Hitting Internet Escape Velocity (#21)

Hitting Internet Escape Velocity,
w/ Brett BIVENS

Our guest today is Brett Bivens— a venture investor at TechNexus Venture Collaborative, an early-stage venture capital firm — and he is going to talk about why he is so optimistic about Spotify and how the future of audio will be a social experience with various network effects loops. One of the core investment areas for TechNexus is audio and media. And so, in this episode, you’ll hear Brett talking about that, with your host, Ben Robinson, as well as talk about the various concepts that Brett has coined, including ‘escape velocity’ and ‘clampetition’.



  1. Venture Desktop Newsletter — by Brett Bivens
  2. Brett’s Medium Essays
  3. Brett’ Telegram channel for high-cadence thoughts

Full podcast transcript:


I think that a lot of people might actually get their first onboarding into VR-like experiences through audio-first experiences — Brett Bivens

[00:01:51.12] Ben: So, you work in venture capital. The home of venture capital is the United States. You, yourself, are American. So, why practice the trade from Paris?

Brett: Yeah, it’s a good question. I think the first thing is that our investment model kind of dictates it, to a degree. So, we work with a number of large corporates across industries and these companies all have global businesses. And so, as they think about what the future of their company looks like, they need access to the global innovation ecosystem. And so, from day one, we’ve always had a very geographically-agnostic perspective on where we want to invest and the types of companies that we want to work with. And, on top of that, I think we really do buy into the idea that great companies are being built everywhere and have been being built everywhere. And so, that was a big part of it, trying to now, given that we’ve seen so much talent and so many great companies built in Europe, get a little bit more involved over here. And then, why Paris specifically: so, partially family. My wife is from France. I’ve spent a lot of time over here building relationships, following the ecosystem. I was getting just really excited about what was happening with the types of companies that were being built here. So, it was kind of just natural that it worked out that way. And it turns out, actually, that the first investment that we made through this model that we have at TechNexus, about three or four years ago, was a company founded by French founders, partially based in the US, partially based in France. And so, that gave us a perspective, as well, on this distributed nature of teams that were being built. So, yeah, that’s kind of why I ended up here. Our team is still based in the US and we invest in the US, North America, and Europe.

[00:03:28.16] Ben: We could argue that France, within Europe, is probably one of the hottest ecosystems, right? So I think I read that VC money going into French tech is up to something like 5x since 2014. So, I suppose, as you said, it was a bit because of family but it was also because you think that Paris is increasingly becoming the hottest or the hub for tech in Europe?

Brett: I think so. I think there’s great things that you could say about any of the ecosystems in Europe — Berlin obviously has some incredible companies that have come out of air, the cities and the countries in the Nordics just kind of incredible per capita output of innovation, and then, obviously, London being the centerpiece of the European tech ecosystem. But yeah, Paris, again, we were just really excited about the companies that we were seeing here, the attention that was being paid to the region and the ecosystem by investors. And, even apart from all of that kind of stuff, even at later stages, so, sort of beyond where we invest, we were seeing a tremendous amount of talent kind of flow into the ecosystem from all over the world to launch Europe for American companies and doing that from Paris or joining teams in Paris, leaving Silicon Valley companies to do that here. So we sort of saw this confluence of things, all of these different things — capital and talent and attention, and even governmental resources being poured in that just got us really excited about where the ecosystem was headed.

We’re getting new technologies coming to market […] that are expanding the addressable daily hours for audio content to be accessed, creating more social opportunities for audio, creating more contextual opportunities for audio — Brett Bivens

[00:04:57.21] Ben: I wanted to get you next on Spotify because for anybody who subscribes to your newsletter, is a company that you focus on, almost disproportionately, and it’s obvious you’re really excited about the prospects for Spotify. But, if you listen to most commentators on Spotify, most of them see it as a company that has quite difficult unit economics — low gross margins, high variable costs — and a company that’s up against really deep-pocketed competitors. And so, why is it that you rate Spotify so highly?

Brett: Yeah, so, I think there’s a few reasons. So, one, I see it as emblematic or as an embodiment of what’s kind of happening to European tech in this world where you have the American tech giants and the Chinese tech giants kind of squeezing it out and seeing where that lands. And so, I find that interesting. At the same time, at TechNexus, one of the core investment areas for us has always been audio and media and we have a large portfolio of companies there. And so, it’s just natural that we follow that space, try to understand the key players in that market. And I think Spotify is a very central company in the sense that they have to work with, and integrate with, and serve different stakeholders across all different parts of the audio ecosystem and value chain. And so, from that perspective, that kind of speaks to why I follow the company so closely.

Brett: In terms of my optimism about it, and how I see them fitting into the broader picture, I think you’re spot on. I mean, anytime a company puts a competitor slide up, or you build a competitor slide for a company — it includes Apple and Amazon and Google and Tencent and ByteDance with TikTok — it’s a little bit scary. I think that Spotify has done a very good job of delivering a differentiated user experience within the limitations that they have. I mean, it’s well-known at this point, that they have a tough supplier relationship with the record labels, and that’s kind of slowed down their ability to innovate. Like you said, that flows through to their margins and the way that the business functions. So, I would say I’m cautiously optimistic. I think they’ve done a lot of really great things. As a company, I think they have a lot of hills to climb. But that optimism and the upshot of what I think Spotify can be in the future is really just as much about my excitement about where audio is going, and what’s sort of evolving within the audio ecosystem.

Brett: I think, for a lot of the same reasons that a company like Spotify has been forced to innovate rather slowly, I think it’s just true of the broader ecosystem as well. So, I think we often underrate path dependency in the way that technology is adopted, and the audio ecosystem has had that play out in the spades with regards to, again, the record labels and the way that Apple has been an early mover on podcasts and not really done anything there but their scale and size has scared a lot of people away from doing anything interesting there. The same thing has happened in audiobooks with Amazon. People are kind of scared away from that, and so, it sort of slowed down innovation in the ecosystem. But we’re starting to see different things break through and different user experiences develop. We’re getting new technologies coming to market, like AirPods and voice interfaces that are, I would say, expanding the addressable daily hours for audio content to be accessed, creating more social opportunities for audio, creating more contextual opportunities for audio, and kind of having it always with us.

Brett: So, we’re on this path almost to an ambient audio experience where, in a very, I guess, optimistic reading of what the future looks like, we have these different audio experiences and scenes and technologies that can be applied to whatever activity we’re undertaking at the time to just improve our daily lives. And so, that’s kind of the upshot for Spotify and for the company in audio: the engagement surface area just kind of continues to expand, monetization catches up, and they continue to deliver good user experiences along the way and incrementally innovate. And so, yeah, that’s kind of how I view Spotify in the broader audio market, in general, I’d say.

[00:08:59.25] Ben: Yeah, I think there was one really spiffy statement in one of your essays. I think it was something like, “The ear is under-monetized vis-a-vis the eye.” And I think that’s a pretty good starting point, to start to look at the companies in this space.

Brett: Yeah. I think that came from Daniel Ek, the CEO of Spotify, but it’s something that a lot of other executives in the industry have sort of echoed. You have podcasts that really haven’t had internet-scale advertising applied to them. They have always been this hobbyist kind of enterprise where the host reads their own ads and it’s not particularly programmatic, not particularly scalable, which has kept a lot of large brands and companies that are going to spend millions and millions of dollars on advertising through some medium kind of out or just barely dipping their toes in the water. And so, yeah, I think we’re starting to see that all catch up. We’re starting to see social experiences catch up in a significant degree. I mean, not to dip too far into the tech Twitter topic du jour but a company like Clubhouse which recently raised money from Andreessen Horowitz at a pretty lofty valuation — or people think it’s a pretty lofty valuation — kind of gets at this as well, which is, audio as a social experience and the different network effects that can be driven through that.

[00:10:20.07] Ben: You talk a lot about patient investing, in the context of Spotify. And I think the term you use is something like, they have a different investment horizon, compared to some of their competitors. Is that through design, or is that because you almost have to patiently invest, you have to stealthily invest because your competitors are so powerful?

Brett: It seems like a little bit of both. I mean, as a total outsider to the company and not really knowing the inner workings so much, I do get a sense from hearing executives talk and people like Daniel, like the CEO, talk that there is just sort of this cultural patience to the way that the company thinks about building this business and the long-term opportunity that they’re going after. So, again, without knowing anything from the inside, that’s kind of how I perceive their culture a little bit to be. But yeah, I think that, because of the fact that they are squeezed in the middle of all of these different powerhouses, these different monopolies, basically, they have to tread lightly and carefully and sort of eke out what they can over time. They’ve maybe been forced to slow play their hand in social because of the friction that might create with record labels who think they’re trying to go around them; the same thing with Spotify going direct to artists and working directly with artists — they probably had to slow-play that a little bit; their relationship with platforms like Apple or like Google, where they’re reliant on those platforms for distribution to a degree through the app store, but they’re also directly competitive with them creates some challenges. So yeah, I think it’s a little bit of both and they probably feed off of each other. By design, it’s baked into the culture, but it’s also just inherent to the business model and how they have to operate.

I think that most people look to gaming as the first path for immersive social media. And they’re definitely not wrong about that. — Brett Bivens

[00:11:57.16] Ben: Do you think they need to win the podcasting war, in order to completely change the unit economics of their business?

Brett: I think so. I think that that’s one piece of it. I think that that’s only one piece of it. There’s so much more and I think that there’s an interesting comment that I heard once and I agree with, and that’s to say that, “A category isn’t really one until a social product emerges.” And I think that that is kind of the long-term play for a company like Spotify, is to have a more social component to their business. But to get there, I do think that they need to continue to innovate across these different categories and continue to expand beyond music to podcasts, to books, to health and wellness, to all of these different categories that help them build up that user demand and help them build up the leverage against all of the people that they’re working against in the industry, to then layer on additional social experiences.

[00:12:52.10] Ben: And is it the importance of social experiences what makes you think that a marriage between Spotify and Snap might be a good idea? Because you’re the only person I’ve ever seen to put those two names together as a potential merger, and I’m just quite curious about that.

Brett: Yeah. Well, it was sort of a throwaway comment at first, in response to what I just said, which was this idea that a category isn’t one until a social product emerges. And like I said, I agree with that. And I don’t think it’s likely at all that that would happen but it does get you to start thinking about, again, the evolution of audio and social media, how they come together, as well as immersive reality, virtual reality, and how all of these things converge at some point in the future. I mean, I think that most people look to gaming as the first path for immersive social media. And they’re definitely not wrong about that. I mean, we’re seeing that play out in real time with things like Fortnite and these massive games that have created virtual universes, but if we think about the things that create immersive, kind of these metaverse-like experiences, even on a partial basis, and you have things like persistent worlds and synchronous collaboration and communication and the ability for the platform to be populated by content that’s created by a wide range of contributors, and even interoperability across platforms — I think all of those things work well with audio. And so, I think that a lot of people might actually get their first onboarding into VR-like experiences through audio-first experiences — and that’s where Snap as this AR and VR company, they do some really interesting things there; Spotify as an audio company — I think there’s some interesting tie-ins there that just gets you thinking about what the future of the media market looks like. But no, I don’t think it’s likely.

There’s this balance between being a great product or a great platform for your core customers versus going broad and scaling and alienating that core customer set. And so, it’s a delicate balance, and I think ‘internet escape velocity’ is just a way of thinking about that. -Brett Bivens

[00:14:38.25] Ben: As I was saying to you earlier on, I read all of your newsletters in one go. I mean, I’ve read many of them before, but then I read them all in one go. And the thing that’s striking is just how many terms you seem to have coined. It’s like you have your own personal lexical set. And so, if you don’t mind, I’m just going to ask you about some of these terms — what they mean. So, I’ll do one now, and then I think later in the podcast, we’ll cover a couple of others. The first one I wanted to cover was ‘escape velocity’. What do you mean by escape velocity?

Brett: Yeah. So, a couple of weeks ago, or whenever it was, there’s an investor named Gavin Baker, who is a growth and public market technology investor, has really, really interesting thoughts about just the development of a lot of the things that I know you think about and that I think about, and he wrote a piece talking about the two things that he looks at when evaluating competitive advantage for consumer internet companies — and those things being scale and loyalty. And those are really the only two ways to get out of this rat race, where you’re paying Facebook and Google 40% of venture capital dollars that come in or some massive amount of money every year to just maintain your growth and your customers.

