Overview of Financial Innovation Theories

1           Executive Summary

• Financial innovation theories and application across financial technology companies (FinTechs) have brought key advances in the use of digital technologies to drive financially inclusive products and services for typically underserved markets.
• In this discussion, three theories of innovation and their applications are reviewed and assessed in the context of a new micro-savings start-up, i-Save, and associated regulatory body implications.
• The innovation theories reviewed were Disruption Innovation, Blue Ocean Strategy and Open Innovation approach.
• Key findings for the discussion were that a combination of the innovation theories would need to be adopted dependent on specific market strategies adopted.
• Key factors included level of financial literacy, mobile penetration, geographical location and regulatory environment.
• Geographical location was more important for regulation requirements as specific regulation required was specific for countries.
• In order to grow, key recommendation include

2           Main Body

Innovation Theories and Characteristics

A clear understanding of key innovation theories enhances i-Save’s decision-making ability to achieve a competitive advantage in targeted markets. The following paragraph will examine three key innovation concepts and their characteristics that are most relevant to i-Save’s future business aspirations. Christensen (1997) describes innovation as either Sustaining or Disruptive. He describes Sustaining Innovation as improvements made to existing product or service qualities targeting existing customers. He then further describes Disruption Innovation as the type of innovation that is achieved by technological advancements that are typically limited in complexity but generally provide a differentiated value proposition to a previously underserved market and customer base (Harvard Business Review, 2012). As a start-up company, disruption theory is particularly relevant for i-Save as it will be creating a product for the market.

The second innovation theory for consideration is Closed and Open Innovation, that were made popular by Chesbrough (2003). He describes Closed Innovation as the process where the typical research and development process for idea-generation was generally a centralised function in traditional businesses, where key specialists preserve intellectual property to create competitive advantage. On the other hand, Chesbrough (2003) further describes Open Innovation theory as a process that utilises internal and external parties for outsourcing activities for idea-generation or strategic partnerships across the value chain. He further adds that the advantage of Open Innovation has is that it creates access to  vast intellectual knowledge to create multiple routes to markets and adapts business models to changing competitive landscapes.

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The last theories of innovation are discussed by Kim and Mauborgne (2015) as Red Ocean and Blue Ocean Strategies. They describe a Red Ocean strategy as business that focus on competing with existing competitors and current customer demand for a piece of the existing market share. On the other hand, they suggest that businesses should follow a Blue Ocean strategy that focuses business strategies on pursuing untapped markets and create new customer demand to achieve commercial success. They further add that sustainable competitive advantage is achieved by focusing a business’s strategy on new differentiated product features, whilst removing costly components that the industry typically competes over. The current has a set of tools to assist the strategy. I-Save’s focus on generally underserved micro-savings product by traditional banks and its use of mobile phone as a distribution channel speak to the blue ocean strategic approach.

Critique of Theories

The following paragraphs will now consider some of the theories mentioned key drawbacks and assess how useful they would be in the market entry approach. I-Save is a start-up and therefore disruption theory seems to be more relevant than using a sustaining approach. However, King and Baatartogtokh (2015) provides evidence that Disrupting Innovation theory lacks the robustness of predicting how existing competitors in the market will react to new market entries and thus limits its success predicting power.

In the current information age, Chesbrough (2003) prefers Open to Closed Innovation citing the key drawbacks of the traditional Closed Innovation idea general process as mainly internally focussed and generally limits business to a single path to market. Whereas Open Innovation possess the potential risk of data privacy issues and lose of intellectual property (Spithoven, Vanhaverbeke and Roijakkers, 2013). Kampa, Cziulik, and Estorilio (2013) suggest that Blue Ocean strategy is useful in providing tools for businesses to create strategic focus but is limited in its ability to provide practical guidance on which tools to use and is more suitable for retrospective analysis and limited in creating new markets.

