Structuring a Bank Groupon – 101

30 Nov 2011 (as always pardon the typos)

My post yesterday resulted in some good feedback. Theme was “are you bank friendly…? Stop telling me about what does not work.. how about recommending what does!”  My previous blogs covered a number of lessons learned.. so today I’ll give my view on What Does Work as Banks attempt to extend their existing business models. Your feedback is certainly appreciated..

As background.. here are my previous related blogs

What Works?

Well perhaps the first step is to frame the objective.. what does the Bank want to accomplish? For simplicity let’s reuse yesterday’s example: a Bank Groupon.  What is the Bank’s objective? Maximize revenue? Of the Groupon Unit? Of the Corporation?   Given the recruiters response..  it would seem that maximizing the revenue of the Corporation is the focus and their method is control. The Bank emphasizes control because it has significant uncertainty on entity and outcome.

Example BankGroupon Conversation “we have no idea how this thing will play out.. we have a number of the assets necessary to make BankGroupon a success and should be able to put something together.. so hey lets give it a try.. get some leader in here that has some experience in a big bank.. and some with start ups.. lets see what he proposes”.

Banks are the best institutions in the world at managing investment and risk.  When a bank contemplates an investment in another company, it is certainly appropriate for them to assess the business model, the team, the environment and price the risk.  This ability to make and manage investments is much different than an ability to run a NON CORE business and react to market forces (Elephants don’t dance).  While banks may have individuals in their company with these skills.. these employees did NOT develop the skills within the bank.

There is an obvious need to decouple the Bank Asset (customer data), Capital, and Entity that executes the plan. Commercial and Investment banks have tremendous experience in structuring entities that separate a bank asset and capital. Bonds, SPVs, CDSs, CDOs, … these vehicles not only allow banks to move assets off balance sheet, but they also allow investors to take different tranches of risk and even insure/hedge against loss.  The first stage of these commercial bank activities is defining the underlying asset (with appropriate continuity and underwriting in portfolio).

“Asset Definition” is the critical piece I believe is missing in structuring most bank owned NewCos. If the business is core.. keep the asset in house. If it is non-core.. define it and let someone else go maximize it within covenants.

CEO Prospect – Approach

In the BankGroupon example, if I were a prospect CEO here is how I would approach the task.

1) Define the bank asset (non monetary).

What is the bank contributing? BankGroupon is a separate company. What is the operating agreement between the 2 entities. Optimally this asset would be a 10 yr exclusive agreement to sell pre-paid offers leveraging bank data. Just as with Bonds, SPVs, the agreement would have covenants to protect the bank in certain events, as well as MUTUAL performance guarantees. This operating agreement would be the central asset around which the business would be formed. The focus of a NewCo CEO would be to ensure that this operating agreement is sustainable and fine tune the covenants.  Can I build a sustainable business off of this asset?

Operating agreements are NOT easy to create, they require much thought and planning. However, these agreements HAVE BEEN the core asset of many successful bank driven entities (Visa, MA, Early Warning, Clearing House, …). Quite simply, it defines the asset, how it can be used and also governs the roles of other entities in participation.  If you happen to meet one of the bankers/lawyers that were involved in the creation of any of the operating models above.. they would probably say it was like 2 years in North Korea.  By not creating these agreements, the Bank has shifted the burden of defining the asset AND building the business to NewCo.  Ask any recent bank spin off CEO and they will tell you their lives were like 2 years in a place much hotter than North Korea.  Spin offs have very little leverage to influence asset definition AFTER they have taken the capital.

This is my central point.. and should probably stop here.. but let me finish up a few other thoughts. I see the prospect bank CEO and the bank investment lead (future BOD member) working on this for a year or so. During this time.. the CEO comp is heavy on cash with an incentive if bank cancels or funding is successful.  Just as with Capital markets folks.. lining up investors for a $200M offering.

2) Capital to start the business.

