American Banker

Rebuilding Banking Piecemeal, on Web

Charles Farkas and Bob Bechek draw an analogy between the game of Jenga and e-commerce companies.

글 Charles M. Farkas and Bob Bechek

First published on 5월 28, 1999
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The game of Jenga, which takes its name from the Swahili word for construction, challenges each player to remove as many blocks as possible from a cross-hatched tower of wooden beams, then to use the removed blocks to build additional stories, all without causing the tower to crash. The game being about both disassembly and reassembly, it provides a fitting analogy for the way electronic commerce companies are currently plucking out key blocks from the business complex of financial services and moving them on-line. The key question, in the Jenga-like context: Will such activity destabilize the financial industry as we know it? The answer: Absolutely, and the winners, as in the game of Jenga, will be those who achieve new levels of reconstruction. To understand the loose blocks in financial services today, first think about this diverse sector's varied products, services, channels, and customers. Second, think about the sector's value chain, including everything from customer acquisition to product and service design, product and service structuring, risk-holding, distribution, and servicing. Many pieces of the business mix or segments of the value chain could come loose and find new homes on the Internet, much as traditional print classified ads and job listings have found a solid niche in cyberspace. The Internet auction site eBay, which has spurred competition from the likes of Amazon.com, fairmarket.com, and others, initially felt like a minor irritant to newspaper publishers and owners. But it has become a high-volume, worldwide competitor, attracting advertisers who might otherwise stick with newsprint, because of low prices, geographic reach, and personalized, albeit virtual, customer service. eBay has plucked off several customer segments: multiple-region advertisers, price-sensitive advertisers, and do-it-yourselfers who want to virtually "typeset" their copy. It also covers a vast geography: the world. Yet eBay has not crashed the value chain in classified advertising. You still need sellers, products, information, and buyers. But eBay has dismantled classifieds from their position as one of the revenue blocks that fuel newspaper publishing and moved that block to the Internet. Instead of thinking about how a whole business could be done differently, financial services companies should think about how pieces of their business could be safely removed from the Jenga of the industry and rebuilt on the Internet. The pieces most vulnerable to removal will be those where the profit pool is deepest, where information is the service, or, one level deeper, where complexity of information is woven into product options. Take, for instance, stock trading, which is dominated by major brokerage houses, or bulge-bracket firms such as Merrill Lynch. Here the profit pool is relatively deep, with trading fees fixed relative to shares traded, not stock-price performance. On-line trading operations led by Schwab, Waterhouse, E-Trade, and Datek are already plucking off the customer segment of "active traders," particularly those focused on Internet stocks, by offering convenient, discounted service. In April, Merrill and other big brokers counterattacked, announcing they would offer some on-line trading at more competitive rates. Electronic Crossing Networks, or ECNs, such as Island, Instinet, and Archipelago, are creating communities of buyers and sellers of large volumes of securities. They are poised to gain an even weightier customer segment: block traders. The ECNs have grown rapidly because of their connections to the on-line brokers, their ability to facilitate after-hours trading, and their low pricing. These very attributes will allow them to compete successfully for the profitable business of anonymous block trades, once easy profit for bulge-bracket firms that charged institutional customers a premium to "leak" their shares on the market. Now the institutions themselves can anonymously leak shares after hours, through an ECN. In areas where information is the service, financial planners, commodities brokers, and mortgage originators seem destined to face tough competition from digital intermediaries who can supply information more quickly and efficiently. This has already happened in analogous industries like travel agencies and classifieds. Internet-based mortgage originators without bricks-and-mortar cost structures, such as Intuit's quickenmortgage.com, are forcing others to find ways to compete. Indeed, Intuit did $375 million of mortgage originations in six months of offering the service. The e-commerce competition forces traditional intermediaries to differentiate their service in the flesh from that on the screen. The latter actually perfects the market, offering full transparency of information at any time, anywhere. Moreover, the on-line competition can be personalized: It can cheaply develop detailed customer profiles through tracking of purchase patterns, and then tailor investment or mortgage suggestions to fit each customer's price points, service preferences, and risk bias, much as Amazon.com's personalized "new book notifications" are based on individual customers' literary tastes. Finally, we can think about areas in financial services where products are developed by masterfully weaving together a complexity of information that could potentially be delivered on line. Research-intense financial products like derivatives, mutual funds, and loan syndications come to mind. Just think about mutual fund companies like Fidelity and Vanguard, the research they own, and the way they use it to create attractive investment bundles of stocks and bonds. How long before someone builds an intelligent site that allows investors to build their own mutual funds? Or allows institutional customers to develop their own derivatives? Or loan syndicates? Thus entire financial product segments could move on-line, much as Imagineradio.com now lets a music lover preempt radio stations and customize his or her listening menu for play on the Internet. Against all of the above-mentioned threats, street-level financial service operations need to develop a defensive and offensive strategy. What should the defenses be? How does one prevent competitors from removing Jenga blocks and causing real damage? Above all, you must understand your value chain and revenue sources and build protective barriers where the profit pool is highest. You can do this by actually knowing where information transparency would hurt you, and what information you can control and deny to the outside system. If you hold the key to inventories and pricing for a specific market, lock the door. But the best defense is often a strong offense. To this end, you can block pure-play e-commerce competition by announcing your own aggressive response to the Internet challenge and scaring off venture capital funding for rival start-ups. How do you develop your response? Where can you create a new-business story around a block of the Jenga tower? For starters, get your wares on-line-know where you can enter the e-commerce market and reach new segments of customers or anticipate current segments that are liable to switch channels. Next, understand your "adjacencies"-identify where you can expand product or service offerings in a way that leverages your core costs and/or customer capabilities. To do so requires knowing what information you can release to the system for your own gain. For example, for an airline, releasing seat availability close to flight dates is smart. It stands to add a last-minute fare for the cost of one additional meal. A low-cost provider in the financial services business could stand to gain by creating more transparency of market information, such as management fees in mutual funds. One needs to understand new models of business and get ahead of the curve-much as Dell Computer understood the service edge of allowing customers to configure their own computer orders on-line. This means it is possible to be the first to develop a smart site for mutual funds, and preempt distributors. Or a logistics specialist might distribute any standard product at low cost, the way Peapod.com now picks and packs groceries for on-line customers. It is clear that the Internet is poised to destabilize and rebuild-the Jenga of financial services. But no one today can fully describe how that decomposition and recomposition will play out. At the same time, those not looking carefully at their building blocks, and at the potential for business redesign given a loose block here or available block there, is foolhardy. The tower of products and services, customer segments, and geographies could come crashing down, and the players may lack the tools and materials for rebuilding. This story ran on page 8 of American Banker on 5/28/99. © Copyright 1999 American Banker inc. All rights reserved.

