Embrace change, take risks, and disrupt yourself

Hosted by top 5 banking and fintech influencer, Jim Marous, Banking Transformed highlights the challenges facing the banking industry. Featuring some of the top minds in business, this podcast explores how financial institutions can prepare for the future of banking.

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Are Big Banks Hurting Competition, Innovation and Equality?

Competition in banking has expanded in the past twenty years, yet banking and technology giants are increasingly using proprietary technology and data-driven insights to tilt the playing field.

When smaller financial firms can’t reach the scale needed to compete effectively, there is potential for economic inequality, reduced social responsiveness, and less innovation.

My guest on the Banking Transformed podcast is James Bessen, lecturer at Boston University School of Law and author of the book, ‘The New Goliaths’. Jim shares his perspective that the largest firms have a major competitive advantage, and how democratizing technology, insights and innovation can level the playing field.

This Episode of Banking Transformed is sponsored by FIS

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The Global Payments Report makes it easy to understand what your consumerswant now – and in the future. Read about the trends transforming payments and what they mean for your business. FIS also gives you an in-depth view of how consumers pay when shopping online and at the point of sale in more than 40 markets, along with the latest insights into real-time payments trends, digital wallets, and even Crypto. Discover how the latest payments technologies could affect your business. Get your report today by visiting fisglobal.com/gpr.

FIS. Advancing the way the world pays banks and invests.

Jim Marous:
Hello, and welcome to Banking Transform, the top podcast in retail banking. I'm your host, Jim Marous, founder and CEO of the Digital Banking Report and co-publisher of The Financial Brand. Competition in banking has greatly decreased in the past 20 years with banking and technology giants using proprietary technology and data to tilt the playing field. Despite many new players in our industry, these firms don't always reach the scale that is needed to compete effectively and potentially changing the economic inequality, social responsiveness, and even the speed of innovation that is needed.

Jim Marous:
My guest in the Banking Transform podcast is James Bessen. Lecturer at Boston University School of Law and bestselling author of the new book, The New Goliaths. Jim shares his perspective on innovation and competitive balance that can be restored not by breaking up large corporations, but by compelling these firms to democratize their data and technology for others in the industry.

Jim Marous:
So welcome to the show today, James. Information technology has transformed our economy and brought innovations to the marketplace faster than ever before. The question is whether these technologies, data and insights have become the domain of only the biggest organization, stifling competition, innovation, the potential for equality and even social responsibility.

Jim Marous:
So, Jim, I reached to you after reading an article that was written by MIT Technology Review about your research and then I read your book. And it really is interesting. The book, The New Goliaths: How Corporations Use Software to Dominate Industries, Kill Innovation and Undermine Regulation. You can certainly say that's a bit of a controversial title, but can you share the foundation of your findings?

James Bessen:
Well, first thanks for having me. Yeah. So, well, this summarizes maybe five years of research, so by myself and by many other people. It's become very clear that in the last 10, or 20 years, there's a whole new generation of proprietary software platforms being built by large firms. And I'm not just talking big tech here, we're talking big banks, we're talking big auto companies, we're talking Walmart, we're talking... But also Amazon and Google. Digital technology has been... Well, the PC is what? 50 years, 40 years old now?

Jim Marous:
The iPhone 15 years this week.

James Bessen:
Yeah, pretty amazing. In the early days it was a very heady positive thing that the low cost computing was opening up all sorts of possibilities to all sorts of people, big and small. In fact, some of the small firms really benefited the most from some of the early innovations, but these large systems are a new and different beast. And it's huge. You look at firms spending on own developed software. It's well over 200 billion a year now. Big, big investment.

James Bessen:
And many of the effects of this are positive, but there are some downsize as well. So that's sort of what the book explores. I started by noticing that or exploring the question of whether the... A number of economists had noticed that industries were becoming more dominant in their... Firms becoming more dominant in their industry, the top firms. The market share of the top four firms has increased overall over the last 30 to 50 years.

James Bessen:
But wasn't sure what that meant, but I wondered whether it had anything to do with these large software systems. And the initial research said, yeah, there's something going on here. The firms that invest... The industries where they're making these investments are exactly the ones where... The industry concentration as we call it has risen. So I started to tease apart what's going on? What is this? So one thing we connected was, "Well, the firms have also become more persistent," that in the '90s and '80s firms were disrupted.