My next job after obtaining the right operating agreement is to get Capital. What is the path toward revenue and what will it cost me to get there? Most Banks have taken approach of supplying all of the capital.. or perhaps partnering with one other big organization. Since the source of capital drives the direction of the business it is very important to have CEO drive source and mix. For example, BankGroupon needs to attract retailers.. Retailers don’t like banks.. and Banks don’t understand Retailers. Having an entity that is 100% controlled by a bank is not a great sales asset. I would want a clear path to reducing Banks control to under 50%…  and gaining investors who are retailer friendly. I would do this by either converting Bank stock to non-voting, non bank investors, or other commitments.

Wrap up for now

I could probably write a book on this.. but won’t bore you with the diatribe.  There is no shortage of talent interested in running a bank owned Groupon. But most of these CEO prospects haven’t had to survive in a bank owned company/consortium before.  The high failure rate of bank driven start ups is because banks have not taken the time to define the asset and separate it from the capital.  If a BankGroupon is core to the business.. it should remain in the business. If it is not core, and you have assets to leverage.. define the asset and let someone else grow it.

Your feedback is appreciated..  I’m sure there are several of you that think this viewpoint is insane.. but hey.. sometimes great ideas are generated from dissecting insane ones.

Best

Card Linked Offers

28 November 2011

pdf version here (sorry for previous Typos.. I need an editor.. so pardon the mess)

I’m fat and happy from all the Turkey.. and was thinking of what to blog about.  I’ve decided to link a funny story… with a complex market. Earlier this month I was called by a recruiter to lead a new company. Here is the abbreviated dialog

  • What is it? “a bank Groupon”..
  • How is it structured? A separate company? A Bank Division? “Both, it is a separate company 100% owned by bank”
  • Are they looking to spin it out? Will there be other investors? “no”
  • So CEO (with no equity upside) building a business from Scratch within a complex bank? “yes”
  • Where will it be based? “right here in NYC next to the Bank”
  • Did you know the COO of Groupon was given about $xxM in options… how are you going to compete with that? “we are not looking to compete on compensation.. but we do want to compete with Groupon”
  • Good luck with that!  (See my previous blog for lessons learned on bank spin offs)

Message here is that top banks and payment networks are getting into the “offers” space. I haven’t seen an industry analysis of CARD LINKED OFFERS…. So I thought I would create one. Today I was reading 2 month old post in All Things Digital: Will the next Groupon Killer be your Bank.. ? One of my first Blog posts (2.5 yrs ago) covered this subject as I saw in back in 2008/09 “Googlization of Financial Services”.  Here are a list of current leaders in Card Linked offers

Not all of the companies above are the same. Here are a few basic strategies behind these start ups

Strategy #1 – Improve Existing Loyalty Effectiveness. Colloquy.com is the industry leader in research on loyalty programs. Two recently published white papers by Colloquy.com display a macroeconomic view of the size and value of loyalty programs for U.S. consumers. Colloquy estimates the total value of loyalty currency issued to U.S. consumers in 2010 is a $48 billion dollar industry across financial, travel and hospitality, and retail sectors of U.S.

economy in 2 billion U.S. household loyalty program memberships. Edgar Dunn provide a great graphical view on the purpose of loyalty programs

Why do banks want to improve Loyalty?

A) Credit cards carry a much improved interchange (250-350bps vs $0.21 flat of Debit)

B) Loyalty Programs are highly effective card use AND retention tool. From Edgar Dunn

Strategy #2 – Redemption Network. Improve the way redemption works. Enable redemption of specific items. Catera and Cardlytics are leaders here. Great Article on Clovr (now Linkable Networks).

Banks used to see card offers as part of a large revenue stream.  Now banks need to find unique technologies in order to capture the customers’ attention again.  Some of that technology comes from mergers such as Cartera and Vesidia to form a new more innovative merchant network platform.  Other pieces of the card-linked offer space is coming from companies that are focused on card-linked offers, such as Boston-based Clovr Media.

… The card-linked offer company wants to make sure that promotions they are powering are meaningful.  They do that by getting down to the SKU level (the long number on products that identifies a unique product within a store. Tom said, “we can go right down into a particular product within a store, get right down into the SKU level.  Instead of 10 dollars off at Staples, it’s 10 dollars off a cannon printer at Staples.  We see that as a very powerful concept.

