Customers Are a Beach
This is the fifth installment of the Five Forces series, and today we’re talking about the Bargaining Power of Customers. To be frank, the buying power of customers in the financial services world is low. Despite a large number of customers that could literally put their money where their mouth is, customers often have their hands tied when it comes to their relationships with banks.
Per Porter’s Five Forces model, the bargaining power of customers is dependent upon several factors, including the number of customers, size of each customer order, differences between competitors, price sensitivity, buyer’s ability to substitute, buyer’s information availability, and switching costs. Let’s dive into how some of those factors are playing out in the current landscape.
More Ebb Than Flow
The rate at which people switch banks is low and there is hardly a demand for new products. You won’t find customers picketing outside of their local Chase branch, chanting about how much its product stinks. In fact, there are very few differences between products, and the bulk of that differentiation lies in the interpersonal relationships each bank has with its customers. What’s more, banking is geography-driven; people want a local branch where they can establish relationships with people and where they can turn to for customer service.
Uniform pricing is another stumbling block. Most differences in pricing are driven by bundling: the customer receives a lower mortgage rate if they obtain a mortgage through the same institution where they hold a savings account. Merchants receive a free business checking account when they sign up for merchant processing through the bank. In sum, customers “enjoy” marginal products in a somewhat-marginally improved way, but only when they bundle them together.
Here’s the other rub: it’s difficult to switch. When high switching costs outweigh any new value that might be derived from a competitor (in most cases, they do), there's no impetus for a customer to make a change. Customers hold little power in this regard and are relegated to whatever level of service and marginal product suite their current bank offers.
This is part of the reason the first fintechs were so revolutionary — they brought power to the people by merging financial services and technology, with technology being the operative word. Technology facilitated a change to the variables that had previously given banks the most leverage. Specifically, fintech now enabled customers to:
Use products outside of their zip code
Get a loan where a traditional underwriting process said they were too risky
Establish a new lending relationship on a Saturday night
Seek out a better interest rate
When evaluating how these changes have impacted the bargaining power of customers, it’s important to look at the constitution of a bank’s business. A bank’s customer base is made up of a large number of consumers and small businesses, each representing a relatively small relationship to a bank. Subsequently, this shift in bargaining power is more like a slow-moving tide than a crashing wave.
Banks Believe They Are Going With the Flow
This slow change in customer bargaining power hasn’t changed the way most banks compete. In fact, many say these changes haven’t impacted them at all and they haven’t modified behaviors to adapt. What contributes to this myopia? Several factors.
The internet doesn’t abide by geographical boundaries, which means that the change in customers and customer behaviors are spread across a much larger base. For example, most bankers will say they don’t compete with Rocket Mortgage because 1) their rates are higher, 2) there’s no way to meet with a mortgage broker, or 3) they don’t even know what Rocket Mortgage is. Yet, there is no denying that someone competes with Rocket Mortgage because they are the largest mortgage originator in the US.
Another contributing factor is the changing nature of customer behavior. The internet and digitization of financial services have rendered physical locations for servicing a moot point. It’s much easier for customers to have a polyamorous relationship with several financial service providers than to have an exclusive (or largely exclusive) relationship with a single institution.
The bank-customer relationship has become an open one where customers maintain old accounts while experimenting with new options. This gives the customer freedom to try new things while enjoying a safety net. Switching is harder than opening a new account and transacting while holding onto old accounts in case things don’t work out with the new service provider. It’s this experimentation rather than outright switching that masks the true nature of the shift that is occurring.
Change is Closer Than it Appears
The CEO of Liveoak Technologies, a former executive from an incumbent that joined the fintech startup, gave me this analogy: “It’s easy to dismiss rising ocean temperatures and the commiserate melting of oceanic ice because the increments are small. Except taken as a whole, that’s a sh!t ton of water.“
Many banks claim their strategy is to be a “fast follower.” As JP Nichols puts it, they’re half right. Banks are followers, but they are rarely fast. Swiftly changing a strategy to respond to shifting power dynamics is nearly impossible when we are talking about customer preferences that are powered by a sudden change in the underlying dynamics.
Blackberries dominated the smartphone world, especially in financial services, even after the introduction of the iPhone...right up until they didn’t. IBM’s mainframe business dominated the computing landscape until the threat of a substitute (microcomputers) both became viable and presented as a less expensive alternative (low switching costs), giving customers more power. Blockbuster won on geographic reach and product availability but passed up the opportunity to buy Netflix for a steal because they didn’t see the small changes in customer behavior as indicative of a larger trend.
The shifting tides of customer power and preference are like the tide creeping toward a beach blanket. The change is subtle and insignificant, especially compared to the action going on down by the surf line. That is, until that slow creep brings a big wave within reach of the blanket, umbrella, cooler, and bag. There is no fast follower when change is already within reach.