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Transforming Financial Services into Modern Digital Businesses
By Prashant Gandhi, Principal Financial Services
and Luke Vinogradov, Principal Digital Transformation


Every organization fears the Kodak moment. The moment at which your business loses all relevance. Kodak failed to capitalize on their digital photography innovation because they had a virtual monopoly in the print market – from cameras to film to processing. Kodak executives failed to recognize the computing revolution that would make digital photography mainstream and paid for it with losing more than 97% of their market capitalization over the years.


The annals of corporate history are filled with such missed opportunities and usually with fatal results. The challenge for most firms has never been a lack of early-stage innovation or technology adoption. Businesses failed to capitalize on the technological opportunity because they failed to understand the accompanying architecture innovation.


Systems of knowledge


Within every organization, there are two systems of knowledge at work – one is the knowledge of the “components” and the other is the knowledge of its “architecture” [Henderson-Clark, 1990]. Component knowledge refers to a focused body of knowledge that can be mastered by individuals or a tight-knit team. For example a credit analysis team has the component knowledge for developing models for credit decisioning. Architecture knowledge refers to the knowledge about how these components interact with each other and the impact of the component design decisions on the whole product. For example,integrating and linking components such as credit decisioning, payments, client onboarding and compliance together as a coherent lending business is architecture knowledge. 


Architecture innovation happens when the system is reconfigured to link together components in a new way. The framework below explains the impact of any innovation on the existing architectural and component knowledge of the firm.

When there is an architecture innovation, it destroys the usefulness of current architectural knowledge. Established firms miss reacting to disruption signals because they often see these innovations through the lens of their current architectural knowledge. The subtle architectural change with the innovation is often ignored because the organizational knowledge is deeply embedded in its communication channels, information filters and problem-solving strategies. For example, Digital lending is not just a digital channel for a normal lending business. It is about establishing a data-driven relationship between customer data, underwriting, collections and business risk appetite to dynamically price and monitor loans. This makes it fundamentally an architectural innovation. 


Blackberry famously ignored the iPhone’s disruptive potential because they judged the threat on Apple’s keyboard experience and poor battery life. These attributes were problematic in Blackberry’s architecture-specific view, but did not represent the same constraints on the architecture that Apple was putting forward.  


Dominant design pervades the thinking within FS Firms


Many industries later criticized for failure to adapt have rich histories of innovation. Financial Services firms were the first to adopt technology for record-keeping. They were also some of the early adopters of newer technologies to provide customer self-service models and reduce their operating costs. Bank of Scotland had an online banking service as early as 1983 via TV to check account balance and pay bills. Midland Bank formed the branchless direct bank First Direct in 1989. Deutsche Bank launched its internet banking in LATAM in 1996.  


In these cases, the successful model to achieve this digitalization became a “dominant design” for the firm’s IT organization and how it grows its technical capabilities. Most firms have instituted a project-based approach (“Change the Bank”) for developing initial ideas, design and delivery of technology assets. The long-term evolution of these assets was handed over to a separate part of the organization ( “Run the Bank”), to keep the lights on and fix incidents. The incentives for both these organizations are at odds with each other and often drives the wrong behavior. This model has also dictated organizational practices for resourcing, governance, funding, vendor selection and shape of delivery teams. This is now deeply embedded architectural knowledge with the incumbents, knowledge which is hard to break away from when the system fundamentally changes.


Imperative for change 


The disruption potential of converging technology evolutions like the internet, mobile and cloud computing is significant. A new class of competitors is building on these tech evolutions to evolve different business models and addressing newer markets and customer segments. The confluence of these technologies, the rise of venture capital, the easing regulatory barriers and the changing customer expectations mark a significant horizon shift.  


Financial Services firms are already seeing the attack on their core business model. The threats of disintermediation and commodification are real. Retail banks fear that open banking will consign them to a utility. Institutional brokerage services are being disintermediated by electronic platforms. Advisors are feeling the existential threat from robo-advisors. At the same time, fees and commissions are being driven down towards zero. Addressing these disruptive threats requires incumbents to reinvent themselves as a modern digital business. 


