Dynamics in the Financial Services Industry
This paper discusses a view of the evolution of the financial services industry, particularly in the (life) insurance industry. It is based on experiences of working with several large organisations, both in the insurance and banking services over the last seven years, in various capacities (problem solving, planning and training). In this work some patterns emerged, all relating to changes and pressures these organisations were trying to deal with. One simple example is ‘unbundeling’: Whilst it means a packaged service or product being dis-aggregated, sourced and sold in modular form, what is striking is the pervasiveness of this concept. It occurs in many different places and in different forms. As a concept it is easy to say what is happening, but what is really happening? From a holistic perspective the pervasiveness of this phenomenon requires explanation. There are other examples of such phenomena, but this is the clearest.
Taken together the changes seem very confusing with an unclear future as to the shape of the industry over the longer term. In this context, the problem that I saw recurring with senior management in the industry, is a struggle to understand where to aim, and what to do in order to manage this change. Striking in this struggle for clarity is the lack of a comprehensive and widely accepted model of what is actually happening. For me, in coming into contact with the same kinds of people in seemingly very different organisations, this was notable, in the light of their being in the same industry boat. In this context, Gary Hamel (Gibson, 1997, p79) wrote:
‘The dilemma is that, if you look at many industries today, the clarity in the industry structure, in the value chain, in the relative roles of the participants, just doesn’t exist anymore. If I look at the financial services industry today, where does the industry begin and end?”
The only problem in this is that the complexity and profoundness of the changes seem to defy understanding. I started looking wider, into other areas and industries to see if there is a pattern in this. The short answer is yes, there seems to be a model for what is happening. One can see this model more clearly by fast forwarding the changes, so to speak, by looking at what is happening in high technology industries. In these industries, eg communications and information technology, the changes are very rapid and takes place on a large scale throughout the world.
Most of the rest of this paper is devoted to exploring this analogy, and looking at its implications.
Before doing that, a note on the implications of this kind of understanding. I believe, and will show this later, that the financial services is undergoing a fundamental change that will necessitate a complete makeover of the classical institutions like banks and insurance organisations. This makeover will change in fundamental ways the form of institutions, their functioning, including management style and practices, their processes, their market focus, everything. Those institutions that understand what is happening, and have this future clarity, will be able to shift and exploit these change profitably. Those that do not will become the counterpoint in management case studies.
Andy Grove, President and CEO of Intel, wrote a recent book with the title Only the Paranoid Survive. In Chapter 3 of this (highly recommended) book, he discusses the “Morphing of the Computer Industry.” I will briefly summarise what he says using the following figures, and add an interpretation of that in terms of the value chain.
In Figure 1, he shows the structure of the computer industry in about 1980. He makes the point (p40):
“This combination of the company’s own chips, own, computers, own operating systems and own applications software would then be sold as a package by the company’s own sales people. This is what we mean by a vertical alignment. Note how often the word ‘own’ occurs in this description. In fact we might as well say ‘proprietary’, which, in fact, was the byword of the old computer industry.”
…Salesmen would show up and offer their vertical combination of things, and the company they were selling to would decide to buy one proprietary line and not the others. … If there was a problem [for the customer], you couldn’t throw out just one part of the vertical stack; you had to throw out the entire stack, and that was a big deal. … [C]ompetition for the first sale was ferocious in the extreme, because who-ever won that sale had the long term advantage. This was how the business was done for decades”
The point behind this model of a computer business, is that its focus, and particularly, its value chain is very clear. Around this stability one can organise, differentiate parts and integrate the whole to be coherent. Figure 2 shows a meaningful way to think of a value chain in this context: Where the customer sits, who they are, and what they buy are relatively clear concepts, and uncertainties around them can be researched in a coherent manner.
Grove notes that this was how things were for a long time in the industry. In his book he deals with what he refers to as a “10x” (ten times) force that may originate in any one of the six dimensions indicated in Figure 3 (from Grove, p29).
(I do not believe this Porter-Grove model is sufficient for organisations such as those in South Africa. The reason is their model does not enable sufficient enquiry into the importance and effect of socio-political changes on the business. There are 10x forces originating form this source that are as important for business as these other six dimension they indicate. I believe the reason they omit this is that in their American centred management world there is sufficient stability form this seventh dimension that this need not be considered as a source for major turbulence. Globally there are clearly many societies where this is no longer so.)