James Bessen:
There would be some new upstart comes along and Walmart came along and disrupted Sears. And that's really reversed over the last 20 years. The probability of disruption has gone way down. So again, another puzzle. But when I started to connect the dots, what I was seeing was sort of a commonality that what these large system do systems do is enable big firms to manage complexity, to handle greater variety, to handle more product features, to target more finally target products to customers, and to advertise and reach those customers.

James Bessen:
So Walmart stores stock over a hundred thousand items. If you want to have a big advantage in retail, one stop shopping is one way to do that. And by stock all those items and tracking them well, they're able to streamline their logistics so that they can get the goods to the stores, A quickly and B, at a lower cost, so they can charge lower prices and they can respond more rapidly as they detect demand changes. And they've developed this whole system, so that decisions tend to be made not by so much by centralized merchandise buyers, but also by store managers and in many cases, suppliers.

James Bessen:
So it becomes this very flexible. It's not just the technology, but the technology is the core of this whole new system of taking advantage of greater variety and flexibility to deliver what customers want. And you see similar ways of managing complexity in banking, in manufactured goods like automobiles, which are now largely software driven as well as the standard target marketing of Google and Facebook. So maybe I should pause here and let you get a word in.

Jim Marous:
No, it's interesting because you mentioned the banking industry. As in many industries, we have seen new firms enter the marketplace at an unprecedented pace. These firms are addressing the needs, the unmet needs in the marketplace usually leveraging digital technologies that are not yet being leveraged by legacy firms. But are you saying that the majority of these firms, these startups, these innovators, and such that they'll ultimately fail either because they won't reach scale or that they'll actually be acquired by these same big firms that you're speaking of?

James Bessen:
This is one of the downsides of these new systems. The systems have allowed big firms to dominate their industries. They're bringing great... I mean, they're doing this because they're bringing great benefits to consumers, but at the same time, one of the critical things is they make it much harder for an innovative startup firm to grow. So here's a key aspect of what... Let me just back up a second. A key aspect of what drives productivity growth in the economy. It's not just that some firms improve their own productivity, it's actually more so that the more productive firms grow faster. And eventually they may replace the large incumbent firms.

James Bessen:
One of the most disturbing findings is that over the last 20 years, this growth rate of highly productive firms has slowed. And that in fact accounts for much of the slow down in productivity growth that we've seen in the aggregate economy.

James Bessen:
Now, I don't know about banking specifically, but what we see in the numbers generally for technology based firms and for all firms is that the rate of entry hasn't slowed. We still get new firms coming in with new ideas and often they're more productive. But what we do see is productive firms are growing much slower. Maybe half the rate as firms that were equally productive 20 years ago.

Jim Marous:
Well, it's interesting because in the banking industry we see the biggest banks getting bigger. We also see them actually growing at a pace that is certainly slower than what they used to be able to do, but still they have the scale that allows them to perform at a rate that's unachievable by many of the smaller fintechs. Now, we have the big tech firms that are also planning in banking, but really what you're talking about, and I think you referenced in your book as the superstar economy, and the movement from opened to closed capitalism, what you're saying is that the big firms are actually slowing the rate of innovation, slowing the rate of growth, and slowing the rate of actually transforming an industry because they're so big, correct?

James Bessen:
Yeah. So they may be growing fast and they may be innovating. And in fact the evidence shows that the larger firms are becoming more innovative at a faster rate than medium or smaller firms. In fact, there's a growing gap between the biggest firm in terms of... You just look at revenues per employee. There's a growing gap between what the top firms, largest firms make in revenue per employee and everybody else. And that's troubling. What that says in a way is that those firms are able to access technology that the rest of the market can access.

James Bessen:
And if you look at what's involved in these large systems, that's very much the case so that the big firms have access to data, to software systems, to organizations that can take advantage of this new sort of technology that the little guys can't for the most part. I mean, I was just going to sum up and say even though you've got some great companies come along with important innovations and sometimes, yeah, they get bought out. But what we're seeing is they're growing more slowly. It takes longer for a startup to raise funds. Once it raises funds, it takes longer for it to be acquired or to go public. It's all stretched out and that slow growth hurts the economy.

Jim Marous:
Well, even name recognition. You have a lot of small companies that have done well, but if you go in the marketplace and ask people, "Do you know what Acorns is?" Many people don't know that Acorns is an investment and savings platform in the banking industry. Many people may not know what Chime is. But they know what Chase is, they know what Wells Fargo is, they know what Bank of America is. So that's even there. One of the biggest challenges that companies are facing today is reaching the efficiency possible with just like digital technology.

