Carpadium Consulting

It appears like NAB is continuing to put downwards pressure on fees, with the recent announcement that it will further lower fees on accounts and card products.

Along with earlier announcements by NAB and others, this is all very welcome news. However, you can start to get a sense of the scale of the fee regime here in Australia when we see one of the big banks foregoing an alleged $110 million per year in revenue at what has routinely been called the worst financial crisis for a generation. Quite clearly, things are not so bad that they can’t afford to take a lazy $110m of the bottom line.

Now that this fee reduction program has really kicked off in earnest with the major banks, you are starting to hear them using “low fees” language in their communications, so it is obviously something that is resonating with consumers. There is still quite a long way to go, but it certainly seems like things are moving in the right direction. Unfortunately, there has not been much movement on fees and charges for businesses – a fact that is just now starting to get some public attention.

I imagine that we will see all of the Big 4 come more or less into line over the next 6 months or so on fees for retail customers. It remains an open question if any one of them will blink and start reducing fees for business customers.

M@

The Australian is reporting that CBA is in the process of rolling out contactless payments, apparently with a view to shortening the lines for pie and chips and your next footy match.

I think this is a good move, because I believe that it can have a real impact on the way people make purchases. If you can cut down the time it takes to make a payment, then you can obviously cut down the time taken waiting in line. This will obviously be really good at the big venue scenario, where you often have to wait a very long time in huge queues.

However, there is another angle where it could be very useful: public transport. There has been a long running effort to try to roll out a stored value transport card system here in NSW. This is similar to existing systems around the world, with the exception that our Government has not been able to make it work as yet. Perhaps an alternative to building a new stored value system specifically for transport would be to make use of one of these emerging contactless payments mechanisms? If done properly, this would obviate the need for a dedicated stored value card system altogether.

It will also be interesting to see how the fees and charges work. In the past, this is something that the banks would have placed a whole bunch of new fees onto from the outset, but my sense is that there is a bit more competitive tension these days between the Big4 banks on fees, so I’m guessing that there will not be too many (at least in the short term).

M@

This article from the Age represents an interesting development for payments regulation in Australia.

For some time now, there has been a regulatory dance between banks and the RBA. As with many situations of this nature, the regulator has asked for the banks to make interchange fees more transparent, and to make it easier for new entrants to enter the market, but not surprisingly, the banks (in most cases) have really only done what was absolutely necessary. I expect that will continue.

There was a move earlier on the year to make fees more transparent by allowing direct charging at the ATM. This was supposed to open things up and give the customers more information about fees, but I am not entirely sure the outcome has been what the regulator was hoping for. Following these changes, any time a customer uses an ATM from another bank, they are hit with a direct $2 charge. In some cases, the charge is even greater. There has been some consumer outcry over this.

Also, it was revealed yesterday the extent to which Australian banks make money from non-spread revenue such as fees. All up, it was about AU$12b across the banks, which is a staggeringly large number, and an 8% uptick year on year. Most of the fees were charged to business, but about $5b was charged to consumers.

These factors are probably contributing to a slightly more bellicose position from the regulator as it becomes increasingly difficult for banks to justify these types of fees and charges as “cost recovery” when they make so much money from them. I think that everyone from the regulator to the public has long since realised that fees are really a very big source of revenue for the banks, and not just cost recovery for expenses incurred providing services. It’s a prickly issue, especially politically, and I expect that it will get pricklier as the year progresses.

What makes this issue even more interesting is the fact that since the GFC, the Australian Government has provided banks with a wholesale borrowing guarantee (effectively giving them all a AAA credit rating) as well as a guarantee for retail funds on deposit, which has put them all in a very strong position. There is starting to be some public questioning of this given the fees and profit results, and people are asking if the Government should not also be able to exert some pressure of the banks given the privileged position that it has afforded them.

How this will play out is anyone’s guess, but I can definitely anticipate some more political machinations over the coming months, because just about everyone loves to bash the banks.

M@

I’ve been following the blogosphere closely over the last couple of weeks and I’m kicking myself that I didn’t get this post out a little earlier! When I read articles like this [update: and THIS!] it just confirms everything I believe about the essential elements of a good product and good product strategy.