Brett: And so, for me, that brought up the next question of, what does the company have to do in order to achieve the level of loyalty that allows them to generate word-of-mouth acquisition, lower their customer acquisition costs, create long-term stickiness in a product, and then how do you translate that into scaling without losing the essence of what helped you get to that loyalty in the first place? Because that’s something that I think constantly happens is there’s this balance between being a great product or a great platform for your core customers versus going broad and scaling and alienating that core customer set. And so, it’s a delicate balance, and I think internet escape velocity is just a way of thinking about that. It’s not a thing that I necessarily have a prescription for. I think there’s a lot of elements that play into it. It depends heavily on the business model and the stage of the company but it is just a way to think about, “Okay, what are the factors that allow us to build community and build word of mouth and build that stickiness? What are the technical features for how we can serve customers if behavior changes? Or, as new competitors come into the market, what are the core features? What are the ways that we stay aligned with our customers from a product and technology perspective? And then, what are the areas of new business that we can go into that keep us aligned with those customers, but don’t sacrifice things like margins and profitability long term?” And so, it’s kind of a loaded analysis to try to do and again, it’s very different for every company, so it’s not necessarily a prescriptive thing. But I think it’s important for companies, for investors to think about if scale and loyalty are the two strongest drivers of competitive advantage for consumer internet companies, what are the core elements that underlie those things and allow you to reach those two points.

[00:17:37.19] Ben: And you said it’s not prescriptive, but you do set out three, almost preconditions, right?

The way that I think about ‘business model leverage’ is you build up your core business on what might be considered a low margin business that presents opportunities to then scale in a way that helps you expand the margin or sets you up to at least scale in a way that helps you maintain margin. And so, when I think of Spotify with […] by owning the consumer demand via the lower margin streaming business, they have the opportunity to expand into those areas. Lululemon, as I talked about, is a similar company — they have a high-margin business, to begin with, relative to peers, but because of the fact that they’ve invested in digital, they’ve invested in all of these community-level features, they also have additional areas to grow that help them maintain their high-margin status. — Brett Bivens

Brett: Yeah. I’m certainly happy to walk through those. I think the notion of responsive instrumentation gets to this idea of loyalty and there’s one company that I talk about in the piece — Lululemon — who I think demonstrates this extremely well. It’s this idea of, again, being able to quickly adjust from an operational perspective, from a product perspective, being able to make sure you meet your customers where you are, and stay aligned with your customers, and no matter what the situation is, deliver on your brand promise. And they’re an example of a company that, in this kind of crazy time that we’re in right now where their stores have closed and people aren’t going to yoga studios anymore, they need to figure out how do they continue to engage those customers, how do they continue to deliver on the brand promise that they’ve always offered. And one of the things that they’ve done early on, and again, this isn’t for every company, but it’s worked for them, is sort of this idea of vertical integration, owning the entire value chain that they use to deliver their product. So, they have a very direct and strict product focus, they don’t have this broad range trying to serve every type of customer; they manage and run and own their own stores. And so, they’ve been able to turn those retail locations into distribution outlets, and they’ve been early — maybe not early — they’ve been active in understanding digital content and how they can use that to further engage their customers. And so, I guess, a short way of saying, it’s adaptability. So, it’s the ability to adapt when situations change rapidly.

[00:19:20.13] Ben: Another one was ‘business model leverage’, I think. Right?

Brett: Yeah, exactly. And that, I guess, goes back to Spotify a little bit. I think that’s a company that has a pretty interesting business model leverage. And the way that I think about business model leverage is you build up your core business on what might be considered low margin, or whatever it may be, but a low margin business that presents opportunities for you to then scale in a way that helps you expand the margin or sets you up to at least scale in a way that helps you maintain margin. And so, when I think of Spotify with that, we talked a little about it earlier, but it’s this low gross margin streaming business where they’re paying a ton of money to the labels, but over time, as they expand and gain leverage, podcasts are a higher margin business, social products are a higher margin business, marketplace products are a higher margin business for them. And so, by owning the consumer demand via the lower margin streaming business, they have the opportunity to expand into those areas. Lululemon, as I talked about, is a similar company — they have a high-margin business, to begin with, relative to peers, but because of the fact that they’ve invested in digital, they’ve invested in all of these community-level features, they also have additional areas to grow that help them maintain their high-margin status. So, there’s probably a million other companies that do these types of things particularly well, but those are two that come to mind, there.

For us as early-stage investors, it really does come down to the founding team and the way that they set the vision for the company and the way that they think about culture; and so an interesting way to frame that is maybe ‘followability’ — Brett Bivens

[00:20:40.15] Ben: I’m going to quote you from one of your essays here. You wrote, “Company culture is the bridge between theory and action. It is the operationalization of a company’s values and it expresses itself as a set of frameworks that a company uses to make decisions under uncertainty.” I thought that was a really eloquent definition of culture. It’s clear that culture is really important for you when you assess companies you invest in, but how easy is it for you, and how practical is it for you, as an outsider, as an external investor, to get a really good gauge over a company’s culture, whether it’s private, or whether it’s public?

Brett: Good question! And it’s a challenging thing to assess, quite frankly, I think, especially in a world like venture capital, where at times, you don’t have full control necessarily over the timeline in which you get to invest. There are companies that raise funding rounds, and maybe the opportunity doesn’t exist for too long. And so, you have to figure out a way to build that conviction and build an understanding of that culture very quickly. I think that there’s a few ways — and this is not comprehensive by any means, and I think everybody has their own way of assessing these things. But when I think about it, from our perspective, as early-stage venture investors, we’re often trying to understand a few things. I mean, if there’s a team that’s already been built up around the core founders, it’s always helpful to understand why the next person, why that first engineer, first salesperson or whoever are some of the more recent people to the team, why they’ve joined the team? Why they’re excited about the mission? What that mission is, in their mind? Does that mission align with what you’re hearing from the founders that you’re talking to? And really, is there this true north that the whole company is pushing towards? I think that’s one interesting way that we try to test for that and solve for that.

Brett: And that gets back a little bit to this idea of alignment with customers and being very customer-centric. I think if companies are very clearly focused, first and foremost, on delivering the kind of value like that to customers, that can be a hint of a really strong culture and an aligned culture. And then, for us as early-stage investors, it really does come down to the founding team and the way that they set the vision for the company and the way that they think about culture and so, one of the things that we always talk about and I think is an interesting way to frame that maybe is, ‘followability’. It’s this idea of, are these people that are leading this company, that have founded this company, maybe key early executives, are they going to be able to attract and retain talent and capital and customers and tell a story and stay true to that story personally, that is going to help them compete over the long term? And so, these are a few different ways that we look at it and think about it. But, I think, regardless whether it’s an early-stage company that you have access to, whether it’s a growth-stage company, or a public company, it’s always a challenging thing to really assess out how that plays out.

The (venture capital) investment thesis […], surely becomes sort of a marketing vehicle, a way for you to tell the market who you are and what you stand for and how you think. The challenge comes when you start to overly believe your own view of the future and close your mind off to the ideas that founders are coming to the table with and some of the emergent opportunities that develop in the ecosystem. And that’s really where the friction comes in between bottom-up investing and being overly thematic. — Brett Bivens

[00:23:42.08] Ben: And how important is it, relative to everything else? So, for example, if you came across a company, and you love the business model, you’re really comfortable with the unit economics, it had responsive instrumentation, it had business model leverage, but you didn’t like the culture. Would that be a red flag that would lead you to potentially not invest?

Brett: Absolutely. I think that, for us, as early-stage investors, all of those things are important. You know, there’s always this, ‘is the product great? Is the market great? Is the team great? And how do you weight all of those?’ And the answer is, it kind of depends on the company and the market and everything like that. But yeah, for us, that’s the first checkpoint — is this a team with whom we have intellectual and emotional alignment on where they’re going as a business? Because all of those other things can fall apart very, very quickly if you don’t have the culture right, if you don’t have the leadership right, product decisions can go awry, new market development can certainly go awry, talents and how you keep that around, that’s so core to building the business can sort of go awry. And so, I always think that, yes, the culture and the leadership team at the early stage is so, so critical to making sure that the right market is captured and the right product is built and the right strategy is applied for the long term.

[00:24:59.28] Ben: Just another question on investing. So, one of the articles I really enjoyed reading at the time, and then I also really enjoyed rereading it in the weekend was the one about bottom-up versus top-down or thesis-driven investing. It sounds like you see the thesis is the marketing narrative, and then the bottom-up stuff is the hard work you need to do to actually arrive at the right solution. So, it’s almost like the thesis helps you to raise money, and the bottoms-up investing helps you to deploy the money, and you shouldn’t confuse the two, almost.

Brett: Yeah, I think that’s true. I think that even applying thematic investing at an operational level is totally fine. I mean, there’s a circle of competence element to it, where, if you’re truly just saying, “I’m going to invest in everything”, there’s challenges with that, as well. So, there’s a give and a take. I certainly hope that that’s the case, that there can be those two opposing forces at once, just because that’s, as you mentioned with Spotify and the way that we invest in our funds, this vertical focus that develops. But you’re right. The investment thesis and the way that you talk about where you invest in the venture capital world, surely becomes sort of a marketing vehicle, a way for you to tell the market who you are and what you stand for, and how you think, and all of these different things. The challenge comes when you start to overly believe your own view of the future and close your mind off to maybe the ideas that founders are coming to the table with and some of the emergent opportunities that develop in the ecosystem. And that’s really where the friction comes in between this bottoms-up investing and being overly thematic. I think that if you’re trying to predict the future and do all of that, I mean, that’s the job of the founder, in my opinion, and the team that’s kind of building the company. So, that’s definitely the way that I think about that.

A really interesting term that I learned about a couple of months ago, called ‘accumulated accidents’, […] and it basically prompts us to say about different societal behaviors or institutions, whether this is actually representative of an ideal expression of society, or whether is built upon a series of accidents that can actually be unwound in the right circumstances. And, really, for lack of a better term, it’s creative destruction. It’s how new innovation comes to market. And in a lot of cases, you can unwind some of these accidents via a better business model or via better technology but some of the really, really big things, some of the things that we’ve really screwed up in the past that have just accumulated on themselves and where incumbent interests have become extremely entrenched and difficult to pull away, I think that’s what this crisis is giving us — an opportunity to rethink and reset with. — Brett Bivens

[00:26:54.24] Ben: And it sounds like you shouldn’t shut yourself off from opportunistic opportunity, as well, by being too sticky and too rigidly to thesis. I just wonder, does that happen to you? So, as much as you do have sectors you prefer and business models you prefer, I guess you’ve had instances of where founders pitch to you and even though it wasn’t something that was on your radar, you were struck by the passion and the vision and the team. Would you argue that it’s almost unhealthy to deny yourself the chance of being opportunistic?

Brett: Oh, yeah, absolutely! And it’s something that I think about a lot, and our team thinks about a lot because we do have a handful of different verticals that we focus on, different funds that are completely divergent from one another. I mentioned audio quite a bit, we do a lot in travel and recreation, and public safety, and industrial markets. And so, we’re touching all these different areas and I think that’s exactly right. I mean, this idea of thinking about new technologies, new business models that founders are coming to you with, new angles for how to bring a product to market is benefited by this broader approach of understanding, “Okay, what did we see over here in this market that worked or didn’t work? And how can we apply it to this completely different area?” And if you do just get overly rigid, you kind of miss out on those opportunities for, I guess, transferred learning, in a way.

[00:28:23.19] Ben: I think we’ve done an amazing job because we’re at the halfway point and we haven’t talked about the pandemic yet. I am actually going to start to steer us in that direction now, by asking you about remote work. You wrote an essay on remote work, and if I were to summarize it — and badly, by the way — but if I were to try to summarize it, your view is that a lot of the “easy” solutions to remote work have been tackled but we’re only at the very early stages of starting to tackle some of the harder aspects of remote work. So, I suppose the question is, what are those harder aspects and those harder problems that we need to solve?

Brett: The thing about remote work and distributed work is it’s very challenging to crack, as a company that’s trying to do it well, and as a company that’s trying to build products and services for that market. And so, because it’s been so hard to do historically, as a company — and really many have shied away from actually even trying it until the pandemic sort of hit — maybe the addressable market hasn’t been big enough, or companies looked to build solutions that could be purchased and used by companies that were maybe trying remote, but also had people in an office. And so, you had that fact in play. You also had the fact that a lot of the easy things — we talked about video conferencing and all of these different tools that we’re using for remote work — every company and every use case is so idiosyncratic, that it’s easy to say, “Oh, well, this doesn’t work. This doesn’t work. So I’m going to build to scratch my own itch here”, which is great. I mean, it’s how a lot of great innovation occurs. So, that was kind of the reason that a lot of these easy solutions get a lot of attention and a lot of traction, that are maybe fun to play with and test out and are buzzy.

