It is a kind of cliché to state that the financial services industry landscape is changing rapidly, continuously and often unexpectedly. Customers don’t seem to care about those incumbent financial services firms that are not responsive to their needs. Although there has been a constant stream of assurances from various banks, wealth managers, and insurance companies that they are customer-oriented and responsive to customer needs, a lot of things remain to be done.
Customer-orientation hot talk, as I call it, is a form of self-deception, and although most of the financial services companies still heavily rely on old-dated goods-dominant logic, they talk as if the reality is something entirely different. The truth is that most financial services companies are again faking true customer-orientation and this is a real problem. This is very problematic as it deceives both the client as well as shareholders (or stakeholders). Signaling, shouting out loud random words, is simple but redeeming those promises is much more difficult.
Financial services firms think that they are relevant to their customers. If they weren’t connected, people would switch over to some other business, right? Right and wrong. I have noticed that in many contexts representatives of the financial services industry seem to think that they – their firm and the specific product or service they offer in exchange – create and deliver a particular kind of value to their customers. This idea – the notion of goods-dominant value production – is pervasive in the financial services industry, and although someone might note that this is just nitpicking over small details, I don’t share this conception. Value is a purely subjective notion, and value is never created by the service provider. As Ludwig von Mises argues in his magnum opus,
“Value is not intrinsic, it is not in things. It is within us; it is the way in which man reacts to the conditions of his environment. Neither is value in words and doctrines, it is reflected in human conduct. It is not what a man or groups of men say about value that counts, but how they act.” 1)p. 96
The idea that the product – and in our case, financial product – is the thing that creates value is utter nonsense. There is no reasonable way to argue that an entity is able to generate value into a product/service, and then think that this value is somehow consumed by the consumer as the product/service is bought and used. There is no such thing as measurable value incorporated in a product/service, and it’s important to remember this. As Reijo Karhinen, the Chairman of Executive Board and President of OP Financial Group pointed out years ago, everything depends on understanding the daily lives of the customers. There are no shortcuts available, so its essential for financial services industry to grasp that clients are not actually motivated only by monetary considerations but also by the fact that they want their jobs to be done. Transformation, in the context of financial services, is really about abandoning goods-dominant/firm-centered logic and moving towards service(-dominant) logic.
Innovation focus is the standard, right?
There is no need to cite those numerous famous and more academic studies that show that innovative companies are genuinely high performing companies. 2)Baldwin, J. & Gellatly, G. (2003). Innovation Strategies and Performance in Small Firms. Cheltenham, UK: Edward Elgar; Roberts, J. (2007). The Modern Firm: Organizational Design for Performance and Growth. Oxford, Oxford University Press; Gerybanze, A., et al. (2010). Innovation and International Corporate Growth. Heidelberg: Springer-Verlag; Turner, N. (2013). “How innovative firms get twice as profitable“. Today, 18.12.2013; Ringel, M., Taylor, A. & Zablit, H. (2015).”The Most Innovative Companies 2015: Four Factors That Differentiate Leaders“. Boston Consulting Group, December 2015; Forbes Corporate Communications (2016). “Forbes Releases Sixth Annual List Of The World’s Most Innovative Companies“. Forbes, 24.8.2016. It’s often said that there are five primary sources of growth: (1) increasing the number of people working and/or labor hours (labor force), (2) increasing human capital (the quality of labor force), (3) increasing the capital stock, (4) discovering and applying new technologies and new goods (technological change), and (5) improve the mix of 1, 2, 3 and 4 (so-called total factor productivity).
In the long run, total factor productivity is the only sustainable source of economic growth. 3)Mankins, M. (2017). “Great Companies Obsess Over Productivity, Not Efficiency“. Harvard Business Review, 1.3.2017. As Accenture’s Mark Purdy has pointed out, there is a significant slowdown in the total factor productivity growth (see Figure 1), and he argues that artificial intelligence could be a major factor boosting total factor productivity as the new factor of production. 4)Purdy, M. & Daugherty, P. (2017). “Why Artificial Intelligence is the Future of Growth“. Accenture.
