Using the tried and tested TED 20min format, it was a great opportunity for me to collect my thoughts into (what I hope was) a coherent overview of how I think technological and economic forces will shape the optimally adapted ‘industrial stack’ for the sixth paradigm. It’s a great summary of the prism through which we look at potential investment opportunities and I hope will help us articulate this more powerfully to entrepreneurs and prospective investors.
I’d love to hear any feedback (good, bad and ugly) from any of the eComm delegates who saw my presentation and hope to continue the conversation with you and others here. You can also follow me on twitter @nauiokaspark.
Thanks to Paul and Lee for inviting me and especially to those of you who took the time to respond to my call for input – it was tremendously valuable in helping me to shape and refine my thinking and in building the presentation; just a few years ago, assembling this kind of distributed brainpower would have been impossible, and I hope I never lose my ‘childlike sense of wonder’ at the boundless possibilities that technology enables.)
The debate du jour around the world’s capitals and financial centers is of course “How do we save the banking system?” Good banks. Bad banks. Private banks. State banks. Capital injections. Credit insurance. Etcetera. But in this Dr. Seuss world of solutions, and despite thousands upon thousands of articles, blog posts and editorials, I have been very surprised to see that one crucial element seems to be missing from all the solutions being discussed: innovation and entrepreneurialism.
Governments should invest (at least) a small amount of the billions and billions they are ploughing into the financial system into new banks. That’s right – start-ups. But not carbon copies of the banks we have today. 21st century banks. Banks that aren’t built on foundations of obsolete business models and technologies. Banks that are “digital natives”. Banks that by design answer the question: “If you had a blank sheet of paper, how would you build a platform and and organization to provide banking services in today’s (and tomorrow’s) world?” Banks that not only understand the importance of Moore’s (and Kryder’s) and Metcalfe’s and Linus’ and Amara’s laws but also their ramifications for a business that is intrinsically and structurally about managing digital information flows in a connected society and economy. Banks without (literally and psychologically) the corrosive burden of legacy costs and structures. Banks who apply Coase’s theories in the context of transacting in a networked world. Banks who embrace the lessons of Dunbar and Kahneman and Thaler (and Sunstein) when designing their management and compensation policies. Banks that strive to live up to Einstein’s suggestion that “things should be made as simple as possible, but not any simpler” and have an instinctive bias against complexity and a copy of Maeda‘s The Laws of Simplicity in the Board room. Banks that recognize that when you boil it all down, the product they are ultimately selling is trust.
(adapted from Wikipedia) A bank is a financial institution whose primary activity is to act as a payment agent for customers and to borrow and lend money. It is an institution for receiving, keeping, and lending [and investing] money.
Obviously in order to build such a bank you need a team of leaders who not only understand banking and finance but understand intuitively the social and technological landscape of the 21st century. Bankers who refuse to trivialize novel tools and modes of communication and interaction simply because they are unfamiliar. Bankers who are as comfortable on Facebook or Twitter as they are on a trading floor or in a branch. Bankers who collect and collate their daily information via RSS readers and wikis and blogs and not just from the FT or CNBC or Bloomberg. Bankers who have accepted that the value they can create no longer comes from arbitraging information scarcity and building black boxes that hide complexity but from embracing abundance and building tools to help people navigate this complexity as partners. Bankers who would be equally comfortable discussing the future of finance with the founders of Google as they would be with the governor of a Central Bank. Bankers who are passionate yet sober. Bankers who are focused on the future and on providing a service that doesn’t rely on coercion or inertia or lack of alternatives to keep their customers satisfied. Bankers who realize what a tremendous opportunity exists to start afresh and be part of creating a new paradigm in financial services.
These individuals exist. Many are readers of this blog. I am one of them. So is Amy. We are connected to many more via our networks. I suspect that many of them would jump at the chance to participate in a venture (or ventures) like this. And not just because the financial opportunity cost of doing so has plummeted (although that clearly helps, everyone has bills to pay…) but because it’s exciting. Because it would be challenging. Because it’s the right thing to do.
So why not just do it? Why the government? Why a billion dollars? Because building a bank by bootstrapping from nothing is exceedingly difficult, perhaps impossible. There are many reasons, importantly:
The fundamental nature of the business – selling trust-based products and services in a highly regulated environment – means that the minimum level of operating costs and capital required to be credible is substantial.
Perceptions are important, especially in these turbulent economic times; no matter how abusive the relationship (with their existing bankers), people and companies are going to be initially very cautious about giving their custom to a new bank, especially one that is obviously not too big to fail (indeed the implicit endorsement of the government in this context is probably even more important than the capital itself.)
