From Bo Derek Investments, Cockroach Theory, Black Swans to Dead Cat Bounces, no other industry attracts buzzwords quite like financial services. “Innovative disruption” is one of them, as Julian Plummer explains.
The term “innovative disruption” has become so well lodged in our collective consciousness it deserves investigation.
For it seems that “disruption” is no longer the simple adjective it once was.
What is innovative disruption?
Clayton Christensen, a Harvard Business School professor, introduced the concept of disruption as an explanation of how upstart firms drive incumbent firms out of business.
The thinking used to be that incumbents failed because they could not keep up technologically with other firms.
Innovative disruption instead says that incumbent firms continually try to climb up “value chains” by incrementally moving to higher tiers of their markets.
This allows them to charge higher prices to sophisticated customers at the top of the market – resulting in maximum profitability.
However, in doing so, incumbent firms unwittingly allow disruptive innovation to occur at the bottom of the market. A disruptive innovation by a new firm gives consumers at the bottom of the market access to a product or service previously available only to high-end customers.
While incumbent firms will be aware of this disruption, they tend to ignore it because the new low-end consumers do not provide enough profit, or the new market is too small to provide good growth rates.
The classic example of disruptive innovation is the disk drive market in the 1980s.
Manufacturers of large disk drives went out of business due to the onslaught of smaller disk drives, even though smaller drives were inferior (both in storage capacity and cost per megabyte).
The same thinking can be applied to PCs and the introduction of tablets.
Disruption and financial services
According to a report by the Centre for Financial Services Innovation, there are a number of reasons why financial services firms easily succumb to disruption:
Changing shifts in the usage of cash in the economy and the race to provide financial services to people with lower credit scores (think low-doc home loans, reverse mortgages, retirees with insufficient retirement savings) stimulate product innovation.
- Nimble financial services companies “enjoy a comparative advantage if they can structure products to successfully navigate the regulatory landscape, tolerate the risks associated with still-pending regulations, and stay ahead of the regulatory curve by designing high-quality products with a consumer-focused orientation”.
- Incumbents are impeded by their existing infrastructure making innovation infeasible for them. Financial services start-ups are more easily able to disrupt by developing new transaction networks or other new approaches.
- Supply chains in financial services are cumbersome. Custodians, trustees, clearing systems, agents, white label licensee distribution arrangements and so on, allow new players to introduce themselves at different pressure points in the supply chain.
- New start-ups exploit the weaker relationship consumers have with established financial services firms and instead concentrate on the sticky relationship consumers have with social networks.
Historically, disruption can be seen everywhere within the context of Australian financial planning landscape. New markets have been introduced, prices lowered. Examples include:
- The introduction of mandate-structured platforms in the face of traditional master funds, and
- Online “discount” brokers, once only targeting the low-end broking market, now are the dominant force in the industry.
The three big dominant themes that will disrupt financial planning in the coming years are:
- The cloud – the biggest disruptor of them all. Not only is the cloud disruptive, it enables disruption itself. The most advanced technologies previously only available to large enterprises are now available to smaller enterprises. The cloud allows those smaller enterprises to scale their tech up-and-out as required. The same dramatic changes that have occurred with the emergence of cloud based accounting software will happen to financial advice software, decreasing the marginal cost of delivering advice. Count on it.
- Scaled advice will continue to disrupt the advice market. Scaling down the advice makes it more affordable for lower-balance clients, and a whole new generation is now more aware of the value of advice. Scaled advice provides an opportunity to fill the vacuum between intra-fund and comprehensive advice.
- Commoditisation of self-managed superannuation funds (SMSFs) due to advances in SMSF administration software will continue to disrupt the status quo of platforms. Hard lessons have been learnt by investment managers who have been largely ignored by SMSF trustees in favour of cash and property. In addition, the further growth in SMSFs from Generation X and post-retirement baby boomers will continue to pose problems for product manufacturers.
What can planners learn from disruption?
Lessons from disruption can be applied in managing your practice. Question everything. Don’t ignore threats to you that originate from the lower end of the market.
Investigate ways that technology and advice software can help you access the lower end of the market to fight off disruptive challengers.
To turn your planning practice into an innovation leader, you must motivate your talent by revaluating your values and purpose.
When researching investments for your clients, be aware that finding disruptive companies early is the key to making early-stage and momentum-based investing successful.
Disruptive stocks usually pay smaller dividends and have higher price-to-earning ratios as they typically reinvest retained earnings.
The big lesson here is to avoid investing in (and partnering with) firms with ‘good enough’ solutions in the face of a disruptive challenger.
Julian Plummer is the managing director of software developer Midwinter Financial Services.