It has been pointed out by many economists and experts that the only way to grow in the future is to raise total factor productivity mainly with the help of new technology and innovation and investments in human capital as there are limits to how many people can be employed, what they can be paid, etc. 5)For dissenting opinion, see Gordon, R. J. (2016). The Rise and Fall of American Growth The U.S. Standard of Living since the Civil War. Princeton, NJ: Princeton University Press. So it’s not so surprising that innovation and innovation management have generated so much industrial and academic interest, and that innovation and continuous improvement are the top strategic focus for most companies. 6)von Krogh, G. & Raisch, S. (2009). “Focus Intensely on a Few Great Innovation Ideas“. Harvard Business Review 87(10), 32; Bates, J. D. (2010). “How to explore for innovation on your organization’s strategic frontier“. Strategy & Leadership 38(1): 32-36; Jaruzelski, B., Staack, V. & Goehle, B. (2014). “The Global Innovation 1000: Proven Paths to Innovation Success“. strategy+business 77, 28.10.2014; Kerner, L. (2014). “Running Scared? Big Companies Increase Innovation Spending“. Technomy, 8.11.2014; Frigo, M. L. & Snellgrove, D. (2016). “Why Innovation Should Be Every CFO’s Top Priority“. Strategic Finance, 1.10.2016.
Innovation is essential all the time, all the time innovating is essential
According to the recent 2017 Global Innovation 1000 study published by Strategy&, global R&D spending among the world’s 1000 largest corporate R&D Spenders increased by approximately 3.2 percent in 2017. Tech companies, no surprise here, are yet again the biggest innovation spenders. Last year Strategy&’s similar study highlighted the fact that companies are reallocating innovation spending and shifting their focus from physical product-based offerings to digital offerings. 7)For differing perspective on R&D and innovation spending, see Jaruzelski, B., Dehoff, K. & Bordia, R. (2016). “Smart Spenders: The Global Innovation 1000“. strategy+business 45, 30.11.2006; Mudambi, R., Swift, T. & Hannigan, T. J. (2015). “Sometimes Cutting R&D Spending Can Yield More Innovation” Harvard Business Review, 8.1.2015; Viki, T. (2016). “Why R&D Spending Is Not A Measure Of Innovation“. Forbes, 21.8.2016. As Daniel Fasnacht says in his book Open Innovation in the Financial Services Growing Through Openness, Flexibility and Customer Integration, based on a study by the Boston Consulting Group, “global innovators that encompass the top 25 most innovative companies overall had a median annualized shareholder return of 14.3% from 1996 to 2005, a full 300 basis points better than that of the S&P Global 1,200 median. The survey confirmed for all regions that innovative companies have the capacity to generate more total shareholder return. The reason for that outperformance was these companies’ ability to expand margins at a superior rate without sacrificing growth.” 8)p. 36 On the other hand, as John Hagel III, John Seely Brown and Lang Davison point out in their article “Shaping Strategy in a World of Constant Disruption“, Mark W. Johnson, Clayton M. Christensen and Henning Kagermann in their study “Reinventing Your Business Model“, and Raphael Amit and Christoph Zott in their papers “Creating Value Through Business Model Innovation“, the most innovative firms don’t concentrate primarily on product, service and product innovations, modular and architectural innovations, etc. but rather they focus on innovation at the business model level in the surrounding ecosystem. 9)Henderson, R. M., & Clark, K. B. (1990). “Architectural Innovation: The Reconfiguration of Existing Product Technologies and The Failure of Established Firms“. Administrative Science Quarterly 35(1): 9-30; Paulus-Rohmer, D., Schatton, H. & Bauernhansl, T. (2016). “Ecosystems, Strategy and Business Models in the age of Digitization – How the Manufacturing Industry is Going to Change its Logic” Procedia CIRP 57: 8-13. There is no unique business model that would last forever, and therefore it’s imperative to frequently and actively seek out new business opportunities that might affect – modify, replace, support or update – the current business model. “It’s a trap,” as Admiral Ackbar shouted in Star Wars, to think that one business model to rule them all.