Jim Marous:
It's possible to do it. But the problem is those mid-size firms that you're talking about. It costs a lot of money. So while firms can become more efficient, they still have legacy systems and delivery networks they have to deal with. Is there another case where the biggest firms have an advantage being able to spread these costs over a bigger platform and the ability to automate the back office faster as well?

James Bessen:
Yeah, well, it's scale and it's scope. I mean, my argument is really about scope. They're able to offer more products and address more different consumers. I mean, that's exactly part of the story.

Jim Marous:
It's interesting too, because while Chase is still building physical facilities, they still are able to spread those costs across a much greater platform. And one other thing you bring up in your book and it's interesting is we've talked about it in the past in banking, but it's something we forget about often. And when we're talking about the cost of delivery that the cost of compliance is pretty much a fixed cost for almost any organization.

Jim Marous:
It's the same amount of money to manage the compliance issues of Amazon. It's a small retailer. I would assume that because the fact that it's a fixed cost, this obviously falls the heaviest again on the smaller players, the midsize organizations and that makes it so that just the efficiency ratio, just the effectiveness of being able to hit the types of back office automation and scale that's needed. It again puts those smaller innovative firms and those midsize organizations at a tremendous disadvantage.

Jim Marous:
Now, I'm going to ask you a question here about those midsize. Do you see a way where midsize organizations can combine and possibly play the same level playing fields, the big guys, or is the field just going away from them? Or the big are just getting so big that you can't acquire enough mid-size organizations to bring the scale that the big guys have?

James Bessen:
Yeah, I think that's one possibility. In the book, I talk about another one, which is the notion that the biggest firms may open up. So we've seen examples of this. In the past and also currently. I call it unbundling or it's been called unbundling in the case of IBM. So there was this famous case where IBM used to sell the computers and the software together. And it became very difficult both for other computer vendors because IBM was bigger. It had more software written for it. And it became very difficult for... There was really no independent software industry because you could write it for IBM, but it wouldn't run on the CDC computer or whatever, Honeywell computer.

James Bessen:
Well, under threat of the Justice Department for over an antitrust concern, in 1969, IBM unbundled. It allowed you to buy the hardware without the software, and they sold the software separately. And that essentially created the modern independent software industry. And that was a huge, huge boost. And while you think that might have hurt IBM, it actually turned out to be hugely profitable for IBM. They now had more competitors in software, but every competitor and software improved the value of the hardware they were selling. And the size of the entire market just exploded.

James Bessen:
A modern day example of that, several examples of that come from Amazon. So Amazon developed this tremendous in-house IT capability. They had to, to handle their website. Handle transactions rapidly, large numbers of transactions. They realized around 2004 that this gave them a real competitive advantage. Well, most companies, I think would probably say, "Competitive advantage, let's hold on to it as tight as we can."

James Bessen:
They took another idea. They said, "Let's open it up. Let's standardize it, so there's a standard API. Let anybody come and use our IT facilities for fee, of course, but they created the cloud industry." And that too has been hugely profitable for them, but also hugely productive because the tiniest company in the world can gain access to very sophisticated data storage, data handling, IT processing, AI. You name it. There's just a tremendous ability so that Amazon has the scale, but they make it available for fee to everybody else, so the middle and big size players can get involved in the app.

James Bessen:
Now, they do a similar thing with their logistics and their marketplace. I won't say that there aren't some concerns and issues, antitrust possibilities. Amazon has to walk a narrow line between being a competitor and a supplier. But I think that's been a hugely beneficial thing and what I would like to see, and I think what may solve some of these problems is to spread that more broadly.

James Bessen:
Now, in one of the big things in the US, in banking, I understand. Now, you guys understand more about this than I do, I think, is access to customer data that the FinTech companies have just been struggling. They're getting more of it, but there's no standard API. Not every FinTech can get what it needs. And it's burdensome. There's no reason the bank should be... Well, they obviously feel they have a proprietary advantage from all that data. And they do. They do tremendous things with it.

James Bessen:
They can make different credit offerings to different consumers for home equity or for credit card and target them. And God knows what they do with it. But if customers can get their own data and make it easily portable to another platform, they could do many more things that they can't get from the large banks. And I think that may be the frontier of where things need to open up in banking.

Jim Marous:
So let's take a short break here, and I'm going to get back to that whole issue of the democratization of data, expanding what Amazon had done with the democratization of technology and innovation because I think there's a lot there. So let's take a short break here and recognize the sponsors of this podcast.