Brett: But yeah, you’re right about the hard solutions and I think that’s something that hasn’t been paid enough attention to until I would say before the pandemic; I think it was really becoming clear for a lot of companies who were trying this and a lot of onlookers who were starting to spend more time thinking about how distributed work would develop, that there were a lot of infrastructural things, whether that’s around how do you do a payroll across borders for a company without being this massive Fortune 500 company that has teams of lawyers and regulatory people who can handle that kind of stuff, or how do you manage insurance across countries, how do you handle security — cybersecurity — for people that are working from home now. One of the things that I think has really come ahead with this pandemic is just mental health and how you manage the psychology and wellness of all of the people that are working in this situation. And so, I think all of those challenges present new opportunities for companies that in the past, maybe it didn’t seem like it was worth it to go through all the legal and regulatory headache because you couldn’t really predict when we were going to hit that inflection point to really start seeing that curve go up super, super fast in terms of adoption of distributed work. But we’re kind of there now. I think, every day, there’s a news item that comes out about XYZ massive company is letting employees work from home forever. And so, the reality is that the market, so to speak, is big enough for people to go after now and I think we’ll see a massive amount of innovation happening there. And the good thing is there’s a lot of companies already that have been doing great stuff there for a while to kind of build out that infrastructure layer.

The pandemic has given a lot of companies this carte blanche to do innovative stuff that they may have not had the boldness to do before. The way that I think about this term, ‘clampetition’, it’s a word that just joins together competition and classiness, which is essentially companies using this totally disjointed economic situation to make moves that are classy in terms of helping their customers or helping their suppliers, but also double as these smart customer retention or acquisition tactics. — Brett Bivens

[00:31:50.10] Ben: It’s almost like what you’re saying is we’ve got very excited about the first-order effects. So, we need to work from home, therefore we need to communicate, therefore buy Zoom — we get excited about video conferencing. And what you’re saying is actually, the second and third-order effects, in terms of stuff that are potentially overlooked at first, like mental health. So, beyond just remote working, what do you think are some of the most interesting second-order, third-order effects of what’s happening with the pandemic?

Brett: I think if I’m going to answer this, honestly, I’ll kind of answer with a non-answer, and saying, I don’t think any of us know at this point. But I do think that you’re right, there are these really interesting second and third-order effects that are going to occur that, as investors, as analysts, as people watching this space, you almost just have to really keep your eyes open, keep an open mind towards how demand is trending in these different areas, how some of the things are changing. I think that a couple of areas that I think of that will be ripe for interesting things to happen: certainly cities is one — and that means both in terms of transportation and mobility, but also in terms of retail and physical locations; of course, offices and stores and things like that. There’s this interesting, potentially nonlinear jump that might occur as a lot of small businesses are going out of business and what happens when we need to start backfilling that and people are reopening restaurants or starting new restaurants or trying to start new gyms or what does that new experience look like? How does it now bridge digital and physical experiences in a different way than maybe before? So, I think there’s a lot of things to look out for, there, but I guess the short answer would be it’s tough to say.

[00:33:45.22] Ben: And are you excited as an investor? Because, as we know, it’s difficult to displace incumbent organizations, whether it’s Facebook or whether it’s a local restaurant. I suppose it’s even harder if it’s an online company. But what we’re seeing is there’s this one-off discordant event, this discontinuity, which must, therefore, create opportunities for companies to move in and do something different. And so, are you very excited? I mean, it seems almost paradoxical to ask if you’re excited in a time of pandemic. Are you very optimistic about the silver lining, the opportunities that will come out of this?

Brett: There’s a really interesting term that I learned about a couple of months ago, called ‘accumulated accidents’, which originated with an analyst and a writer named Clay Shirky, and it basically prompts us to say about different societal behaviors or institutions, whether this is actually representative of an ideal expression of society, or whether it’s sort of built upon a series of accidents that can actually be unwound in the right circumstances. And, really, for lack of a better term, it’s creative destruction. It’s how new innovation comes to market. And in a lot of cases, you can unwind some of these accidents via a better business model or via better technology but some of the really, really big things, some of the things that we’ve really screwed up in the past that have just accumulated on themselves and where incumbent interests have become extremely entrenched and difficult to sort of pull away, I think that’s what this crisis is giving us — an opportunity to rethink and reset with. I think about healthcare in the United States and just the layer upon layer upon layer of difficult things to unwind with that, that we hadn’t been able to do forever, that are now just becoming completely undone with consumer products playing the role of helping early-warning and telemedicine and regulations coming down there and things that could never have been done without this. And so, does that create an opportunity for a reset? I think it does in really interesting ways.

Brett: The same thing with higher education and doing a lot with being more precise in helping people learn at their own pace, on their own schedule in a way that aligns with what they want to accomplish throughout life — whether that’s an elementary level or adults that are needing to change careers and do things there. And so, I think that we’re at a unique opportunity where we have business model innovation that can come to market, technology innovation that can come to market, and this massive catalyzing force, which is in our face on a daily basis, that’s saying, “You need to change because the world as you knew it does not represent this ideal state.” And you may have known that, but now you have the opportunity to actually take action and move in the right direction.

[00:36:41.15] Ben: I thought one of the interesting points you made in one of your essays was, I think you called it, ‘daily active crisis’. So this is just providing air cover, if you like, for innovation in a way we haven’t seen, and then you draw the distinction from climate change, which is clearly a more pressing issue than the pandemic, but it can’t achieve the same headspace, the same focus with regulators and innovators and business people because it’s not a daily active crisis. It’s something that periodically we hear about, you know, a forest fire, we hear about a drought. But it’s not every day in our consciousness, in the way that this pandemic is.

Brett: It’s a bit of a damning statement on human psychology and our inability to plan for the long term and think about the future, I guess. But yeah, I think that’s just the reality of the situation. Without this kind of a crisis hitting us in the face, reminding us daily of the impact that’s having on our lives, there’s really less of an impetus for people, at large, to really try to change their behavior and push for behavioral change. And, who knows, I think that we are the way that we are for a good reason in a lot of ways. I don’t think we’re going to suddenly change overnight with this and start thinking at a societal level much more about the future. I mean, that could be the case, but at the very least, this can help us, again, reset, and at least at this point in time, do the right kind of planning for the future so that maybe we compound some happier accidents, I guess, in the future than what we’ve done in the past.

[00:38:15.27] Ben: Yeah. And out of previous daily active crises, we have achieved great things, right? The Second World War was a daily active crisis, where we built the welfare state. I wanted to actually just take you back for a second to the second-order, and third-order effects of the pandemic. It’s almost like I don’t want to let you off the hook, but I’m not asking you to necessarily make predictions, but I thought you had a really nice framework for thinking about the future, which is what you call ‘economic oceans’. And, actually, what we’re talking about, is we’re talking about clusters of attention. And so, what businesses do you build that leverage those clusters of attention?

Brett: Yeah, that’s maybe a good thing to focus on. Yeah, I’ve called them ‘economic oceans’. I like this oceans analogy to describe the way that attention is flowing in our world today because we can’t really think about the economy and everything that exists out there, as defined by verticals or just specific areas because there is so much overlap between the types of companies that are being built, the types of innovation that’s being brought to market. I mean, I think if we look at all the companies that have been built over the last decade, maybe just take a couple of companies like Square or Uber or even Zoom — they’re built at the intersection of these different pools of attention: the way that we think about work, the way that we think about cities, the way that media is evolving, the way that commerce is evolving. None of those are industries in and of themselves, but they’re, again, these areas where, at the intersection of those things, is where some really, really interesting innovation can kind of be created. And I think that more than anything, as we think about where value gets created in the future, it is less about predicting, and it’s more about staying close to where those areas are overlapping, and how, for example, to take one area, how does this new approach to wellness and well-being and managing our health and understanding our health in the wake of this, change the way that cities are constructed or change the way that we consume media, or change the way that we think about work and value work and prioritize work in our world. And so, I think that there’s going to be some really interesting bundling of these categories that is sort of not predictive, and it’s hard to say exactly how it’s going to play out, but to try to focus on those intersections is maybe the right approach.

[00:40:46.12] Ben: Yeah. And I think that’s very consistent with what you said earlier on, which is it’s very difficult to have a winning business model unless you’ve captured demand, right? Or, I think you said, what was the term? To introduce a business model without social aspect. Because it’s almost that. I mean, look, if we think about finance, for example, it doesn’t have that social aspect, therefore, it’s a service that almost increasingly lends itself to be bundled with other activities within an economic ocean, because in itself is obviously intrinsic to economic activity, but it’s not something where you have particularly strong social network effects, for example.

Brett: Yeah, it’s kind of the way that any company on the internet seems to trend. Those commoditized services get bundled into a company that owns significant demand in one area or another. It’s sort of like, you know, that you always hear the term every enterprise SAS company becomes a FinTech company at some point because you get deeply enough integrated with the workflows of your customers that then you can start offering them just different features, different financial products, etc. And I think the same thing is happening in the consumer internet world as well, as you see the proliferation of digital wallets across the board with every company trying to offer them, thinking about how to offer them. It’s sort of the same thing. So, yeah, if you can identify the companies, I think, that are owning that demand and generating that demand, and I guess going back to that idea of generating intense loyalty from a customer base and finding the right ways to scale that loyalty, then you can really figure out where the next steps lie for that company and where the next features and monetization paths are.

[00:42:25.28] Ben: I want to ask you about another term, which I think is yours. I think it’s another one of your idioms, which is ‘clampetition’. What is clampetition? And can you give us an example? Because, again, it’s quite specifically used at the moment, within the pandemic, I think.

Brett: You touched on it earlier, where the pandemic has given a lot of companies this cover to do different things or interesting things or this carte blanche to do innovative stuff that they may have not had the boldness to do before. The way that I think about this term, ‘clampetition’, it’s a word that just joins together competition and classiness, which is essentially companies using this totally disjointed economic situation to make moves that are classy in terms of helping their customers or helping their suppliers, but also double as these smart customer retention or acquisition tactics. And a lot of these moves are pretty minor. I mean, I’ve probably gotten a million emails from companies saying, “Our product is free for 30 days during the pandemic” or something like that, that are just really lightweight attempts to acquire new customers when they may not have otherwise had a channel. To assume upgrading its education users to a free plan is one example of that.

Brett: There’s others that run a lot deeper and I think the food delivery space provided an early interesting model of that. So, in the US, at least, there’s sort of these four companies that are vying for the leadership role in that world and it’s Grubhub and Uber Eats and Postmates and DoorDash — and Grubhub is the only one of those companies that’s actually profitable. Postmates and DoorDash are kind of these venture-backed companies that are burning a ton of cash, Uber Eats burns ton of cash as well. And DoorDash used this opportunity to do something that their competitors couldn’t, because they’re burning so much cash and have this existential runway threat where Grubhub suspended commission payments from restaurants and was able to do that, and it’s a classy move — it helps restaurants, in theory, not have to pay and save working capital and things like that — but at the same time, it’s pointed directly at their competitors and saying, “We can do a thing that you can’t, and hopefully that’ll allow us to serve our customers better, acquire more customers, pull them away from you and hurt your business long term.” So, I think it’s a type of thing that’s been happening quite often across the board and it’s just an interesting, unique thing that’s been birthed by the pandemic.

There’s a new paradigm — places where there’s a significant gap between engagement and monetization, where companies have been positively impacted by spatial economics, where there is network effect developing or positional scarcity developing. But, the market hasn’t quite caught up to that or understood that yet. — Brett Bivens

[00:44:53.05] Ben: Square is another company that you’ve consistently been really bullish on and a company where, a bit like Spotify — maybe that’s changing with Spotify, and it’s certainly changed with Square — but where, for a long time, you were almost contrarian in really rating the prospects for Spotify and for Square. Why is it you’re bullish on Square and what have they done in terms of clampetition? Because I think you used the example of Square a couple of times in the essay.

Brett: Yeah. So, Square is a really interesting company as well, just because they are one of those companies that have hit that internet escape velocity state. They’ve driven so much demand with this Cash App, and they’ve just understood culture to such a degree and have driven so much loyalty within that product that their biggest challenge or threat as a business right now is their SMB customers just going out of business. That’s a massive threat to them. They’re the type of company that has this sort of responsive instrumentation, this ability to adjust incentives, adjust operations in real time. And because of the fact that they’ve built up this two-sided business where they’ve got SMB customers on one side, massive demand with Cash App on the other side, they can actually drive significant relief to those SMB customers over time by doing things like offering rewards to their digital wallet customers for shopping at those places and recommending different Square SMB customers, so they can be the force that drives the recovery of a lot of their customers. And I think that’s a really, really interesting company to keep tabs on and follow and yeah, I’m very bullish about their prospects and where they’re going.

[00:46:36.12] Ben: They’re almost a good example, as well, of patient investing, right? Because they started with that card reader that a lot of people saw as just being almost like perpetuating the same because it ran on all the same networks. But from there, they’ve innovated and innovated, and I suppose they did it under the radar to some extent or patiently because, again, they’re formidable competitors, and they’ve run on other people’s networks. And so, they’re a little bit the same as Spotify, in the sense that they’re operating in a space where they’re surrounded by very, very powerful players. And then, would you also argue that they’ve got business model leverage, i.e, they’ve now established a really good unit of exchange, and a loyal customer base and scale, and are in a position where they can start to layer on new product offerings and expand within their economic ocean? I’ve tried to use as many of your terms as possible.