That’s because a successful, long-term product strategy involves a platform, not just a product. A platform has three essential components: an endpoint, some content and a distribution mechanism. Content and distribution are pretty much self explanatory. By endpoint, I mean a place for consumption to occur. In different markets and different products, the endpoint can be quite different, but its essential property is that it facilitates consumption by the end user.

For example, with cola-flavoured beverages, the content is the drink itself, the distribution mechanism is the fleet of vans and supporting warehouse infrastructure that get the soft drinks into stores, and the endpoint is the can or bottle. In the traditional (ie non-digital) music business, content is obvious – its the music itself – and distribution is pretty straightforward as well, it’s the record companies ability to manufacture CDs and get them into the hands of the music buying public. What’s the endpoint in this case? Devices like CD players and other stereo equipment components that allow an end user to play music.

With PCs the endpoint is the machine itself. The content is the operating system and applications that rely on it. Distribution revolves around the ability of operating system and application vendors to get their software onto the device and into the hands of users. Microsoft managed to create an amazingly (economically) successful ecosystem around the DOS and Windows operating systems by making sure that PC vendors shipped it pre-installed. The mechanisms they used to make this happen have already been the subject of many column inches, so I won’t go into them further here.

Domination in a market occurs if a single player (or group of players) manages to gain control over one or more of the three essential components, or if a player manages to commoditise one or more of the parts. This is best understood by example.

In the PC business, Microsoft’s great innovation happened a long time ago – way back in the early days of DOS, and it was only partly technical. Whether or not it was Microsoft’s intent at the time is another story altogether, but the the real innovation was that DOS commoditised the hardware platform. DOS created a nexus between hardware and applications that allowed the hardware vendors to ignore the application software, and software vendors to largely ignore the hardware. Consumers ended up with choice in hardware, and consequently, choice in application software. The creation of an intermediary “standard” was the thing that really allowed the PC market to explode. With this in place, there was proliferation of hardware vendors and a proliferation of software vendors too.

This is a classic case of commoditising the endpoint. They also managed to wrap up distribution by tying the sale of Windows to the sale of a new PC, rather than the sale of the operating system itself. Cleverly from Microsoft’s point of view, it didn’t matter whether the machine actually had the operating system installed because the deals that MS struck with Original Equipment Manufacturers (OEMs) were based on hardware sales. For each box they sold, they had to pay Microsoft a license, a trend that continued right through the transition to Windows.

It’s worth considering the fact that while the price of PC hardware has dropped by more than an order of magnitude over the lifetime of Microsoft’s operating system dominance, the cost of the operating system has increased by more than an order of magnitude. That makes it pretty clear which part of the network ended up being commoditised.

The music business is interesting because we can see the endpoint/content/distribution framework in action in the traditional physical music market as well as with digital music, but with some very different players. In the traditional music business, distribution is more or less completely controlled by the record companies. Up until the advent of the iTunes Music Store (and notwithstanding the small number of independent music stores) the vast majority of physical music sales occurred through large national or global chain stores, such as Sanity here in Australia, Virgin and, HMV globally, and Walmart in North America. The music played on radio stations is also heavily influenced by record companies, by legal means or otherwise. The subtlety of that part of the music business is beyond the scope of this post, but if you’re interested, see Wikipedia for “payola“.

The difference with digital music is not that the endpoint/content/distribution framework has changed, but rather that the players have changed. And if you have any remaining questions that Apple’s iTunes Music Store has changed the game in the music business, then the fact the store sold its 5 billionth song in June this year should relieve you of any doubt.

What Apple managed to do to change the game is create a great endpoint in the iPod that consumers the world over just love, and a highly compelling distribution model in the iTunes Music Store that makes it so easy to buy digital music that it verges on the transparent. The end-to-end user experience enabled by the iPod and iTunes is so compelling that the iPod is now the most successful consumer product of all time. Tellingly, the company that Apple knocked off the perch for most successful product of all time (Sony, with the Walkman) is also one of the companies likely to experience some pain when their control over the distribution of music changes as consumer tastes switch from CDs to digital music.

