Apple, Alibaba, Google and Tencent are all moving into payments. Alibaba is also moving into consumer loans and small business loans. How should banks react to the tech giants muscling into their industry?
First it is important to understand the difference between Apple, Google and co, and banks. The name “tech giants” highlights that they tend to use much more advanced technology than banks, which mostly struggle with a complex landscape of legacy IT systems,
often centred on mainframes. Sometimes the success of tech giants is attributed to SMAC – Social, Mobile, Analytics and Cloud. But the technology difference is far less important than the difference in business models. While banks are traditional product companies,
Apple, Google and co are platform companies.
There is a radical difference between the two. A product company sells its own products, so the value of the company is roughly proportional to the number of customers. By contrast, a platform company leverages value created by its users, so its value is
proportional to the square of the number of users. This network effect means that large networks attract even more users, and can drive a “winner takes all” scenario.
While some platforms such as Facebook are “one sided” – all users play a similar role – other platforms are “two-sided”, where users play different roles – for example, eBay users can be buyers or sellers. This gives platform businesses the ability to cross-subsidise,
and even offer services for free to one group, because they are making money from the other group. This makes life impossible for traditional product businesses who are trying to sell similar products to the subsidised group – the platform will win every time.
One final observation is that platforms have a “core interaction” involving participants (producers and consumers), value units (the goods or services on offer), and a filter (the ability to match the consumers to the relevant producers). Platforms do not
create value, they are information factories. There are various approaches to monetizing a platform, and one of the most common is for the platform to charge a fee on each completed transaction. Hence it is vital to keep payments on-platform to track them
and calculate fees.
Moving now to the specific question about banks and payments. When consumers want to make a payment on a platform, banks are at a big disadvantage because the payment forms part of the core interaction, so a wise platform owner is going to make the payment
as seamless as possible. The classic example of this is Amazon one-click.
However, one-click simply provides a slick UI to an underlying card payment, and the card is operated by the consumer's bank, and the bank still makes a profit out of each payment. Even Apple Pay uses bank cards in their wallet, so banks still make a profit
(though Apple uses its dominant market position to squeeze bank fees to a minimum). A more threatening model is Apple's iTunes, where the payment is made from an underlying stored value account, and the consumer's bank is not involved at all.
As soon as we look at off-platform payments, especially at physical point of sales, platforms do not have such an advantage. Apple Pay is still only used by 3% of
eligible transactions. Most consumers see no advantage in ease of use, speed at checkout, security or convenience compared with paying by bank card.
In terms of information, banks are much better placed because they see all of a customer's transaction history, while the platform provider sees only on-platform transactions. Nevertheless, the platform companies have leveraged this information better than
banks; for example Square offer small business loans based on their knowledge of the borrower’s historical cash flow,
and take repayments automatically from the revenues flowing across the platform.
So how can banks respond to these platform competitors? In the short term many will continue with their traditional strategy models, relying on barriers to entry such as heavy regulation to protect them from newcomers. This will provide some temporary protection
because banking is a very heavily regulated industry, which is one of the contra-indications for moving from a pipeline to a platform model.
Others are partnering with FinTechs in the mistaken belief that access to newer technology will enable them to compete against the platforms. As we’ve seen, the technology is not the determining factor.
In the longer term, banks will have to build bridges to platforms and play a role in their ecosystem. Possible roles are:
- Become a "producer" on one or more platforms. This leverages the insight that it's better to have 5% of a 1bn industry than 100% of a 1M industry. A platform that can expose your products to hundreds of millions of consumers could drive more profit than
selling your products to your existing relatively small customer base. Bear in mind that in this situation you will only be one among many producers offering financial services on the platform. Plus, this model is much more suited to high value services such
as loans, rather than low-value, low-margin products such as payments.
- A better solution for payments is to become a partner to an existing large platform. A bank with connections to global payment networks is an attractive partner to a global platform, which is unlikely to want to build that functionality themselves - it's
"plumbing" that just has to work, allowing the platform to focus on enhancing the core interaction.
It's also important to remember that Visa, Mastercard and SWIFT are already strong platforms in their own right, with a single sponsor (the payment network that sets the rules and owns the payment network) and multiple providers (the banks that issue Visa
and Mastercards to their customers). Banks should reconceptualise these networks as platforms, and apply platform strategies to leveraging them.