Brett: Yeah! I think that’s spot on and I think it’s true for both sides, if you think about their SMB customers, again, because they can potentially drive so much demand to those customers, because they’re so deeply embedded in their workflows. They have an opportunity to offer additional services over time that, again, they’ve got this captive audience, they don’t need to acquire them for a huge cost or anything. They’ve got them right there, so they can just continue to upsell. And that’s great. And then yes, on the customer side, this sort of digital wallet, the Cash App, the payments, the peer-to-peer stuff is a great starting point. But then, they get into areas like stock trading and other places like that where they can just keep serving out new services, new features, new products to these users over time. And that whole flywheel just kind of keeps spinning. Yeah, I mean, it sounds easy. It’s certainly not easy. I think, for any of these companies, there’s massive competition from all sides for a company like Square but they certainly do sit in a pretty advantaged position.

[00:48:36.02] Ben: So Brett, I want to ask you also, now, about the shifting economics of distance. So, I’m going to quote again to you from one of your essays. You said, “We are seeing, for the first time an economic shock create a discontinuous divergence in the spatial economics — the cost of distance between the physical and the digital worlds.” What did you mean by that? And also, if you don’t mind, can you also talk us through this matrix that you’ve got? It puts people in quadrants based on positional scarcity versus spatial economic impact of COVID-19. Because it’s a great diagram.

Brett: Yeah, absolutely. I think over the last few decades, we’ve seen a broad-based decline in the cost of distance across digital and physical worlds. It’s cheaper to ship things, it’s increasingly cheaper to travel all around the world. So, doing things in the physical world, at a long distance, is increasingly less expensive. So that cost has been coming down. The cost of doing that, from a digital perspective is coming down even faster. It really hasn’t been necessarily significant enough to break the status quo that’s kept many things functioning as they have — I mean, the cost of delivering education or the cost of doing a business meeting digitally has gotten less expensive for higher quality over time. But, because of the fact that the other pieces of the physical world side of it have also been declining in value and because of the fact that there is an element of positional scarcity to these things — there’s prestige tied into jumping on a flight and going to a business meeting or there’s prestige in being on location at a university, getting your degree there — they really haven’t decoupled and I think that this pandemic situation has totally decoupled those things from, again, health to education to the way that we do business, and it’s really broken down those things, and it’s having a pretty significant impact on capital and attention flows. I think you can see this play out. There’s a really good tweet from Chamath Palihapitiya of Social Capital, that talks about just the different terms that a company like Slack who has significantly benefited by this rapid decoupling in what they were able to get as they went out to the markets to raise debt versus a company like Airbnb, who has been really, really challenged and put in a tough position through all of this.

Brett: And so, the quadrant that you’re talking about, or the chart that you’re talking about, looks at four different areas. So, is a company negatively impacted by the spatial economic shifts of COVID-19? On the negative side, you get things like movie theaters or non-elite secondary education institutions. And then, on the positive side, you get things like digital wellness and telehealth and teleconferencing and distance education and things like that. And then, on the positional scarcity side, sort of high and low, it again kind of comes back to, is there prestige or legitimacy tied up in this activity? Is there a physical or regulatory monopoly around this activity? Are there network effects that will come back as we sort of start to ease away from this? So, the four categories, if we look at it, there’s a resilient recovery category, which is sort of this high-level…

Ben: It’s top left in the quadrant, right?

Brett: Exactly! Top left, and it’s sort of high positional scarcity, high signaling value, high degree of assets that will be valuable over time — and that’s things like Airbnb, or the NBA, or Harvard; those are things that will have a dip but should recover pretty resiliently.

[00:52:34.01] Ben: Yes. These fit in the bounce-back category, right?

Brett: Exactly, yeah. And then, there’s the side of that where an activity or a company has been negatively impacted, but does not have the benefit of prestige or legitimacy and has seen significant brand impairment or a massive shift in the value chain. And again, that’s what I talked about a second ago with movie theaters and non-elite institutions. There’s the obvious growth category, which is, these companies that have been positively impacted, but don’t really have that positional scarcity or any kind of real signaling value. And again, things like Zoom, things like distance medicine, etc, where it’s kind of obvious that those are going to grow — if you’re already invested in those categories, great; if you’re not already invested, it’s possible that the valuation gap has closed already on those things and it’s not really clear where the alpha is, so to speak, in there. And then there’s, I guess, a new paradigm, and this is maybe hard to judge or hard to understand exactly where it plays out. But places where there’s a significant gap between engagement and monetization, where companies have been positively impacted by spatial economics, where there is network effect developing or positional scarcity developing. But, the market hasn’t quite caught up to that or understood that yet. And, again, who knows what this category is going to be. If any of us knew that, we’d be in a pretty good situation, but potentially things like gaming and distance primary education fit into this category. But yeah, we’ll see how that plays out.

Ben: Fantastic! Brett, thank you so much for coming on the podcast. That’s been a fantastic conversation! And I think not only have you opened our eyes to lots of different opportunities that we maybe weren’t thinking about, but I think you’ve also given us a new vocabulary to talk about those opportunities. My last question to you, before we conclude is, where do people find your writing? How can they engage with you because I think you’ve also got a Telegram channel now, right?

Brett: Yeah. So, Twitter — I’m pretty active on there, @brettbivens. I have a weekly newsletter that I put out where I talk about a lot of this stuff, at venturedesktop.com, and then, like you said, I also have a Telegram channel where I have more high-cadence thoughts, rapid thoughts on different things, share different links that I’m reading, stuff like that. It’s been a fun experiment to try to connect with some new people and share more thoughts in real time. So, those are probably the three areas to connect with me.

Ben: Brett, thank you so much, indeed!

Brett: Thanks, Ben! I appreciate the time.

To turn Adversity into Advantage, Banks need to Renovate in Winter

Renovate in Winter

To turn Adversity into Advantage, Banks need to Renovate in Winter

by Ben Robinson | March 30, 2020 | 8 minutes read

Crisis is not the time to stop all IT projects, but to double down on the ones that really matter.

Don’t pull up the drawbridge

Beware risk and opportunity cost

Bag some quick wins

Enterprise Software Stack Systems of Intelligence
How the Banking Enterprise Software stack is splitting

Consider Impact on the future

The Future of Banking
The Future of Banking and the Strategic Imperative

This a data play. It requires understanding customer context (interaction preferences, financial situation, needs) and be able to match to the right offering. In the first instance, financial services companies will do this for their own labelled services, but increasingly — to maximize utility and convenience — they’ll need to do it for third-parties services as well (requiring an extensible product catalog) and intermediating and bundling if necessary (which necessitates managing real-time risk). As a third phase, these same institutions can then orchestrate value between the different parties on the platform, stepping back from intermediating and becoming a system of collective intelligence.

Don’t waste a crisis

Articulate the change narrative

Use stop/go triggers

In summary

The new moat in financial services (and why P. Thiel, not W. Buffett,…

The new moat in financial services

The new moat in financial services (and why Peter Thiel, not Warren Buffett, is the new investment wizard)

by Ben Robinson | July 26, 2019 | 11 minutes read

In the networked age, scale of production is no longer a moat. Instead, network effects are the new moat. Peter Thiel gets this; Buffet doesn’t.

I look for economic castles protected by unbreachable ‘moats’ –Warren Buffett

The quote above from Warren Buffet, a statement he first made in a 1996 investor letter, is one of his most famous. It neatly encapsulates his investment approach: invest in giant companies that can achieve a “moat” by operating at a scale that others can’t reach.

By spreading the fixed costs of expensive, non-transferable assets like machinery or a banking licence, as well as highly-geared operating expenses like brand marketing and regulatory compliance, over a larger revenue base than competitors, these companies could be better known and cheaper. And, if you look at Buffet’s portfolio, it’s full of companies operating in industries with high fixed costs and high operational gearing: capital goods companies like BYD, consumer goods like Coca Cola and, above all, financial services companies like Wells Fargo, Amex and Bank of America.

The investment approach was massively successful — until it wasn’t. In the period 1979 to 2008, Warren Buffet outperformed the S&P 500 by 12.6% a year on average, cementing his reputation as the Wizard of Omaha, the most successful investor of all time. But — a less known fact — since the financial crisis, Warren Buffett has underperformed the S&P. One might be tempted to attribute this relative under-performance to the heavy financial services weighting in the Berkshire Hathaway portfolio. However, while a factor, deeper structural changes are at play.

Problem number one with the Buffett investment philosophy is that, in the digital age, critical mass is within most companies’ reach. Critical mass — or minimum efficient level of scale — is the scale of production a company needs to reach where it won’t have a major unit cost disadvantage compared to its competitors. After this point, diminishing returns to scale kick in, which means that even if a competitor has greater volume it won’t translate into the same order of magnitude differential in unit costs.

However, as we’ve written before, companies can now plug into the scale economies of third-parties like AWS, which spread fixed costs over the volumes of all customers, to get to scale faster. In banking, you see the emergence of banking-as-a-servce providers, like Railsbank or SolarisBank, levelling the field for new entrants. All in all, this means that scale does not represent the barrier to entry it used to.

Scale can become a hindrance

The second problem with Buffet’s investment philosophy is that diseconomies of scale, or negative returns to scale, manifest themselves more frequently and earlier.

In the industrial age, the trick to achieving an unbreachable moat was to produce standardized goods at mass scale and then invest in marketing to create sufficient demand to sell all of these goods. The challenge now is two-fold. Firstly, the broadcast channels that companies used to advertise are being eroded at the same time as there are many more demands on the consumer’s attention, making it harder to engage in the same type of mass-marketing.

The second issue is that, since consumers are now online, we can know much more about them, as well as have a direct relationship with them. This means that at the same time as it’s become possible to operate profitably at smaller scales of production, it’s become possible to produce goods which cater to smaller customer demographics, and to reach these customers directly — which explains the rise of artisanal goods and direct-to-consumer brands.

But, for digital goods, it goes further, artificial intelligence increasingly allows platforms to match services to customers as well as personalize services to each customer.

To put it another way, in the digital age, the mass consumer is dead.

The new moat

This begs the question, is it still possible to create a moat in the digital age? One answer could be that the idea of a moat is obsolete, a relic of the industrial age, sort of what Elon Musk said when he challenged Warren Buffett recently. But, the reality is a new moat is possible and it’s the diametric opposite of what came before.

Scale isn’t the barrier to keep out new entrants, scale is what attracts new entrants to work with you. Scale doesn’t allow you to push a mass produced product to the mass consumer, scale is what enables you to tailor an individualized product to every consumer.

“I think moats are lame. If your only defense against invading armies is a moat, you will not last long” – Elon Musk

This definition of scale is one that accepts and capitalizes on the new realities of the digital age. Maximizing production scale by itself is less of a competitive advantage and, increasingly, a competitive disadvantage. But the fact that consumers and business are connected means that a new competitive advantage can be achieved by maximizing network size.

Where a network has strong social engagement, like Facebook, adding more users increases the value of the network for everyone. Where a network matches buyers and sellers, like Amazon, increasing the network size increases choice and, by extension, value. Where a platform analyzes data to serve up the best results, like Google, the more data that comes from adding users, the better the results become. And most platforms are a combination of these social, two-sided and data network effects.

What is more, the new moat is a superior moat. Supply-side economies of scale, while a formidable barrier to entry in the industrial age, always suffered from diminishing returns.

Demand-side economies of scale, however, are subject to increasing returns to scale since more users create more value for other users in a self-reinforcing positive cycle. This is why in markets where network effects are strongest, there are winner-takes-all dynamics.

Does this mean that supply-side economies of scale are irrelevant? Not at all, as we wrote a few years ago, these platforms based on demand-side economies of scale (network effects) often become asset heavy as a way to reinforce the strength of these network effects and maximize profitability. But the difference is that maximizing scale economies was not the goal in itself. Instead, these companies found a route to mass adoption and, from there, put in place the assets to sustain the network. In other words, a business grows its assets top down like the roots of a tree.

If the new moat is to achieve network effects, how can these be achieved in banking? In our mind, this is probably asking the wrong question. Banking is inherently a transaction-based activity. This makes it unsuitable to most types of network effects.

For example, most companies that have tried to build social network effects into banking, either as part or whole of their USP, have failed. We don’t want to chat with our friends specifically about money, we don’t want to share all of the information on our assets and liabilities. Which means that, although the new banks sprouting up might be cheaper and more convenient than what came before, they aren’t able to arrive at meaningfully and sustainably lower costs of customer acquisition numbers once they’ve gone beyond the early adopter audience.

It is possible to create marketplaces for financial services, but because banking is transaction-based (and fundamentally not a social activity), the surface area around which to create a marketplace is limited. Basically, we don’t spend much time on banking apps, which makes it difficult to introduce us to other products and services, which we then don’t purchase frequently anyway.