CONCEPT is the key word here as “networks” are minimal beyond eCommerce store fronts capable of redeeming offers for specific products. In the physical world, none of the participants above have cracked the code on the scenario above. POS integration is too hard AND retailers will not give up their data.  Entities like Catera are using other parties (ex SavingStar in Grocery) to give item level credit hours, days or weeks  after the sale.

Strategy #3 –  Advertising.  The first 2 strategies above are about leveraging the $48B in loyalty “value” to incent merchant participation. A third strategy is geared to attract retailer participation in an advertising network. The primary value proposition: target card customers with specific offers.  This strategy usually driven by card NETWORKS and Issuers looking to expand “value delivery” on existing networks (the  googlization article above provides an example). Although Banks certainly have the data to make this work, this is NOT a merchant friendly platform. Can you imagine using your Amex card at Macy’s then getting an incentive at Neimen Marcus? This is one reason why retailers are loathe to share any item detail information.. it would only help banks/networks more accurately target their customers.

Apparel, QSR, Furniture and a few other niches could be served in this model (few other retail categories have significant ad budget), but the price is credit card interchange.

Summary

Retailers will respond to Banks’ loyalty spend initiatives ($48B), but “redemption” will largely be online (restricted merchandise lists) because retailers do not share data at the point of sale.  Banks and the Networks are attempting to expand Card Linked Offers into the advertising space, but this means someone will have to sell retailers and construct campaigns.  Given that neither Banks nor Networks are adept at selling retailers anything, there will be a need for 3rd party ad exchange (ex freemonee) where advertisers can bid to place across multiple issuers (ie each issuer controls their respective cards).  These Ad Exchanges will be slow to mature because there is no proven CPA for card linked offers (and associated merchant sales lift/profitability). In other words the Merchant cost of accepting a credit card, paying for an offer, and tracking profitability is not a home run today. We need only to look at Visa Offers to see the confusing and bleak future. Consumers are overloaded with e-mail and messages.. behavior will not change until there is compelling value. Value cannot be delivered until there is a critical mass of ads which can be targeted. Targeting can not be done effectively because issuers only have merchant level preferences (not item level/brand). … Only certain categories of retailers have substantial marketing budgets… the majority of marketing is spent by manufactures.  Manufactures don’t know their customers.. (hence is why Shopper Marketing is red hot). … and so on

A logical extension of card linked offers is card linked pre-paid offers. This goes back to “Bank Groupon” listed above. Banks want to run a pre-paid program for retailers.. a “pay before” you eat… at a discount. Keeping it on the card so consumers don’t loose the offer and redemption is a seamless process within the existing card settlement flow. Hey this is a great idea for consumers and merchants. Problem is business model for banks. If this pre-paid was sold by a regulated bank entity I doubt if they would be able to take advantage of the breakage which drives Groupon’s profitability. Banks will also be responsible for things like escheatment..  this is where state regulators come looking for unclaimed funds.

Your thoughts and feedback are appreciated.

A related blog on Visa’s activities is listed below.

http://tomnoyes.wordpress.com/2011/05/20/visas-mobile-strategy-portfolio-manager/

PayPal at POS?

18 Nov 2011

The most frequent question I get from eBay’s institutional investors and start ups is about PayPal’s opportunity to win at the POS. I met with 3 top Retailers who  have been pitched PayPal’s new service. Quite frankly they were laughing.. it goes something like this

“we [Retailers] just won Durbin and are in the midst of planning how we incent customers to use their debit card … and we get presentation from PayPal with a rate of 150-200 bps..  am I going to loose any customers because I don’t have paypal payment? Will Paypal bring me new customers that would not have shopped here in the first place? Is there going to be a 100% conversion of credit card customers to paypal? Why on earth would I want to do this?”

PayPal of course is also pitching a gaggle of new mobile tools that let people scan in aisle and shop online to pick up in store.. but does a retailer really want to outsource this?  PayPal’s core value was built around commerce, specifically the new form of commerce that eBay marketplaces brought. Buyers and sellers flocked to a tool that met their needs. No one came to eBay because of PayPal.  Payments are just the last phase of a successful commerce interaction. PayPal still has tremendous global opportunity, but their opportunity is an evolutionary one driven from their COMMERCE core. Their business model (and cost of funds) does not adapt well to the physical world.

