Economics of free and banking

The excellent Chris Anderson is presently exploring concepts for his new magnum opus, “Free”. The central point he makes is that there is a market trend – certainly for digital goods at least – to a consumer price of zero. And, he suggests, this is being seen in other real-world markets as well, such as transportation.

In a post today, he talks about the redefinition of markets and the trend towards giving things away. I find this quote interesting:

“Think of these markets not as a two-way relationship between buyers and sellers, but a three way relationship where the third party can be drawn in by something free that creates the product to be sold”.

This is something that has begun to happen in banking. When we examine our industry closely for third parties in the customer/bank relationship, there are inevitably instance of “free” starting to occur.

For those familiar with banking parlance, it is interesting to substitute the word “disintermediation” with “free” and look at our industry in the context of these new kinds of markets.

Here is, perhaps, the best case in point. Mortgage advisers routinely offer their services, which include market scanning and advisory, to their customers, the homebuyer, for free. By going to an advisor, you can get a good picture of the available loans that are out there, without doing much research yourself. And you’re way more likely to get a loan that suits you than if you were buying directly from your institution. For a bank, the trailing commissions that must be paid to secure this new “free” channel have been denting mortgage profitability for some time.

There are other examples too. Buyer comparison sites offer valuable information to consumers because they let you unpick the product propositions from major institutions. I don’t have to see an offer as a harmonious whole (which is certainly the situation when I go to a bank’s online channel or the branch), I can compare on any attribute that is important to me, such as price. For example, when I do a search on MoneySupermarket.com, I find Lloyds TSB card products at the top of the list only when I search for premium products. Not on price, which is what most people do. Money Supermarket has announced plans to go public, and makes a lot of its money offering its valuable service for nothing. The revenue comes from introduction fees to institutions, as well as the grand staple of “free”, advertising.

Another example. In the UK, current accounts are, theoretically, free. You can open an account and there won’t be any service charges accrued as long as you keep the account in good order. You’ll get charges for other things though, but those will be for other services you consume on the back of your free current account.

What about ATM charges? Free, so long as you use a high street ATM from a major bank. The revenue stream is interchange, in other words, banks charge each other for the use of their ATMs. I can think of several other major examples of “free” in banks as well, but all this got me to wondering where this might lead our industry. Is anything we do immune to these new kinds of markets?

Lets face it, we already give away money for nothing. Just today I got a thing in the post offering me a credit card balance transfer for 12 months - for free. In this instance, I am getting free use of the money, in exchange for paying a “transfer charge”. The bank is making money from moving balances, not from interest on the balance. Quite a shift from the traditional banking model.

Perhaps that example is stretching things a little but it is not so hard to imagine writing more general loans for nothing and paying some kind of subscription fee or service charge. That is, after all, what P2P lending sites like Prosper and Zopa do. You pay for the service associated with managing the loan.

But even here, things get dicey in markets where “free” is possible. Wesabe, Mint, and sites of their ilk make it possible to get the account service for free too. In fact, those services might provide better outcomes than I’d ordinary get from my bank, since they leverage the wisdom of crowds on top of raw transaction data.

So, if there is a trend here, it is a trend towards a consumer price of nothing for banking services. That’s especially challenging at the moment, because customers, used to their free services, certainly do not expect their deposits to be free to the bank.

Comments

[P2P-Banking.com]

Hi James,

I don't think Prosper and Zopa are good examples for FREE services. While it is true that a loan request is free until it is successful, both do charge fees from the borrower upon loan origination.
The fees may be lower then in traditional banking but this is not a free service.
And as you noted lenders do get charged a service fee.

Claus
http://www.p2p-banking.com

[James Gardner]

Claus,

That's a good point... Perhaps Prosper and Zopa aren't good examples of free, but they are excellent examples of the economics of free. They are selling one thing (loans) but making their money somewhere else (service fees for providing the matching service)rather than on interest from the loan.

Granted, the actual lender is getting interest income...

[Julian R Harris]

Fascinating thoughts James, as always.

I think there's degrees of free, some of which you touched on. Off the top of my head we have:

1. Truly free. Like interconnect charges like ATM networks and dial up ISPs.

2. Pay with time. Ads. Still 'free'. I never would have thought this would be successful but Google's still worth > $180bn so I guess people are still ok with ads (I block all ads entirely from my browser automatically using Adblock plus).

3. Loss-leader consulting: you pay implicitly through commission -- mortgage brokers give the advice for free in anticipation for the business.

4. Loss-leader free. You get something free as part of a business's 'cost of customer acquisition'. £50 cash for free to open a bank account for instance.