This podcast was recorded at FinTECHTalents’19 Festival: we’re exploring the potential of unleashing network effects in financial services. Ben Robinson is joined into the conversation by: Evgenia Plotnikova (Partner @ Dawn Capital); Martin McCann (CEO at Trade Ledger); Oliver Prill (CEO at Tide Business Banking).

Some banks and fintech providers get round this by targeting specific demographics and then giving them the tools they need to run their business/life, such as Tide, which understands that freelancers and small businesses will send invoices and submit expenses more frequently than they’ll apply for a loan. But, these business are niche.

When this is attempted on a bigger scale, it comes back to the same problem of unit economies: high CAC in the absence of social network effects and low lifetime value in the absence of the engagement.

The mistake we think many people make when they think about banking and network effects is to apply the following logic: banking is a massive market, therefore we must target it and find a way to generate network effects. We believe it is smarter to turn the logic on its head and think about how to put banking into channels and services that have high engagement and strong network effects, what Anthemis calls “Embedded Finance”.

As Amazon is showing, the goal isn’t picking off a few high value revenue lines, but making value flow ever more easily within the Amazon ecosystem, removing friction and making it easier for buyers and sellers to trade. Similarly, the Alibaba and WeChat models both serve a higher purpose: to embed financial services into people’s lifestyles.

The direction of travel can go in the other direction too: that is, starting with banking and seeking to embed it in other services with higher engagement. This is what Moneo is trying to do and what TinkOff Bank in Russia has done so successfully. Through partnerships as well as launching its own products, Tinkoff has created a super app akin to WeChat in China where consumer can do everything from booking theatre tickets to giving their kids chores.

But, in general, it seems more probable that banking will get embedded into other services than vice versa for the reasons already stated: it’s a high CAC and low engagement starting point from which to build out an ecosystem or Super App.

That doesn’t mean that there won’t be plenty of opportunities to build big businesses in banking, that enjoy strong network effects. But, to our mind, these are unlikely to be directly client-facing.

Earlier this year, we wrote a piece about systems of intelligence in finance. The piece looked at these systems mostly from a supply-side and architectural standpoint, arguing that solution architecture needed to change in response to the split of distribution and manufacturing and to capitalize on open banking. It concluded that systems of intelligence would emerge as the most valuable parts of the Enterprise IT value chain.

Here we make the same argument, but from more of a market standpoint. If we accept that banking will become increasingly embedded in third-party services and channels, it doesn’t necessarily follow that, as many people argue, banking will become completely commoditized.

As markets digitize, two types of intermediaries tend to emerge: those that seek to internalize network effects by commoditizing supply, aggregators like Amazon or Facebook, and platforms that externalize network effects by empowering suppliers, like the Apple AppStore or Shopify (Ben Thompson sets out this distinction very well in this much recommended post).

In financial services, then, the same pattern will play out: aggregators like Amazon will commoditize financial services suppliers, while platforms will emerge to intermediate between suppliers and distributors in a non-zero-sum, value accretive way. These platforms will be systems of intelligence.

Systems of intelligence are evolving. Today, most systems of intelligence are deployed for individual clients and with the end of digitizing services. But this is just the first step. Digitizing services makes them consumable through non-proprietary bank channels, but it also generates a new stream of data that can be used to make the services better fit consumer needs. So the next step will be that systems of intelligence will then use that data to help providers more intelligently price and package financial services.

But once that has been achieved, the opportunity will exist to then serve up the right service to the consumer at the moment of need, which mean systems of intelligence become systems of network intelligence, matching the needs of consumers with the inventory of suppliers in the smartest way.

This is the evolution we observe happening at companies like additiv, Assure Hedge and Trade Ledger. Trade Ledger is digitizing the origination of credit services so that lenders can supply credit at the right price and with the speed needed by fast-growing SMEs. But beyond that, it is able to use data to give lenders a real-time picture of asset quality, even for intangibles assets, allowing lenders to offer new types of services better matched to changing customer needs. But, ultimately, the opportunity exists to then link lenders with the different players in the ecosystem, helping embed banking into whatever is the right channel to serve the customer at the point of need. Martin McCann, Trade Ledger CEO, puts it well in this excellent blog:

“Within business finance, the opportunity exists not just to connect banks with their customers, but banks with banks, corporates with corporates, corporates with complementary third-party services providers and so on.”

If Warren Buffett has missed the shift from supply- to demand-side economies of scale, there is one investor who most certainly hasn’t. That is Peter Thiel. His investment in Facebook, a business underpinned by massive network effects, made him a billionaire. Conversely, Buffett passed on Facebook, like Google and Amazon, because he couldn’t get comfortable with the valuation, saying “I didn’t understand the power of the model as I went along.”

And the performance of the two investors also couldn’t be more divergent. Whereas Buffett has underperformed the S&P since 2009, Thiel’s Founders Fund has more than two-fold outperformed the VC fund industry since 2011 (the only figures we could find in the public domain). Since 2011, the Founders Fund is up by $4.6 for every $1 invested.

And where is Peter Thiel investing now? If you look at his holdings, there are many B2C companies there for sure. But, more than anything, there are systems of intelligence — across many industries, but especially in financial services. This leaves Peter Thiel well-placed to capitalize on what Matthew Harris, another venture capitalist, sees as the fourth major wave of digitization after internet, cloud and mobile; one that, in his view, will create more value— $3.6 trillion — that its three predecessors combined.

So, you don’t need to believe us that systems of intelligence are the next big thing. Just look to Peter Thiel, the new investment wizard.

Digital Era Banking Systems

Digital Era Banking Systems of Intelligence

Digital Era Banking Systems

by Ben Robinson | Dec 17, 2019 | 11 minutes read

The banking software market is reconfiguring around the demands of the digital economy — and value is accruing to new systems of intelligence

In Clayton Christensen’s Law of Conservation of Attractive Profits, he talks about the “reciprocal processes of commoditization and de-commoditization” that occur in technology value chains when product architectures change:

“The law states that when modularity and commoditization cause attractive profits to disappear at one stage in the value chain, the opportunity to earn attractive profits will usually emerge at an adjacent stage.”

Our view is that this same process of commoditization and de-commoditization is playing out in the market for banking software. Changes in technology (cloud and AI) as well as changes in regulation (real-time payments and open banking) are causing a formerly integrated system to become modularized and new players are emerging to exploit this shift— new core banking systems but also new systems of intelligence that, akin to operating systems, orchestrate value across their networks.

A brief history of banking software systems

When we look at the technology debt in the banking industry, we might forget that banks were once IT pioneers. Banks were among the first industries to use software, adopting branch accounting systems to keep records of customer bank balances as well as to calculate interest, fees and tax.

But, because banks were such early adopters, they wrote their own applications — there was no software industry at that time from which to buy applications. This might not have been a problem except that 1/banks didn’t stop writing applications when commercial software arrived and 2/they have kept and extended those same branch accounting systems ever since — producing the kind of unwieldy system architecture depicted below.

A typical universal bank system architecture (source BCG)
A typical universal bank system architecture (source BCG)

Smaller and newer banks (from the 1980s onwards) skipped the branch accounting system and instead moved to packaged software, integrated core banking systems. These systems had many advantages: they could run on much cheaper hardware (and software) than S/360 mainframes; they could keep separate records based on parties and products (so that it was possible to have the same customer across branches and products and to provide consolidated views of customer holdings); and, they were integrated front-to-back — from the teller to the general ledger — meaning that changes could be applied across the whole system, reducing significantly both the run-the-bank and change-the-bank costs. And so banks running integrated core banking systems were in a position to achieve scale economies as well as to cross-sell effectively and, when product builders were added, to launch new products to market quickly.

System S/360

Bank systems in the internet era

With the arrival of the internet, banks opened up proprietary channels (apps and internet portals) which allowed customers to query their own bank records and set up payment instructions. But that was the extent of the upgrade: neither branch-based accounting systems nor integrated core banking systems were significantly re-architected in response to internet banking. In fairness, some core banking systems were already real-time and most have been scalable enough to cope with the rise in customer interactions. But the situation is changing.

Integrated to Internet Banking

The open banking era

In most industries, product manufacturers have a choice about whether or not they sell through distributors. In banking, in Europe and an expanding number of other places, this agency is being lost. Open Banking legislation is forcing banks to put their inventory online by obliging them to share customer transactional data with third parties (where customers give consent). In effect, banks face a stark choice: become aggregators of own-labelled and third-party products or risk being disintermediated by other aggregators, whether from inside the industry or outside (e.g Amazon or Alibaba).

The Open Banking era
CB Insights showing the spread of Open Banking legislation across the globe

In addition to open banking regulations, most jurisdictions have enacted — or are enacting — legislation related to real-time payments. This will likely have a profound impact on value chains outside of just banking — for payment schemes, for instance — but in banking it will usher in an era of not just higher volumes, but lower fees per transaction, requiring a step change in scalability if banks are to be able to keep up — and to do so profitably.

In response to these two changes, the integrated nature of most banking systems is unsustainable. If banks are to distribute third-party as well as own-labelled products, they will need a separate system for distribution. If banks are to cope with the demands of ever-increasing payment volume as well as continually rising interactions, they will need to separate channels from manufacturing to boost straight-through processing (STP). To put this last point in context, if a bank moves from 99% STP to 99.9% STP, this would likely translate not to a 1% reduction in costs but more likely a 10x reduction in costs.

The future model for banking systems could be the retail industry where the major players have all created distribution systems independently of accounting systems. But there is precedent that is much closer to home: when regulators pushed for higher STP in capital markets in the early 2000s, the industry very quickly split between front office (the buy side) and middle office (the sell side) and systems were re-architected accordingly. And, whereas in capital markets there was a push for faster transactions, in banking there is both a push for faster transactions and a push to open up the industry to new competitors. As such, this split seems all but certain.

Systems of intelligence

At the moment, there is a tendency to try to put more and more logic into banking channels, but this is flawed. Proprietary banking channels are likely to disappear as banking becomes more “embedded” in other products and services (such as WeChat), making these investments increasingly pointless.

Instead, this logic needs to sit somewhere else, where it can be used to produce a high level of engagement across multiple channels, where it can be combined with data from multiple other parties and systems, and where it can handle inquiries independently of orders and order entry asynchronously from order execution. This somewhere else is a system of intelligence.

Systems of Intelligence Basic.png

We borrow the term “system of intelligence” from this seminal article from Jerry Chen, a Partner at Greylock. In his article, Jerry describes how application software is splitting into three layers: systems of engagement, systems of intelligence and systems of record. If we apply the same taxonomy here, customer channels are the system of engagement (although we prefer to use the term system of interaction because we see these as thin clients, integrated using REST principles); core banking systems are the principal system of record; and distribution systems are the systems of intelligence.

In Jerry’s article, he highlights the importance of technology changes in creating the opening for new systems of intelligence. One is cloud in that it adds a new level of scalability on which to build these systems, but the more important is AI, which fundamentally changes the amount of data we can process and the insights we can draw from it. Echoing Clayton Christensen, Jerry Chen says that, because of AI, 

Systems of intelligence in banking

In Jerry Chen’s article, he makes the point that providers of systems of record often have an advantage in creating systems of intelligence because they have privileged access to their own data. This is true for banking also, although open banking removes part of this advantage (for transactional information). A bigger advantage for incumbent banking software comes by dint of serving hundreds or, in some cases, thousands of banks; creating the pull to attract other data sources to mash up with data from their own system of record.

The playbook for incumbents, regardless of industry, remains Salesforce. A lot of people get excited about the Salesforce AppExchange, a marketplace for complementary applications, since it created a platform business model with two-sided network effects. But at least as important in amassing the data to become a system of intelligence are Force.com (now the Lightning Platform), its platform-as-a-service on which third-parties build native applications, and Mulesoft, its API integration platform, which allows third-parties to integrate their existing applications and datasets. Lightning and MuleSoft don’t just provide a route to data but lock-in and switching costs around that data. And then, working on this data and giving an additional incentive to share the data is Einstein, the Salesforce system for artificial intelligence, deriving insights for Salesforce and its customers. We would argue that it is ensemble — MuleSoft, Lightning, AppExchange and Einstein — that makes up the system of intelligence.

Salesforce’s system of intelligence

And so in banking it is unlikely that creating an AppExchange equivalent will be sufficient to create a system of intelligence.

It is likely to need all of the above components: an API platform, PaaS, AI and an app store. And let’s not forget that because of open banking, the distribution play for a banking system of intelligence goes further than distributing apps — to helping banks distribute third-party banking services.

This extends the list of necessary capabilities to include, for example, order management and an extensible product catalogue, as well as customer engagement tools that, among other things, would help identify the right content and services to offer up to customers at the right time and over the right channel.

In addition, we believe a key component of successful systems of intelligence will be to share intelligence across their ecosystems.