PayPal has no tools in its shed to deliver incremental value within a PHYSICAL commerce orchestration role. They simply do not touch consumers or influence them prior to purchase. Facebook, Apple, Google, MSFT all have a much better chance of orchestrating commerce..  This is why Google’s Wallet will win against ISIS… the business opportunity is commerce orchestration…NOT about mobile payments. Never before has a customer had the ability to interact real time in store with products and offers.  Who will win? Which company above has a sales force of over 2000 globally selling to retailers today? Driving business growth? There will be no contest here.

How can PayPal use its tremendous consumer network to deliver value off of eBay?  The answer revolves around what they “could” orchestrate.. perhaps in a junior capacity.  What problems can they solve? If PayPal’s biggest asset is Consumers.. and objective is physical commerce… why not create a “reverse auction” for goods? Let consumers describe what they are in the market for and have sellers bid for the privilege to sell (and service) it. Give consumers option to buy it now in store down the street. This would relegate physical retailers to competing on price alone.. and certainly would not make them many new merchant friends…but they could start off doing this for excess inventory or mark downs.  This could be a very stupid idea.. but PayPal’s efforts to go head to head with Visa and MA in an area where they add no value at a high cost is not much better.

One corollary here is that Payments will become dumb pipes. Banks had a traditional role as the intermediary in commerce. They have fouled the well.. and continue to cry against the harm done to them by Durbin instead of engaging in an honest assessment of the future of their business.  Banks believe they have a lock on payments.. and similarly to ISIS engage in a strategy of control instead of value delivery. This dynamic will push “Commerce orchestrators” to find the path of least resistance (least cost routing) for payment. Not all payments are the same, for example Credit card payments are much different.. because they extend financing to benefit merchant consumer and bank. However there is no reason to force everything through this CREDIT card channel, which is precisely what the banks are trying to do with NFC (for example there is no debit NFC product.. it is not a technical issue but a business one).

Even if payments are dumb pipes they must have a reservoir to pull from, either in a DDA, stored value account or credit line. During my meeting with the Kansas City Fed last week, I discussed the McKinsey report describing how the bottom 4 deciles of retail banking customers are unprofitable. In other words the big 5 banks are trying to find a way to sponsor “switch your bank day” for 40% of their customers.  Many will leave the banking system all together, and this reservoir of funds will translate to cash, pre-paid or some other non-bank product. Banks loss of control over DDA is a slippery slope. If every American has a PayPal account, an iTunes account, an Amazon account, a Google Wallet and a pre-paid card they could find their control strategies are no longer effective.

I apologize in advance for the brevity of this note, and I certainly appreciate comments.. but this is how I see it.

Customer Centered Design … Why is it SO Hard?

7 Nov 2011

I woke up this AM thinking about consumer value. Why is it that so few existing companies can deliver disruptive consumer value propositions? Execute innovation? It seems as if big companies are more interested in imitating what their competitors are doing … as opposed to focusing on customer (to deliver value). Steve Jobs was one of the few big business CEOs that focused on Customer. He knew that creating a fantastic customer experience was essential in anything to be “sold” to consumers, whether that was Apple or Pixar . Everything flowed from a consumer DESIGN and experience which then evolved to product and subsequently to engineering. Apple was fanatical about customer experience and customer centered design, obviously quality (hardware and software) and connected services were also essential in driving the experience to establish behavior.  How many products in the market start with customer centered design? How many of your product heads know their customers and how they differ by segment?  My time at Gartner and Oracle led me to a few hypotheses on software products:

  • Every Software product usually starts with a customer in mind… but customer focus typically fades fast as other objectives (financial, competitive, alliances, big “special” customers, timeline: execution on “something”…) move the product off of the initial customer centered goal.
  • Delivering any consumer value proposition requires either a killer value proposition or a killer distribution channel.  Consumer adoption is “unpredictable” at best…  be highly skeptical of any initial success (acquiring early adopters of a product) never resembles the broader launch when the product goes mainstream.
  • Small companies (leading delivery of a visionary consumer service) require alliance partners… Alliance partners require financial incentives that quickly erode the original value proposition. “when you dance with an 800lb Gorilla, you can expect to have your toes stepped on”. Give equity and it biases your board (focus on their problems/customers), give cash and it kills the consumer or the distribution channel. Equity is better.. but structure in a way you can take them out.
  • New Software products within large companies (ie MSFT, SAP, Oracle) are either poorly integrated into the core, or not integrated at all.  Product teams can spend over 50% of resources focusing only on internal integration… which further distracts from original  customer centered design. There is usually a case for 2 product teams here.. one focused externally on customer and market, they other focused internally on integration requirements.
  • Customer testing and trial is a 9 month+ process… no exceptions. Few companies go out of their way to solicit negative customer feedback on a new product. They are much more concerned about “secrecy”…  Companies may have justification for short-circuiting (Example: “what are we supposed to do with the engineering team while we wait for feedback”) usually come back to haunt as products in market are much more difficult to change AND effect consumer perception/adoption.  Cloud based services are no exception , “lets throw our product out there and see what happens, we will fix bugs later” is not a great business plan. This model makes your early adopters unpaid quality assurance participants..
  • Few companies can survive by tackling a niche in the consumer market. There are only 3 markets (US, EU, China) where a 10% market share equates to a sustainable business
  • Large companies may not be able to “win” in delivering a new value proposition, but they can muck it up for everyone else. Their game plan is one of “control” over value. They leverage their existing network, infrastructure, products, communication and market power to influence potential customers.
  • Consumer visionaries and innovators play a distant second to executives driving financial performance. There are exceptions. For example, Google is also a fantastic innovator, a result of having the best minds working round the clock with pressure to do something great.. not to drive a revenue target.

Story.. my lessons

My lessons learned on customer centered design are many… After Oracle I went back to my old team at Wachovia (which had just bought First Union) our team had launched the world’s first major online bank in 1995 (Cyberbanking).. I was fortunate to return to oversee the complete remaking of our online and payment services infrastructure… a $200M project (2002). As an engineer.. I have many faults..  among them thinking that I know what the customer wants without ever talking to them… We had 2 excellent execs at Wachovia that completely changed the way I thought about customer centered design.  We brought customers into the product design process at every stage.. hand drawn screen mock ups.. asking them obvious questions… Why do you do this? what are you looking for? When do you typically do this? What does this mean to you? Jason Ward’s amazing team took this customer feedback and analyzed it to prioritize product design changes.  When I started at Wachovia…. we had no facilities or process for including customer feedback, it was the call center’s problem to deal with. After development was complete, we did extended “dog fooding” with employees and customers.. then brought that feedback into refine final release. We also communicated with ALL customers.. why are we upgrading? what will be changing? We explained what things will look like. 3 months before it happened (believe it or not customers don’t like surprises in their bank).

What happened next was something that still amazes me.. During upgrade customer call volume went DOWN.. we transitioned customers from one system to another… completely changed screen flows … and they did not call to ask questions, they did not call to complain..  We had budgeted for extra call center staff.. and we didn’t have anything for them to do..  What was more amazing is that our customer satisfaction went up… DURING the transition to the new system. This is unheard of..

I have now learned that I don’t know what the customer wants or needs.. and the direct customer interaction is VERY beneficial to all involved.. from product to engineering to the call center. Communicating to the customer (if done correctly) is a great thing.. great customers love you and they want to know what you are working on.. find ways to share it with them. If customers perceive they are getting value they want to HELP you. It is imperative to build facilities to get this feedback.  In Wachovia there was only 2 regular standing meetings that the CEO would attend… financial and customer listening.  Although Wachovia failed on many other grounds.. it taught me the importance of keeping eyes on the customer and ensuring I received the RAW customer data. My priorities became my teams priorities.

Sorry to ramble… I have quite a few peers and former employees read this. Wells Fargo just completed the last migration off of our $200M Wachovia platform. The migration was very well done.. but quite frankly I miss what we had. WFC’s online banking is too clumsy.. too much information.. The difference between using an iPhone and flying the space shuttle (photo below). … although I miss that too.