In the last article, 360F assessed the automation solutions in the investment services industry, namely the Robo-Advisors and Digital-Assistants. The former faces a non-scalable future while the latter an uphill struggle towards an otherwise viable future. To resolve the automation solutions’ challenges, it is necessary to identify the required “killer features” in the industry. What are the criteria for deciding if a feature is absolutely necessary and significant? 360F asserts that the critical criteria must be based on value generation.

Digitalization: Awash in Gimmicks, Thirst for Value

The digitalization theme in today’s market is awash in gimmicks and neglects to focus sensibly on value generation for either or both the financial institutions and the client. This observation is reminiscent of the dot-com days when “internet” was a buzzword as commonly abused as “digital” today. Venture Capital (VC) funding exacerbates the situation. In the third quarter of 2016, Asia was flooded by US$1.2 billion of VC funds, up from US$800 million in the previous quarter.

The hype will however come to a screeching halt as the thirst for value becomes unbearable. Take the case of the market enthusiasm for Robo-Advisors. Autonomous Research estimates Robo-Advisors spend at least $500 to acquire just one new client. Assuming an average annual charge of 0.25 per cent on assets of $25,000, it would take eight years to break even on the cost of client acquisition alone. It may have been easy to win investors’ initial favour but it will be trying to ask for their patience.

The Fourth Industrial Revolution: A Value-Generating Digitalization Reality

In 2016, the CEO of ING declared, “Employment in finance will decrease”. His statement sums up the current industry dynamics. Overall, as many as 1.7m jobs are expected to disappear as banks digitalize operations. While automated production dominated the third industrial revolution, the fourth industrial revolution creates infinite possibilities, thanks to unprecedented processing power, storage capacity, connectivity and access to knowledge. The fourth industrial revolution connects the dots among digital, physical and biological systems and leverages customer insights to create tremendous value for both demand (customer-related) and supply-side (efficiency and productivity) economics.

What does this mean for the financial industry? Banks are still trapped in the third industrial revolution, where automation is synonymous with “digitalization”. Now that the decreasing returns of automation have set in, banks in general are not optimistic that their profitability can rebound to pre-crisis levels. Between 2012 and 2015, the revenue margin in Asia dropped from 64.7 the return on equity (ROE) dropped significantly below 10%, which is even below the cost of capital (WACC). To stabilize profits, costs are reduced to a level of 66.3% (Asia).

While the world’s biggest banks “digitalize” to cope with profitability, relatively new players digitalize to mark new heights of success. Ant Financial, the digital payment arm of Alibaba, China’s e-commerce colossus, gained about 100m clients in 2016, taking its total above 500m, almost 10 times the world’s biggest banks. Positioned as a digital “ecosystem orchestrator”, Ant Financial transcends the gimmicks of digitalization, skips over the third industrial revolution to focus on value generation (see Market Sample 4).

Value Generation: A New Look at an Old Concept

The concept of value dates back to the mid-seventeenth century, beginning with the objective classical theory and then overshadowed by the subjective value theory as the mainstream approach today. The objective approach determines value by the labour inputs – a house is 100 times more valuable than a car because it takes 100 times as much labour to produce as the car. The subjective approach assumes that individuals seek to maximize their utilities (satisfaction from acquiring/ consuming the economic good) and maintains that their preferences determine the fundamental value of economic goods – an individual who must catch the last flight home to attend a workshop early next morning is willing to pay twice as much as another individual who has no urgent schedule.

After close to 400 years of existence and evolution, the value concept sits firmly at the heart of modern value management methodologies, specifically Lean Management and Customer Lifetime Value (CLV). Retaining the essence of objective and subjective value theory, Lean Management seeks to maximize customer value by ensuring that processes are value-adding and result in output which customers are willing to pay for. Unlike Lean Management which can be deployed throughout an organization, CLV is usually applied in the sales and marketing space. Defined as the “present value of the expected benefits (e.g. gross margin) less the burdens (e.g. direct costs of servicing and communicating) from customers”, CLV subscribes to the subjective approach and underpins the importance of not only understanding customers’ profiles but also predicting their future individual and network behaviour to maximize effectiveness of marketing expenditure.

Considering the pragmatism of Lean Management and the forward-looking orientation of CLV, 360F proposes to integrate both methodologies’ understanding of value to yield an all-encompassing concept – “360 Value” which is capable of making sense from revenue and cost perspectives in space and time.

Killer Features

After intensively scanning the market for best-of-breed-examples, 360F has identified five killer features which fulfil the “360 Value” criteria.

360 Value Criteria: Understand what the customer perceives as value
Matching Killer Feature (#1): Customer insights as currency

Customers are willing to share their personal data – as long they receive something in return. Effectively creating customer insights will drive the financial institutions’ valuation in the near future. Currently, client preferences are barely retrievable in a structured manner and hence not used to engage the customer. In an optimistic scenario, the financial advisor will have an intuitive understanding of the customer profile including the customer’s life goals, investment objectives, fears and concerns and his/her desired communication method and pattern with the financial institution. If such insights are sourced for and analysed systematically, they will facilitate the development of tailor-made products, increase cross-selling effectiveness and pre-empt destructive emotional behaviour.

360 Value Criteria: Capture the excess surplus
Matching Killer Feature (#2): Customization driven by customer insights

Lean management focuses on perceived customer value while CLV measures the captured value. A potential gap exists as firms can fail to capture the full perceived value, leading to excess consumer surplus i.e. the price a consumer actually pays is less than what they would have been willing to pay. The airline industry does a fine job of capturing such excess surplus by engaging in price discrimination methods – made possible by offering product and service differentiation supported by structured client insights. In the investment space, the motivation to capture excess surplus will be born out of both push and pull factors. While stiff competition from passive funds such as Vanguard and Blackrock has started to erode incumbent Asset Managers’ market share, availability of customer insights will encourage these Asset Managers to offer customization.

360 Value Criteria: Eliminate waste which undermine the whole
Matching Killer Feature (#3): Workflow automation to orchestrate processes

In Lean Management, waste (“muda”) refers to non-value adding work which not only reduces profitability but also does not serve the customers. In financial services, the bulk of waste comes from manual interventions and passive processes. The growing stringency of regulations, contributes to at least three types of muda – defects, over-processing and waiting. Work flow automation eliminates these muda by embedding system intelligence and flexibility for future adaptations.

360 Value Criteria: Co-create value
Matching Killer Feature (#4): Customer empowerment made possible

When customers are helped to understand their products, they are more likely to stay loyal and give repeat business. This empowerment is especially critical as financial institutions do not have simple products. Even if complexity is seemingly eliminated by skimming on details, the products remain fundamentally challenging to understand. Selling such products to poorly informed customers creates the “Lehman-Bonds-effect”, permanently staining not only the reputation of the affected financial institutions, but also the whole financial services industry.

360 Value Criteria: Scale for lifetime and network value
Matching Killer Feature (#5): Ecosystem integration

Scalability is possible via network effects and cross-selling powered by an ecosystem. Customers will interact with each component of the ecosystem to fulfil their daily needs (banking, insurance, driving, shopping, etc.), creating a digital footprint which reveals not only personal preferences to support customized offerings but also opportunities for cross-selling. In contrast to traditional financial service companies, clients’ needs are identified at an early stage with the help of information acquired from adjacent players in the ecosystem. Easy social share functions strengthen the network benefits and thus value of a customer.