Although it’s not clear that the money invested in R&D and innovation will eventually increase profits, innovation is still hailed as the primary way to move away from the increasingly red ocean – competing in existing market space, exploiting existing demand and outperforming rivals to increase the share of the existing market – towards the blue ocean. Innovation is the only way to sustainably differentiate offerings, create and deliver more compelling and profitable complete solutions to the customers, and ultimately outperform the competitors. As BCG’s Michael Ringel, Andrew Taylor and Haidi Zablit argue, “Innovation is ultimately about creating value. Customers flock to novel products and business models. Investors bid up new revenue streams.” On the other hand, as Shahid Yusuf emphasizes, “excessive spending can be dysfunctional if it throws up barriers to innovation by making scientists into constituents who become wedded to the status quo. The most successful innovative companies are ones that can extract the maximum innovation from a modest R&D budget.” 10)p. 36
We should nonetheless remember that what George Eckes says about management’s involvement and commitment in his book The Six Sigma Revolution: How General Electric and Others Turned Process Into Profits applies to innovation as well:
“Therein lies the difference between involvement and commitment. Management will find it easy to commit to Six Sigma. Who can be against committing to a course of action that improves the effectiveness and efficiency of an organization? To be committed to a course of action is one thing, but to be successful in implementing Six Sigma there must be management involvement.” 11)p. 261; see de Jong, M., Marston, N. & Roth, E. (2015). “The eight essentials of innovation“. McKinsey Quarterly, Apr 2015.
So, in conclusion, as Joseph Schumpeter argued in Capitalism Socialism and Democracy, innovation is the necessary force driving the process of creative destruction that ultimately affects the success of the firms relative to their rivals and leads indirectly to economic progress. According to Schumpeter, creative destruction is a dynamic process:
“Old concerns and established industries, whether or not directly attacked, still live in the perennial gale. Situations emerge in the process of creative destruction in which many firms may have to perish that nevertheless would be able to live on vigorously and usefully if they could weather a particular storm. Short of such general crises or depressions, sectional situations arise in which the rapid change of data that is characteristic of that process so disorganizes an industry for the time being as to inflict functionless losses and to create avoidable unemployment. Finally, there is certainly no point in trying to conserve obsolescent industries indefinitely; but there is point in trying to avoid their coming down with a crash and in attempting to turn a rout, which may become a center of cumulative depressive effects, into orderly retreat.” 12)1994 [1943], p. 90
Furthermore, as Schumpeter argues, competition in capitalistic reality is “competition from the new commodity, the new technology, the new source of supply, the new type of organization (the largest-scale unit of control for instance) — competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives.” 13)1994 [1943], p. 84 So, in the end, innovation is all about “combining new and old technologies into new composite technologies, ” and this process by itself is important in creating something new and possibly unique. 14)Eliasson, G. & Eliasson, Å. (2005). “The theory of the firm and the markets for strategic acquisitions“. Working Paper 44, p. 12; see Bostaph, S. (2013). “Driving the Market Process: ‘Alertness’ Versus Innovation and ‘Creative Destruction’” The Quarterly Journal of Austrian Economics 16(4): 421-458.
