The Business Models of Tomorrow

All too often, a successful new business model becomes the business model for companies not creative enough to invent their own. – Gary Hamel; Leading the Revolution: How to Thrive in Turbulent Times by Making Innovation a Way of Life?

Let us address the elephant in the room – most existing business models in banks today will soon be irrelevant. But banks, as businesses, must earn money to keep moving forward. Most of them do not have deep pockets like Uber or are not as disruptive as Open AI to have investors chasing them. They are ‘everyday enterprises’ – can’t take a risk, need to be stable, and must make money.??

But things have not been easy for banks in recent years. Before the global financial crisis of 2008, banks were making record profits, but the post-crisis life has not been as kind. While profits have been steady in recent years, they have certainly plummeted from the highs of mid-2000s. And digital disruptors have made things tougher by proactively attacking the banks in the areas that really matter.??

In fact, a research by McKinsey indicates that 59% of the banks’ profits come from pure fee products, such as advice or payments. As does the origination, sales, and distribution component of balance-sheet products, like loans or deposits. The remaining 41% comes from balance sheet provisioning such as loans. Return on equity (ROE) on the pure fee products average was at an attractive 22%. But the balance sheet provisions, and fulfilment component of products had an average ROE of just 6%. The new age competition is exploiting this mismatch in the bank’s business model. Many of the challengers hope to disintermediate the relationships that banks have with customers. They intend to slice off the higher-ROE segments of the banking value chain in origination and sales, leaving banks with the basics of asset and liability management. And they intend to do this by offering targeted and more convenient services that are also very seamless in nature. Apart from this attack from new-age competitors, banks are also facing a host of other challenges — evolving regulatory changes are leading to higher costs and low interest rates. And compliance costs are constraining banks’ profitability. Further, customer needs and behavior are evolving, and unregulated competitors offer customers an easier access to new and alternate sources of funding.?

But all hope is not lost for the traditional banking sector.? Banks are undergoing a period of transition, and to navigate this successfully, they must answer five questions related to their business models.??

Question 1 – Where will the bank of tomorrow operate in the value chain??

The banking industry’s value chain starts from the point of raising of funds from the industry and runs all the way to the customer. The bank of today operates across the entire value chain. The bank of tomorrow will have to realize that it will not be easy to be a universal bank and take care of all aspects across the value chain. The bank of tomorrow will have to give up something to achieve something.??

The possible options for the bank of tomorrow are the following:?

1. The bank of tomorrow can focus on providing the best products and services to its customers by managing just the entire product lifecycle.? Financial management, business support, advisory, sales, and associated operations can be handled by partners. This is a fundamental part of following a platform-based business model.??

1. The bank of tomorrow can focus on selling different financial management products and services to potential customers. In this option, the financial management partners will handle business support, advisory, associated operations and product management functions. This is even closer to a platform-based model and will help the banks become customer owners. The key element that will help banks become customer owners is the large amount of trust that they have built over the years.??

1. Banks can provide financial management services to its customers while the business support, advisory, sales, and product management functions are handled by partners.??

1. Banks can focus on providing strategy and advisory services to clients while the partners can focus on other components of the value chain.??

Banks can choose one or a combination of multiple value chain components. It is also important to note that there may be negative impact on revenues in the short term. But the banks of tomorrow must consider it as a necessary surgical procedure to ensure longevity.??

Question 2 – Will the bank become a customer owner or a service provider??

Once the bank decides on where it wants to play in the value chain, they must find an answer to the million-dollar question – do they want to become a customer owner, or do want to become a service provider? If the banks want to become customer owners, they need to focus on their core capabilities, i.e., creating and selling the best products and services for their customers and depend on partners for the rest. To reduce the impact on revenue and to integrate further in their customers lives, banks must move beyond traditional banking services.??

For banks globally, the shift towards becoming a customer owner will be tough, especially after several years of being a total service provider. In such cases, they can create separate entities.? This will include a customer owner entity and several service provider entities and each of the entities can do what is best for them. This will also help global banks obtain more control over their entire value chain.?????

But there are more questions that banks must ask themselves. In the next edition, we will look at three more questions that the banks of today must ask themselves to be ready to adopt the business models of tomorrow.?

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