienced by all service providers in a low–rate, low–return, low–growth environment requires an unrelenting focus on the bottom line, with banks pursuing cost reductions wherever possible. Both regulatory and macroeconomic drivers will force wealth managers and private banks to be more rigorous in how they select partners; APIs will enable them to bring together the best overall package to their end–users, delivered digitally for the best possible, highly personalised user experience.
Fintechs might have shown a glimpse of the future with their flexible, low–cost, customer–focused apps, but are they a real threat to the well–heeled, well established world of wealth management? Time will tell, but there are good arguments for suggesting that fast–moving incumbents could be better placed to wield the power of technology innovation to grab greater market share.