The number of community banks (those with less than $10 billion in assets) shrank 14% between 2010 and late 2014. Why have community banks been disappearing? The same reason that traditional taxi drivers have been struggling over the last few years. Disruption from technology enabled challengers. Even larger financial institutions need to be concerned with this disruption. They too are at risk of losing business to technology enabled challengers.
These challengers follow a common archetype regardless of the industry. Technology enabled challengers look to provide a more convenient and frictionless experience to consumers by reimagining the industry-standard business model. Challengers are able to provide these improved experiences by leveraging consumer technology to provide convenient, low-cost solutions. Today we will examine how Uber disrupted the taxi industry, and why financial services are at risk of disruption.
Uber: A Case Study
What does Uber have in common with FinTech firms? A willingness to disrupt an industry by utilizing innovative technology solutions.
Uber disrupted the taxi industry by using technology solutions to provide a more convenient, lower cost experience to consumers. The taxi industry carried high costs from ownership of vehicles, an inconvenient and inefficient system for hailing rides, and relied on regulation to protect the industry from competition. Uber managed to win a large portion of the market share from traditional taxi drivers. Their rides cost less, arrive faster, and are simply more convenient to use.
Consumers quickly saw the benefits of Uber’s business model. They were attracted to the convenience of ordering a ride from their smartphone, and the fact that ordering an Uber cost less than taking a taxi. Uber is both more convenient and cheaper than a ride in a traditional taxi. Many consumers quickly abandoned taxi rides and began Ubering instead. The marriage of technology and convenience was too much for the taxi industry to compete against. Worldwide, Uber took $6.5 billion of revenue from the taxi industry in 2016 alone.
The financial services industry can learn lessons from what happened to the taxi industry. If banks and other financial service providers do not change their business models, their industry will be disrupted as well.
Similarities in Financial Services
The financial services industry has many things in common with the taxi industry. Some of the biggest similarities that financial services have with the taxi industry are:
- legacy systems,
- a lack of integration with consumer technology,
- reliance on regulatory barriers to protect the industry from competition,
- inconvenient service offerings.
These similarities mean that the banking industry is vulnerable to the same type of disruption that turned the taxi industry on its head.
Consumers want convenient and competitively priced solutions to their problems. Those same factors are important when selecting a financial service provider. There are three main factors that stop financial institutions from offering a solution with those attributes, and they happen to be the similarities that financial services share with the taxi industry.
1. Legacy Systems
Financial services institutions, especially large banks, are known to have outdated legacy systems that hinder the ability to alter or add to their technology suite. These legacy systems have been in place for years and many legacy systems are outdated due to the pace of technological change over the last decade. Outdated and expensive legacy systems represent significant costs to financial institutions. They are one of the primary reasons that the financial services industry is at risk of disruption from FinTech firms.
Legacy systems are a reason that financial institutions cannot offer low-cost, convenient, technology-enabled features to consumers. While features that fully integrate financial services with their everyday devices would be greatly appreciated by consumers, they are difficult for financial services institutions to implement because of legacy technology. The existing technologies already in place simply do not have the capabilities that customers need.
2. Lack of Integration with Consumer Technology
Legacy systems might play a part in preventing FinServ firms from adopting technology solutions that integrate with consumer technology. Regardless, FinServ firms need to integrate their services with consumer technologies. People want to use their smartphone to transfer money or check on a payment. Mobile and online banking is no longer something that adds value, it is now a requirement. The next steps for integrating financial services with consumer technology will be to prepare for virtual assistants, artificial intelligence and a hyper-connected world where the smartphone is central to all the activities in a person’s life.
People want convenience. The best way to provide that is by making your services accessible to those using popular consumer technologies.
3. Reliance on Regulatory Barriers
The financial services industry is one of the most heavily regulated industries on Earth. These regulations increase costs for financial institutions and add steps to a variety of financial services workflows. The additional steps created by compliance can dramatically slow down business processes. Regulations also represent a significant barrier to entry for FinTech firms due to the significant costs associated with maintaining compliance. Some regulatory requirements that limit competition in financial services include minimum capital requirements, multiple points of oversight and particular requirements regarding oversight of information assets. These barriers are difficult for any new challenger to overcome.
Existing financial institutions have relied on these barriers of entry to protect themselves from competition. Without these regulations FinTech firms, challenger banks and other technology companies would be able to enter the financial services industry and compete with traditional financial service providers.
Regulations Won’t Protect Financial Services Forever
As Uber began taking market share from taxi drivers, the taxi drivers pushed back. They called on governments around the world to regulate ride-sharing services. In some jurisdictions, ride-sharing services were regulated by government bodies. In many others, they were not.
Relying on regulation to avoid competition did not work well for the taxi industry. Politicians tasked with regulating ride-sharing services realized the benefits companies, like Uber, bring to consumers, and therefore are unlikely to ban them completely. The same thinking goes for FinTech firms. If a service is a net positive to society, politicians will allow that service to continue. They will remove regulations, opening the industry to new competitors to better service their constituents.
Financial service providers cannot rely on the same regulatory landscape forever. In 2017, the United States government made plans to repeal the Dodd-Frank act, a lynchpin of financial regulation for the past decade.
As FinTech becomes more refined and builds trust with consumers, regulations will inevitably be loosened. If traditional providers of financial services do not prepare to compete head-to-head with these innovative challengers, they may face the same fate that the taxi industry did in their battle with ride-sharing services.
Culture of Innovation
The biggest reason that banks and traditional financial services firms are at risk of disruption is because they lack a culture of innovation.
Financial technology firms were born out of innovation. Innovation is embedded in the fabric of these companies. Their whole purpose was to disrupt the financial services industry through innovation, and to date, they have done an excellent job of achieving that disruption.
To avoid losing market share to disruption from FinTech firms, traditional financial institutions will need to change their culture. They will need to embrace change and be more willing to change their ways. Just because a process has worked for 50 years does not mean that it will work for 50 more.
The taxi industry did not embrace innovation. Ride-sharing services changed the way the industry worked, and it severely affected taxi drivers everywhere. A taxi license used to cost over $1,000,000 in New York City. Today, that cost has dropped to around $600,000. The value of a license has dropped substantially because nearly anybody can become an Uber driver.
Financial Services needs to invest in modern technology solutions or risk disruption from FinTech firms. Be more like Uber and less like the taxi industry. Only adopting a culture of innovation can help financial institutions retain their market share.
Over the course of history, many industries have been disrupted because of technology. The introduction of paper money disrupted finance once already. There is no reason why the industry cannot be disrupted again. The internet and improved methods of communication have disrupted many industries over time, showing that change is inevitable.
Today, technology solutions make industries with seemingly insurmountable barriers to entry accessible to smaller competitors. Finance is no exception. Big banks and other financial institutions should begin to adopt FinTech solutions to get ahead of the competition. As consumers become more comfortable with digital payments, blockchain based ledgers and other innovative technology solutions (including some we have yet to imagine), firms that specialize in these technologies will gain a large competitive advantage. The financial services industry can reduce the threat of disruption by listening to their customers and evolve with their wants and needs.