Whether an assumed innovation really succeeds in increasing quality and performance, lowering and limiting costs, creating a unique customer experience, in better positioning the brand, increase customer loyalty and employee happiness, and/or improving financial performance depends on various internal and external considerations. As Fasnacht asserts, it’s important to “understand the [innovation] process itself that tells us which innovations lead to new growth. This is important because growth can only be achieved if aligned with innovation strategy.” 15)p. 36 Shahid Yusuf argues that “only a weak relationship seems to exist between the level of research and development (R&D) spending and the metrics used to measure the financial and market related performance of firms.” 16)p. 496
From closed/linear innovation to open/dynamic innovation
It should also be self-evident that innovation is not simply about internal R&D activities anymore. From the beginning of the 21st century, there has been growing interest in research in the idea of “open innovation,” both in academia as well as in business and in practice. Although first coined as a theoretical concept and research paradigm by Henry Chesbrough in 2003 in his most popular book Open Innovation: The New Imperative for Creating and Profiting from Technology, the idea of open innovation draws on multiple management and innovation research traditions. Chesbrough’s main idea is that as today companies are strongly moving from the so-called closed innovation paradigm towards a much more open and porous way of innovating. As Yusuf explains, the most successful innovative companies share a number of characteristics ranging from “an innovation culture deliberately cultivated and constantly reinforced by top management and innovation strategy fully aligned with corporate strategy” to “an open and collaborative approach to innovation, recognizing that they cannot excel in more than a few areas of research and need to canvass ideas from a variety of sources”. 17)pp. 36-37
Facing the backdrop of intensifying competition, changing demographics, shifts in client demands and needs, accelerating digital disruption, and increasing regulatory burden in the financial services industry, the need to innovate and innovate fast to adapt well to the new market conditions is becoming increasingly important. Banks and other financial institutions have had great times but as one can see from the latest list of the most innovative companies produced by the Boston Consulting Company, there are only a few financial services companies in the latest list. 18)The first financial services firm on the list is JP Morgan Chase ranked 28th, another is AXA ranked 30th and last is Allianz ranked 33rd in the world (among top 50 most innovative companies) in 2017. Numerous financial services companies, such as American Express, Bank of America, Citigroup, Goldman Sachs, HSBC, MasterCard, and Visa, have been on the list in the past but they have lost their position as one of the top 50 most innovative companies. So, what has happened? I really don’t know but my hypothesis is that multiple factors are at play here, and one of these sub-hypotheses is that many financial services companies are relying on the dangerous impression that it’s going to be business-as-usual for years to come and therefore major industry focus has been incremental innovation that might offer only moderate gains in cost, quality and/or performance, so their diffusion may be very slow.
But as Bhaskar Chakravorti has emphasized, the necessity to innovate at the business model level “can indeed be the mother of some serious inventions” – troubles, difficulties, and adversity, rarely comfortable everyday life, are the real source of competitive advantage as Michael E. Porter once said. 19)See Joan Margetta‘s excellent article published in the Harvard Business Review in 2002 on the importance of business model (innovation). The need to innovate has, however, quickly become the most critical priority for financial services industry in the midst of various retail banking, capital markets, lending and leasing, payments, wealth management, and insurance trends affecting the global financial services industry. Also, digital transformation, technological development, marketing, and distribution models are changing the industry. There are numerous continuities and discontinuities from industry/consumer (mega)trends and competing moves to weak signals and emerging opportunities affecting the financial services industry that it’s crucial to have a holistic overview of the ongoing changes to make sense out of it.
We, as consumers, yearn for simple, convenient and affordable solutions that reduce insecurity and are relevant in their everyday context. This means that, as I pointed out earlier, that banks and other financial services firms need to embrace the idea of open innovation and orchestrate a wide variety of digital business ecosystems, including fintechs and various digital platforms, together so that it pushes the whole financial services industry towards openness and transparency in terms of their way of conducting business. Already back in 2015 Accenture’s CTO Paul Daugherty stressed the importance of ecosystem orchestration:
“The new power brokers will be the master orchestrators that place themselves at the center of these digital ecosystems. These leaders will quickly master new digital relationships with their customers, end users, suppliers, alliance partners, developers, data sources, makers of smart devices, and sources of specialty talent. All will share the same goals: to grow new markets… and their individual businesses.”
