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June 01, 2012

Are Banks Simply Too Big To Innovate?

Mary Meeker's periodic review of the Internet industry is always a must-read presentation.  This year was no exception - chock full of data, insights and thought-provoking charts.

There is a theme that Mary espoused that I have become a big fan of ever since I read Marc Andresseen's article in the Wall Street Journal "Why software is eating the world."  She framed it as the "re-imagination of nearly everything."  The simple notion is that the confluence of broadband, mobile and globalization in combination with Moore's Law have allowed the technology industry to innovate almost everything in existence.  Facebook's IPO brought their "hack" culture to the forefront of the world's conscience.  Well it turns out, technologists are hacking everything - from advertising to media, from retail to health care, from education to banking.

Ah, banking.  This has not been a good few weeks for the banking industry.  The surprise $2 billion trading loss  at JP Morgan Chase has caused erstwhile superhero Jamie Dimon to appear fallable.  Many are pointing out that the crisis at JP Morgan is an example of a banking sector that is increasingly concentrated in the hands of a few and results in a systemic risk because the top 5 banks are simply "too big to fail."

I would argue, there is an even larger risk for the financial services industry, that in turn provides a larger opportunity.  I think banks are now simply too big to innovate.

Let's look at Meeker's slide 86 below:

She lists the industries that are ripe for "re-invention" sorted by their 2012 market capitalization.  Financials are on top at a leviathan-like $7 trillion.  There are 200,000 employees at JP Morgan Chase and Bank of America each and 350,000 at Citigroup.  Structurally speaking, these organizations are simpy too large to develop breakthrough, out-of-the-box, re-invent banking solutions.  That opportunity is left to entrepreneurs.

As a result, there are a slew of start-ups "hacking" banking.  We have invested in a number of them that are hacking away at pieces of the financial system.  ZestCash is hacking consumer lending.  SimpleTuition is hacking student loans and banking.  Cartera Commerce is hacking credit card marketing.  AccountNow is hacking checking accounts and debit cards.  Plastiq will soon be hacking large ticket purchasing.  There are hundreds, if not thousands, of others that other investors have backed as well.

So when I look at the innovative progress being made in payments, mobile banking and other major areas, it makes me smile.  Because while the major titans in the industry are caught up in looking backwards, the entrepreneurs are re-inventing the future of finance.  That's an exciting prospect.


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Too big isn't the issue. I've done some work at a variety of banks (mostly in the security sphere) based here in Boston (hint hint). At the mid-levels there is often innovation in conversation. The kind of innovation that's not about packaging CDOs but about doing interesting things with payments, loans, etc.

The problem is once it goes beyond that level, it gets trapped by the enforced regulatory FUD that exists in banks. Layers and layers of human beings who's job it is to be scared of security and regulatory compliance. Change management policies that take months to push code out. A startup of mine was bought by a large financial institution. We went from new code daily to no developers having any kind of access to any production machine (even if that machine isn't anywhere near real accounts). It just shut down innovation. And all the good engineers (myself included) left as soon as earn-out was over... mostly due to policies like that.

It's not a big-ness issue, it's an unnecessarily bureaucratic issue. Automate the change-management. Small autonomous teams with automated controls for regulations. That'll do it. But it's the job-protection humans who get in the way.

As my wife always says to me, "size doesn't matter."

I noticed the same thing about Meeker's presentation, Financials is #1 to get re-invented. As a former employee of Citibank's Growth Ventures and Innovation team, let me slightly correct this statement you made:

"Structurally speaking, these organizations are simpy too large to develop breakthrough, out-of-the-box, re-invent banking solutions."

100% agree it is structural, however it is NOT size that prevents innovation it is lack of incentive. People do what they are incented to do. The head of cards at Citibank was incented to ensure, actually guarantee that the cards business never changed. His (occasionally her) incentive program is based on the trailing 12 months business indicators and adding 10% to them in the coming 12 months, rinse, repeat. There was no track for this person or team to really move the needle and change the business. Why on earth would this person innovate when that can only damage the coming 12 month "results" as measured by the trailing 12 months. Imagine telling the spouse, sorry I missed my annual bonus, BUT I did do some amazingly innovative things at work that will be enjoyed for years to come. (most likely by the person that replaces him when he gets fired)

The Growth Ventures and Innovation team I was apart of for 3 years was supposed to address this gap, but was not connected enough to the business to really change it.

So, entrepreneurs step in and change it for them. That is the way of the ecosystem.

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Hm…I won’t comment on your wife’s quote, but I hear you on size and innovation.  3M, Apple and Google are examples of big companies that have proven they can still innovate.  It’s just really, really hard.  

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Great points, Dion.  I wonder if banks will begin acquiring technology companies with more frequency, as software becomes a more important part of their value chain.  

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