To what extent, if at all, does the rise in social media affect the fundamental business model of financial services?

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Jadgesh Ramjit's picture

To what extent, if at all, does the rise in social media affect the fundamental business model of financial services?  

The increasing preponderance of social media use is impacting proven business models to such an extent that businesses are now being challenged to respond with immediate strategies for successfully riding the social media wave in this ultra-competitive environment. Fuelled by ubiquitous mobile and internet technology, social media is not only constantly creating online communities of consumers, but also expediting conversation among them, influencing their sense of identity and belonging, and enabling widespread idea-sharing; a phenomena that has drastically changed the way customer services are provided, in fields such as patient care, education, advertising and public relations. However, amidst such existential growth and flux, the fundamental business model of financial services remains largely a monument to a highly regulated financial services industry that was birthed in an era of mass production. In fact, given that the industry utilizes a business model built around low transaction and information costs and in light of the consistently high volume of users of social media sites such as Facebook, Google+, Pinterest, Twitter, and LinkedIn which have accelerated the speed at which new information reaches and is shared among users, it is reasonable to infer that the rise in social media would impact how the fundamental business model operates.

One fascinating instance of this impact is in the area of information flow and acquisition. For instance, in the contemporary financial services industry, where social media usage is now a sine qua non, the speed of information transfer occasioned from such usage combines with faster and easier accessibility to a constant flow of information via social media micro bloggers and tweets from various analysts to generate expanded market efficiency. In other words, with the rise in social media usage the market now has more timely information to make informed decisions, resulting in money going towards its most productive use. Imagine the marketing manager, who, by merely utilizing available social media, being able to remain literally desk-bound yet also being able to acquire essential demographic data such as who has a family of two, who has a child in college, who just inherited an estate or who just acquired a new job, thereby easily and comfortably being able to determine how to market financial services! Consequently, financial services institutions can no longer herald as a competitive advantage their monopolization of information gained from relationship banking or data mining. Rather, the accessibility and availability of information induced by the rise in social media, demands that financial services institutions, particularly banks, should overhaul or reassess their modus operandi to re-develop a cost advantage. As such, to the extent that social media illuminate market transparency, one will expect that the fundamental financial services business model will be affected.

However, given the tight regulatory framework that financial service organizations operate in and their role in the recent financial crisis, such organizations may be constrained in how they employ social media to add value to the bottom line. In fact, the Financial Industry Regulatory Authority (FINRA) in the United States of America (USA) provides prescriptive guidance as to how the financial services industry can/should use social media to conduct business. This has the effect of limiting the extent to which the industry can harness any benefits from the rise in social media use. Accordingly, Morgan Stanley Smith Barney (MSSB), which has invested significantly in the use of social media for its personal financing services business segment, has had to revamp its business model. MSSB now cautiously networks more frequently with high net worth customers via LinkedIn than at conferences and seminars. Such networking through social media reduces MSSB’s transaction/communication costs and given the exposure to more customers, it enables the spread of fixed costs over a larger base. Despite the lucrativeness of such social media use, however, the financial services industry has to be precautionary in social media utilization given the strict regulatory framework within which the industry operates.

German-based Fidor Bank AG has also tapped into social media tools by constructing its vision on social media platforms like Twitter, Facebook, YouTube and XING1 (small-world network for professionals), while also building trust with transparent, open, fair dialogue in its community. Other financial service providers have started using key words from customers’ social interactions to inform data algorithms that compute credit scores. Using social media in those ways is a shift from the traditional manner of executing personal financing transactions or credit scoring. Additionally, the democratization of data and information services such as Bloomberg LLC and Reuters, through social media usage, has now made available to everyone what was once available only to a select few. This results in a cut in professional services fees and a reduction in research cost as now customer feedback can be derived instantaneously from the content that one feeds into the social media. Consequently, the profitability to be generated by the reduction of costs bolsters the use of social media in financial services and thus begs for a corresponding change in its fundamental business model.

While investors’ decisions have traditionally revealed their expectations of the future performance of financial instruments, the contemporary rise in the usage of social media now enables those revelations to be further interpreted from investors’ online conversations, discussions, and general hype or ‘rants and raves.’ Additionally, although the financial services industry may not have yet fully embraced the theoretical construct of behavioral finance, it is apparent that individual investment decisions and market outcomes are being systematically influenced by the information shared on social media sites and the characteristics demonstrated by the sites’ participants. Thus, through the usage of social media, financial service providers can more accurately predict the market relative to a particular company’s outlook or expectation about the general price levels. Accordingly, if the financial services’ company stock is not part of the conversation of bloggers and ‘socialites’, then a company will be well advised to seed ethical and positive comments into those media in order to stimulate a bright future for the company. The fact is, therefore, that although investor’ expectations do not directly affect a company’s business model, it is clear that adapting to the growth in social media which can influence investor’ expectations will affect shareholder value.

Additionally, it is also clear that financial services providers can benefit from sharing content and giving product guidance to customers. However, given that information security and customer privacy constitute the backbone of the financial services industry, those aspects will have to be duly considered before changing a proven business model to capitalize on the use of social media. For instance, if a financial service provider advises a customer via Twitter that he/she should consider a floating rate mortgage instead of a fixed rate mortgage; this would publicize the customer’s financial needs and at worst, create a free rider problem where others can take advantage of the tweeted information at no cost. Accordingly, given that customers may solicit financial services from providers who utilize social media, financial services need to have a strategic plan as to how this would be done so as to maintain the integrity of customer relationships and profit from it.

Overall, the business model that the financial services industry uses today was conceived to contribute to the bottom line as long as transactional and informational cost advantages prevailed. Notwithstanding that truism but given the current social media wave, there has been a reduction in the cost of providing financial services with a parallel intensification of the sharing of ideas and investor expectations, an enhancement of market transparency and an increase in the speed at which new information is accessed by the market, attainments that could only lead to revolutionary changes in the fundamental business models used by financial services providers. Despite such prospects, however, there is a limit to the capacity of financial services to actually make draconian changes to their present business model which was built in the era of mass production. It should be noted though, that given the financial services industry’s success with innovation and with lobbying regulators, one can expect that its fundamental business model will continue to be adapted to match the rise in social media and thus capitalize on its benefits. Moreover, the industry will need to to critically analyze the issues provoked by social media, particularly those relating to the incumbent steep regulations and information security / privacy to determine whether it would be prudent to invest in social media usage before making changes to its proven fundamental business model.

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