Competitive forces in an industry are rooted in its underlying economics, with different forces taking on different levels of significance in shaping competition. In the financial services industry, new digital technology has proven itself to be the key force in shaping new competitive frontiers and should carry the highest priority from a strategic standpoint. Many financial institutions are responding to this, appointing Chief Digital Officers and rolling out various, diverse digital initiatives in their efforts to create customer value and deliver competitive advantage. Vast amounts of money has been spent on these efforts, but for the most part, they have only served to provide banks with a process by which they digitise the ‘now’, not a strategy that redefines where to focus efforts, how to compete and ultimately how to create value.

It is essential for financial institutions to better understand the supply and demand side economics affecting their firm, and the constructs of consumer surplus in their industry. They may be making lots of short term changes or incremental pivots in an effort to avail of new technology, but they need to go through these economic fundamentals if they are to define strategic direction and decisions amid the impact of disruptive digital forces.

Supply and demand side analysis can surface poignant insights into the opportunities that firms can avail of through digital technology, and can help them prioritise initiatives and threats. When evaluating the demand side, it is important to consider whether the main effect of a new technology on consumer behaviour is augmentation of volume or substitution.

Analysis may highlight if it is possible for someone to offer the banks’ value proposition as part of something else that the customer already has – smartphones in the payment space, for example. Banks would then be able better understand how to position themselves as part of that ecosystem. Analysis of the supply side can, for example, further help banks to prioritise threats – banks have extensive infrastructures, close networks with other financial institutions, and solutions for compliance and regulatory challenges which all provide significant barriers to effective competition for new entrants. However, new digital technologies are allowing non-banks to offer profitable ancillary banking services whilst avoiding regulated core banking activities.

If banks don’t define how to compete and insist on owning and operating everything, then will they be left with only the expensive ‘plumbing’?

Greater understanding of the constructs of consumer surplus in the industry – the value consumers get from a good but do not have to pay for – is also required. This is currently where fintech firms are adding most value. For example, they recognised the importance of enabling customers to make informed decisions about their money and have used new technology to empower their customers with greater information, packaged with user experience at the forefront. Couple this with the cost base advantage that fintech firms have and the fact that they are often offering these services for free to the customer (through new economic models; i.e. customers subsidising the consumer surplus ‘tax’ by the revenue gained from selling their data to advertisers or B2B users ), and we see greater value creation.

Financial institutions must analyse these constructs and recognise how new technologies may affect or alter them, and how they may increase customer willingness to pay, increase benefits, or decrease consumers’ costs of consuming their products and services.

With a full understanding of supply and demand side economics, the constructs of consumer surplus, and a better definition of strategy in the digital future, financial institutions may then conduct a strategy-based resource allocation and portfolio review to detail the various initiatives needed to create value and gain competitive advantage amidst the digital backdrop.

Callum Russell, Senior Consultant – Financial Services