Much can be achieved within the existing legal and regulatory framework, but many of the most interesting opportunities rely on this “institutional framework” evolving to “catch up” to the technological and economic reality; having the government as a partner would facilitate the dialog and help to counter the inevitable resistance from incumbents who have a vested interest in maintaining the (old) environment to which they have adapted.
Because as a taxpayer if I am forced to invest in the old (to mitigate catastrophic systemic risk), I want to also invest at least a part of my money in the future (to help build and profit from the reinvention of banking): remove the cancer yes, but start working on the cure.
As for the billion dollars, this was just a nice round back-of-the-envelope (somewhat informed) guess (plus it fit with the song!); this would be sufficient equity to build an operation with credibility and critical mass, and would support a sufficiently large but conservatively leveraged asset base to produce enough operating income to sustain growth and profitability (and pay back the government in full over a 5-15 year horizon without jeopardizing the business.) The right (minimum) amount needed could well be less, is unlikely to be more and would not need to come 100% from government coffers – indeed private co-investment would be desirable – and further the bulk of the capital would likely be called over a period of 1-3 years as the balance sheet is built up.
I’m deadly serious but to be frank, I’m not sure where to go with this. Although I have a pretty interesting and diverse network that includes a number of even better connected people, I don’t think I’d have much success cold calling Mr. Brown or Mr. Darling and getting a chance to pitch this over a latte at the local Costa… Even less Mr. Obama or Mr. Geithner… But perhaps if nothing else, I can catalyze the conversation and bring this option – earmarking at least a small portion of the various btrillions of rescue funds to seeding a new generation of 21st century banks – to the attention of the politicians and the public.
I know there is a risk that this proposal sounds like just one more in a never ending line of petitioners going to the government for a handout. I hope that (at least, especially regular) readers will not doubt my integrity when I assure you that this is not my intent, and I genuinely believe that this is an idea worthy of serious consideration. And most importantly that – in this context – the government’s money is actually more valuable than anyone else’s. To get started. Essentially I’m suggesting the government(s) have a unique competitive advantage that makes them the ideal incubators for a new generation of banks (and that they would realize excess financial returns by exercising this advantage.)
(on the reasons why the Citigroup Board was finding it hard to find a replacement for Chuck Prince) But the number 1 reason is thatâ€¦(drum roll please)â€¦ it is an impossible job. Citigroup (and they are not alone here, itâ€™s just more obvious sans CEO) is too big. And more importantly too complex for any one individual to manage efficiently in its current form. Like many mega-financial services firms, it is a jumble of heterogeneous businesses, risks and activities some of which gain greatly from economies of scale, but others that equally have significant dis-economies of scale. And the combination of all these businesses injects massive complexity. Letâ€™s just say that I would guess Mr. Coase would find Citigroup â€œunoptimalâ€. They have too many variables and not enough equations. For anyone to claim that they could â€œdo itâ€ would just be hubris.
My concerns really grew out of my thinking on size vs. complexity in the context of the networked economy of the 21st century. This thinking probably really started to take shape as a result of the consequences of my AmazonBay story of 2005 which unintentionally (as a by-product of the main storyline) predicted a never-ending sequence of mergers and was rightly criticized as a result. Through the Looking Glass (2005)
In addressing this criticism I was led to think of how if Coase’s theory on the Nature of the Firm was correct, how the optimal business ecosystem of the 21st century would differ from that of the 20th century as the external transaction costs dropped to and then below the cost of internal transactions within (sufficiently large and complex) corporations. And the rest, as they say, is history as I decided to try to put my money where my mouth/blog is!
Now usually I am rational enough to understand that someone else’s gain is not my loss, but it does strike me as strange that it’s pretty clear that I would have a bloody good chance of being a more effective board member in many ways than the legendary Bob Rubin…and a lot cheaper. Then again, even if by some strange turn of events I had been offered and accepted such an appointment it’s not sure I would have been listened to (ie I’d have been the strange energetic, entertaining eccentric at the table ticking the mental diversity box…been there done that, no thank you…) or worse I would have been seduced and corrupted to go along blindly with the thinking of all these very smart, powerful and rich people and look just as dumb if not more. 😉
So I’ll stick to blogging and venture investing (for now) and continue to follow this matinee from the cheap seats. Pass the popcorn.