In many ways, the change in the game that occurred in the music business has strong parallels in the PC business. The pattern is clear: a new player emerges on the back of a compelling endpoint, and then delivers a distribution mechanism that just blows away the competition. The iPod/iTMS combination is vastly superior in terms of the end-to-end experience (but arguably, not sound quality) than the CD/store combination. The Google user experience changed the game on search, which they then went on to overlay with an amazingly profitable advertising business model, as well as a variety of new user services which the competition just do not seem to be able to match.

In both cases, the incumbent didn’t really see the change coming, and when they finally did, tried everything to ignore it or make it go away. By the time they reacted, it was just too late. Or at least, it looks like it was too late. Apple’s success with the iPod and iTunes represents one of the most amazing turnarounds in corporate history, and although there is a lot of competition, both in terms of MP3 devices and distribution mechanisms for digital music, few apart from Apple seem to have any real traction.

In terms of the operating system market, we are probably a little further away from declaring such a convincing winner, but the signs are definitely there. They must be worrying for Microsoft as it continues to struggle for mind share with Vista. Perhaps more worrying is the fact that its online properties (with the exception of PhotoSynth – which is really brilliant) are a little underwhelming. There is no question that the Microsoft business model generates staggering amounts of cash from operating systems and desktop applications, but the point here is simply that its
not impenetrable.

What I find fascinating is that few seem to have noticed that Apple looks very likely to repeat the success of the iPod/iTMS combination with the iPhone and the iPhone App Store. All of the pieces are in place: a compelling endpoint in the iPhone and a distribution system that connects application developers with consumers like never before. Analysts have been quick to predict failure for Apple and the iPhone, not to mention the end of the run for the iPod. The reality is that Apple just keeps getting stronger, and if Mac sales continue this kind of growth, there may be some very different conversations about the power base of the PC industry in the future.

The amusing thing for an observer is that the role played by Big Music in the iPod/iTMS product mix is now being played by Big Telcos. They just do not seem to get what is going on. And if you need any clearer proof of this fact, check out the pricing plans for an iPhone on Telstra’s NextG network here in Australia. Are they serious?

The risk for Apple is in maintaining this success without looking like its developing a monopoly that harms consumers. I don’t think that they will have any problems maintaining this with the iPod/iTMS combination because there are many alternatives (just not very many good ones). Just because you have the most compelling product does not mean you are extracting monopoly rents. However, it might be different with the App Store. If its early success continues, then the 30% margin that Apple takes on all App Store sales might raise some questions. However, as with the iPod, no one is forcing you to buy an iPhone. Which is quite a different scenario to the PC world, where even if you do not want to run Windows on your machine, in most cases you still end up paying for it.

From a product perspective, the takeaway here is how powerful the combination of great endpoint, compelling distribution and engaging content can be. The advice to incumbents at risk of losing their endowments is to consider that all three parts of the platform need to be working effectively. When one leg weakens, the whole stool can fall down, but when all three are strong, then it forms the basis of a truly great product.

M@

PS: Update: here’s a slightly different view of what makes a platform. Well worth a read.

Following on from yesterday’s post [1] regarding the Australian Federal Government’s push to make switching bank accounts easier for customers, comes this article in the TheSheet.com.au [2]. Quoting research from Roy Morgan, it suggests the desire to switch is actually not that high. In fact, less than 10% of people surveyed were dissatisfied with their primary financial institution, and over the last 12 months, only a touch over 3% of those surveyed had changed financial institution.

This says to me one of two things: Either, a) customers really are happy with their financial institutions and the politicians have got it wrong, or b) it’s just so painful and expensive to switch that customers have convinced themselves that they do not want to have anything to do with the idea.

I wonder which one it is?

M@

References
[1] Original identification: impeding or enabling churn
[2] Not much demand for switching accounts

Because of my background with Westpac’s Trust Centre, and a general interest in economics and the banking system, I have found the recent comments by the new Australian Government regarding account switching very interesting.