The game of Jenga, which takes its name from the Swahili word for construction, challenges each player to remove as many blocks as possible from a cross-hatched tower of wooden beams, then to use the removed blocks to build additional stories, all without causing the tower to crash.

The game being about both disassembly and reassembly, it provides a fitting analogy for the way electronic commerce companies are currently plucking out key blocks from the business complex of financial services and moving them on-line.

The key question, in the Jenga-like context: Will such activity destabilize the financial industry as we know it?

The answer: Absolutely, and the winners, as in the game of Jenga, will be those who achieve new levels of reconstruction.

To understand the loose blocks in financial services today, first think about this diverse sector's varied products, services, channels, and customers. Second, think about the sector's value chain, including everything from customer acquisition to product and service design, product and service structuring, risk-holding, distribution, and servicing.

Many pieces of the business mix or segments of the value chain could come loose and find new homes on the Internet, much as traditional print classified ads and job listings have found a solid niche in cyberspace.

The Internet auction site eBay, which has spurred competition from the likes of Amazon.com, fairmarket.com, and others, initially felt like a minor irritant to newspaper publishers and owners. But it has become a high-volume, worldwide competitor, attracting advertisers who might otherwise stick with newsprint, because of low prices, geographic reach, and personalized, albeit virtual, customer service.

eBay has plucked off several customer segments: multiple-region advertisers, price-sensitive advertisers, and do-it-yourselfers who want to virtually "typeset" their copy. It also covers a vast geography: the world.

Yet eBay has not crashed the value chain in classified advertising. You still need sellers, products, information, and buyers. But eBay has dismantled classifieds from their position as one of the revenue blocks that fuel newspaper publishing and moved that block to the Internet.

Instead of thinking about how a whole business could be done differently, financial services companies should think about how pieces of their business could be safely removed from the Jenga of the industry and rebuilt on the Internet.

The pieces most vulnerable to removal will be those where the profit pool is deepest, where information is the service, or, one level deeper, where complexity of information is woven into product options.

Take, for instance, stock trading, which is dominated by major brokerage houses, or bulge-bracket firms such as Merrill Lynch. Here the profit pool is relatively deep, with trading fees fixed relative to shares traded, not stock-price performance.

