I keep coming back to this chart, as it typifies a lot of my thinking right now:
I mentioned the Uber example of this cycle, which began as a start-up but, as it grew into an upstart, it started to be attacked by the incumbents. Then the regulators woke up and started to consider the implications of the insurance of drivers, the employment status of the drivers, the safety of the passengers, etc. Then the upstart becomes the incumbent as the regulator restricts its innovation risks to be more in line with the industry it has attacked. Eventually there is a new business model that has evolved the regulations thanks to the innovation, and this new business model has a new compliance structure that must also be adhered to.
You could say that we see this in most other cycles of change. Take music. It began with Napster which morphed into iTunes and now Spotify but, with each change cycle, a new structure of guidelines is produced that must be adhered to. The same with film and film downloads and other services.
This is therefore what we see now with digital currencies, Fintech disruptors and crowdfunding lenders. They begin with an innovation model that is unlicensed and unknown but, as risks become noted, their models have their wings clipped to be more in line with the requirements of the incumbent service providers.
A great example is bitcoin. bitcoin begins life as an innovative libertarian dream of money without government. It soon encounters issues where losses mount wit Mt.Gox, Bitstamp and even the Bitcoin Foundation, and people call for protection of their bitcoins. The result is that the regulator steps in and creates a bitlicense, something that looks like a bank license but is specifically for bitcoins. Following such regulatory moves, the innovation begins to be institutionalised and is used in a new hybrid form between the incumbents and the innovators. Eventually, the innovation becomes the incumbent and the cycle starts up all over again.
This is demonstrated in many other forms. Let’s take Facebook. When Facebook started it was up against Friendster, Friends Reunited, MySpace and more. Gradually, over time, Facebook spread its wings and created risks, in terms of privacy, data usage, data sharing, advertising and more. This has led to regulatory structures that manage the Facebook ecosystem and now Facebook is the incumbent and many new innovators are trying to attack and defeat them.
In fact, I could lay another chart over this one, which is the innovator to incumbent cycle.
Uber moves from start-up to up-start and so a target for all players to attack and, eventually, becomes an incumbent once their business model is understood, regulated and compliant. Airbnb moves from start-up to up-start and so a target for all players to attack and, eventually, becomes an incumbent once their business model is understood, regulated and compliant. Facebook moves from start-up to up-start and so a target for all players to attack and, eventually, becomes an incumbent once their business model is understood, regulated and compliant. PayPal moves from start-up to up-start and so a target for all players to attack and, eventually, becomes an incumbent once their business model is understood, regulated and compliant. M-Pesa moves from start-up to up-start and so a target for all players to attack and, eventually, becomes an incumbent once their business model is understood, regulated and compliant. bitcoin moves from start-up to up-start and so a target for all players to attack and, eventually, becomes an incumbent once their business model is understood, regulated and compliant.
During the third phase of the innovation cycle discussed on Friday, the upstart has been noticed by the incumbents and becomes a target to be attacked.
PayPal was targeted by banks for its risk and lack of security (falsely); M-Pesa saw incumbent banks saying they were fraudulent (falsely); whilst bitcoin created its own mess with Mt.Gox.
Meanwhile, we are now seeing the target phase for Fintech, as US banks hope to stop the march of Fintech through regulation. In August, the Clearing House produced a white paper that effectively said that the world of Fintech or, as they call them Alternative Payments Providers (APPs), is a Wild West.
Banks are subject to extensive regulatory, supervisory, and enforcement scrutiny by their regulators with respect to privacy and data security, APPs, by contrast, are providing their products and services by continuing to rely on the backbone of existing bank payment systems while capitalizing on innovations in communications platforms, thus generally managing to avoid the reach of the traditional financial regulators. Additionally, APPs only face punishment for lax data security practices if they suffer an actual cybersecurity breach that is discovered by the government, because unlike banks, APPs are not subject to regular examinations and enforcement actions by regulators.
What is key in this process is that you will always get an attack phase in innovation, where the disruptors become the targets of the incumbents before they become incumbents themselves. And yes, you guessed it, the Fintech unicorns are becoming incumbents.
I realised this when I watched SoFi and Lending Club presenting in a bank conference recently and they said over and over that banks are their partners; that they are serving underserved markets; that their operations were being funded by banks; and that banks are their preferred targets for partnership.
Talking with P2P lenders in the UK, they’ve had lots of regulatory to’s and fro’s but the key call here is that Zopa wanted regulation. When the regulations were introduced for P2P Lending by the Financial Conduct Authority (FCA) in April 2014, the upstart made clear that they wanted regulation:
“Zopa has been lobbying for regulation for a number of years and was a founding member of the trade body P2PFA which has been successful in securing regulation for peer-to-peer lending.”