I don’t know these gentlemen, and obviously I am not privy to the internal workings of the financial behemoths that they were charged with piloting, but I wonder if the problem isn’t so much who is at the helm but the ship they were trying to steer. As Mr. Prince said, taking personal responsibility was the “honorable thing to do” as a leader (I’m reminded of the immortal words of Hopper – “The first rule of leadership: everything is your fault”) and I would tend to agree. And there is no reason to cry for these men – they were amply rewarded for their efforts and will – I’m sure – land on their feet so to speak, so don’t misunderstand what is to follow as sentimental apologia for their failings (real or perceived.) However I wonder if these giant firms are manageable at all – at least under the current constructs of managerial science – and ask honestly if any one individual however smart, charismatic or experienced (Mr. Rubin would seem to have all these qualities in excess) can realistically succeed in steering the turn-of-the-21st-century financial megafirm through the oceans of Extremistan (Mr. Taleb‘s metaphorical “province where the total can be conceivably impacted by a single observation.”)
For some years now, I have been interested in trying to understand how the corporate ecosystem would change under the effects of the onslaught of accelerating social and economic change driven by the revolution in information and communication technologies. Applying Coase’s Theory of the Firm to a world where communication and transaction costs move unrelentingly towards zero (at least in many contexts) must in my mind lead to a fundamental – quantum – shift in the optimal organizational dynamics of companies and the economy more broadly speaking. The vision I seem to be ineluctably drawn towards is one that looks like the classic map of a network, containing millions (or billions) of nodes and interconnections, with a fractal geometry. So yes I do think that ‘super-nodes’ (read mega-corporations) will continue to exist and even grow, but I think that complexity will migrate away from any particular node to the network. So in my mind, bigger is only sustainable if ‘simpler’. Today’s financial behemoths are anything but ‘simpler’.
If we look back from a vantage point twenty years hence, I suspect that the period between 2002 and 2012 (or so, I’m not hung up on exact dates…) will be seen as a transitionary period – when the one wave (of linear giganticism) crested, and another of specialization and the migration of organizational complexity to the network (the “edge”) emerges. Will the takeover of ABN Amro be the last of the mega-mergers (although and perhaps fittingly the 3-way break-up involved added an element of deconstruction to the transaction…)? If I had to guess, probably not but it will more likely be ‘one of’ the last of its kind. Of course, I am far from alone in wondering if these giants have passed the point of diminishing returns on scale (from the BBC article on Mr. Prince’s resignation:)
“The actual structure of Citigroup is broken – it’s too big, it’s too bloated and we think it should be broken up into three of four pieces,” added Bill Smith from Smith Asset Management in New York.
Ronald Coase, the economist, famously observed that private companies are different, because they are not the only place to do business. An alternative to costly and complex banks is an atomised market, where individuals and institutions do business without a large financial intermediary. Banks may merge to survive this inevitable transition; but in the long run many of their functions will disappearâ€¦the core functions of any Wall Street Bank cannot remain inside the same complex and costly shell forever.
Given this is probably a topic worthy of a doctoral dissertation (and if done well perhaps a Nobel prize in 25 years), there is no way I can even start to do it justice in a short blog post, but I hope I have been able to give at least a taste of how I think this might play out and why it is likely to be a core consideration in any investment thesis for financial services over the coming two or three decades.
“Ronald Coase, the economist, famously observed that private companies are different, because they are not the only place to do business. An alternative to costly and complex banks is an atomised market, where individuals and institutions do business without a large financial intermediary. Banks may merge to survive this inevitable transition; but in the long run many of their functions will disappear…the core functions of any Wall Street Bank cannot remain inside the same complex and costly shell forever.” – Frank Partnoy, FT, April 5th, 2005
Last spring I wrote a fictional article titled “Through the Looking Glass”, with the goal of provoking reflection on the future of the investment banking and securities intermediation businesses. (The article was published in Euroweek.) But to be candid I was surprised and a bit disappointed at the lack of reaction or debate that the article engendered. Perhaps it was because it was published in specialist journal? or perhaps because it was perceived by those in the industry (99+% of the readers of Euroweek I would imagine) as too far-fetched as to merit any serious discussion? While it is obvious that the various combinations and the exact timeline are extremely unlikely to play out in the way I imagine in the article, the general premise that I sought to present through this conceit is entirely plausible and worthy of further discussion and debate in my opinion. So in the hope of reaching a wider audience through a more engaging and friendly medium, the article has been adapted into a short film.
Enjoy and if you think I am crazy, I’ll hope it is the right kind of crazy!