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Marketplaces in the financial industry - Here to stay?

Marketplaces are hip and trendy on the internet and will likely evolve even more in the near future. In some markets (like food delivery, transportation, commerce, holiday…​) they already represent double digit market shares (e.g. in 2018 $1.86 trillion was spent globally on the top 100 online marketplaces), but for the financial services sector, their impact (even though there are a few unicorn FinTechs in this space) on the industry is still limited.

Any form of intermediation (travel agents, taxi dispatchers…​) will likely be replaced by a modern, digital and more direct equivalent, i.e. a digital marketplace. As the business of banks is exactly the intermediation between people having excess money and people needing money, the financial services sector will be significantly impacted.

Furthermore, marketplaces are strongly intertwined with other concepts like the gig-economy, the sharing-economy and the API-economy. All these trends will ultimately lead to

  • More flexible, short term jobs (gig-economy), e.g. all Uber taxi drivers are independent

  • People owning less assets:

    • Share assets in a user-friendly and controlled way or

    • "Everything as a Service" (e.g. Amazon Prime, Uber Eat subscription…​)

  • Outsourcing all day-to-day household jobs (cleaning, cooking, driving, shopping, groceries…​)

  • limited set of distribution access points on the internet selling items and services from different "Product Factories" (e.g. a very big part of Amazon’s revenues is already made from 3rd party vendors selling their products on the Amazon platform)

All this will impact the financial services sector even more. Especially the rise of Open Banking APIs (currently only in cash accounts and payments space via PSD2, but likely also for other domains in the future) will allow to create marketplaces on top of the financial industry, instead of the current marketplaces, which aim to create a sort of financial system next to the existing one.

But before going into more details about the characteristics and trends of digital marketplaces, it’s probably a good idea to first define, what we understand under the term "digital marketplace" (as this buzz-word has become so overloaded, that there is no unique definition anymore). For me, a "digital marketplace" is a system, which meets below 3 criteria:

  • A platform, i.e. a stand-alone software solution, which is open for users to onboard independent from other software solutions

  • Multi-tenant, i.e. multiple parties can work together on the same application instance, while still respecting certain security/privacy rules, so that not all data is available to anyone

  • A place which brings together multiple parties with different needs(parties which offer something and parties which search something):

    • Minimum 2 party types (consumer & producers) - but more is possible (e.g. broker/intermediary/…​)

    • For each party type there are minimum 2 actors (but usually more).

The most important part in this definition is the fact that it groups X consumers with Y producers. This is where a marketplace deviates from most SaaS software solutions and corporate websites (e.g. internet banking solution of a bank), as typically you only have 1 producer on those platforms.

This double-sided nature of a marketplace gives some interesting dynamics. Where a typical company only needs to grow out its customer base, a marketplace needs to grow out both sides and preferably keep them balanced (otherwise 1 side will be disatisfied and leave the marketplace, after which the other side automatically will leave as well). This means a marketplace typically struggles with a "Chicken and Egg" problem in the beginning, but once passed this point, a marketplace can scale exponentially thanks to its enormous scale/network effects (i.e. not burdened by constraints of conventional transactional businesses like inventory supply and balance sheet). Furthermore, once a marketplace is established, it is enormously sticky and tends to grow to a monopoly.

Other dynamics of a marketplace are:

  • High initial cost (lot of initial capital required) for implementing the platform and getting the critical mass (i.e. high customer acquisition cost)

  • Once operational and critical mass is achieved, very limited capital cost, as inventory is brought by the (external) suppliers

  • Hard to control quality, as quality is not directly under the control of the marketplace, but rather distributed to the different parties acting on the marketplace

  • Hard to avoid that producers and consumers don’t match on the marketplace, but execute outside the marketplace (to avoid any commission linked to the marketplace)

  • Marketplaces need to establish trust between producers and consumers (parties which didn’t interact directly before onboarding on the marketplace). This can be obtained via several mechanisms, like a due diligence during the onboarding process, party rating, reviews, asking collaterals, marketplace providing guarantees and/or insurances…​

  • Marketplaces need to provide autonomous value. This means providing value-added services that benefit producers and consumers beyond the transaction.

Given these dynamics, it is safe to say, that financial service incumbents(banks and insurers) are ideally positioned to build out marketplaces:

  • Banks & insurers have cheap access to capital, required to back the high initial cost of a new marketplace

  • Banks & insurers have a strong brand, which is required to promote a marketplace

  • Banks & insurers have strong trust reputation, providing the necessary trust for consumers and producers to transact

  • Banks & insurers already have a large customer base, allowing to jump-start the platform directly with a critical mass

  • Banks & insurers can profit from a lot of cross-selling opportunitiesfor financial products/services

  • Banks & Insurers have already (multi-lingual) large customer contact centers, which can be used to operate the platform

  • Most products and services linked to the financial services industry are high-value, high-frequency transactions, which is the sweet spot for a marketplace.