The idea, very well articulated in this blog by Peter Zhegin, is that the source of competitive advantage (the moat) is constantly shifting. Processes— and software — are declining in importance relative to data. And within data, Peter argues that the moat is moving away from data collection — amassing the largest possible data set with which to train a model that benefits the company’s product — to improving the collective intelligence of the network.

In banking software, therefore, advantage is moving from having the best application to having the most value-added ecosystem around that application (app store) to helping customers make smarter decisions (system of intelligence) to helping the whole ecosystem perform better (a system of network intelligence).

As a practical example, this could mean moving from providing independent banks with the best credit scoring model to facilitating an open banking network.

Commoditization and de-commoditization — the emerging vendor landscape

As in any market where the value chain is being broken up, there is likely to be a significant shake-up in the competitive landscape for banking software. The keenest fight will be to dominate the market for systems of intelligence, since this is where value will accumulate. But we are also seeing new entrants into the core banking market.

Since the system of intelligence aggregates logic away from the system of record, the system of record is required to do less. Effectively, the most important characteristics of the system of record will increasingly become speed and cost.

As a result, these systems will be re-architected for speed (into microservices) and they will be deployed in the public cloud. And it is no surprise, therefore, that we are seeing the arrival of new cloud-native core banking systems such as Mambu, one of the first and the most successful so far.

Furthermore, as the need for scalability increases, we predict that we may even see these systems further fragment, with the accounting capabilities (fees, limits, etc) splitting from the manufacturing capabilities, which, incidentally, seems to be how Thought Machine is architected.

Digital Banking to Real-time Banking

As regards the systems of intelligence, we foresee a three-player race.

The first players are horizontal systems of intelligence. Insofar as the system of intelligence is like an operating system (nCino actually calls itself “a revolutionary bank operating system”) — providing a consistent set of interfaces, mashing up and running analytics on multiple data sets — these systems do not need to be as domain-specific as systems of record.

Accordingly, there is the potential for horizontal players to make bigger inroads into banking software — such as Salesforce, which already has good traction in wealth management and is pushing aggressively into retail banking.

The second players are the incumbent providers of systems of record. Many are well-positioned — having the pull of large customer bases and investing in the tech infrastructure. Finastra, for instance, has assembled many of the underlying components of a system of intelligence — an app store (Fusion Store), a PaaS (Fusion Operate) and an API platform (Fusion Create). The bigger question is likely to be whether management at these companies will place enough importance on a platform strategy to be able to overcome the immune system challenges.

The third set of players are the new entrants. With a couple of exceptions, such as nCino, these are chiefly vertically focused: for example, Additiv is focused on wealth management (and increasingly credit), The Glue is focused on retail banking, and Trade Ledger on lending. While there are likely many more shared than vertically-specific components in banking systems of intelligence, which makes a cross-banking strategy possible, an initial vertical focus makes sense to build a network quicker (the micromarket strategy to overcoming the chicken-and-egg challenge) and conforms with the pattern of disruptive innovations, which are typically commercialized first in smaller and emerging segments.

To sum up…

In response to regulatory and technology changes, the banking market is undergoing a digital upgrade with new networked business models emerging.

The most successful banking technology companies will be those that align themselves with — and enable — this change.

Our bet is on those that can create the best systems of intelligence.

What is a Challenger Bank for?

What is a Challenger Bank for?
The battle is on to see which firms will dominate the internet-era banking market

What is a Challenger Bank for?

by Ben Robinson | Sep 18 2019 | 13 minutes read

The last couple of months have seen JP Morgan close its digital bank Finn, as well as BPCE close the UK arm of its digital bank, Fidor. This has led to a lot of speculation about whether it’s possible to run a disruptive business within an incumbent organisation. But, it also raises a simpler point. When does it make sense to launch a challenger bank?

Challenger banks are definitely in vogue. In the aftermath of the financial crisis, regulators sought to introduce more competition into their domestic banking markets. One of the most progressive was the UK regulator, which lowered capital requirements for start-up banks as well shortened the application process, leading to a influx of new competitors. But many jurisdictions, including the UK, also introduce Open Banking legislation, which obliges banks to share customer data with third-party providers, also increasing competition.

The Open Banking era
This graphic from CB Insights shows the spread of Open Banking legislation across the globe

In addition to the regulators’ efforts, technology has also lowered barriers to entry. Infrastructure services like AWS have reduced start-up costs while smartphones have opened up distribution at the same time as making possible new digital features, such as remote, paperless customer onboarding.

The result has been an explosion in the number of new companies offering banking services — 17% of all companies having been created since 2005, according to Accenture.

Accenture Beyond North Star Gazing Open Banking
Source: Accenture, Beyond North Star Gazing
Challenger Banks a Global Phenomenon

But digital banks are not just banks without branches. They are offering something different. Part of this is about customer experience — they have built their offerings from scratch, taking advantage of new technology to mould their services around people’s lives. But part is also around business model.

A look at the latest Monzo annual report illustrates this well. It has over 2m customers, but it makes significant losses. It has over 2m customers, but makes net operating income of only £9.2m (£5.7/customer). The majority of its money comes from fee income, not interest income. And, despite heavy losses, it is ramping up marketing expenses (up 700%) and pushing forward with international expansion.

Note: Monzo reported 2m customers as of May 2019. However, most of the metrics above are calculated based on the total number of customers (1.6m) at the end of fiscal year, Feb 2019

In this regard, Monzo — like the other challenger banks — is operating a classic digital-era business model. In contrast to traditional banking models, it recognizes that distribution is not the primary point of differentiation in the value chain; but, instead, customers are.

Number of Customers per Challenger Bank

It is this desire to maximize customer numbers that explains why, despite a historical customer acquisition cost of less than £3, Monzo is engaging in TV ad campaigns. This explains why its investors are prepared to cover its losses and fund its international expansion. And lastly it explains why most income comes through fees, not interest income. Because this is a business where, with low customer acquisition costs, low churn (NPS is +80%) and low cost to serve (GBP30 per account at present and falling fast as scale economies kick in), the incentive is to maximize lifetime value.

Valuation per customer Challenger Banks

Monzo, like other challengers, will seek some direct customer monetization for sure — Monzo is now offering loans — but this is likely to be levied on those who can most afford it, in the shape of premium subscriptions, ensuring that most services remain free (current account, foreign ATM fees) to attract as many new customers as possible. Instead, most of its monetization will be indirect, using the pull of its large customer base to bring in third-party fees. At present, most of its fee income comes from interchange fees as its customers spend money using their Monzo debit card, but over time other routes will make more meaningful contributions. Monzo has said that it wishes to become its customers’ “financial control centre” by introducing them to the best possible third-party financial services and, although the resulting commissions from these introductions are small at present (just £85k), this will grow as two-sided network effects materialize.

Monzo customer contribution margin

For incumbent financial institutions, it is difficult to match the challenger bank model. Their businesses were created for a different age, where distribution was the choke point in the value chain. The need for a costly and difficult-to-achieve banking licence plus a network of physical branches kept out new entrants, meaning banks could push undifferentiated, expensive products to captive clients. And now it is extremely difficult for banks to change course and match challenger banks like-for-like — they don’t have the cost base, the financial incentives or innovation capabilities to do so. And so many banks are starting to launch challenger banks themselves.

Incumbent Banks Offering
The now defunct universal business model where banks were able to mass produce undifferentiated products

However, the bank-within-a-bank model is also difficult to pull off.

Firstly, as Aperture-subscriber John Hagel so eloquently describes in this piece, you have the problem of the immune system fighting off anything that threatens the business model and revenue streams of the body corporate (what in more successful companies might be described as the Innovator’s Dilemma). This likely contributed to closure of Fidor UK and explains why the rest of the business is up for sale. But the challenge to incumbents is very real. As the following table from Citi shows, banks’ RoE is much more sensitive to falls in revenue than reduction in costs, meaning that with stubbornly high costs — and in the absence of business model change (see below) — it will be difficult for banks to countenance a strategy that cannibalizes existing revenue streams.

Source: Citi GPS Research

Assuming that the immune system can be countered — by creating a completely separate organization, with different people, processes, tech, brand, incentives and reporting directly into the CEO — then you have the problem that innovation is hard. This seems to have been more of the root issue at Finn. Built on the bank’s existing IT infrastructure, its objective was more around putting a new UX on traditional products than using the virtues of digital to create a unique offering. As a result, it didn’t manage to attract large numbers, let alone introduce viral features that leverage the power of networked consumers, as Revolut has successfully done.


The last problem is one of strategic intent. If a bank launches a digital bank because its strategy is a) to defend itself against challenger banks; b) to lower cost to serve by using digital channels; c) to improve User Experience; d) to capitalize on Blockchain/AI/IoT/Cloud or e) to change its perception among younger customers, it’s probably going to fail.

Launching a digital bank is about launching a digital era business model, which goes way beyond changing brand perception, user experience or moving customers onto cheaper-to-serve channels. As noted above, it is about maximizing customer numbers and engagement to activate demand side economies of scale. This requires clear strategic intent because, in turn, it requires organizational transformation. Launching a challenger bank can be a (faster and less disruptive) route to digitization, but it is neither an easy option nor a panacea.

Our view is that a challenger bank strategy has a higher likelihood of success if is underpinned by one (or more) of the following six objectives.

It is interesting to see Goldman Sachs’ digital bank Marcus referenced in so many of the articles on Finn. For us, it is very different. For instance, it is built on a new technology stack. But most importantly, it moves Goldman into a completely new space, consumer finance, where it does not have the cannibalization concerns that trigger the corporate immune system. This allows it to operate under very different constraints and, like other new entrants, challenge the status quo with a proposition that includes market-beating interest rates, no origination or late fees as well as customizable payment dates and payments. And it’s working: Marcus had 4 million customers and $46bn in deposits at the end of March 2019, two and half years after launch.

In the same way as entering new markets allows the new business to operate more freely, so does entering new countries. It is also a less risky strategy than M&A, which made sense at a time when distribution was the barrier to entry, but now encumbers the acquirer with all of the legacy issues they inherit. And this is why the challenger-led strategy is being pursued by many banks, including DBS, which has launched digibank (“a bank in a smartphone”) in India and Indonesia with already over 3m customers — and why it is looking to do the same in Vietnam.

Launching a challenger bank with the purpose of bringing banking to the unbanked is by definition the antithesis of cannibalization — because no one was providing these services in the first place. And, as banks like CBA in Kenya have shown with M-Shwari and now Stawi, when you combine mobile distribution with low costs and intuitive user experience, you can succeed in bringing financial services to millions of people. But, as demonstrated below, while countries like Kenya and China have very successfully leveraged digitization to tackle financial inclusion, there still exists massive scope to do the same in populous counties like Egypt, Indonesia or Pakistan.

The Financial Inclusion Opportunity

Another reason for launching Marcus was that Goldman Sachs can use retail deposits to lower its group cost of capital. But a business where this is more transparently the objective is EQ Bank in Canada. It is a subsidiary of Equitable Bank, which provides residential and commercial real estate lending services, and the bank uses EQ customers’ savings to fund its lending, allowing it to start to increase its net interest margin (now at 1.6%) in a low interest environment. Structuring the group like this not only creates complementarity between the bank and its challenger brand, as opposed to a cannibalization threat, but also reinforces incumbency advantages. EQ Bank can sustain its above-market deposit rates thanks to its parent’s large lending book.

Equitable EQ Bank Funding Mix

Another reason to launch a challenger bank is to attempt lower-risk and faster-to-value technology renovation. Banks sit on decades of technology debt, batch-based legacy systems built around products not people that have been continually added to over time, resulting in massive cost and massive complexity. If banks are to compete on price and on user experience with digitally-native challenger banks, then they will have to address this technology debt. But doing so is expensive and risky, which why it is tempting for many banks to start again — create a new bank with new technology.

A typical universal bank system architecture (source BCG)
This BCG image shows the mass of interdependent systems and interfaces within a typical universal bank

This “build and migrate” strategy is still somewhat unproven , even though it looks like some banks like Santander, with Openbank, may be going down this route (its annual report states that Openbank is “the testing ground for our future technology platform”).

For banks considering this strategy, they should be mindful that they will have to run two IT platforms in parallel for a good while (it is unlikely that regulators would let incumbents close all branches — or indeed the bank itself — for a long time). They should also be aware that there will be customer attrition in the base business as they divert investment into the new bank and also likely attrition when they try to move across customers to the new bank. In addition, they should start small, that is, with a single product offering like savings, which will enable them to test the market proposition before committing big expenditure, get fast RoI on the initial capital expenditure and minimize the risk of rejection from the corporate immune system — at the same time as probably lowering cost of funding (or, in the case of one challenger bank we consulted, whose first product will be to lend boomer savings to millennials, increase asset yield). Furthermore, if the technological renovation is successful and the bank creates a great platform, then, as Starling, OakNorth and Ant Financial have done, it can sell this to other banks — the “make yourself the first customer” model of creating an exponential software business.

