The Supremacy of Business Model in Digital Transformation of FSIs
Singularity and Aberration of Operating Target State in FSI. Other FSI Digital Transformation Weekly Reads
The Supremacy of Business Model in Digital Transformation of FSIs
As we discussed in the previous newsletter about the North Star metrics, the objective for digital transformation should be profitable and significant improvements to the P&L. That is, if financial services and insurance (FSI) executives cannot confidently explain how digital transformation significantly contributes to earnings on tangible assets and/or earnings growth, then that FSI is better off punting on those initiatives until the impact is clear.
However, most FSIs don’t pursue digital transformation with the North Star metrics in mind or even with understanding a qualitative impact on the business model. In fact, they approach digital transformation strategy in the opposite way:
Digital business models could take various forms. Progressive auto insurance, Capital One credit cards, Wise money transfers all have different unit economics and fixed cost structures, but it is the business decisions that made these companies superior to direct competitors despite multiple cloning attempts. Even the most effective operating and technology models can't compensate for a flawed business model, as evidenced by the 80-90% drop in the stock price of some well-known financial services and insurance challengers.
Are the above financial services and insurance “unicorns” not agile or don’t use cutting-edge technology? No, the main doubt is whether their business model has a sustainable competitive advantage. The best example of this phenomenon is Root Insurance. Launched in 2016 to disrupt the US car insurance industry via telematics, Root had all attributes of the leading operating and technology practices. Only two years later, Root became a “unicorn” with a $1B valuation, and it went public in 2020 with a valuation of $7B. The insurtech stock price has declined 99% since then:
Root’s key mistakes were all business-model-related: unusually high prices and losses, coupled with not using credit scores in underwriting. Business model deficiency could not have been balanced out by a solid operating model and technology stack. Those components are the accelerators, not the engine of value in digital transformation. Each FSI has at least one business executive who would be curious to figure out the impact of digital transformation in their area. Do you know such a person in your FSI?
Singularity and Aberration of Operating Target State in FSI
In 2023, the path to conducting digital transformation has become significantly easier. One major factor contributing to this ease is that "the what" is singular. Unlike in 2008 or even 2013, financial services and insurance companies (FSIs) no longer need to engage in lengthy debates about where digital transformation should take them in terms of their target state operating model. In fact, thousands of traditional FSIs and fin/ins/wealthtechs across all continents are all moving in the same direction towards a shared vision.
What's fascinating is that this target state operating model didn't originate from a research or consulting outfit, or from a professor or writer. Instead, it emerged from the practical experience of leading "digital natives" who were unable to find a practical scaling theory and had to invent one on their own.
These three companies designed the operating pinnacle of corporate evolutionary progress in the 21st century. Since 2012, there has been no leap forward in a more effective target state vision. Whenever someone suggests that there may be a better operating model out there, I simply ask them to name a successful digital business that has scaled it. Time and time again there is no response.
The truth is, FSI executives have been aware of this optimal model for years, maybe a decade. They have been hearing about it from their peers and consultants. They post about it on LinkedIn and even present their insights at conferences. The autonomy, risk-taking, excellence, and collaboration elements of such a target state seem almost intuitive. And yet, when it comes to actually advancing toward that operating model, the same FSI executives often resist it. Why? Because it's an aberration to how most people prefer to operate. It runs counter to their deeply ingrained preferences for "normal" human behavior:
Ownership mindset: humans enjoy frivolous spending of other people's money on more initiatives and resources with unclear ROI, which they would never do if they owned the same FSI
Embrace of complexity: humans generally prefer simplicity, with a default reductive tendency to a one-size-fits-all approach, no matter a massive difference in digital needs and operating maturity across FSI’s departments
Enabling autonomy: humans strive for the stability of higher status, and this can make it difficult to share power with less senior employees and vigorously debate ideas with peers
Muscle development: individuals are more interested in asserting their own voice and complaining than in asking insightful questions and learning from others
These aberrations are so strong that many FSIs embraced an unironically called SAFe Agile which allows FSI executives to mostly preserve the previous ways of working while making it cooler. Even previously effective companies could succumb to regular human traits and become decadent corporate bureaucracies.
Then, it takes drastic measures from a founder or new CEO to bring the organization back to its original effective operating model. That is how Elon Musk was able to shed 80% of Twitter’s employees in late 2022 while deploying more features into production.
Or, here is how the founder of Facebook, Mark Zuckerberg, explained 25% cuts. Notice the similarity between Reed Hastings’ learning about the effects of cutting more than half of Netflix employees in 1999-2000 and Mark’s surprising re-discovery in early 2023:
Do you think you and your FSI are ready for aberration?
Other FSI Digital Transformation Weekly Reads
3 digital transformation takeaways from CNA's finance team (paywall)
Seven high-impact automation targets for financial institutions