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The economics of the network

I often talk about the business model of a bank (or any business) being made up of three major parts:

  • A back office that manufactures the product and administers the service;
  • A middle office where the infrastructure is built to connect the back and front office; and
  • A front office where the relationship exists between the customer and the company.

In the industrial world, this structure was tightly integrated and completely controlled by the companies that operated. A car manufacturer would make the product, distribute the product and service the product.

They were a manufacturer (back office), a processor (middle office), and a retailer (front office).

In fact, it went further than this. They would make all the components of the car, they would manage all of the distribution of the car and they would demand to be the only firm you dealt with for servicing the car. They managed the whole supply chain and value chain.

That model has been broken apart.

No automobile company makes the components anymore and, in many cases, they don’t even sell or service the car. Specialists do all the work. Nine out of ten components of a car are common to all, and changing your wheels or exhaust can be done by any firm specialising in wheels and exhausts.

Finally, the same is happening in banking and finance. Thousands of specialist firms are automating the manufacturing, processing and retailing of finance through APIs. Fantastic.

But there’s anther nuance here.

In the 1990s, a book came out that many of us took to heart. It was called The Discipline of Market Leaders by Michael Treacy and Fred Wiersema. A very good book. One of the tenets of this book is that companies are comprised of these three disciplines: manufacturing, processing and retailing; and are only good at one of them. They make great products, process all the time and every time on-time, or have great relationships with their customers. But they cannot be good at all three.

This was true … then.

The issue is that if you want to be a great manufacturer, that’s where your investment goes. It goes there, at the expense of infrastructure and people. Hence, the processing and retailing suffers as the manufacturing succeeds.

Alternatively, you focus upon being an amazing retailer. All your money goes into the front office, the people, the relationship. As a result, everything else suffers and your back and middle office whither on the vine.

You get the drift.

Now, what’s interesting, is that the internet breaks this idea apart and trashes it to pieces. With cloud and APIs, you can build infrastructure that costs nothing and scales to any size that fits. With apps and connectivity, you can create relationships that are viral and reach billions without spending a dime on front office. In other words, the front office retailing and middle office processing are free and unlimitedly scalable.

The same is true in the back office. The product. Why do you think that Uber is one of the greatest taxi firms that owns no vehicles and Airbnb the best hospitality chain that owns no rooms? Their product is delivered by those on the network.

In other words, in this platform revolution, we have no manufacturing, processing or retailing anymore. There is no back-, middle- or front- office. There’s just the platform, the network and the code. There is no supply chain or value chain integration. There is no control. There’s just a focus, a specialisation and a bit of plug-and-play. Amazing new economics. Have you got it?



About Chris M Skinner

Chris M Skinner
Chris Skinner is best known as an independent commentator on the financial markets through his blog, TheFinanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal’s Financial News. To learn more click here...

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