In our previous blog post we considered the transformations in digital banking and the types of services available. In this edition our focus shifts to the development of a viable plan.
We advise adopting a structured approach to the creation of a new digital bank that focuses first on the transition from problem statement to value proposition, and then progresses to the business plan. Once these steps have been completed, testing and development are required to create a comprehensive proposition.
Where’s the value?
It is important to set out what value customers will gain from using a product or service. While this might seem trivial, most business ideas never develop into a solid value proposition. A common pitfall is to focus on creating a sophisticated product or feature as opposed to focusing on delivering real customer value.
The process begins with the problem statement, which can be defined as a summation of the issue the new entity is setting out to address. This will necessitate a full strategic market review and assessment of customer demand and current pain points.
The following is an example of a problem statement: ‘By providing low cost and real time cross-border money transfer services, we aim to support the African immigrant population in Europe to send their money home, so that they and their families improve their welfare’.
The process of defining the problem statement should include analysis of market size, competitive landscape, product segments and margins, together with a detailed profile of the target customer.
Cross-sectional market research should be conducted to validate the initial problem statement definition. The scope is generally based on the three aforementioned areas of product segment (for example, credit card payments); customer segment (such as millennials), and geographical market (for instance, Asia Pacific).
The validation serves various purposes and is performed in multiple ways. It improves understanding of the selected market (including the composition, size, development and segmentation of the market) and its financial viability at an early stage.
At the same time the objective is to create profiles of customers that take account of characteristics such as demographics, values, and social status, as well as the characteristics of the key players in the market.
The process of validation and extensive research typically leads to new insights, which should be used for refinement of the initial problem statement.
A validated problem statement, backed by detailed research, provides the foundation for the design of the value proposition, which is based on design thinking methodology.
Creative brainstorming sessions with multidisciplinary teams are used to identify a wide variety of potential solutions addressing gains, pain points and tasks from a customer’s perspective, as well as products and services, gain creators and pain relievers from a business perspective. These potential solutions are screened and curated.
A good value proposition can – or even should - consist of multiple products and services. A mock-up or minimum viable product MVP) will help the project team understand the proposition and enable them to fine-tune it rapidly and efficiently.
Identifying the critical assumptions on which the success of the value proposition depends is the next important stage of the process. The sort of questions that need to be asked here include whether customers (or someone else) will pay for this service; the extent to which this value proposition solves the customer’s problem; the degree to which customers understand the task; whether the value proposition creates new problems; and whether it is feasible to create this solution.
A key consideration here is how the bank will make money. As mentioned in our previous blog, the global financial crisis of 2008 triggered a wave of new digital banks designed to capitalise on the negative sentiment around traditional banks and their (perceived) focus on profits. These digital banks took a client-centric perspective in their value proposition development but many struggled to realise profitability.
During the testing and refining of the value proposition, the objective is to keep developing the mock-ups into a (near) MVP. It is crucial to formulate specific, measurable, attainable, realistic and timely (SMART) performance metrics.
It is also important to determine the qualities of a successful test. One possible criterion might be that 99% of potential customers understand how to use the service within five minutes and 80% of those potential customers are willing to pay a monthly fee of $5 or more for the product/service.
BMC or business model canvas is a useful tool for embedding the value proposition across the key business development areas
Commercial - The customer relationship describes the type of relationship to establish and through which channels. The channels are typically quite straightforward for digital banks - as they all focus on digital channels, they are usually centred around a mobile experience, at least initially. However, there can be differences between mobile app vs. internet-based solutions, the role of customer service centres (for example digital chatbot versus in person), digital only or omni-channel, etc.
The customer segments include information on topics such as demographics, financial behaviour and values and build on the extensive work already done during the process of value proposition development.
Operational – The critical processes required to deliver the services are covered in some detail in the key activities. For instance, many digital banks focus on rapid digital onboarding for customers - therefore seamless digital onboarding is one of the key activities to address.
Detailing this key activity and process flow early on allows you to optimise the customer journey and internal process for the most important activities.
Financial resources refers to resources for operational activities, such as funding for lending activities. The financial resources required depend on the value proposition, as payment services require different resources from lending.
This area also outlines partnerships with third parties, including strategic alliances.
Financial – The cost structure defines all expenses required to build and run the value proposition, thus including both one-off investment and ongoing operational cost. The revenue structure defines all revenue streams, including their sources (such as direct customer fees, in-direct interchange fees), and type (for example one-off transaction fees, recurring subscription fees).
Given that digital banks are attempting to strike a balance between offering a top quality experience to the customer and providing the lowest possible pricing for basic banking services in particular, it is generally critically important that they are able to operate at very low cost levels, coupled with sufficient scale of operations.
Depending on the ownership, digital banks typically have limited financial resources, while at the same time building a bank is capital intensive. It is important to form a broad financial picture early on, to ensure you are not only building a great customer proposition, but also are creating an economically viable business.
It is vital that the completion of the BMC and the creation of the business model are undertaken in a rigorous manner rather than as a ‘box ticking’ exercise. Building a robust model capable of determining the technical and operational feasibility of the project – as well as its commercial viability – is a vital precursor to any significant investment and requires a thorough analysis of all key aspects of your business model.
The business plan will evolve as you progress through each stage of the development processes. It is our view that it should be constructed by someone who can be objective and has expertise in the financial sector and reflects the business model.
Revenue streams can include transaction fees for payments and brokerage, transaction margins on foreign currency exchange, interest margins on deposits and loans, and subscription fees, amongst others.
The cost side should consider both one-off investments and operational costs. Initial investment costs could include IT development or the regulatory licence application, while operational costs include market expenses to drive customer acquisition, licensing fees to service providers, sales fees to distribution partners, IT costs and staffing costs.
Obviously, this will be heavily influenced by factors such as the type of services offered and whether technology is developed in-house or sourced from an IT vendor.
As well as the income statement detailing revenue and cost, the balance sheet with the assets, liabilities and capital structure also needs to be detailed. The capital structure is especially important for financial institutions as a banking licence requires certain levels of capital.
Once the full financial plan has been completed, the next step should be to carefully review the end result and consider whether the assumptions made within it stand up to close scrutiny. One could question, for example, whether the target level of operational efficiency is too optimistic; whether the customer growth path is realistic; and whether the upsell ratio is feasible.
A critical evaluation can be based on benchmarking with other digital banks and market averages.
This assessment allows you to refine your business model and enhance your business case.
Reassessing the entire business model is good practice. Some of the questions you need to ask include whether it could be more efficient and effective; whether marketing expenses could be reduced; and the extent to which (non-core) activities could be outsourced against lower costs.
It is very likely that adjustments will be necessary in order to enhance the business case. However, it is important to note that changes to the business case also require changes to the business model.
It would be highly unlikely for adjustments not to be necessary in the interests of strengthening the business case. However, it is important to note that changes to the business case also require changes to the business model.
For example, one cannot raise prices and simply expect customers to pay. Such changes and assumptions will have to be tested repeatedly.
In the next blog in this series we will look at the implementation phase of building a digital bank with particular emphasis on the target operating model, processes and activities, and technology as well as the human resource requirements.