Latest great guest post by Paul Rohan, author: PSD2 in Plain English. Image from Pixabay.
Dominant design is a technology management concept introduced by Utterback and Abernathy in 1978, identifying key technological features that become a de facto standard. A dominant design is the one that wins the allegiance of the marketplace, the one that competitors and innovators must adhere to if they hope to command significant market following. The emergence of a technology solution itself goes through two distinct phases and the shift between these is marked by the emergence of a “dominant design.”
When a solution first emerges, multiple firms will enter the fray with competing alternative designs. In the early phases of a platform market, a variety of firms experiment with different types of features, capabilities, and designs to assess the market’s response. The predominant design phase is marked by mass entry of competitors and multiple solutions to address the same market needs.
In the specific case of PSD2 and Open Banking in the EU, a pattern of clues to the emerging dominant designs could emerge from multiple regions. Given the longer term direction, EU banks will start to plan for an Open Banking Ecosystem. However, Open Banking will not be adopted as a fully deliberate process, to the detriment of emergent activities.
The evolution of this ecosystem will be influenced by the specific environments, capabilities and ambitions of EU regional banks. Their account-servicing installed bases are quite firmly anchored. Many bank brands are heavily linked to specific regions, languages and cultures. They are not seeking global ubiquity like the giant social media platforms.
We can safely suggest that the dominant designs for consumers and businesses will be different. Business Units in mature banks will influence corporate strategy through segment-level initiatives, such as a Small Business Open API Strategy, a Corporate Banking Open API Strategy and a Consumer Banking Open API Strategy.
The Private Banking Open API Strategy will be advanced; screen-scrapers have already targeted the multi-account, multi-product and multi-currency high net worth consumers. The acquisition of Yodlee by Envestnet probably bears that out.
Private Banking is a subset of consumers. Corporate banking is a subset of businesses. Therefore, there will likely be early competing alternative designs for Open Banking for Consumers and Open Banking for Businesses.
At some point, one design will become widely accepted as the winning standard. This happens when both customers and producers arrive at some tacit consensus about the optimal solution attributes that best meets customers’ needs out of all competing designs. This then becomes the industry’s dominant design and is usually associated with an exit of competitors from the market or switching over to the dominant design.
In becoming the dominant design, speed is as important as technical elegance. The dominant design does not mean that every competitor will use the same technology. Rather, this design defines the expected norms for meeting users’ needs. The dominant design is often not the technologically superior solution. It may involve compromises since it is designed to appeal to a broad range of users. However, even after a dominant design emerges, rival ecosystems (platforms and apps) can persist without one clear winner. But they usually share strong commonalities with the dominant design. This can lead to legal problems over Intellectual Property rights, as evidenced by “patent wars” involving Apple, Samsung and Google.
— Paul Rohan (@paulrohan) April 10, 2017
So, what will be the “iPhone” design for Open Banking? The key design features of the Apple iPhone pretty much defines the features for competing in that industry: a touch-based interface, a typical set of internal functions (email, browser, text), pocket-size, software upgrades and a virtual keyboard.
After a dominant design emerged, the surviving competitors modelled their own solutions on the dominant design and compete by making incremental improvements on it. The basis of competition shifts away from different approaches to meeting customer needs. Instead, competition focuses on trying to improve on the dominant design.
Of course, the iPhone is only part of Apple’s multi-sided platform. Are banks already “multi-sided” or must they pursue it? A key property of platforms is their multi-sidedness, where each “side” refers to a distinct group of stakeholders that the platform brings together. In theory, both sides can find and trade with each other directly without the platform. Yet, this must be costlier for a platform to be viable.
A software platform is multi-sided if two or more distinct types of participant groups use the platform to directly interact with each other. In the domain of fast-growth software platforms, traditional banks are not platforms. Banks transform maturities and absorb risk for depositors and borrowers but these two sides of a bank’s balance sheet don’t directly interact with each other.
Network effects will be needed to establish a dominant design for Open Banking. Network effects refer to the degree to which every additional user of a platform or app makes it more valuable to every other existing user. Economists call these network externalities or Metcalfe’s law.
Each additional user potentially increases the value of the system to other users dramatically rather than gradually. Once such network effects are triggered, the platform can enter a self-reinforcing cycle. While network effects create high barriers to entry into platform markets, they also create a hard-to-beat position once they are in place. This will also apply to Open Banking.
The dominant design in Open Banking will have to work hard to minimise multi-homing. The simplest example of multi-homing in financial services is to have more than one credit card, perhaps a Mastercard as primary and a Visa backup. An App developer who simultaneously develops an app for Android and iOS is multi-homing on those platforms.
The banking industry has historically relied on the low portability of bank account data and information opacity in the lending process to encourage customers to single-home. PSD2 and Open Banking will improve the portability of bank account data, the API Economy will reduce opacity in the lending process and intense market competition between fast-growth platforms to achieve dominant designs will encourage new multi-homing for financial services.
