The walls are coming down. The #NewFinance ecosystem is alive. And in this post we are going to explore how Business Model Innovation (BMi) is driving the creation of a new generation of dealflow.
Rigid. Opaque. Vertical.
Would be a few of many possible words that would come to mind to describe the world of Finance as we know it today.
Fluid. Transparent. Horizontal.
Is how the Finance industry of tomorrow will look.
The shakeup has begun, and while we don’t know exactly what lies in between yesterday’s world of crony capitalism and tomorrow’s world of boundless entrepreneurship, big moves are already being made.
In recent blogs, we have looked at how BMi is reshaping the food (#realfood) and fashion (#sustfash) industries, today we are going to look at how #NewFinance is the beacon for BMi among the three.
Through a combination of digital platforms and network-as-market theories, Finance is being flipped on its head. Rather than going to a bank to ask for a loan or a venture capitalist for an investment, SMBs and entrepreneurs are logging into their laptop and tapping dispersed networks of investors.
It’s faster, it’s cheaper and it’s engaging. The wisdom and knowhow of those who make the deals flow is no longer being locked down in an investment bank or holed up on the 45th floor of a skyscraper. It’s being distributed and shared, becoming accessible for the average guy and girl with a dream to start their own company.
Not to say that the old grey hairs of Finance will be left on the sidelines; quite the contrary. It’s the mechanism that will change, as the real juicy deals will originate from outside of the traditional intermediaries and be packaged in simpler terms.
And the upside will be explosive. That’s what happens when you start to open the pipelines to previously unserved markets. In the same way that a spark can set a pool of gas ablaze, it only takes a shot of capital to set pent-up demand on fire.
Using BMi as the tool, a host of impact-driven entrepreneurs are bringing their scrappy, scalable upstarts to the global stage and collaborating with others in order to reshape the financial landscape.
What is Business Model Innovation?
A business model is defined as the rationale of how an organization creates, delivers and captures value.
Business model innovation is the process of reinventing the business model itself. Rather than being focused on end-product innovation, like derivatives and securitized debt, BMi focuses on changes in the process of exchange across the value chain, whether it be a new pricing structure, collaborative partnership or customer channel. In the end, it is the model itself that SHIFTS, rather than simply the product or service.
How do we bring BMi to the Finance Industry?
It’s already happening.
While most of the traditional finance institutions have gone on with business as usual on a debt-driven consumption model, others are opening the door to a new model of finance based on productivity and creation. Finance BMi is being driven from the bottom up – by entrepreneurs, customers and investors alike – while in the process, the old-school economic theories about efficiency and the free market are being torn to shreds.
Because the whole industry, as we know it today, is predicated on control and ownership, neither of which are conducive to economic ‘efficiency’ in a ‘free-market’ system.
How can markets be efficient when key information is controlled by a few?
How is our system free market when a few ‘own’ and disburse key resources?
+ see New Scientist’s analysis of the Capitalist Network
If we really wanted to have a system where entrepreneurship could thrive and ‘free-market capitalism’ could flourish, it sure wouldn’t look like this.
Governments would enable global currency exchange at fair-market value. Banks would lend to growing small businesses. Investors would take chances on high-impact entrepreneurs. Communities would ‘crowd fund’ cultural and social projects. People would loan money to one another to help make important purchases.
And so that’s how it’s going down. It’s distributed. It’s disintermediated. And most importantly, it’s driven by a collective.
How do we tweak the business model to make this happen?
The finance business model can primarily be broken down into two main categories: retail and investment banking. The retail banking business model is built off of scale, while the investment-banking business model is more centred around dealflow depth and securitization. There are many ancillary service providers who help fill the gaps in the market via partnerships and alliances with the banks.
The primary cost drivers are: staff salaries, real estate, compliance, back-end infrastructure and front-end systems.
While one business model is based on scale (retail) and another more on depth (investment), both are low-margin businesses. Retail banking profitability is dictated by the spread, the difference between the cost of borrowing versus lending, whereas investment banking is a fee-based business where profitability is more related to the bank’s brand and advisory services. So while one side focuses on scaling, the other is more focused on relationships. In the end though, both fall into the low-margin categories, with retail margins originating from the interest-rate spread oscillating between 0.5 – 5 % depending on macro factors, while investment banking fees typically ranging between 1 – 10 % depending on the type of service (M&A, IPO, etc), the amount of the deal and other factors.
