INNOBLOG

Wal-Mart's announcement this week that it is forging ahead with banking services -- despite having been denied a broad banking license due to lobbying by community banks -- seemed to shock some in the financial services industry. It shouldn't have. The company's move is firmly in line with how it approaches new markets, but the approach is quite distinct from how US financial services firms have traditionally functioned. Wal-Mart is circumventing its recent lobbying defeat by partnering with an array of third party firms, such as GE, to provide a wide array of services such as debit cards, low-cost check cashing, and money transfers. It will use its brick-and-mortar infrastructure to great effect, but will also leverage the convenience of banking while you shop and its reputation for offering excellent value (in a market where pricing can be more than a little opaque). The focus of its effort -- for now -- will be on the unbanked, including immigrants. The firm is laying the foundation of a highly disruptive business. It will offer simple banking services, without the frills of branches, nicely-dressed staff, and drive-through tellers. While consumers may give up these now-standard features of the banking experience, they will gain convenience, value, and access (including the ability to set up basic accounts without all the Know Your Customer paperwork that hinders many who are currently unbanked). Wal-Mart is attacking a market that most banks don't value very highly, and on turf where the firm's asset and brand advantages give it a clear Right to Win. These are all harbingers of success. The move may startle many in the industry, but it shouldn't. Wal-Mart has often outsourced the provision of services that require different competencies than its core, e.g. optician services and health clinics. And there is vast experience overseas, particularly in developing countries such as South Africa and Brazil, of retailers creating powerful banking franchises. These franchises often start with financing purchases at the store, perhaps using transactional data to supplement spotty credit histories. How will financial services firms respond? Likely, many community banks will focus even harder on their long-term customers, who tend to be significantly older than the national average. That is not a formula for long-term success. Check cashing shops may lower price and consolidate -- hard times ahead. Big banks may ignore Wal-Mart's move given that it targets customers they have not traditionally valued. More prescient big banks will realize that Wal-Mart's success at the low tiers of the market will give it every incentive to move up and to start attacking the critical mid-market. Each of these competitors needs to create business model innovation of its own to respond effectively. Business model innovation has become a fashionable term of late, but it is harder to execute than many firms perceive. It must start with the customer value proposition, and then work its way through to the profit system and the firm's resources and processes. Unfortunately, many firms get this backward, fixing the profit system, resources, and processes in place, and thereby severely constraining the type of business model innovation that can occur. They would be well-served to chart their current model in a disciplined fashion, recognizing the divergences that must happen for the company to thrive in the new competitive environment. Then, they can systematically liberate the constraints that remove degrees of freedom from their desired response. It is not easy, but if it were then it wouldn't be so profitable. Wal-Mart's move adheres closely to the model of successful business model innovations. In this case, it has the requisite profit system, resources, and processes already in place. For Wal-Mart, banking is as natural an extension as Internet sales were to a leading catalog retailer of PCs -- Dell. We shall see whether competing banks will be the new Compaq.