Oak North, a unicorn SME challenger bank, sells its lending analytics platform to other banks

The counterargument to the “build and migrate” strategy is two-fold. Firstly, modern core banking systems are modular, meaning that progressive renovation is possible — replacing systems one by one — to combat risk and speed up time to value. In our experience, however, these projects tend to more complex than they seem and subject to the same issues as all in situ transformations, such a scope creep. A better argument for not executing a build and migrate strategy is that it is increasingly possible to achieve what banks want — improve customer user experience, launch digitally-native products, run advanced analytics and open up to third-parties — without replacing all of their back-office systems, as vendors like Additiv and The Glue are helping institutions to do.

In a blog we wrote last year, we set out what we thought were five viable banking business models for the digital age. However, at least three of these new business models were off limit to banks given their organizational constraints. Launching a challenger bank removes those constraints and allows banks to unbundle themselves by launching a narrowly-focused digital proposition (in terms of product offering as well as demographics) and then to rebundle themselves around this proposition. This is what fintech companies like Transferwise, Robin Hood and Zopa have done successfully and we are starting to see banks do the same — like Imagine Bank from Caixa which successfully attracted a new customer demographic with a convenient and high margin savings product and has since rebundled a whole set of own label and third-party services.

Unbundle to Rebundle

There is also the possibility to do this unbundling to rebundling via a holding company model. This represents the digital equivalent of the traditional universal banking model but where each product offering is run by a separate subsidiary. Doing this keeps each unit nimble enough to compete to respond to market shifts, permits partial customer acquisition, but also allows the overall group to achieve economies of scale (both supply-side, like IT, and demand-side, like customer data insights). In banking, the best example of this seems to be Pepper from Bank Leumi, which is building up a set of discrete product propositions.

If an incumbent bank chooses not to launch a challenger bank, what are its options?

It could choose to do nothing, essentially pursuing a mix of tactical options like cutting discretionary spend, shrinking risk-weighted assets and lobbying the regulator to slow, or reverse course on, new legislation. But, even though this might get management through to its next stock option vest, this isn’t a long-term remedy.

Another option could be to go upstream. We see this a lot in wealth management. Since HNWIs want a somewhat bespoke service and interaction with a relationship manager, then a lot of banks are moving to serve exclusively these HNWIs and UHNWIs where they think they can earn good fees for the foreseeable future. However, since many banks — as well as independent asset managers and family-offices-as-a-service focus on the same market — fees are gradually eroding. But more importantly, it leaves the banks open to classic disruptive innovation as the providers who now serve retail and mass affluent customers with digitally native services start themselves to move upstream.

In our view, for the banks that don’t want to launch challenger banks, there are only really two options. One is to become a bank-as-a-service, offering their back office and compliance to other banks and fintech providers, as banks like Bancorp in the US have done. But, this is a low-margin business. A better option is what we call the thin, vertically-integrated bank, where a bank starts to offer third-party services alongside some of its own products, capitalizing on its advantages —a bank licence, trust, the pull of a large customer base — to give its customers more choice. The challenge here is, of course, that this is a radically different business model which is likely to activate the corporate immune system.

Vertically integrated digital bank

So, the conclusion seems to be: if a company can dismantle the corporate immune system for long enough to adapt its existing business, then a challenger bank might not be the right option. Otherwise, it probably is.

The Rise of the Growth Platform

The Rise of the Growth Platform
In pursuit of faster growth, firms must choose what not to do

The Rise of the Growth Platform

by Ben Robinson | May 9, 2019 | 9 minutes read

As Michael Porter once said, 

“The essence of strategy is choosing what not to do.” 

Strategy, as an exercise in weighing up opportunity cost and allocating resources between competing priorities, has always been about making choices and this is truer than ever.

Bruce Henderson, BCG Founder, standing in front of the ubiquitous growth/share matrix

However, traditional strategic theory has not kept up with the digital age. It presents a static view of the world at a time when technology is fundamentally changing the nature of scale, the nature of work and the nature of the firm. Where sustainable competitive advantage used to come from maximizing the scale of production, it now comes via the network effects of connecting consumers with external producers. This move to networked business models raises fresh strategic questions about what not to do, both in terms of what a firm produces, but also in terms of what skills and resources it needs to employ itself. In future, the most successful companies won’t just be those with networked supply chains, but those with networked workforces.

There are many routes to creating a highly profitable business, but the most dependable and sustainable is to seek scale.

For the most successful industrial age companies like Ford or General Electric, this meant systematizing production to maximize output. If a firm could produce a good, say a Model T car, at greater scale than competitors, it could spread its fixed costs over larger volumes, allowing it to charge less while spending more on distribution and marketing. Achieving mass scale was a formidable barrier to entry leading to very high levels of return on capital — without necessarily having high-quality products.

In our networked world, what is inside and outside a company becomes increasingly fungible and it is clear that the bedrock of competitive advantage moves from how to scale internal organizations to how to orchestrate the most valuable ecosystem.

Today, while scale remains critical to achieving sustainable advantage, the nature of that scale is changing.

As platform companies like Uber and Amazon have demonstrated, in the age of networks and ubiquitous computing, achieving scale no longer requires firms to manufacture all of their products and services. Instead, they can source some or all of these products and services from third parties. This allows them to operate at higher scale since supply is elastic and to achieve greater quality since they offer consumers more personalized choice.

The Changing Nature of Scale

These platform models are underpinned by network effects, or demand-side economies of scale, as opposed to supply-side economies of scale. These arise not from maximizing production, but facilitating the interactions that make the platform more valuable for every participant, such as making it quicker and cheaper to get a taxi. And since network effects are not subject to diminishing, but instead increasing, returns to scale, markets move from having a few dominant players to winner-takes-most.

However, strategic theories have not kept up with this change. They continue to draw a sharp distinction between what is internal and external and ask how firms can maximize profits with existing resources or with the resources they could hire, build or buy. But, in our networked world, what is inside and outside a company becomes increasingly fungible and it is clear that the bedrock of competitive advantage moves from how to scale internal organizations to how to orchestrate the most valuable ecosystem.

This shift clearly calls for new strategic tools, but it also calls for a new approach to resourcing, one that reflects the inevitable move away from hierarchies to networks.

When competitive advantage meant maximizing output from a given set of resources, it was important to organize work into standard, repeatable tasks. These tasks were governed by strict processes and overseen by formal hierarchies. The role of senior management was to formulate strategy, the role of the rest of the organization was execute it with little autonomy to think or act for themselves.

Industrial Work Henry Ford Museum Pic

Today, the nature of work is dramatically different, almost diametrically opposed. Ours is an information age. Networked technology has connected us and broken down the siloed and hierarchical flows of information. We have become knowledge workers whose work, where once routine and predictable, is now varied and exceptional. This requires simultaneously new ways of organizing work and also new ways of planning work.

Networked technologies have also dissolved geographical boundaries and unpicked the fixed form of work. We don’t just do different work, we can work from where we want, at the hours we choose and on the tasks we select. In other words, work has become more global, more varied and more liquid.

In its new form, it makes much less sense for work to be organised in hierarchies and we could argue whether it needs to be managed under the umbrella of companies at all. More and more people are choosing to become freelancers and, when you look at their motivation, it owes a lot to self-empowerment. They want to be free from the constraints of companies which not only set their hours, but in their pursuit of productivity, put limits on their learning and self-actualization.

The big shifts in the nature of work and the nature of scale are taking place against a backdrop of accelerated change which has seen the longevity of S&P 500 firms shrink by a factor of 5 since the 1930s.

In response, firms have started to shorten strategic planning horizons, but what is really needed is to split strategy in two. Long term considerations like value proposition, business model and purpose seldom change and should only do so in response to major structural shifts. However, for shorter term considerations, it is important for strategy to become more closely aligned with innovation. That is to say, strategy should pivot from a function that makes well-informed yes/no decisions to one that creates the conditions for maximum agility so to impose as few of these constraints as possible. This means devolving autonomy. This means embracing a culture of experimentation. But, above all, it means embracing the power of networks.

Traditional resourcing decisions were anchored in an old paradigm. They assumed that the best people wanted to work for companies and that companies were the best place to manage them.

Some might argue that firms have already capitalized on the changing nature of the workforce. But outsourcing, nearshoring and offshoring were aimed at exploiting wage arbitrage — doing the same work, but with cheaper workers. There was no attempt to use the networked properties of the internet to revolutionize the way work was done.

Furthermore, the scope of any outsourcing or offshoring decisions was constrained by management theory that said companies’ internal resources must be focused on “core” areas, those with the highest strategic and operational importance. But what constitutes a core activity will change over time. When a firm is starting out, everything is core. It needs to establish its culture, its product/market fit, its business model. But, once these are established, its focus should shift to how to scale as quickly as possible and this means looking to external networks to alleviate the constraints and lower risk. It is only once a firm crosses the chasm and becomes its market’s winner-takes-most that it should it think about bringing back in house some of these activities — either to deepen its moat (like Amazon having its own logistics network) or to reduce its reliance on third-parties (like Dropbox choosing to move off AWS).

And so a new approach is needed. Traditional resourcing decisions were anchored in an old paradigm. They assumed that the best people wanted to work for companies and that companies were the best place to manage them. They were conceived for a world of slower change when the opportunity cost of either being too slow to hire or hiring the wrong people was less material. They assumed all core activities had to be performed by internal resources. And they didn’t take account of the power of network effects.

In the knowledge economy, having the best people matters more than ever and establishing flows of information between independent yet interdependent individuals is critical to ensuring that they grow. As such, management place artificial and damaging impediments to fast growth when they seek to hire all of these people within their company.

Some digitally native platforms have emerged to let companies tap a broader talent pool on an on-demand basis, but these have limitations. In the case of platforms like Uber, they work against the self-empowerment of workers by subjugating them to management by algorithm, making them interchangeable commodities and internalizing all of the network effects. Platforms like Upwork are much better in that they allow for differentiation, empowering workers to be more selective about what they do as well as earn a better return on that effort. But in not sharing risk with the end client, these platforms add much less value than they otherwise could, creating an opening for a new type of business model, what we call the Growth Platform.

Growth Platforms are more capital intensive and take longer to scale than aggregation platforms, but they add much more value and are critical to the next phase of the digital economy. AWS is a growth platform, using the strength of its balance sheet to give firms access to cheap and liquid computing power and sharing network effects through the AWS Marketplace. WeWork is another example, taking the upfront risk on large real estate investment that it parcels out and makes it affordable to smaller firms, while plugging them into its network effects around community and optimized design.

However, up until now, we had not seen a growth platform for creative people and skills. Platforms that pair companies with the right teams of go-to-market people and creatives, to form a partnership that maximizes value and transfers risk from both sides. Companies get immediate access to the best go-to-market talent, but also the infrastructure to make these people perform at their best. The people don’t just get to work with fast-growing companies, but also job security with optionality as well as the ability to constantly learn.

The platform should then supercharge its value-add through network effects. The teams are external to the companies they work for, but in substance they’re very much part of it, adapting to the culture and working towards the same goals. They’re external only as condition of achieving network effects. By operating at increasing scale, these platforms accrue the network effects that enable it to better match not just requirements with people, but people with people, assembling the fluid and interdisciplinary teams to let companies adapt to greater complexity and pace of change. Furthermore, it accumulates the domain expertise, market knowledge and the ecosystem of partners that allows for continual and compounding rates of success.

The Rise of the Growth Platform

Until now, firms had a binary choice: hire all of their own people or outsource. One allowed for control, the other speed. Similarly, the best people had to choose between working for one company or becoming a freelancer. One gave security, the other freedom.

Now, owing to network effects and the changing nature of work, these constraints are disappearing. By plugging into growth platforms, firms achieve control, speed and quality — at scale. And people gain freedom, security and the opportunity to keep learning.

We’re now in a new paradigm, then, where mutual success depends on firms choosing what not to do and workers choosing what to do.

Firms need Business Model change, not Blockchain

Firms need business model change, not blockchain

Firms need Business Model Change, not Blockchain

by Ben Robinson | Jun 1, 2018 | 13 minutes read

When Jimmy Song, a venture partner at Blockchain Capital, took to the stage at Consensus two weeks ago (wearing a black cowboy hat), he launched an attack on the blockchain-is-the-answer-to-everything mentality. He said,

“When you have a technology in search of a use, you end up with the crap that we see out there in the enterprise today.”

Jimmy Song
Jimmy Song

Jimmy was clearly trying to be provocative and burst the bubble of blockchain fanatics, but he has a point. It’s not so much about blockchain per se (although this may be where the worst offences are committed) but about the focus on technology in general. Every day we are bombarded with articles about the need to digitize or about how [Blockchain/AI/APIs/Cloud/Mobile/IoT] will transform or disrupt such and such an industry. But we forget that technology in the absence of new business models never changed anything.