Treasurer Wayne Swan [1] and Finance Minister Lindsay Tanner [2] have both been in the press [6] over the last week berating the banks for raising interest rates above the recent increment by the Reserve Bank of Australia (RBA).

The twist here is that under the Australian banking system, there is, by design, very little the Government can do about the rates banks choose to charge borrowers. Some time back (under the previous Government), the Reserve Bank was given the power to independently set rates, and the banks now respond to this, setting rates as they deem appropriate for market conditions.

Of course, this is a Good Thing. Leave the Reserve Bank to handle the cash rate and leave the Government to look after fiscal policy. That’s a sound economic principle and a pillar of the Australian banking system. And for the most part it works.

Unfortunately, the fact that falling interest rates often signal a worsening economy and rising rates often signal a warming (or even overheating) economy is lost on most people. Complicating issues further is the fact that almost all of the reasons rates move around lie beyond the control of a single Government, or jurisdiction. They rest pivotally with the machinations of the global financial system, and the large economies of the World such as the US, China, Europe and Japan. Regardless of this fact, politicians of all kinds love to take credit for rates falling, and shift the blame onto external factors when rates go up.

What is interesting about the new Government’s response to the recent rises is that instead of simplistically trying to move the blame for the rise to external factors, or shaming the banks publicly, they’ve taken the unusual step (at least in this country) of resorting to competition policy.

One thing that characterises the Australian retail banking sector is that it is highly concentrated. We have 4 very large banks and 1 not-quite-so-large bank, plus a handful of smaller regional institutions and credit unions. Between them, the Big 4+1 have the vast majority of retail banking business in Australia.

This concentration has lead to a rather stable market where there are very few positive incentives for customers to change banks. From the banks’ point of view, any kind of price competition simply ends up eroding value, so they do not typically engage in that kind of behaviour.

This has led to a situation where it is quite difficult (by design) to move around from bank to bank. Closing down direct debits and re-initiating them is a complete nightmare, and changing mortgages is even worse. Exit and entry fees generally make it so expensive that the average person finds just too hard to switch.

And so the Government, in the face of some banks raising home loan mortgage rates by an amount greater than the recent RBA increment, has turned to competition policy. It has taken the view that if banks are going to do that, then the Government will seek to make it easier for consumers to switch.

Like the independence of the Reserve Bank, this is a Good Thing. In fact, it’s precisely the kind of thing a Government should do in a mature and sophisticated banking market – make sure that structural inefficiencies (such as barriers to changing banks) do not artificially distort the retail interest rate. If it is too hard for a customer to switch banks, then it is easier for the bank to load up rate increases without fear that it will lose customers. Conversely, if it is easy to move, then a rational customer presented with an artificially high rate rise will simply change banks and choose the provider with the lowest rate. Over time, this will place downward pressure on the retail rate.

What does this have to do with the Trust Centre? In order to switch banks, I have to identify myself to the institution. Up until recently, this process was known as the ’100 point check’, where I used a variety of physical identity credentials to demonstrate my identity to the bank. Now that the banks have switched over to a ‘risk based approach’ under the Anti-Money Laundering and Counter Terrorism Financing Act, the process is not so straightforward. Organisations are using different methods to identify customers, and some are stronger than others.

An obvious attack in a switching-enabled system would be to establish an account with an organisation that had low identification standards and switch it over to an account with an institution that higher identification standards. So, whatever measures the Government implements with respect to switching, it is going to have to take serious care with working through the process of original identification.

Of course, if the consumer is strongly identified in the first place, and issued with an equally strong uniformly recognised identity credential, then switching is pretty easy. But the questions here remain as ever: What process? What credential? Who pays for it?

These were precisely the questions asked during the Trust Centre project. I wonder if anyone has the answers?

M@

References
[1] The Hon Wayne Swan MP, Treasurer
[2] The Hon Lindsay Tanner MP, Minister for Finance and Deregulation
[3] Accelerated account switching planned
[4] Switching in vogue
[5] Identity checks an equal barrier to account switching
[6] Cost of bank switches to be cut