Envelopment of banking software
There is a distinct possibility that a bank or banks may not be the owner of the platform that achieves a dominant position in financial services, leveraging the advent of Open APIs from banks. Relevant and adjacent platforms could envelop generic banking software. Envelopment is an evolutionary dynamic where one subsystem expands into the turf of another solution with which it has an overlapping user base by offering its functionality as part of an expanded multiproduct bundle of functionality.
This evolutionary dynamic can be projected into an emerging Open Banking Ecosystem in both the consumer and business segments. In the consumer segment, the Personal Financial Management subsystem could use Open Banking APIs to expand into the turf of the consumer banking solution with which it has an overlapping user base by offering its functionality as part of an expanded bundle of functionality. In the business segment, the Cloud Accounting subsystem could use Open Banking APIs to expand into the turf of the small business banking solution.
What are the ingredients needed for successful envelopment process, using the business banking segment as an example? Envelopment depends on leveraging overlapping user bases and common components to offer a bundle that includes both the original subsystem’s functionality and the target solution’s functionality. Opportunities for envelopment arise primarily due to convergence of unrelated industries or applications either due to the convergence of previously disparate technology solutions (no standard Open APIs from banking) or due to regulatory changes (PSD2 forcing banks to open APIs, PSD2 prohibiting the persistence of screen-scraping).
What might trigger the envelopment of banking software by accounting software for businesses? Envelopment opportunities arise from the application of existing or new technologies (cloud based accounting) to deliver the functionality of the enveloped solution in a completely new way. Use of the Open Banking APIs after PSD2 will allow a Cloud Accounting solution to replicate the ability of generic banking software to initiate payments, extract account data and automate reconciliation between business ledgers and bank accounts.
The core architecture of generic banking software is monolithic and dates from the mid-1980s. However, the core architecture of cloud accounting software is modular and dates from the mid-2000s. The App Developer Communities and the large End User Bases already generated by Cloud Accounting Software is a valuable source of initial advantage and momentum against any progressive banks that cultivate new Developer Communities post-PSD2.
The Cloud-based architecture of new modular accounting software allows dual access for the business’s professional advisors. This dual access already helps drive network effects, as more SMEs attract more Accountancy Practices and more Accounting Practices attract more SMEs. This is a valuable and sustainable source of advantage for new Accounting platforms over generic banking software.
Accounting software using Open Banking APIs captures cash flow data in bank accounts, credit sales, credit purchases, debtor days, creditor days, stock turnover and balance sheet items. Generic banking software captures cash flow data in bank accounts. This extended data set for loan appraisal and deposit placement processes is a valuable and sustainable source of advantage for new Accounting platforms over generic banking software.
If this sounds like a credible scenario, we can apply the same logic and devise a checklist for both the Consumer Segment and the Business Segment. There are two types of “adjacencies” that could assist in the envelopment of generic banking software. Customer (horizontal) adjacency means that the enveloping subsystem and the enveloped solution have substantially overlapping customer bases.
Envelopment occurs here when the enveloping subsystem expands to offer the functionality of a different solution that is also used by a large percentage of its own users. Value chain (vertical) adjacency means that envelopment occurs when the enveloping subsystem expands to span a different link in the value chain that was previously served by a different solution. So:
1. Which platforms have been indirectly or directly benefiting from screen-scraping?
2. Which platforms have over-lapping customer bases with EU banks?
3. Which platforms are already achieving network effects in their growth?
4. Which platforms could see the acquisition the routine financial activities of a large number of either consumers or businesses across the EU as a key driver of additional network effects on their platform?
5. Which platforms are in an End User and App Developer acquisition growth race with other platforms?
6. Which platforms have services that are vertically upstream or downstream of the cash movements in a bank account (shopping, retailing, book-keeping, financial planning, lending, deposit taking etc.)?
7. Which platforms have relatively modern software architecture that is modular and can connect to the API Economy?
8. Which platforms are already active in the EU or would see the EU as the starting point for a global strategy to envelop generic banking software?
9. Which platforms can envelop bank account data into of a wider and more valuable data set for End Users than banks can?
10. Which platforms have the capital and the brands to pursue this envelopment strategy at high scale?
In crude conclusion, the platform revolution will probably produce candidate platforms that can meet some or even all of the 10 hurdles listed above. Post the emergence of a dominant design, the focus shifts toward price-based competition. The majority of adopters arrive after the emergence of a dominant design. The more a dominant design is used, the more they are improved. The reinforcing feedback loop makes the dominant design more dominant whether competing designs are technologically superior or not.
Crucially, specialised complements (such as Apps) emerge that are designed specifically to work with that dominant design. This seems to be the key question facing App Developers that might wish to leverage routine banking data in an Open Banking Ecosystem. Should they join a Developer Community promoted by a bank or join a Developer Community promoted by a platform that has the potential to achieve a dominant design by leveraging Open APIs offered by banks? This logic also presents a ‘fork in the road’ for lending/deposit taking banks. If a Loan Application or Deposit pricing process is destined to become an App, shouldn’t it be designed as a specialised complement to the likely dominant design, even if this is not likely to be the bank’s own platform?