UBER Business Model, by Tim O'Reilly
UBER Business Model, by Tim O'Reilly

It wasn’t the internet that transformed retail or music. It wasn’t the smartphone that created Uber. Instead, it took business model change which exploited new technologies. In retail, it was the Amazon business model of one-click checkout, marketplace and next-day delivery. In music, it was the iTunes model of unbundling music to let us buy individual songs and then the Spotify rebundling model of all-you-can-listen streaming subscription service. And Uber didn’t just use the smartphone to let people order cabs (as many of the incumbents did), but instead uses the power of GPS to allow anyone with a car to become a taxi driver, transforming supply in the course of transforming user convenience and experience.

And so in banking we can safely predict that it won’t be blockchain or APIs or AI that transform the industry. Instead, it will be new business models empowered by those technologies.

Implementing technology without a clear plan risks making matters worse

In fact, we could probably go further and say that implementing new technologies without a clear idea of the future business model may make matters worse because it could well entrench existing practices.

The reason for this is that these new technologies will be implemented in support of existing business models rather than in pursuit of new ones. This means — as we have seen so often in banking — that digital technologies are used to digitize analogue products, rather than reinventing them for the digital age. But, it means more importantly that these technologies will be used to double-down on scale.

Economies of Scale Illustrated

The industrial economy was all about scale. Once a company had come up with a winning product, the challenge was to exploit economies of scale as fully as possible. This allowed unit costs to be minimized and allowed firms to undercut rivals, seeing them gain more market share and scale and thereby locking in their leadership position. So all investments were aimed at maximizing scale — mass marketing, mass production, mass distribution — and business were organized into centralized, hierarchical structures to make this possible.

But these investments in scale in the digital age are quickly moving from sources of competitive advantage to sources of competitive disadvantage.

Technology and platforms have neutralized scale advantages

In their recent book, , Hemant Taneja and Kevin Maney talk about how the technologies of cloud and AI have turned scale economies on their head.

In the world of cloud computing, IT resources are available cheaply to everyone meaning that — other than for the platform providers like Microsoft— scale doesn’t matter. A business can rent as little or as much IT as it needs, conferring little scale advantage in running massive operations.

But it’s not just IT resources, the same model is being applied everywhere. Take human resources, it is becoming increasingly easy to contract the people a company needs at the time they need them through platforms such as Malt and through a new breed of companies like  and .

In economic terms, technology has lowered the minimum efficient scale of production to a point that is within the reach of most SMEs. And with a monolithic business structure, diseconomies of scale kick in sooner and are more material.

Artificial Intelligence is also having a profound impact on scale. If new technologies and platforms make it possible to manufacture profitably without scale, AI is making it possible to know what each and every customer wants — so that product and service can be tailored to everyone.

While the slight flaw in the unscaled argument is that more scale leads to more data and more data leads to better AI, it is nonetheless the case that any company offering undifferentiated products at scale will soon lose market share and scale. And so we see white space for new kinds of business models, where firms — or platforms — are able to take advantage of these new technologies to offer mass customization at scale.

The incumbents’ challenge

The incumbents challenge is, therefore, how to move away from this heritage of scale. This is likely a bigger challenge than it seems. Many companies in the industrial age missed shifts in consumer trends, but because of scale they could in many cases afford to catch up — copying rivals, buying rivals, etc.

In this digital age, the scaled business model is likely to lead to the double whammy of failing to spot new trends and the impossibility of catching up. Moreover, scale is so deeply embedded — across company structures, performance metrics, remuneration, processes, employee skillsets, cultures — that it will be so difficult for incumbents to make the transition.

Number of investments in tech companies by country — source Atomico
Number of investments in tech companies by country — source Atomico

And it’s not just an issue facing companies. Take Germany, for instance. For so long, its industrial sector has been admired all over the world for consistently high quality engineering. But, the German economy is struggling to make the transition to the unscaled, digital world. It doesn’t (yet) have a  from which the new unscaled models are emerging and the .

But there is hope. We do see many incumbent companies, including in the banking industry, adopting new, unscaled business models for the digital age.

New banking business models for the digital age

In many ways, the following section is an update  ago looking at how technology and new regulations, particularly PSD 2, were likely to lead to new business models. Where back then we identified 4 business models, now we identify 5 (but now fully discount the universal banking model as a relic of the industrial age). And where back then we framed the choices around asset intensity and profitability, we now frame the choices around the size of the demographic a firm wishes to serve and the number of products it offers to this demographic (although profitability is likely to improve in correlation with these factors).

Let us consider each in turn.

The unbundled start-up

This is the model that most B2C fintech companies have pursued until now. They spot a niche, which could one of: a product that wasn’t previously offered (e.g Coinbase), a demographic that is un- or underserved (e.g Lending Club), a much better experience (with likely cheaper pricing), combining tech and design thinking (e.g Transferwise) or all of the above(e.g. WealthFront).

It is very much the embodiment of an unscaled model: using cloud infrastructure to operate at low volumes and using AI to serve small segments of the market. However, given it is both targeting a niche and targeting the consumer directly, it is often difficult to make this model profitable. The low infrastructure costs are more than offset by high customer acquisition costs which, because these tend to be single product companies, cannot be spread over many revenue lines. There are exceptions, of course, where the regulatory costs are low and the market is large (e.g WorldRemit), where there is a virality in the product design that lowers acquisition costs (e.g Revolut) or where the product solves a big issue in a big market such that it becomes a very large company (PayPal, M-Pesa, Stripe).

The unbundled startup
The unbundled startup

But the much more likely outcome is that successful unbundled start-ups start to bundle multiple products under the same brand.

The rebundled start-up

Once a start-up has found a strong product/market fit, it is logical for it to offer multiple products in order to boost its return on capital by cross-selling and upselling to its existing clients. It effectively moves from a single, unbundled product offering to rebundling a full banking service over time. However, it is different from a traditional universal banking model in a number of ways, such as the fact that it is digitally native but more importantly because it remains focused on serving the same demographic. In that sense, it doesn’t engage in mass marketing and production, but sticks to a narrow target market. Were it to begin to offer all products to all customers, it then risks becoming the victim of unbundling itself.

Unbundle to Rebundle
Unbundle to re-bundle strategy

Examples of successful unblundled to rebundled start-ups include Zopa, Transferwise and Revolut.

The platform model

The platform model is somewhat of an anomaly in this list since it is essentially a scale play. However, it is likely to be an enduring model since:

1/ it is underpinned by strong network effects in a way that the universal banking model isn’t;

2/ it is often executed as part of an unscaled holding company strategy (see later); and,

3/ it is offered in the service of (and helps to make sustainable) the model of unbundled start-ups.

The platform model is simple. Banks rent out their back office as a service to others. For the unbundled start-ups who would be clients, it offers the advantage of not having to undertake a bunch of low value-added regulation and IT activities and it helps them to go beyond just renting IT infrastructure to renting IT applications and compliance. For the banks, it helps them to spread the largely fixed costs of IT and compliance over much larger volumes, improving economics.

Infrastructure Play
Infrastructure Play

The challenge, as pointed out in the last blog, is that this is a difficult model to scale across borders, limiting its profitability potential and meaning that there will be likely only one or two platform players per country/geo.

Examples of this model we have seen so far include Wirecard, Railsbank, Solaris and Bancorp. And it is no surprise that they are cropping up in the largest banking markets first where potential for scale economies is greatest.

The aggregator model

The aggregator model is where a firm uses its grip over distribution to introduce the consumer to the right unbundled services. Effectively it uses AI and machine learning to understand the customer’s financial affairs and preferences and to anticipate their needs so that it can make the right service recommendations at the right time. With the introduction of PSD 2 — and similar regulation across the world — this model becomes easier to operate since it forces banks to share customer data. And, theoretically, it becomes possible to operate this model without engaging in any product manufacturing or without having a banking licence or any compliance team — as firms like Centralway Numbrs are trying to implement.

The Aggregator Model
The Aggregator Model

Nonetheless, our view — consistent with the blog from two years ago — is that this model will be thin, open but vertically integrated. By this we mean that aggregators will work with many different unbundled start-ups, but because of the nature of banking, they will likely manufacture some products — like current accounts that require a banking licence. And because of the need to deliver exceptional customer experience, they will end up having to become more vertically integrated. We , such as with Amazon and Netflix, and now we observe the same thing happening in banking. When unbundled fintech start-ups rebundle, they tend to become more vertically integrated — witness Transferwise’s move off the Currency Cloud platform or N26’s move off Wirecard.

Vertical Bank Business Model
Vertically-integrated, thin digital bank

And so it is not a surprise that the aggregator models we are starting to observe in banking are thin and vertically integrated, such as M-Shwari and Starling Bank.

However, there are a couple of potential issues with the aggregator model. The first might arise from regulation. Will regulators allow banks that offer own-labelled services to aggregate services from third-parties and trust them to do so completely impartially? Especially given the marked tendency for aggregators to move from . Moreover, there may be a business model challenge in that, as , models like Starling’s rely on third-parties while seeking to internalize the network effects, especially around data.

Aggregators vs Platforms
Aggregators vs Platforms adaption of Ben Thompson's diagram

So, while we continue to believe that this is a sound model, aggregators of this type will need to look to empower the ecosystem by externalizing network effects and may seek to use arms-length intermediaries, like Bud, to avoid potential pitfalls around regulation.

And, where these potential issues are not addressed, aggregators leave themselves open to the threat from rebundled start-ups and from holding company models.

The Holding Company Model

The holding company model attempts to replicate the universal banking model — or conglomerate model in other industries — for the unscaled world and in a way that confers competitive advantage on the subsidiaries, especially by dint of network effects.

There is probably no “standard” for the holding company model. Berkshire Hathway is a great example of how a holding company structure can create competitive advantage across the group companies, in its case by using the cashflows and very low cost of capital of its insurance business to provide the cheap cash for investing.

Amazon is another great model to study and probably more relevant for banking. Jeff Bezos made a decision in 2002 to standardize the way information is shared across Amazon using APIs. It was a brilliant move in how to achieve control at scale. Essentially, the inputs and the outputs of every team were measurable in real time, such that their performance was instantly calculable and all other teams would get the information needed to conduct their work without bottlenecks, but it still allowed the teams autonomy in how to execute. The upside of this API model, so well documented in this , was manifold:

  • it allowed the different teams to operate autonomously so that that those business could be opened up to work with third-parties (as happened with AWS)
  • It allowed each unit to be kept focused on its own KPIs, which essentially means that they are forced to remain close to customer trends. As , the genius of Amazon’s customer obsession is that it forces every part of the business to innovate at the same time as making it practically impossible to overshoot consumer demands.
  • It critically allows every business unit to stay focused on its niche (essentially an unscaled model) but allowing for scale at a group level (e.g IT resources, distribution and brand), positive working capital flows, and the exploitation (internalization) of network effects across group companies.

This is what makes Amazon such a formidable company. It has figured out how to make the conglomerate model work in the digital age — through a holding company structure. And, furthemore, in its digital form, it overcomes one of the key shortcomings of its industrial age predecessor — it can achieve increasing returns to scale thanks network effects.

In the financial services space, the best example of this holding company structure is Ant Financial. Where Amazon has figured out how to adapt the conglomerate model for the digital age, Ant Financial has figured out how to recreate the universal banking model for an unscaled world. Its hub and spoke model sees the group leverage data, brand and distribution while the subsidiaries remain narrowly enough focused — on unsecured lending, investing, money market funds — to remain nimble and adaptive in the face of changing technologies and customer trends.

Ant Financial Holding Company
Ant Financial's Business Model as a Holding Company

The Holding Company as a model for reinvention

We see a strong trend in banking for incumbents to launch new digital banks. The examples abound, such as BNP Paribas’ Hello Bank. While this model to reinvention is in many ways sound — it allows these banks to transplant customers and trust into a new digitally native version of themselves — it risks creating another universal banking model, albeit one built on digital foundations. A better way of going about reinvention would seem to be a holding company model. This might be built on a Berkshire Hathaway model, as seems to be the case with Equitable Bank’s creation of its , to create a sticky, low cost source of funds for its lending business. Or, probably more likely, it would be an Ant Financial model of having individual subsidiaries target different business lines, which is the approach that Bank Leumi seems to be taking with Pepper Bank.

Pepper Bank, by Leumi


There is a clear danger that with the constant hype around technology, banks miss the need to redefine their business models before embarking on major technology renovation. In fact, technology renovation in the absence of business model renovation may well make things worse because it would entrench existing business models based on selling undifferentiated products at the greatest possible level of scale. The digital age calls for something else — products, many of which will be new, targeted on specific demographics, made possible now thanks to technology change. In this blog, we have presented 5 models which would work in this new paradigm, of which the holding company offers perhaps the best route to success — especially for incumbent organizations looking to reinvent themselves.