Growing compliance costs, declining fee revenues, low demand for credit have forced banks to turn to cost-cutting measures and acquisitions to create profit. As those pressures continue to mount, banks will need to rely more heavily on innovation to be profitable, and the innovations that will drive profitability are going to need to be more leading-edge, a new PwC study, titled “Breaking the Rules: Achieving Breakthrough Innovation in Financial Services,” argues.
Innovation initiatives at financial services organizations suffer from an over-reliance on incremental improvements that makes products or services better, faster or cheaper, according to the report. The long term answer for sustainable profitability in the current competitive and regulatory landscape is in “breakthrough innovation” that transforms the business model or technology behind a product or service, the study contends.
To illustrate the impact of innovation on the bottom line, PwC’s report looked at the expectations for growth in the next five years for banks compared to top innovators across all industries. Those top innovative companies expect their revenue to grow by an average of 62% over the next five years, according to PwC’s research. Financial institutions expect average revenue growth of 53% over the same period.
That 9% difference in revenue growth over five years would equal $940 million of revenue for a bank with $10 billion in assets, the study says.
“We’re positing that financial services… faces a perfect storm where destructive and strategic innovations are being financed, and the market is ready for those disruptions,” says Michelle Wilkes, managing partner, strategy competency, financial services, at PwC, and co-author of the report. “Banks need to have a strategy to deal with that.”
That kind of disruptive innovation isn’t easy for many banks, and many institutions are held back by a similar set of challenges, according to the report. A PwC survey of 223 financial services executives found that the most common innovation challenges cited were: bringing innovative ideas to market quickly (53%), finding the necessary talent for innovation (48%) and establishing an innovative culture (44%).
Those challenges all point to a direct conflict at the heart of innovation in banking: innovation is about speed and operating with ambiguity, and banks have been functioning on a foundation of structure and policy for a long time, Wilkes says.
“If you have an innovation framework with a management process, that process is going to be slower by default. Banks need to find way to mitigate that issue by setting up different processes for innovation then the ones they use for their business,” she advises.
Along those lines, many major banks have set up innovation labs within their organization that help initiate and test innovative ideas. These innovation labs provide “a safe place for failure” in the organization, Wilkes says.
“Failure is something that was seen as detrimental. But you need to think about how you handle failure. Innovation management is a discipline, just like any other kind of management. [Banks] will develop that when failure is ok… that’s how you become an innovative organization,” she explains.
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Leveraging innovation best practices in an environment where failure is OK can build the foundation for breakthrough innovation that banks need to grow, according to the report, which says that 80% of financial institutions rely too heavily on incremental innovations. In the future, the study posits, banks innovation agenda will have to split more evenly between incremental and breakthrough innovation. That will require a truly empowered innovation officer who understands the bank’s innovation portfolio and how it corresponds to the overall business strategy, Wilkes advises.
The innovation officer can help the bank manage different types of innovation differently (breakthrough innovation will require operating with more ambiguity) and can deploy resources accordingly, she adds. And given the current competitive and regulatory environment, not all banks are going to have the resources available for big, breakthrough innovations. But those banks can still leverage good innovation management to be quick followers in the right areas, Wilkes notes.
“If you don’t have the resources to achieve breakthrough innovations and set up an innovation lab, then you need to look at your business portfolio, and understand where you are playing to win, and where you are playing not to lose. You can say, ‘In payments, we are playing to win,’ and then allocate resources to achieve those goals,” she explains.