Jim Marous:
Welcome back to Banking Transform. So I'm joined today by James Bessen, lecturer at Boston University School of Law, and also the book, The New Goliaths. He would be discussing the potential impact on competition, innovation, and social norms as the biggest organization in every industry are using technology and data to create an imbalance in the marketplace. So before the break, Jim, we were discussing how there's an ability to buy modern technologies and automate businesses. And there may even be a potential to democratize that process.

Jim Marous:
But really at the core of everything, it's the data and insight that these firms hold. I mean, a Chase for instance has so much data on their customer base that a smaller midsize firm would never have, certainly not a FinTech. Does this magnify the advantage of the big firms? And is there a potential as you mentioned before in the break to maybe democratize the data and insights, maybe by a firm such as Google that has so much insights or even Apple, or an Amazon to make it so everybody is on a little bit more of a playing field, certainly at a cost, they make money on it. But to make it so that there's a little bit of a level playing field with regard to what you know about me, the consumer.

James Bessen:
Yeah, absolutely. I mean, I think that's what I was talking about in the Amazon example. I would stress, people do talk a lot about data. It's not just the data and it's not even just the technology. So in the late 1980s, Sears was the lead retailer. It was also a technology pioneer. Sears pioneered eCommerce. They had the prodigy network. Sears was IBM's largest customer. And Sears certainly had a ton of data. What Walmart was able to do though was use the data and marry it to a different sort of organization.

James Bessen:
So it wasn't just the software, it wasn't just the data. It was the whole thing married with a different way of organizing and conducting business activity. But you're right. The potential is there for firms to... Essentially they have these internal platforms and it's about opening up the platforms. That's what Amazon did when it took its internal IT platforms and made them into the AWS, Amazon Web Services.

Jim Marous:
Yeah. It's interesting because when you look at data, we also often look at just the... Oh, do I hold in my file? Not hold in my file. But when you look at payments, payments now is more dominated by the PayPals, the Amazons where people are buying and that data is kept internal. So what happens is financial institutions when they used to have it on their credit card would get the individual transactions and know where people were buying things, what they were buying their preferences.

Jim Marous:
Well, now, it just shows up as Amazon. They don't see the individual detail. So it really becomes even a bigger challenge. One thing you really bring up in the book quite a bit is that this imbalance, this ownership of technology and insight and data, and overall automation, impacts the consumer, both economically and from a social responsibility perspective. We sometimes lose that. Can you explain a little bit about how this really does impact the consumer?

James Bessen:
Yeah. Well, that certainly affects the consumer. So I mean, one of the things is this technology allows consumers to get much greater choice. Choice is to some extent, a double-edge sword. It means it becomes burdensome in some ways to... When you have a hundred thousand items in the store, or you go online and there's this... What was it? I saw in the Wall Street Journal 180 different garlic presses on Amazon. And some of those were fake. Apparently the Chinese have figured out some way of gaming Amazon a little bit, but still there's a lot of choice. There's a lot of lack of information about the quality of products.

James Bessen:
So it provides some real benefits. I can buy things today that I didn't even know existed before in the old retail environment. So there are some great benefits. There are some social impacts though that may be less obvious. So one is on wages.

James Bessen:
It turns out there's this talent war people talk about and it turns out that the large firms with these large systems not only hire more talent people, they pay them more. They'll pay more for a job that has the same characteristics and I'm talking substantially more. 15, 20, 30% more.

Jim Marous:
Wow.

James Bessen:
A, it may make it more difficult for small companies to hire who they need. B, it leads to growing inequality that you have these people who work at the elite firms and you've got everybody else and we're seeing growing gaps. And those, by the way, are also geographical gaps because of where the big companies hire tends to be large cities, coastal, that's one thing. Another implication is these systems get... It becomes much more difficult for government to do its job in terms of regulating systems.

James Bessen:
When products are based on software and services are based on software. So the one of the prime examples is the Volkswagen diesel emissions scandal where a few lines of code and of the hundreds of thousands of lines of software code in a modern automobile, somebody... They got a few engineers to tweak the code so they could fake out an emissions test and the car would operate at low levels of emissions when it was being tested and the computers would tell by the angle of the wheels, the speed, how long it has been driving. And when they detect that they were no longer in an emissions test, they would boost up the nitrogen oxide emissions twentyfold. So the car had a lot more performance all of a sudden, but was polluting 20 times as much. This went on for years and the government regulates both in here and across the world had no clue what was going on.