According to the evidence provided above, there appears to be several benefits and drawbacks from the various innovation theories. The innovation theories mentioned above would therefore require market specific research to provide a route-to-market strategies for each possible emerging market in consideration in response to various customer needs. This can be achieved through strategic analysis to understand the external macroeconomic, industry and competitive environment across markets considered and strategic roadmap to support the implementation activities of the product. Such analysis will provide key strategic questions to consider and guide decision making to better inform decisions Lafley and Martin (2013). CBInsights (2018) go on to further state that the number one reason for startups failures is not initially defining a clear market problem that has a market need for a solution. Examples include what mobile technology to best build product, most adequate level of micro-saving limit caps or any possible partnerships that could support expansion. In conclusion, the evidence highlights that i-Save should consider a combination of the most relevant components of the three mentioned innovation theories, underpinned by an insight driven strategy to achieve desired objectives. In contrast to larger firms, i-Save would typically have lesser resources and capabilities and therefore be more flexible in adapting and changing strategic innovative approach.

To further understand fintech business models, this section will assess how the advancement of key innovative technologies have influenced the rise in adoption of digital services and how these have been employed by fintech companies. Fintech start-ups across emerging markets have typically utilised mobile phones as the underlying technology to deliver their products and services. GSMA (2017) report provides evidence that increases mobile penetration across world is driven by the decrease in costs of traditional SMS and smart phones (GSMA, 2017).

Similarly, advances in cloud computing, application programming interface (API) and big data analytics technology are really accelerating the progress of FinTechs. Cloud computing platforming are forecasting to be the leading infrastructure in financial services, with benefits including scaling at lower costs (PWC, 2016). However, concerns about security and regulatory implications need to be proactively managed.

MSHWARI

M-Shwari Deposit Account is a mobile micro-savings product that is predominantly in East Africa that allows you to deposit from KSHs.1 and earn interest of up to 6.65% without a bank account (Safaricom, 2019). The product forms part of an existing mobile payments service M-PESA through the collaboration with Kenya Commercial Bank and telecoms company Safaricom. Successful open innovative approach with strategically established and trusted payments platform MPESA and a network of in-person agents allows for ease to cash out savings (InterMedia, 2015).

China

Similarly, in China

• agency banking to enable access for rural low-income customers

Fintech and Micro-saving Start-ups

• Failure of MPESA in South Africa

• Financial Education and Saving culture
• LifeCheq example: lifestyle-based analysis on customer needs
• Financial inclusion (IFC paper)
• Target Market: Students -> first time users of financial services

Regulation and supervision

FinTech companies create a challenge and risk f

Having established some understanding key theories of innovation and examples in market, it is now possible to highlight some key regulatory and policies of supervisory bodies considerations that i-Save would be required to comply with.

Open innovation to drive sandboxes and innovation hubs

KYC

• In most sovereign countries, financial services organisations will be subject to Know Your Customer (KYC) regulations/procedures that requires people to verify the identity of their customers (SOURCE).
• By following an open innovation approach, strategic partnerships with either an established bank or telecoms company with customer registration data that generally requires presentation of ID’s could ease the process of customer information acquisition

Treating Customer Fairly

• With transparency at the key of building trust with the brand, i-Save would need to follow a form of Treating Customer Fairly approach to build trust and brand recognition. Such factors include full details of product on offer, benefits, fee structures and comprehensive list of FAQs.
• Mitigate risk of data loss to encourage uptake and usage of products
• Development of robust customer protection frameworks will be key  to drive trust and the protection of data.             
• Using Blue Ocean Strategy tools such as Value Innovation framework to ascertain key customer value and insights.

Security Risk – Operational Governance Risk – Customer Protection Framework – Data Privacy

• Fraud - AML
• Data and Cyber Security risks – against cyber-attacks and information sharing
• Governance 
• Growth in cloud computing and big data analytics as a way of avoiding expensive bring in issues of data protection (WEF, 2015).

Protection of money invested

• If the size of collection increases too much, i-Save would need to consider complying with FCA regulation – Liquidity Risk.
• FCA Compliance: Minimum capital requirements by central banks
• Who regulates the collection of money?