What happened, according to Grove, in the computer industry was that the price/performance advantage swung into the favour of personal computers. This resulted in a total re-organisation of the computer industry into what he refers to as a horizontally, as opposed to the old vertically, organised industry. This is depicted in Figure 4.
Quoting from Grove(p43):
In this diagram we have horizontal bars representing fields of both competence and competition. In chips suppliers of microprocessors using the Intel microprocessor architecture compete with companies such as Motorola and others who supply different types of microprocessors. In computers, a basic computer design is supplied by a variety of computer manufacturers, such as Compaq, IBM, Packard Bell, Dell and many others. These computers are fundamentally similar even if the computer company engineers improve the basic machine as they compete with each other.”
He goes on to show that the same competition exists for operating systems, application software and sales avenues. In each case there is a ‘field of competence’ around which a number of players compete for dominance. The overall picture is one of far greater choice for the customer of each field, but also of far greater complexity and competition in the current computer industry.
In this kind of environment a successful player in the old industry structure, like IBM, suffers severely, as Grove discusses extensively (pp46-48). He makes this point(pp46-47), which I believe is generally true under these circumstances:
“IBM was composed of a group of people who had won time and time again, decade after decade, in the battle among vertical computer players. The managers who ran IBM grew up in this world. They got selected for their excellence in developing products and competing in the marketplace within this framework. Their long reign of success deeply re-inforced and ingrained the thought process and instincts that led to winning in the vertical industry. So when the industry changed, they attempted to use the same type of thinking regarding product development and competitiveness that had worked so well in the past.”
He goes on to give examples of this. CK Pralahad (Gibson, 1997, p71) makes the same kind of observation:
Companies are going to have to unlearn a lot of their past – and also to forget it! The future will not be an extrapolation of the past. Like a space rocket on the way to moon, a company has to be willing to jettison the parts of its past which no longer contain fuel for the journey which are becoming, in effect, excess baggage. That is particularly difficult for the senior managers – those who had actually built the past, and who still have a lot of emotional equity invested in it.
Grove comments (p48):
“Clearly the old [computer] world was no more. Something had changed. And the more successful the players were in the earlier industry, the harder a time they had to change with it.”
The changes Grove talks about took place over a period of time, and are unclear to perceive clearly when they are happening. One way of noticing these changes is to look at something like unbundeling. If I describe unbundeling in terms of the value chain changes that goes with the transition form a vertical to a horizontal industry, Figure 5 shows what happens.
Shown in Figure 5 is the unbundeling of the B and C value chain activities: These can now both be sourced from outside and sold to customers intermediate from the original final customer. For example, in the computer industry, the operating system may be sourced externally and be made available to other competitors. Grove (p47) discusses the example how IBM struggled with exactly this, in its marketing of OS/2. At first they tried to keep it proprietary, and later, when they tried to gain more acceptance for it, the market did not trust IBM because the operating system was not sufficiently independent of the other IBM activities against which the OS/2 customers still had to compete.
When an industry is fully horizontal, the value chain concept from a customer perspective becomes quite confusing. Their is a great difficulty in putting these different layers of products and services together to get what you want, and it can be done in different ways. One way of depicting this picture is given in Figure 6. This shows multiple and interwoven values chains serving disparate and intermediate customers.
Application to financial services
I believe what is happening in the financial services industry is a complex version of what happened in the computer industry. Before discussing that, Grove himself comments on this (Grove, p52):
I … think that there is a general trend towards horizontally based structure in many parts of industry and commerce: As an industry becomes more competitive, companies are forced to retreat to their strongholds and specialize, in order to become world class in whatever segment they end up occupying.
The important point he highlights is that the transformation from horizontal to vertical is general, because it is driven by deeper factors. These underlying drivers are factors such as an increase in competitiveness, driven in turn by globalisation, technology, consumerism. Ultimately all of this is plain and simple survival pressure form an exploding population of individuals and organisations. What is happening is that through education and development there has been an explosion not only in the numbers of individuals and organisations, but in their sophistication with which they pursue survival through competition. I believe the dynamics in most industries world wide may differ, but fundamentally these factors are the ones that in re-inforcing ways working together to increase the level of competition in any sphere. It is this competition increase which lies at the heart of the reshaping of industries at a increasing rate of change. If one looks at the increase in world population and development standards, were are only in the early stages of this dynamic.