Jim Marous:
Given the somewhat dismal painted of a picture you've done around the competition, the innovation, the social norms created by the centralization of technology data, and innovation, and power, you still don't believe, at least in your book and in what I've written or read that you believe these firms should be broken up by the government. You've referenced already, possibly better solutions than that. What are the threats maybe of the government doing what they tend to do, which is like pulling the China shop, just doing what comes easy which is saying, "Oh, we got to step, we got to break up Amazon. We got to break up Google. We got to break up Chase or Bank of America."

James Bessen:
Well, there's certainly people in Congress and in the administration too who might take that view. That may happen. It's not going to solve the problem. I think that's the first answer. Bringing up a company doesn't solve the problem. Somebody is going to still be there and able to build a large system that can dominate. But the other thing is these systems are real benefits to society. It's a real benefit to society for Amazon to have its enormous web services division.

Jim Marous:
Yeah.

James Bessen:
Right? It's a question of how whether that benefit is being tied to proprietary control or whether it's open in a way. And so my solution is this thing I've been talking about that it there are a number of ways that the government can nudge companies to open up. In many cases, it's going to be in the company's own interest.

James Bessen:
There's no doubt that when Amazon opened up web services, it turned out to be hugely profitable to them. Maybe even more beneficial to its customers, but still there was good private reason to do that. There are various government powers that can encourage that. One is intellectual property controls, things like employee non-compete agreements, which are being now used more and more aggressively to keep talented, knowledgeable people, talent at one company from going to another. We need to spread the technology and spread the knowledge more aggressively.

James Bessen:
And that's really what's at the root of most of the social problems. So it doesn't take a sledge hammer to shatter things, to solve that problem, it takes some well-crafted... And it some cases maybe perhaps punitive measures to encourage or in some cases to force firms to share their data, to open their technology in a way.

Jim Marous:
That's interesting because as you were speaking about this, I didn't realize where I didn't put together possibly, even though I've read your book the fact that why you can split up companies, physical assets, you can't all of a sudden say, "Okay, we got to split up your technology. We got to split up what your systems say." That's impossible to do. So I think you're right that splitting up may not get the solutions that they want. It may make the company smaller, but that doesn't make them any less smart. It doesn't make their data any less valuable or it's not a way to do that.

Jim Marous:
And it really gets down to, and we've seen some providers actually democratize what they offer to the marketplace and make a good future. I think we're looking at maybe new revenue opportunities as well as new ways to compete. Do you see the future actually moving to this direction? I mean, as you look, look at... Nobody wants to take the risk of the crystal ball anymore because we know where that gets you.

James Bessen:
Yeah. Well, I'd like to think it moves in that direction. I think it's encouraging that we see companies like Amazon doing it themselves. And there are others. There's certainly others. There's people at Harvard Business School and as a Western Business School at BU, Boston university that are sort of advocating this is a good business strategy for firms. I think in the policy arena, a lot of the policy has been moving in the wrong direction.

James Bessen:
They're giving firms greater controls over employee's knowledge. That's disappointing. But will it happen? I'm not going to hazard a guess. I'd like to see it happen. It's certainly conceivable it could happen.

Jim Marous:
The government tends to not always make the best... They make quick and not... We've seen this too much recently. And I think you're right to try to predict what... Because this can become a governmental thing in one way or the other. It's not going to be driven by the consumer as much as by the government. I think all bets are off when that takes place. So, Jim, how do listeners buy your book?

James Bessen:
It's available at Amazon or at [inaudible 00:31:10] or other common outlets. Yeah.

Jim Marous:
Yep. And this is what it looks like. It's a great book. I suggest my readers, my listeners, I should say, get this book. It was interesting because it has taken a different perspective than we hear in our industry quite a bit. Jim really digs into a number of industries. It's not focused on banking. You really have to open your mind to how this impacts the banking industry. But Jim, thank you so much for being on the podcast today. I really appreciate your time.

James Bessen:
Thanks for having me.

Jim Marous:
Thanks for listening to Banking Transform, the winner of three international awards for podcast excellence. If you enjoy today's show, please take some time to give our show a five star rating. Also, be sure to catch my research on the Digital Banking Report and the articles I'm writing on The Financial Brand. This has been a production of Evergreen Podcast. A special thank you to our producer, Leah Haslage, audio engineer, Sean Rule Hoffman, and video producer, Will Pritts. I'm your host, Jim Marous. Until next time, remember, concentration of power in any industry, if not the preferred outcomes for the consumers or business itself, democratization is the answer.

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