The Crisis of Innovation in Financial Services
Why innovation investment has not delivered expected returns - and what to do about it.
I often compare notes with other veterans of banking, financial services and fintech - and recently have been hearing widespread dissatisfaction with the outcomes of past innovation investments. More and more large Financial Services (FS) organizations have slowed their exploration of fintech, and are scaling back their corporate venturing activities, especially in-house.
This pattern - pulling back from past approaches and investments in innovation - is evident in other industry sectors, from retail to manufacturing. Few corporate leaders are happy with their firm’s innovation programs, as reflected in the latest BCG 2024 Global Innovation Survey. One item that stood out for me was the concept of ‘innovation readiness’ and how many firms' performance on this measure has declined sharply: “just 3% of companies [are] in the ready zone today, compared with 20% as recently as 2022”.
In this environment, the pendulum of investment appears to be swinging towards more seemingly certain, shorter-term goals. But this is a mistake - over a decade of research by various firms has consistently shown that organizations who invest in innovation consistently - across economic cycles - have better financial returns than their competitors over multiple years going forward. [add reference links to McK and older reports]. Moreover, even now in 2024, corporate leaders across all sectors continue to say that innovation is one of their top 3 corporate priorities.
So we have this conundrum: all large corporations believe that innovation is very important to their future - but many are unhappy with the results of their innovation efforts to date. This has long been the case, but it’s even more urgent to address this problem today in 2024, as the world has entered a period of greater uncertainty and risk in many areas - geopolitical, financial, and climate-related.
What is needed in times of uncertainty are: (1) a clear business strategy; linked to (2) a defined innovation strategy; and (3) knowing what capabilities are needed to deliver on these strategies, Strategy &Iinnovation leaders need to make these links clear - to all stakeholders if their organizations are to be successful in the longer-term.
In this article, I will focus on Financial Services (FS), sharing a way to understand innovation capabilities, and how these reinforce an organization’s strategy - at both the business and innovation levels.
Innovation Capability in Financial Services
We recently analyzed innovation in Financial Services (banks, insurers, asset managers), utilizing global innovation datasets available via our firm’s strategic alliance with Innovation 360 Group. The analysis was a deep dive into the innovation capabilities of FS firms in the North American market with more than 500 employees. We chose this to include the many smaller to mid-size FS players, esp. banks. We compared the top 25% of such organizations in terms of innovation capabilities with the rest - and found significant gaps across all 16 dimensions of capability.
The results are shown graphically in the diagram below:
There is a lot of data in this chart, but the key thing to note is that the dimensions align to core elements of both business and innovation strategy - including which customers to serve, with what offerings, via which delivery models and processes, and by working with which partners.
While the gap between the top 25% of firms and the rest can be seen across all dimensions, there are three capability areas with the largest differences:
Organization: This has many elements, but it is mainly about collaboration and prioritization - between business areas, and with external partners.
Services: This is the area of customer service, and the organization’s ability to develop new service models, including systematically testing these before launch.
Learning Capabilities: This is about experimentation and sharing of insights in a repeatable way - teaching a wide range of people across the organization about why this is important and how to do it well.
The top quartile FS organizations are, on average 20% better than other FS players in each of the above capability areas. The impact of this is cumulative over time - leading to orders of magnitude improvement in the outcomes of innovation investment and impact.
By focusing on the top 3 drivers of innovation capability for their sector, size, and market, FS organizations can more rapidly address the dissatisfaction with innovation investment to date - and position themselves of for success going forward.
What’s more, strengthening these innovation capabilities will improve all innovation outcomes over time - including those related to the hot topic of 2024, Generate AI in FS. While GenAI is a technological step-change, it also falls into the continuum of innovation adoption. The core capabilities of effective innovation management outlined below apply equally to GenAI exploration and investment.
Organization:
Many FS players created wholly separate innovation units that run separately from the central business units. Such units are often viewed as disconnected from the needs of the organization, and, over time, trigger ‘corporate antibodies’, leading to their rejection.
The way to avoid this is by having a clearly understood framework for collaborating and sharing of priorities. This needs to include what the line of business areas can expect the innovation unit to help them with; and what is outside of their scope. For example, iInnovation units should never be ‘shadow IT’ functions; rather theay are internal experts that business lines can work with to find novel solutions to difficult business problems.
Getting this right involves understanding the corporate strategy of the FS organization as a whole, as well as the strategies at a business unit level. With this in place, the innovation team has a way to structure conversations with BU leaders, and to jointly agree on priorities to focus on.
Services:
Developing new services and service models is a key priority for all FS players. From the ATM to online and mobile banking, the ability to serve customers in new, more convenient and/or cost-effective ways has been a competitive differentiator.
FS players that deployed these new service models ahead of their competitors and who continuously refined and improved them gained a long-run advantage - often both in terms of efficiencies as well as customer satisfaction.
One of the keys to success in service innovation has been discovering new approaches, whether from inside or outside the FS organization, and evaluating and testing them. The top quartile FS innovator organizations have invested in building up the capability to do these activities in-house - generally at a level 22% better than other FS players. Moreover, as I wrote in a previous article about transformation, successful FS organizations also invest in systems that make collaboration easier and more efficient - and ensure that staff knows (and are incentivized) to use them.
The benefits \ of having a services innovation capability are cumulative over time. As they gain more experience in finding, evaluating and testing new service models, top-quartile FS innovators like US Bank build up a track record and confidence that supports further investment - and growth.
Learning Capabilities:
This driver is the epitome of the difference between investing in capabilities versus investing in a shiny new technology. It links closely with services innovation above, but extends to many other areas.
Top quartile innovators in FS have invested in acquiring the skills associated with successful experimentation, which include:
How to generate meaningful hypotheses to test a new idea;
How to run fast, inexpensive, simple & tiny (‘FIST’) experiments - often a series of them, each focused on proving or disproving one aspect at a time; and
Ensuring that many people across the organization know about these skills, why they are important, and how and when to use them.
This is in many respects a bedrock of successful innovation, embraced almost intuitively by startups, but often almost unknown (or misunderstood) within large corporations.
The benefits of having this capability well-developed are enormous - it enables new ideas to be expressed, debated and tested before rollout, ensuring high levels of support for ideas that do make it through, and a greater sense of ownership across the organization. It short-circuits the ‘Not Invented Here’ resistance to external ideas, while encouraging in-house teams to put forward their best ideas.
Conclusion:
By investing in the above three top capabilities, which our research has shown are linked to the success of the top 25% innovators in FS, all other FS organizations can address many of the bedrock issues holding them back.
By focusing on innovation capabilities, corporate leaders in FS can lay the foundations for more effective and impactful innovation investment. Instead of focusing simply on a new technology or class of startups, FS leaders following this approach create new ways of working, that can be applied to many different contexts - including the new GenAI landscape.
Capabilites are the building blocks that support both a coherent innovation strategy, and the successful execution of corporate strategy. Innovation is a key to long-term growth for all organizations, especially in Financial Services. The current dissatisfaction with innovation investment outcomes can be addressed by taking a capability-building approach, that links innovation to business strategy.