The Business Models of Tomorrow - Part 2
SunTec Business Solutions
Our vision is to enable every value exchange in the digitally driven world.
This edition is a continuation to the newsletter on ''The Business Models of Tomorrow'' published in February, 2024. You can read the first part here.
Will the bank of tomorrow continue to be a universal bank or will it focus on one part of the value chain? Will it become a customer owner or a pure-play service provider??
According to Chris Skinner, there are two key considerations that banks must make before choosing a business model – profitability and scope of services.
While profits are a key driver for any business, banks will have to decide how much is too much. For example, Apple produces iPhones for which the profit margins are very high, driven by the aspiration factor as well as the company’s decision to promote the iPhone as a premium phone. Other phones cannot be compared to the iPhone primarily because of the change in the operating system. But Redmi phones do not focus on that high a profit margin as they aim for volume of business. Similarly, banks must decide whether they want to focus on high or moderate margins. But they must also note that high margins will attract more competitors.???
Likewise, they must focus on the scope of services. They must decide whether they want to have a larger scope or limit their scope to becoming just aggregators.??
With these factors in mind, here are various business models for banks to consider:?
Option 1: Be a universal bank and own the entire value chain?
A universal bank provides a complete set of services to their clients. By choosing to become a universal bank that owns the entire value chain, the bank will not change their existing business model significantly. The bank must understand that profitability will be limited in such a scenario. While the scope of services will certainly be high, this will also leave the bank open to disruptions across their value chain. A universal bank will have to sacrifice some of their agility and will also be limited by their legacy software.??
If banks choose to follow this model, the key will be to rapidly digitize their processes. This will be very challenging, and the bank will have to accept the fact that the chances of failure will be very high.??
Option 2: Become a product leader or opt for Product-as-a-Service (PaaS)?
In this model, banks will do what they know best. They will focus on designing and building products that will help other organizations deliver value to their customers.??
A bank that focuses on becoming a true product leader will be able to charge a strong premium in the market. This will also help them use better technology to create products faster. The benefits that such banks can provide to their clients is faster time to market and increased hyper personalization.??
This model offers only a limited scope of services while providing the chances of a very high margin. Banks choosing this model will have to keep their eyes open for digital disruptors at every point in time.??
Option 3: Become the facilitator of transactions or Transaction-as-a-Service (TaaS)?
This model is like what MasterCard and Visa do these days. This model is appropriate for banks that realize that their strength lies in monitoring, managing, and facilitating transactions. They can use their existing infrastructure to host transactions that other financial service providers make on behalf of their customers. Let us call this as TaaS or Transaction-as-a-Service.??
The rise of cloud-based infrastructure models will certainly help such banks create sustained business value. But they must be cognizant that profit margins will be very low as other organizations that leverage this service will not want to spend a lot on transaction management.??
Option 4: Become an infrastructure provider or a Banking-as-a-Service (BaaS)?
As Chris Skinner points out in his blog, banks can become infrastructure providers. This is what companies like Solaris do – they enable business to offer financial services through their API-accessible banking platform.
Banking experts call this model as Banking-as-a-Service or BaaS. This will help other organizations to focus on providing a superlative customer experience and not worry about aspects like regulatory compliance or other associated complications.??
To make this model successful, the bank will have to achieve significant economies of scale as there will be significant fixed costs. But it is very tough to create differentiation in this model apart from improving the performance and non-performance indices of different components of the infrastructure that will be provided.??
Option 5: Become a trusted advisor and a digital aggregator?
In this model, the bank can focus on becoming a trusted advisor by leveraging their excellent financial know-how built over several years. They can also sell different products that they have aggregated from different financial service providers.??
This model will certainly limit the scope of services.? But it will help the bank increase their specialization focus and if done right, will also enable them to create a premium for their services.??
As an aggregator the bank sits in the middle between the users and the product manufacturers and service providers. The product manufacturers and service providers connect with users through the bank (the aggregator). The model illustration (Fig. 1) showcases this concept.?
In this model, neither are banks focused on designing and building products nor are they creating infrastructure to manage these services. They are focused on sourcing different financial products and services from an ecosystem of partners and providing their customers with access to the same. It can be compared to a basic financial marketplace.??
Banks can either charge the customer or the seller a fee based on a purchase or transaction.??
For a long time, technology and regulatory constraints were key challenges to operating such a model. With the proliferation of big data analytics and artificial intelligence, and with the introduction of regulatory compliance such as PSD2, such a model is now feasible.??
Not only do customers benefit from such a model, but producers too do not have to worry about customer reach as they get access to customers easily.??
The aggregator can connect with millions of customers and help them achieve economies of scale. This will also help them achieve an increased profit margin.? But the scope of services is a question to ponder over as the aggregators will have limited choices if a wider spectrum of products and service providers do not become part of the ecosystem.???
Banks will have to keep in mind that an increased profit margin and reduced scope of services will leave the door open to a lot of competitors. Banks choosing this model will have to focus on continuous innovation to stay ahead of the market.??
Option 6: Become an end-to-end platform or Banking-as-a-Platform (BaaP)?
Banks have certain inherent advantages. This includes enormous customer trust, understanding of the market, the know how to design and build financial products and services, and the strength of a long customer relationship. Becoming an aggregator will certainly offset many of these advantages.?
It is important to understand the difference between a platform and an aggregator. An aggregator sits in between the product manufacturer and customers. In a platform model, the platform is the foundation on which the customers and service providers connect with each other. Google is an aggregator while Android and Microsoft are platforms.
Becoming a vertically integrated, open platform will help banks to take advantage of their inherent strengths as well as offer superior customer experience through a plethora of service providers.??
By becoming platforms, banks can ensure better delivery of the products and services as compared to the aggregator model.??
The platform model will also help banks obtain a superior profit margin by achieving both economies of scale and economies of scope. It will also enable banks to play across an increased scope. More scope means that the barriers of entry will be high.??
The platform model will also deliver one key advantage – network effects. The aggregator model will not provide network effects in a large scale. But in the platform model, network effects will help the bank reach an exponentially large number of customers. As Chris Skinner points out, ‘firstly, there are the two-sided network effects whereby larger customer numbers leads to a larger number of ecosystem partners which then, by offering the widest choice, attracts more customers and so on. But there are also the data network effects, whereby the bank learns more about how best to serve customers the more data it captures meaning it gives better and better services, attracting more data and so on. If the bank also opens its platform for customer interactions with each other – with peers giving advice to each other, for example – then there are also interaction network effects enjoyed by the social network platforms.
Share your thoughts in the comments on which business model you believe is most effective for the banks of the future.?
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