In the vertical model terms described by Grove, it seems to me that the classical life assurer looks similar to Figure 7.
One of the value adding activities under the group business column, would be investment. Originally, the investment column was an internal function to provide this need (also for the individual life column), but has already moved to become a function that also directly serves outside customers. It is becoming a field of excellence and competition, in Grove’s terms, in its own right. Another function under group business is that of risk appraisal. This activity is shifting towards its own field of specialisation and competition. In both cases the classical value chain (Figure 2) is starting to ‘unbundle’ and shift to Figure 5. These are collectively just small steps towards the horizontalisation of the industry. My perception of what is happening is that Figure 8 is a better depiction of the current status of a classical life assurer organisation.
I believe there is much more evidence for this view than that which I presented here. If one accepts this view, the future insurance industry would be a horizontal one, like in Figure 9.
In this diagram I had great reluctance to put any words in to describe the different bars representing the different layers of fields of excellence and competition. The reason is that those need to be formulated based on much debate and reflection. The descriptions I have there serve only to illustrate the kind of fields that may emerge, and are tentative interpretations.
The picture is however more complex that that above. From what I have seen in the banking industry, I believe what is happening is a similar unbundeling of services and products, outsourcing of functions and a widening in the scope of customers types targeted. I am unsure which of the insurance or banking industries have toppled the most from the vertical, but I would depict the banking industry somewhat like that in Figure 10.
The fundamental dynamic I believe taking place is not of two industries, insurance and banking, independently morphing from a vertical to a horizontal structure. It is rather of two industries where the vertical structures are toppling on top of each other into the same horizontal industry; I show this in Figure 11. The horizontal bars in Figure 9 can therefore not be determined by thinking from the insurance industry perspective alone. These new fields of excellence and competition will be determined as much by what is happening in the banking industry.
The limitations of Bill Gates’ products do not allow me to show the splintering, fracturing, crashing and flowing of red that accompanies and will accompany this transformation.
Rowan Gibson interviewed 16 of the top business consultants in the world around these kinds of issues. He makes the point that there are three themes that emerged out of this work (pp3-9):
· the road stop here
· new times call for new organisations
· where do we go next?
I feel this is a framework for looking at the implications of the above model for a specific institution at this point in time.
The road stops here
Unless the company’s top management, including the board, understands the depth and profoundness of changes in the financial services industry, I do not believe the organisation has a way out. It is not a matter of re-organising, of leveraging higher productivity and fighting cost pressures. It is a different world. “If you do not change you die” (Pralahad). If this is not understood and believed, if there is no deep seated and shared “sense of restlessness with the status quo” (Hamel), there is only one way forward. That way is to wait until the crises mount and come sufficiently close to home to be acknowledged by enough people. Obviously, the earlier one moves on the change the more strength there will be in the organisation to deal with it.
Whichever way one looks at it, unless the company sees and believes the end of the past is here, whether through accepting the description of what is happening as given above or through some other reasoning, I do not feel one can move on the rest.
This is probably the hardest part of the change, seeing its necessity and profoundness. Grove in his book spends considerable time on the dilemmas senior management faces in this kind of situation. There are issues of “signal or noise” (is this real?) and incredible complexity confounded by emotions.
New times call for new organisations.
Quoting Gary Hamel (Gibson, p78):
“Most of what companies have been doing for the last four or five years has had an internal focus. The restructuring and the reengineering and so on have all been about: How do we get better internally? So what companies have been working on is closing a performance gap along known parameters of competitiveness. That’s the foundation of benchmarking: let me go out and see who is best in class and make sure that at least I get to that level.
I would argue there is a substantial difference between benchmarking and path breaking – between improving the capabilities of the organization and creating fundamentally new markets. And it is only the latter that, in the long term, is going to produce any new wealth. Simply catching up to where others have been is necessary to stay in the game, but I believe that the winners will ultimately be those with the ability to invent fundamentally new games.
(Italics added, emphasis changed.)
Any thinking about how the company should be changed is futile in my view. New organisations using fundamentally different organisational designs, management practices and thinking will be required to do the required path breaking into the future. Some of the required ideas are described in for example Ackoff, Halal, Geranmayeh and Pourdehnad. Without describing these ideas in detail, the underlying enterprise design principle is that you do not change to get organised for a specific business purpose, but organise to get change. The enterprise design in itself becomes an experiment in evolutionary survival; you do not need to know which fields of competence will yield your future successes, but you create experiments which will show you, by the way they grow and fail in response to the market. The challenge, and the essence of organising the whole, lies in finding strategies that pulls these parts together into a meaningful whole:
“To have a sustainable advantage, [an enterprise] has to integrate across many activities to create a unique positioning involving trade-offs with rivals. … the essence of strategy is the cross-functional, cross-activity integration.