The execution playbook is outdated


To combat the disruptive threat, Financial Services firms are acquiring capabilities in various digital technologies through organic investments as well as acquisitions. Executives are expecting to use these technologies and practices to help them deliver better customer service, cut costs and grow revenue. 


The manifestation of these capabilities into real businesses and products have not always worked out as expected for others. For every successful Marcus, there are many examples of failed endeavours because the existing players fundamentally mistook digital as another channel investment and as an execution problem. They treat digital as an incremental innovation whereas fundamentally it is an architectural innovation.

Goldman Sachs attributes its success in consumer banking to their renewed tech strategy and execution playbook. For example, before they ventured into consumer banking, they conducted more than 10,000 interviews across the country to understand the financial needs of their customers. They launched Marcus online savings account with an attractive rate, no fees and no minimum deposit as a direct response to what they learnt from their customers. Over the 5 years, it has grown more than $60 billion in deposits and $7 billion in loans across the US and UK. They are also adopting that playbook into their existing business operations. 


At the same time, JP Morgan failed to excite the market with their digital bank Finn because it did not offer any differentiated features to their customers compared to their Chase online banking app. Finn also had no compelling market feature to attract new customers compared to other challenger banks. Ultimately, they were unable to succeed because they did not have the focus or the processes to truly understand the needs of their potential customers. They failed to understand that digital-only challenger banks represent an architectural innovation.


A similar narrative played out with Investec’s “Click and Invest” robo-advisor and RBS's digital bank Bo, consuming millions of dollars of investment without achieving traction in the market.  


Digital business is an architectural innovation


With a stream of new market entrants betting on reinvention rather than recharging, pressure on Financial Service firms is increasing, bringing the realization that it isn’t enough to simply buy new components and drop them into an existing model. This brings architectural knowledge to the fore, requiring reimagination of existing business and operating models.


Executives need to recognize that it is no longer sufficient to build only technology capabilities (often focused at the component level) to fully realize the opportunities available to them. By focusing on the components themselves as the endpoint, executives risk undervaluing the knowledge required to successfully develop and integrate these new elements. For example, having a sophisticated AI based credit decision engine is limited value if your current application process captures only standardized data. Firms are forced into a constant flow of change to cater to internal and external consumers, who now expect continuously improving products and services with reduced cycle times. In this situation, the capabilities associated with creating need to be reweighted relative to the traditional focus of operating.


Modern digital businesses – those organizations whose disruptive influence is being felt in Financial Services and well beyond – recognize that a broader set of capabilities contribute to digital success.  


Transforming as a Modern Digital Business 


Embracing the reality of constant change, modern digital businesses have shaped themselves around their customers as the anchor point, and are relentlessly focused on understanding and meeting their needs. Adopting processes suited to the creation of compelling digital propositions, they have a strong learning orientation built on integrated feedback loops and strategic use of data. They use a value-driven approach to prioritize their investments, managing their activities with the expectation of change. A focus on manageable workloads and speed of decision-making gives them the ability to rapidly change direction. 


This digital mindset can be seen not only in their processes but in their structures, governance approaches and leadership styles. Applied right across their business activities – rather than narrowly within the digital domain – this mindset drives the development of capabilities which allow them to innovate at every level. The relative success of firms like Goldman Sachs and DBS Bank is the result of their reinventing themselves ground-up.


Developing the digital mindset


Whether digital natives or organizations who have successfully transformed, those businesses who are competing successfully in an era of significant digital change share a number of characteristics.


Organizations wishing to accelerate their transformation should question themselves on the existence of these characteristics within their own businesses.  


1. Customer value focus

Is customer value truly driving all our operations, or is it simply a by-product of our activities?


Lemonade is focused on customer satisfaction by having quick turnaround on claims. To be able to make these decisions, it sells insurance through chatbots, rather than online forms, allowing it to collect 100x more data.


2. Outcome aligned organization

Do our structures, measures and funding processes reflect this customer focus?


RBS’s major IT failure in 2012, which cost them £70 million in customer compensation, was attributed to its reactive incident management structure with inadequate risk oversight.


3. Responsive to Market Shifts

Do we manage our workload on feedback and flexibility? How rapidly can we change direction?