For example, with the revised Payments Services Directive (PSD2) coming into force in January 2018, European banks need to figure out their strategic position as the PSD2 is one part of the much more extensive open banking paradigm. Open banking is not really about incumbent banks doing some new stuff with innovative new players, opening a couple of APIs here and there, having strong authentication and continuing business-as-usual. Open banking transformation is actually much more than this. It’s about recognizing that banking is actually a massive set of various business ecosystems where collaboration, coopetition, competition, and innovation go side-by-side – eventually serving both the service providers themselves and more importantly creating much compelling customer journeys and value propositions for the external clients. 20)Swaminathan, K. (2017). “Innovative Fintechs Don’t Need No PSD2 Regulation“. Finextra Blog, 14.2.2017; Frisk, M. (2017). “PSD2 & Open Banking: The perfect marriage of technology and regulation“. Finextra Blog, 1.9.2017. According to Accenture Technology Vision 2017, an annual prediction of the technology trends that will shape the future of companies in the next three years and what is predicted to happen up to next seven years, highlights five key trends that affect everyone and all the industries around the globe:
- AI is the new UI (Experience Above All)
- Ecosystem power plays (Beyond Platforms)
- Workforce Marketplace (Invent Your Future)
- Design for Humans (Inspire New Behaviors)
- The Unchartered (Invent New Industries, Set New Standards)
As Valar Afshar points out, the latest 2017 report is a continuation of Accenture’s annual deep-dive studies into the ways that technology is affecting strategy, operations, organizations, people, and businesses worldwide. As seen in Figure 2, 2017 Technology Vision trends have evolved somewhat considerably since 2015, and some trends seem to have significant interaction with each other. Nonetheless, these many trends are “phylogenetically” separate so that they cannot be backtracked to a universal “common trend descent.” Every trend is affected by other existing patterns, but they can still be distinguished from each other.
Banks, wealth managers, insurers and other financial services companies don’t seem to fully understand the need to engage their clients as part of their innovation endeavors. As I previously said, the need to innovate is not something that a financial services firm can bypass with ease or demand employees to be more innovative – it’s a human activity that needs to be participatory, co-creative and collaborative.
If financial services companies genuinely want, in the long run, to improve process efficiency, increase retention, onboard new profitable customers, increase the share of wallet, and avoid price compression and erosion , something more radical has to happen as consumers are becoming more and more informed, networked, and active – they want to know that they will be in the driver’s seat before they even contemplate your particular brand to be part of their initial set of considerable labels. So now, understanding the consumer decision journey alongside open (business model) innovation and open banking paradigm are of great importance as it’s impossible to innovate anything if you don’t understand the everyday life of your prospects and clients in enough detail. You need, at a minimum, to know your customers’ jobs to be done.
If you don’t invite me in, I can’t help you
It is extraordinary how finance and banking are not treated as service but rather as a bundle of services and products. Pekka Puustinen, in his book FinancialServiceLogic: In the Revolution of Exchange in Banking and Insurance, insists that we should reject the old goods-dominant mindset for customers’ sake – only then, Puustinen claims, we are able to truly understand the everyday sphere of ordinary people, what they dream of, what are their intentions and how (reciprocal) value propositions should be constructed in the age of service(-dominant) logic. There is no way to communicate a specific value proposition if the firm focuses on its internal processes, assets, and resources as a source of customer value. Puustinen emphasized the importance of having the right view on the exchange process and value creation: a product is built by the firm but the service it renders for the client, and the possible value it dynamically creates when our individual needs are satisfied, are part of client’s personally contextualized perception. 21)As it has been argued from the beginning in the context of service-dominant logic, “Service is the fundamental basis of exchange.” Products and services are part of the exchange as both parties are using these operant resources to move from a less satisfactory state to a more satisfactory state. It’s important to notice what Ludwig von Mises argues in Theory and History:
“Each individual is the only and final arbiter in matters concerning his own satisfaction and happiness.” 22)p. 13
It’s important to understand, as Pekka Puustinen demonstrates, in the context of financial services, that innovation should not be confused with the traditional notion of product development. As Puustinen says, there is no basis for assuming that that product-/goods-dominant logic is reasonable in the long run. Pure play productization, as Puustinen points out, might not be a winning strategy, and therefore it’s much more important to focus on the idea of service-dominant logic and customer-dominant logic.