(Porter, in Gibson, p55)
Where do we go next?
These new organisations should emerge around specific skills and spheres of competition, what Grove refers to as the fields of competence and competition. Hamel (Gibson, p88) refers to this as:
“To think about opportunity arenas instead of industries. To think about core competencies [competence fields] instead of strategic business units. To think about functionality [what does it do for the client?] instead of existing products or services. To think about competition as a process of shaping the evolution of new space, rather than competing within existing space.”
([Additions made], italics added)
These new organisational forms will be market specialised, ie defined by its market.
“Conceptually, the bigger the market, the more specialized you have to become if you want to succeed”
(Ries and Trout, in Gibson, p182)
One thing is clear: The new financial services industry is going to be very big compared to the existing banking and insurance industries; it will be more than the two sets of blocks heaped together. Within this “opportunity arena” there will need to be a focus. Michael Porter (In Gibson, p32.)puts it this way:
“…it’s not good enough to be different. You’ve got to be different in ways that involve trade-offs with other ways of being different. … if you want to serve a particular target customer group with a particular definition of value, this must be inconsistent with delivering other types of value to other customers. If not, the position is easy to imitate or replicate.
So there must be trade-offs between what your competitors do and what your company does. If there is no trade-offs, then everything can be easily and costlessly imitated.
I will summarise the answer to the question “where to from here?’ with the words: “to the market”.
My concern is that the depth and profoundness of changes taking place are not appreciated in most financial institutions I have come across. My concern is with the degree of organisational change that will be required to survive and thrive in an evolving financial services industry. My concern is with the level of sophistication in thinking about both these two topics.
From a scholarly viewpoint there is an almost disturbing sameness in message coming though from managers and organisational thinkers alike. I do not observe these messages to be the current theories in practice in those organisations I dealt with.
I feel that much of what I observe is an occupation and busyness with things that have a time horizon of at best a few years. I do not observe the same forethought and mental attention with things that matter in the long term. I am saddened by the stress society puts individuals under by measuring their short term performance and discounting their need to act for the future.
I see a phenomenal future in financial services. When I look at most financial institutions I see skilled and intelligent people that can competently walk this future time path.
Dynamics in the Financial Services Industry-General.doc
 Programme For Systems Management, University of Cape Town. Tel 021-650-2600, fax 021-6892737, email email@example.com
 Rowan Gibson, editor: Retinking the Future, Nicholas Brealey Publishing, London, 1997.
 I have also been working with two telecommunications companies over the last seven years on strategic planning.
 Andrew S Grove, Only the Paranoid Survive: How to exploit the crisis points that challenge every company and career. Currency Doubleday, October 1996.
 Prahalad goes on to say (Gibson, p72) that: “ If you want to escape the gravitational pull of the past, you have to be willing to challenge your own orthodoxies, to regenerate your core strategies and rethink your most fundamental assumptions about how you are going to compete.” This is what has been referred to as the need for engaging in ‘double loop learning’ processes -- shared inquiry where fundamental questioning of beliefs and understanding is questioned and improved. Unfortunately, I agree with Prahalad when he says: “ Mostly often it takes a crisis before a company is willing to do that. It takes a sense of urgency, a sense that the company’s future success is not inevitable.” Later on he talks about the need for confronting the “early warning signs of impending doom.” Grove says flatly: “Only the paranoid survive.”
 Charles Handy, Beyond Certainty. Arrow Business Books, 1996.
 Sample: “The traditional concept of management is reaching the end of the road. The notion of management as a significant idea in itself, and as a major part of the organization, is obsolete.” Not from Marx, but from Michael Hammer in Gibson, 1996, p100.
 Russell L Ackoff, The Democratic Corporation. Oxford University Press, 1995.
 WE Halal, A Geranmayeh, J Pourdenhnad. Internal Markets: Bringing the Power of Free Enterprise Inside Your Organization. Wiley, 1993.
 JP Strümpfer, Modular Enterprise Design. Workshop notes. 1996.
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