Minimum Age for deposit holders

• Customer Target
  • Traditionally underserved by most traditional banks
  • Too young to have bank accounts

Upskilling of regulators in evolving FinTech Space

• Increase levels of awareness and knowledge with regulatory authorities and policymakers by upskilling and increasing engagement them.
• Promoting regulatory initiative such as regulatory sandboxes and innovation hubs to drive engagement, assist in understanding technology and learn more about implications, improve the market and drive financial inclusion (UNSGSA and CCAF, 2019). These initiatives further reduces unknown risk that regulators may face. Sandboxes to test product with actual customers.

Future Thoughts – Value Add Features

• Credit worthiness
• Financial Education
• Automatic Savings and Pay Down Apps and Services

3           Conclusion

• Cost drives similar to Blue Ocean Strategy and Disruption Innovation approach, whereas Open Innovation drives approach for more collaboration to supplement idea generation, supplement lack of skills and expertise.
• Expansion into other product lines such as credit lending can use the underlying behavioural saving patterns to inform credit risk assessment data.
• Financial and digital literacy to drive usage.
• Furthermore, given that most MFIs and rural financial
• organisations primarily serve women, fintechs need to be sensitive to traditional gender roles in their marketing and product development efforts (https://www.microsave.net/wp-content/uploads/2018/11/China_Country_Focus_Note.pdf).
• Life long brand attachment to expand into other complex products over lifecycle

References

1. Christensen, C.M. (1997) The innovator's dilemma: when new technologies cause great firms to fail. Boston: Harvard Business Review Press.
2. King, A.A. and BAATARTOGTOKH, B. (2015) How useful is the theory of disruptive innovation?. MIT Sloan Management Review. 57(1), pp. 77-90.
3. Lafley, A. G. and Martin, R. L. (2013) Playing to win: how strategy really works. Boston: Harvard Business Review Press.
4. Harvard Business Review (2012) Disruptive Innovation Explained. [YouTube] 30^th March. Available from: https://www.youtube.com/watch?v=qDrMAzCHFUU&feature=youtu.be [Accessed 26/10/2019].
5. Kim, W. C., and Mauborgne, R. (2015) Blue ocean strategy: How to create uncontested market space and make the competition irrelevant. Boston: Harvard Business Review Press.
6. CBInsights (2018) The Top 20 Reasons Startups Fail: CBInsights Research Briefs, February 2018. Available from: https://www.cbinsights.com/research/startup-failure-reasons-top/ [Accessed 30/10/19].
7. Chesbrough, H.W. (2003) Open Innovation: The New Imperative for Creating and Profiting from Technology. Boston: Harvard Business Review Press.
8. Kampa, J., Cziulik, C. and Estorilio, C. (2013) A critical analysis on the Blue Ocean Strategy and an approach for its integration into the Product Development Process. 10 (2). Revista Product: Management & Development - PMD.
9. Safaricom (2019) M-Shwari & KCB M-PESA. [Online] Safaricom. Available from: https://www.safaricom.co.ke/personal/m-pesa/do-more-with-m-pesa/loans-and-savings [Accessed: 29/10/2019]
10. GSMA (2017) Accelerating affordable smartphone ownership in emerging markets: GSMA research report, July 2017 .
11. InterMedia (2015) Value-added financial services in Kenya M-Shwari: InterMedia financial inclusion insights program – M-Shwari study report, January 2015.
12. WEF (2015) The Future of Financial Services - How disruptive innovations are reshaping the way financial services are structured, provisioned and consumed: World Economic Forum (WEF) Financial Services Report, June 2015.
13. UNSGSA and CCAF (2019) Early Lessons on Regulatory Innovations to Enable Inclusive FinTech: Innovation Offices, Regulatory Sandboxes, and RegTech. New York: United Nations Secretary-General’s Special Advocate for Inclusive Finance for Development UNSGSA and Cambridge: Cambridge Centre for Alternative Finance (CCAF).
14. Spithoven, A., Vanhaverbeke, W. and Roijakkers, N. (2013) Open innovation practices in SMEs and large enterprises. Small Business Economics, 41 (3), pp. 537–562.
15. PWC (2016) Financial services technology 2020 and beyond: embracing disruption