My idea, based on Puustinen’s reflection, is that it’s impossible to copy specific trails of customer engagement, loyalty, and experiences that are embedded with a unique socio-technical system. These are, as anyone familiar with the underlying economic theory, are subjective concepts.
Conclusions
So, in the end, as we have seen, the idea of engaging customers into the innovation process requires us to understand what is innovation all about. There is no reason to think about different business models that different financial firms can adapt to be competitive if the companies don’t even understand the importance of involving the customers to the process.
Discussing solutions before understanding customers’ jobs to be done is irrational, and highly problematic. As Marcus Castenfors, ex-colleague from Nordnet has pointed out, design as an activity is a team sport. There is no way that you could understand specific technical requirements before you actually understand the daily life of a client.
What does it mean that you really understand the daily life of ordinary people? First of all, you need to be humble. Secondly, forget the financial gibberish about compliance, legal and technical systems. Thirdly, just immerse yourself in the world with an emic perspective – and if you are not part of a particular tribe, let some business anthropologist help you out. You have to understand the context – institutional, social and cultural issues – before chasing some specific solution.
In a world where any company with a customer base and scale could be a competitor, it is vital for financial institutions to work out where they are going and how they are going to get there: to construct a clear route to implementing the new business models they plan to exploit when open banking takes hold. As Warren Zevon sings,
“He said, ‘The shit that used to work
It won’t work now’I, I had a dream” 23)See Professor Alf Rehn on “the best practices“; Professor Alf Rehn on innovation.
So, let myself be heard as mentioned in Seether’s lyrics:
“I can’t pass up this opportunity to make myself absurd
I can’t pass up this opportunity to let myself be heard
Would you, like to, be the one who sees me lose this all
Would you, like to, be the one who sees me fall…
Nobody’s gonna stand in my way
Give it up son, I’m doin’ this my way
Nobody’s gonna stand in my way
Give it up son, I’m doin’ this my way”
In the era of the customer, there is a still an essential place for ongoing innovation, but innovation doesn’t matter if the customer is not involved so, as Seether’s a bit modified song says, nobody’s gonna stand in customer’s way. As Matti Alahuhta, former President & CEO of KONE Corporation, says in his book Johtajuus – kirkas suunta ja ihmisten voima, it’s essential for leaders to be humble and understand what employees are actually doing and what makes them tick. It’s vital to understand the opportunities that are presented in engaging both employees and customers in a real dialogue and making sure that you know what they need and want.
Shortly, banks, financial advisor, insurers and every other financial service firms have to acknowledge that innovation is fundamentally a customer-centric activity – it requires financial companies to be radically responsive and open for criticism as internal resources and assets are perceived as operant resources that are applied for the benefit of the client. Schaffer Consulting has concluded that driving innovation results requires constant energy, purposeful discovery, flexible structure, and creative friction. It’s essential to understand that to be innovative, you will need both our point of view as well as the customer’s point of view to succeed. 24)Ojasalo, K. & Ojasalo, J. (2015). “Adapting Business Model Thinking to Service Logic: An Empirical Study on Developing a Service Design Tool”. In Gummerus, J. & von Koskull, K. (eds). The Nordic School – Service Marketing and Management for the Future. Helsinki: CERS, Hanken School of Economics, 309-333. Ojassalo, J. & Ojasalo, K. (2016). “Using Service Logic Business Model Canvas in Lean Service Development“
Innovation management, as Pekka Puustinen argues, is not really about product development per se. Instead it’s more about service system development, and in the end, the value is not embedded into financial products as they are only a part of the overall process.
In my next article, I will delve into the realities of involving real customers as part of the innovation process. In the digital age, dominated by the customer, we need to have new ways to engage clients, and as said, I will show some possible ways to involve client’s and their ideas as part of the process. 25)The most clever readers have already noticed that I have not really defined (a) innovation, (b) innovation process, (c) customer engagement, and (d) the real necessity of having customers part of the innovation process thus far – these definitions are developed in future.
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Photo credit: Ewan McIntosh via Foter.com / CC BY-NC
References