The biggest hurdle for the incumbents is however their low agility and low delivery speed. This can be tackled by creating a dedicated team, which has the mandate to be autonomous and flexible (i.e. create a FinTech within the bank/insurer). While it is difficult to create such autonomous teams for the typical projects within a bank/insurer, it is much easier when setting up a new marketplace, thanks to its isolation from the rest of the application architecture. This separation of the existing architecture and processes gives the additional advantage that the marketplace can be easily spinned-off in a later phase, which is a necessity for ensuring the independence of the marketplace and thus the further expansion of the marketplace.

Of course, everything will start with a good idea for a new marketplace in the financial services industry.
Different techniques can be used to find this good idea:

  • Top-down: brainstorming for new ideas of marketplaces. Once ideas are found, evaluate them on their market potential.

  • Bottom-up: build up ideas by searching for markets which meet the target requirements of a successful marketplace or by combining different classification axes for marketplaces (see below).

In both scenarios, we use 2 tools:

  • Evaluating the business potential of a marketplace

  • Classifying a marketplace according to its characteristics (allowing to easily map to comparable marketplaces, so that ideas and components from those similar marketplaces can be harvested)

The evaluation of the business potential is done via 5 axes:

  • Fragmentation of the market: does the market have a lot of small players (i.e. a variety of producers and consumers) or is the market already consolidated to a few large players. The more fragmented the market, the more potential for a successful marketplace.

  • Transparency of the market: is the market transparent, i.e. easy to compare offers of different producers, are prices publicly available, is it easy to understand how pricing calculations are done…​ The more intransparent a market is, the more potential for a successful marketplace.

  • Market size: is there a large market and is this market still growing or already consolidated. Small markets, which are not expected to grow soon, are to be avoided. However, markets which are small now, might be small due to the lack of a digital marketplace.

  • Monetization potential: how easy is it to ask a commission or fee for the service offered by the marketplace and if so, what is the frequency a user will transaction and what is the amount for which he will typically transact. High-frequency, high-value marketplaces are ideal, but as long as 1 of the 2 criteria (i.e. transaction frequency and amount) is "high" a marketplace can be successful. E.g. Uber is a high-frequency, low-value marketplace, but is definitely successful.

  • Existing competition: are there already good digital marketplaces or equivalent offers in the market? Evidently a flooded market should be avoided as well.

The classification of a financial services marketplace can be done via multiple axes:

  • Type of intermediated item

    • Money (asset/liability)

    • Product (a good, including property)

    • Service (a skill)

    • People

    • Data/Information

  • Type of consumer (= investor)

    • Bank

    • Corporate

    • (Physical) Person

  • Type of producer (= issuer/supplier)

    • Bank

    • Corporate

    • (Physical) Person

  • Number of parties actively involved in the transaction (i.e. taking an active decision via a non-automated manual activity)

    • Two (Producer/Consumer)

    • More than 2 (e.g. producer, consumer and broker/dealer)

  • Supply limitations

    • Supply is limited (product catalogue shows the available supply)

    • Supply is virtually unlimited

  • Method for transaction handling

    • Double-commit: both producer and consumer need to manually agree on conditions to transact. Typical example is a job offer marketplace.

    • Buyer-pick: producer enters his offer (with availability) and consumer can transact directly on the offer (e.g. Airbnb)

    • Supplier-pick: consumer posts a request and supplier claims it (e.g. Uber)

Taking the example of P2P lending for Retail customers (i.e. a physical person can lend directly money to another physical person facilitated via the platform), we can evaluate the business potential and classification of this use case:

  • Business potential

    • Fragmentation: medium to high fragmentation, with a lot of players in the lending market (i.e. credit agencies, banks…​)

    • Transparency: market is already quite transparent, i.e. prices are quite similar for different institutions and are publicly available on the internet. Furthermore price visualization is often standardized (e.g. via SECCI in European Union).

    • Market size: the loan market is still growing, but only with a few percent a year. The P2P loan market can however still grow exponentially by cannibalizing the existing credit market, as customers search for higher returns for investments and lower interest rates for financing.

    • Monetization potential: a commission on a sold loan can be easily requested. Furthermore, situated here in a "low frequency, high value" space, the monetization is guaranteed.

    • Existing competition: competition is fierce, as dozens of P2P lending platforms have flooded the market in recent year. E.g. in the peer-to-peer lending space in the UK alone there are over 100 different platforms. Furthermore, incumbent banks are digitalizing their credit origination processes more and more, making the existing financing options also more efficient and user friendly.

  • Classification

    • Type of intermediated item = Money

    • Type of consumer = Physical Person

    • Type of producer = Physical Person

    • Number of parties actively involved in the transaction = Two (Producer/Consumer)

    • Supply limitations = Supply is limited (only customers wanting to lend money)

    • Method for transaction handling = Buyer-pick (investor can subscribe directly to a loan posted on the platform)

As this article aims to demonstrate, the potential for digital marketplaces is enormous, but an initiative in this space is not just another implementation project. A marketplace has very specific dynamics and characteristics, which are very different from traditional software solutions. Careful upfront research before diving in such a project is there essential.

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