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Friend AND Foe, counter-disruptive strategies in Financial Services

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A previous article discussed the strategic options when facing (disruptive) innovation and threats to our organization and (current) business model.

Let us now put names and descriptions to the operationalization for some of the strategic options, applying some real life examples.

The phrase “Innovate or Die” may then be all too true for a broad range of sectors and companies, Financial Services experiencing this risk of disruption even more than other sectors.

Consequently, with the future seeming more uncertain than ever (except death and taxes!), incumbent players in Financial Services need consequently to assess their proper strategic actions

A methodical approach summarizes five potential strategic (re)actions:

  • Focus on and invest in the traditional business
  • Ignore the innovation – It is not your business
  • Attack Back — Disrupt the Disruption
  • Adopt the Innovation by Playing Both Games at Once
  • Embrace the Innovation Completely and Scale It Up

In short, 4 out of 5 strategic alternatives requires the organization facing potential disruption to (re)act to the possible Threat/Opportunity.

So, if the incumbent bank or insurance company decide “we must do something”, how do they embark upon the journey of operationalizing their choice of action?

Basically, the following strategic actions are available, each have their Pros & Cons:

  • Mergers & Acquisitions
  • Strategic alliances
  • Organic innovation and growth
  • (Variations over the “Open Innovation” angle, such as venture capitalism approach, incubator/accelerator, hackathons, API publications, etc. deserves an article of its own !)

Though the reasons (and anticipated outcome) for non-organic growth and change may vary, they tend to fall into the following categories:

  • Strategic goals: Protecting existing market shares, or accessing new geographical markets, access to products complimentary to your own, acquiring new capabilities and assets such as technology, human skill sets, etc.
  • Synergy: The combined parts/capabilities of the two (joint) firms is bigger than the parts of each firm. Financial synergies as lower cost of debt is achieved, (bigger) economies of scale in terms of procurement costs, production efficiency, sales, Support & Administrative staffing, etc.
  • (M&A) Consolidation of an industry: Possibly, fewer players in the market place will lead to an overall improvement of the profit margin in the industry

Mergers & Aquisitions (M&A)

We will not dive into any practical differences between these two approaches, suffice to say former two organizations afterwards legally operate as one company. Either the two former companies merge into a new company, or the buying company aquires the selling company.

Strategic alliance

A merger or an acquisition results in changes to the involved companies’ legal structure, with the two companies “melting” into one formal entitity. The strategic alliance typically holds a more loosely coupled cooperation between the alliance partners, keeping the organizations legally independent.

Certain strategic alliances may fall within the category of “Frenemies”, where companies are competing in the same significant markets with products and services trying to “get the same job done” towards same customers.

Why does it pay off to enter this kind of “Coopetition”, where two or more rival companies end up cooperating?

One short answer is that incumbent banks will attempt to prevent a higher level of competition in the marketplace, as increased competition typically means lowering profit margins. A coopetition will ensure increased competitiveness of the alliance partners, thus raising the entry barriers for new players.

A strategic alliance holds the same purpose as the M&A alternative; by taking advantage of the other companies’ (complimentary) strengths, your own weaknesses are reduced.

Strategic alliances where competitors cooperate to mutual benefits, have existed for decades.

  • Bankenes BetalingsSentral” (NETS) was jointly owned by several banks and founded more than 40 years ago.
  • Recently, Norwegian banks teamed up within an area where they used to compete; mobile payment apps. VIPPS no longer competes with mCash, instead 106 banks now cooperate also within this service area.

So, what are the Pros & Cons for M&A and a strategic alliance?

The obvious and short answer is that M&A eventually will create one company, causing decisions and resource allocation being the responsibility of one sole management team.

A strategic alliance could be the victim of more bureaucratic layers before decisions are agreed and executed.

Area M&A Strategic alliance Organic Innovation and Growth
Decision making One legal company (eventually), less organizational decision-looping Possibly more bureaucracy = longer chain of commands. Higher risk of administrative conflicts Company may suffer “growing pains”, but still within organizational context
Organizational culture The merger of Bank of America and Merrill Lynch proves the potential “cost and risk” of cultural conflicts Companies’ culture co-exist, less risk of cultural crash Organizational culture will ensure “assimilation” of new hires; culture-values remain intact
Exit options Merger integration costs could be significant, possibly significant costs for exit as well… Operational Exit costs may occur, but are less than under M&A Asset exits (for financial services typically employees) could have direct costs (offboarding) and indirect costs (bad press, lost confidence,..)
Synergy and benefits realization Potentially overestimated, and relying on cost cuts through job redundancies could cause short-term drop in productivity, etc. Synergy and benefits realization may be more based on more efficient utilization of current assets than “revenue and cost synergy realization” Economies of scale may occur, and complementary capabilities (i.e. achieving “critical mass” within core competencies)

 

Creating (sustaining) competitive advantages, through either M&A or Strategic alliances, hold their challenges to put it mildly.

M&A deals are a certain cash cow for the “men in the middle”; advisors, lawyers and consultants alike. For the actual buyer and seller the positive outcome is far from given. Research articles consistently report 50-80 pct of mergers and acquisitions not creating expected value, and in a significant number of the cases actually destroying value for shareholders.

Forming a strategic alliance is no walk in the park either, with a probably rate of failure ranging from 50 to 70 pct.

So, what can be done to improve the slim odds of success? 

…Whether a company places a bet on an acquisition, or gamble on the strategic alliance as part of the business strategy operationalization? What can be done to mitigate the risk of failure?

Studies point to some actions to take for the companies involved, in order to have the alliance or merger live long and prosper (or at least, reducing the probable rate of failure):

And then, some rules of thumbs to be applied concerning the execution of the merger/alliance (in short, treat it with the respect it deserves. i.e. put your money where your mouth is and show consistent, early, and clear backing from top management):

The above rules are no guarantee for success when setting up a merger, acquisition or a strategic alliance. Given the meager odds for delivering (expected) value through these strategic actions, we approach with caution, sobriety, pragmatism and realistic expectations of the outcome.

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