[Dave Birch] Having been reading some of James Gardeners insightful reflections on innovation banking, and in particular having been thinking about some of the questions he posed when talking about Xerox and Microsoft, I am forced to ask a tough question: where is the innovation in payments going to come from? Bank’s IT budgets are going to be sucked up by SEPA initiatives for the foreseeable future and those initiatives mean downward pressure on payment income. Insofar as I understand the strategy of banks that we work for, in recent times it has been to change the cost/income ratio by both increasing income (perhaps by making riskier investments!!) and becoming more operationally efficient: factories for money. But I wonder how this works in the longer term?

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There’s an undeniable tension between operational efficiency and innovation. There was a good case study in the Inside Innovation section of Business Week a while ago. When 3M (a company noted for inovation) switched to “six sigma”, cost-cutting and process improvement, things looked good at first. Now, though, the picture is less rosy. The company used to earn a third of its revenue from products introduced in the previous five years: that is now down to one quarter. The issue of where the next innovation is going to come from has meant undoing the “improvements”. In an innovation economy, process-based approaches are not a cure-all. This may be one of the reasons why management consultants, who are experts in process, don’t always come up with the optimal strategies for new technology and the innovation it facilitates.

You hear a similar story in the banking sector: a focus on operations means the short term is terrific but there’s nothing in the pipeline for the longer term. Now, in the case of banking as a sector, it doesn’t really seem to matter because the income from the core business is so much larger than than the income from payments — as one head of innovation in retail payments (I hope you don’t mind me stealing your quote!) said to me when he left the job, “there is no innovation my team can deliver that will ever generate more profit next quarter than lending a bit more money to a few more people”. The core business is not payments, but if innovation in payments is choked off — by SEPA, by R&D cutbacks, by IT priorities, by lack of interest — then surely the core business is reduced to a back office utility (I don’t mean this in a bad way) because payments are actually the connection to customers.

More than just a connection, it might be argued that It’s clear that in some ways, payments can be seen as being a “portal” into the financial services world. Thus, despite the fact that a bank might make little or no real income from its payments business, it has to keep the payments business not only up-and-running but evolving in a competitive market. This is because the loss of payments businesses means the loss of a significant channel for bringing new customers into the bank. Banks in some regions have to be prepared to give up a fair amount of payment revenue from transactions in order to achieve other goals. For example, ICICI Bank waives transaction fees for customers who transfer more than $1,000 as they recognise that the long-term value of these customers lies not in the remittance fees the bank can earn twelve times a year. Rather, these customers who remit more money each month than the average Indian earns each year are likely to be consumers of credit cards, insurance and other financial services as well. For organisations hoping to compete with banks in providing payments, this means that the game isn’t simply about collecting transactions fees: strategically, banks will fight much harder to retain a share of the payments business than the share of net income directly attributable to payments indicates. But can they do this without innovating?

These opinions are my own (I think) and presented solely in my capacity as an interested member of the general public [posted with ecto]

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