Banks, whether retail or investment, can become extremely profitable if they can scale their brand across a number of different channels and create a diversified product offering. That’s why partnerships are so important. Retail banks partner with (or acquire) credit-card issuers, mortgage-origination entities, loan agencies and any other organization that can help them to extend their brand and add more volume. Investment banks build back-end partnerships to source dealflow, capital and advisory services, anything that will help them land the big deals.
But it’s all changing. As these vertical, debt-driven institutions are coming to a point where their business model will become unsustainable. There is only so much ‘free money’ that can be printed, mortgages issued and fees charged. Change is required from top to bottom.
In the Market Beacons section of our #NewEraBiz research on Finance, we analyzed three companies who are breaking away from the traditional mould and finding scalability through network and transparency strategies:
- Funding Circle
- Seedrs was the first regulator-approved crowdinvesting platform in the world. Built on a nominee model, they allow companies to raise up to £150,000 from everyday investors who have as little as £10, and just recently raised £750,000 through their own platform the fund their European expansion;
- Funding Circle is the pioneer of the P2B (Person-to-Business) Lending market and recently raised $37 Million to expand their presence into the US and build on their momentum in the nascent SMB P2P Loan market;
- Triodos Bank is a Dutch-based entity who are building a ‘sustainable banking model’ on the pillars of transparency and ethics, and taking a lead in the impact and SRI (socially responsible investing) investment sectors.
On a macro level, there are three key areas of focus for sparking Finance BMi:
Given that borders and institutional walls make absolutely zero sense in the Finance world – capital needs to be able to flow – technology is acting as the bulldozer to break down the barriers.
There is a distinctive difference between what is happening in the ‘emerging’ versus the ‘emerged’ economies. Emerging markets are bringing in low-tech solutions to help money move within the boundaries of their country, while emerged markets are using high-tech solutions to remove restrictions on global capital movement.
- Crowdinvesting, where companies like Seedrs enable anyone in Europe, no longer just the UK, to invest as little as £10 in any startup company looking for £150,000 or less in Europe
+ FT – Seedrs spreads across Europe target=“blank”
- Money Movement, where companies like Transferwise, based out of the UK, facilitate global money transfers between bank accounts, saving customers from having to fork over huge fees just to make a wire transfer through their bank
- SMS Money Transfer, where services like M-Pesa enable everyday Kenyans and other Africans to send money between one another using SMS on a basic cellular phone
- Mobile Banking, where companies like CARD Bank, in partnership with the Grameen Foundation, take advantage of existing mobile networks to build banking service solutions for the previously “unbankable” in the Phillipines
Taking the ‘borders-are-silly’ analogy, #NewFinance is being driven by distributed networks who are connected via platforms, creating entirely new channels for driving dealflow and connecting with customers.
In the emerged markets, this can be seen in the form of crowd-based platforms, while in emerging markets, channels are being created to help impoverished citizens and communities form networks and access capital.
- Crowd Lending, where companies like Funding Circle create an entirely new channel for SMBs looking for a loan, making the approval process much faster and the fees lower
- Sustainable Pipeline, where companies like Triodos help finance businesses who meet certain ethical criteria and build a community of customers around those entities, creating a new channel for ‘sustainable’ businesses
- Crowd Micro Finance, where organizations like Aliança Empreendadora in Brazil help micro-entrepreneurs in low-income communities access to capital through their Impacto crowdfunding portal
The movement towards new forms of currencies is in motion. Part of the transition away from the current system is based on the need to move away from purely debt-driven, government-issued currencies and create new forms of exchange between people (P2P).
In emerged markets, new currencies are sprouting up to help spawn new digital ecosystems. In emerging markets, alternative currencies are being developed to help citizens spend their money in local businesses, as typically 90% of the money spent in low-income communities flows out to global conglomerates.
- Digital Dinero, where currencies like Bitcoin are enabling a new method of peer-to-peer payment via a digital currency which can be exchanged for real money. Despite its overhyped valuation and flawed structure, it does provide a signal that bona-fide digital currencies will be emerging in the future.
- Local Currency, where the Sampaio in São Paulo helps steer citizens in the urban neighborhood of Campo Limpo to spend their $Reais on local businesses and build a flourishing community
Overall, if capital is going to flow, we can’t have a million barriers, a thousand fees and a few controllers. Thanks to technology and a growing realization of the need to redistribute dealflow, the #NewFinance movement has come to life. In both emerged and emerging markets, countless examples of BMi exist to show how a few tweaks of the BM can create big impact, both locally and globally. And the beauty is, this is only the beginning.