On-line trading operations led by Schwab, Waterhouse, E-Trade, and Datek are already plucking off the customer segment of "active traders," particularly those focused on Internet stocks, by offering convenient, discounted service.

In April, Merrill and other big brokers counterattacked, announcing they would offer some on-line trading at more competitive rates.

Electronic Crossing Networks, or ECNs, such as Island, Instinet, and Archipelago, are creating communities of buyers and sellers of large volumes of securities. They are poised to gain an even weightier customer segment: block traders.

The ECNs have grown rapidly because of their connections to the on-line brokers, their ability to facilitate after-hours trading, and their low pricing. These very attributes will allow them to compete successfully for the profitable business of anonymous block trades, once easy profit for bulge-bracket firms that charged institutional customers a premium to "leak" their shares on the market. Now the institutions themselves can anonymously leak shares after hours, through an ECN.

In areas where information is the service, financial planners, commodities brokers, and mortgage originators seem destined to face tough competition from digital intermediaries who can supply information more quickly and efficiently.

This has already happened in analogous industries like travel agencies and classifieds. Internet-based mortgage originators without bricks-and-mortar cost structures, such as Intuit's quickenmortgage.com, are forcing others to find ways to compete. Indeed, Intuit did $375 million of mortgage originations in six months of offering the service.

The e-commerce competition forces traditional intermediaries to differentiate their service in the flesh from that on the screen. The latter actually perfects the market, offering full transparency of information at any time, anywhere. Moreover, the on-line competition can be personalized: It can cheaply develop detailed customer profiles through tracking of purchase patterns, and then tailor investment or mortgage suggestions to fit each customer's price points, service preferences, and risk bias, much as Amazon.com's personalized "new book notifications" are based on individual customers' literary tastes.

Finally, we can think about areas in financial services where products are developed by masterfully weaving together a complexity of information that could potentially be delivered on line. Research-intense financial products like derivatives, mutual funds, and loan syndications come to mind.

Just think about mutual fund companies like Fidelity and Vanguard, the research they own, and the way they use it to create attractive investment bundles of stocks and bonds. How long before someone builds an intelligent site that allows investors to build their own mutual funds? Or allows institutional customers to develop their own derivatives? Or loan syndicates? Thus entire financial product segments could move on-line, much as Imagineradio.com now lets a music lover preempt radio stations and customize his or her listening menu for play on the Internet.

Against all of the above-mentioned threats, street-level financial service operations need to develop a defensive and offensive strategy.

What should the defenses be? How does one prevent competitors from removing Jenga blocks and causing real damage?

Above all, you must understand your value chain and revenue sources and build protective barriers where the profit pool is highest. You can do this by actually knowing where information transparency would hurt you, and what information you can control and deny to the outside system. If you hold the key to inventories and pricing for a specific market, lock the door.

But the best defense is often a strong offense. To this end, you can block pure-play e-commerce competition by announcing your own aggressive response to the Internet challenge and scaring off venture capital funding for rival start-ups.

How do you develop your response? Where can you create a new-business story around a block of the Jenga tower?

For starters, get your wares on-line-know where you can enter the e-commerce market and reach new segments of customers or anticipate current segments that are liable to switch channels.

Next, understand your "adjacencies"-identify where you can expand product or service offerings in a way that leverages your core costs and/or customer capabilities.

To do so requires knowing what information you can release to the system for your own gain. For example, for an airline, releasing seat availability close to flight dates is smart. It stands to add a last-minute fare for the cost of one additional meal.

A low-cost provider in the financial services business could stand to gain by creating more transparency of market information, such as management fees in mutual funds.

One needs to understand new models of business and get ahead of the curve-much as Dell Computer understood the service edge of allowing customers to configure their own computer orders on-line.

This means it is possible to be the first to develop a smart site for mutual funds, and preempt distributors. Or a logistics specialist might distribute any standard product at low cost, the way Peapod.com now picks and packs groceries for on-line customers.

It is clear that the Internet is poised to destabilize and rebuild-the Jenga of financial services. But no one today can fully describe how that decomposition and recomposition will play out.

At the same time, those not looking carefully at their building blocks, and at the potential for business redesign given a loose block here or available block there, is foolhardy. The tower of products and services, customer segments, and geographies could come crashing down, and the players may lack the tools and materials for rebuilding.

This story ran on page 8 of American Banker on 5/28/99.