I’ve heard the same from several other Fintech start-ups, and the reason for the demand for regulation is that it makes the start-up trusted and respectable. My assertion of people not wanting to deal with untested and unlicensed firms is that, once they are tested and licensed, you can trust them. That’s why Zopa wanted P2P regulation. As Giles Andrews, CEO of Zopa (and guest of the Financial Services Club as keynote on November 25) states: “there is still faith that regulated industries are more trustworthy than unregulated industry”.
As startups become regulated, they are now able to move into the mainstream. By way of example, Zopa is now partnering with banks like Metro Bank, and being officially recognised as a Government supported tax-exempt savings vehicle by the Treasury.
Having written that the start-up soon becomes the incumbent, a great question on twitter was asked: “so how does the incumbent maintain the innovation culture?” The answer is that they can’t.
Any start-up will eventually gain momentum and size that means they need structure. Structure, historically, meant organisation and organisation, historically, meant hierarchy. That’s certainly true of most organisations I’ve worked for and particularly true for most banks I’ve worked with. Hierarchical organisation structures were managers manage managers manage workers. This is required to ensure targets and objectives are met. After all, it’s all about Management By Objectives, or MBOs for short. We have Key Performance Indicators, KPIs and SMART goals and such like. Then we talk about empowerment, enrichment, diversity and ethics and all those other good corporate things and that’s how we realise we’ve become the incumbent.
Now the new giants of this world don’t talk this way. GAFA – Google, Amazon, Facebook and Apple – have two-pizza teams and customer obsession, but they can still fall into the trap of management hierarchy. Equally, they can be accused of megalomaniac leaders who are hated, corporate cultures that are bullying and structures that are chaotic. It doesn’t matter, as most of those accusations are made out of jealousy. The fact is that some companies do rock, and some companies can still be innovative even when they have 1,000’s of people.
So what’s the difference between a company that rocks and one that stagnates?
The fact is that most of the young firms are led by people unconstrained by the disciplines of the past. When Peter Drucker came up with The Practice of Management in 1954, firms needed structure. We had just started to move from the Industrial Age to the Office Age, and management was relatively unknown. We needed performance schedules and maps of management structure in order to absorb 1,000s of people into suits and cubicles. That was the age of the post-War era, when most banks grew into global powerhouses and, take note, Drucker was a former financial guy.
Now, we need agility and speed. A global powerhouse built upon formal structures of power and operation does not cut the cloth in the digital age. A hierarchical management structure is slow and unwieldy, and we have known this for a while. So we try and adapt. Maybe we create a Matrix Management Structure which, to be honest, is even more unwieldy and slow. Show me any Matrix Management Organisation and I’ll show you a company that cannot make a decision. In a Matrix structure, all you have is 10 people who can say no and not one that can say yes. Get out of there!
So what we really need in the age of the internet where speed, agility and innovation are key, is small, decisive groups who can act upon opportunity and move fast. It’s why I like the two pizza idea of Amazon so, just to repeat and focus this dialogue, here’s the two pizza team idea.
Two-pizza teams are so named because they’re small: 6 to 10 people; you can feed them with two pizzas. The most important aspect of a 2PT isn’t its size, though, but its fitness function. A fitness function is a single key business metric that the senior executive team agrees with the team lead. It’s the equivalent of the P&L for a division: a single metric to provide focus and accountability. In some cases, the fitness function is literally a P&L: for instance, the contribution profit from the sales driven through sponsored links minus the cost of those clicks. In other cases, it’s something more clever: e.g. metrics related to the efficiency of picking, packing, and sorting. Once approved, the team is then free to execute relatively autonomously to maximize its fitness function—to pursue creative strategies and to set its own internal priorities. A handful of engineers, a technical product manager or two, and maybe a designer all report directly to the 2PT lead; there’s I need to coordinate even across teams, let alone across divisions, to get something done. This model has helped Amazon stay nimble and innovative even as it has grown.
Imagine this idea in banking and it seems completely incongruous. Banking is all about structure, control and discipline to avoid risk, exposure and sanctions. A two-pizza team structure where no group is larger than ten people and they all work to a singular specific objective is not going to work. Or is it? Banco Original in Brazil reckon they can make it work. A digital-first bank thinks that the two pizza structure is critical to their operation, so maybe it’s not impossible. I just can’t imagine this thinking in many other financial institutions however.
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