Responding to the changing customer expectations and competitive pressure, Charles Schwab used a rapid prototyping approach to deliver their Robo advisory offering which now accounts for $43 billion in assets under management


4. Test and Learn Culture

Do we use experimentation to learn and reduce uncertainty, or assume we know everything now?


UBS failed with its SmartWealth robo advisor because they assumed that given their minimum $2 million assets requirement for private banks, customers will consider $15000 minimum investment criteria a huge consumer surplus.


5. Strategic use of information assets

Is data easily consumable, fuelling our decision making and maximizing value?


DBS Bank is integrating AI into every operation including compliance, onboarding, sales and even recruitment powered by their data platform-as-a-service. They estimate major efficiency gains that can eliminate 15000 jobs


6. Structures and Governance

Does the way we are organized result in speed or friction? Where are decisions made? 


Among the many reasons for their failure, TSB relied on an overburdened three lines of defense to manage risks for a highly complex programme of work to migrate to a new platform. The resulting IT meltdown cost them upwards of £330 million in penalties.


7. Technology is at the core

Is technology a part of our business strategy, or a separate, even second class, concern?


Goldman Sachs recognized that developers were first class citizens and client developer experience was the key. They have embarked on a platform approach with externalized APIs that can be integrated within the client workflow and systems for a seamless user experience.


Building digital capability


While a digital mindset is the starting point for successful reinvention, ultimately this change is delivered through capability. We have identified five areas of capability which are critical to digital evolution – investment in these areas will have the greatest impact on creating sustainable change within the organization.


As the building blocks of a modern digital business, these foundational capabilities run across the organization, impacting the core operations as well as innovation, and addressing every layer of the organization from senior executives down to developers.


Building Blocks of Modern Digital Business

The range of potential investments in capability within each building block is significant, and the decisions about the direction, sequence and pace of change efforts must be specific to an individual organization. At ThoughtWorks, we use the idea of Digital Fluency to identify and prioritize those capabilities necessary for an organization to achieve its ambitions. 


Rather than a rigid, normative approach setting seemingly impossible goals, fluency instead emphasizes those capabilities which will have the greatest impact on an organization's digital success, relative to its broader ambitions. Goldman Sachs’ platform strategy enables it to gain scale advantages and rapidly integrate new products. Stripe’s product capability allows them to offer enhanced innovations to its customers with new products such as Stripe Atlas and Stripe Connect. Striving for class leadership in an area where customers (or the strategy of the business) don’t require or expect this may distract from more significant opportunities. 


The approach to managing change is also key; our experience is that executing change in the context of ‘thin slices’ which rapidly deliver real-world value for customers is markedly more successful than overweight, complex programmes which focus more on describing than doing. This also removes the tension between changing practices and ‘building things’: the organization can develop and refine its new practices in the context of creating new value for customers. Change brought about in this way is more likely to ‘stick’.


Understanding the impact of our current knowledge


The ambitions and genuine needs of an organization should drive its digital change efforts, but these programs take place against a backdrop of today’s reality. Current architectural knowledge is often a major constraint to effective change; those very approaches which helped an organization be successful in the past are often the main obstacle to its success today.


Executives need to make an honest assessment of current capabilities and approaches. Driving iterative systemic change that traverses every layer of the organization requires an understanding of how in many areas, dominant practices may produce negative effects.

However familiar (or indeed, comfortable) some of these established approaches might be, the contrast between these practices and the desired outcomes for the organization may be stark. The cumulative result of these negative effects goes beyond tolerable inefficiency or lack of pace, or poor outcomes at a project or team level. It can drive a systemic lack of competitiveness for an organization which can mean an existential threat.


Taking action


Digital disruption in Financial services firms is driven primarily by architectural innovation, devaluing the firm’s existing architecture knowledge. The once valuable know-how is now a constraint for progress. Organizations need to transform by developing and strengthening the capabilities required to cope with digital change.


ThoughtWorks’ Digital Fluency Model helps leaders to understand, explore and prioritize those capabilities for their organizations. Investment in these building blocks is an investment in future competitiveness. As modern digital businesses, these firms will be in a leading position whatever the next innovation brings, with the capability to survive and thrive. If you'd like to discuss the current state of digital fluency in your organization, please get in touch with us. 


This article was published on June 25, 2020

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