How to Compete Against the Oligopolies

FEB 4, 2013 12:00pm ET



Easily — and profitably. Even though the trend towards increasing concentration has ground forward inexorably for 50 years and at times seems to be accelerating.

Recent events echo what economics texts propound. Oligopolies set high price umbrellas, under which there is plenty of room for smaller, more efficient and more specialized entrants to prosper and grow.

Competition from leaner, smaller banks can even render oligopoly pricing untenable. For instance, it's the oligopoly banks that have tried hardest to eliminate "free checking." Community banks, American Express (with its de facto checking account Bluebird) and others can profitably undercut their fees. The result is that the banks with the most consumer checking accounts incur the highest costs to maintain market share, and lose money on many accounts.

Visa and MasterCard set what are roughly the world's highest prices for merchant payment services—credit card interchange. These two oligopolists are highly profitable, but they are vulnerable to competition from lower cost networks. Anticompetitive restrictions they impose (the "honor all cards" rule, exclusive routing, prohibition on passing savings on to retail customers) are being pounded and broken.

Spread profits on mortgage origination have risen to record levels as concentration has increased in just the past several years. But the great bulk of this production passes through the GSE's and FHA, which, like the payment networks, are open to large and small banks equally, on comparable terms. Once the refi demand bubble is deflated in 2013, so that the largest banks no longer have an artificial advantage in refinancing their own customers, a crowd of smaller originators will be drawn to this opportunity. Smaller lenders will surely profit increasingly from the high price umbrella as financing of home purchases becomes more important.

The largest banks also are consistently less effective in meeting the preferences of customer segments with differentiated needs. For instance, predominantly small, independent investment advisory firms have consistently taken customer assets from larger securities firms. Many affluent consumers expect more personalized service and flexible investment strategies from smaller, local money managers.

And then there are the remarkably numerous hedge funds, many thousands of them. Long before restrictions were proposed on bank operation of hedge funds, it was already apparent that large banks had great difficulty maintaining the entrepreneurial marketing and management environment in which successful funds flourish. Citi provided a spectacular example of such a failure, with a purchase investment of hundreds of millions being decimated.

Small business lending likewise requires nimbleness and individuated outreach that megabanks have not been able to deploy as effectively as smaller ones. Hence community banks do a greater percentage of this lending than they do of credit cards, mortgages or larger commercial loans. Smaller lenders should bring the same flexibility to other consumer and business services that has been so successful for them with small business customers.

Increasing reliance on more adaptable, outsourced infrastructure also has facilitated strong performance by smaller banks in other markets such as electronic payment services. The megabank that told me "We'll only do what we can run on our in-house systems" has lost ground, because its systems work is too slow, too expensive, and unresponsive to customers' needs. In-house IT repeatedly defeats or blocks innovation.

To compete with the oligopolies, identify the products or customer groups for which their services are too high priced. Find the customer needs that they can't serve or choose not to serve, such as credit cards for people with less-than-excellent credit—a majority of Americans—and individualized, proximity-based asset services for the affluent. Not to mention transaction accounts for the many who don't need branches or who can be satisfied with less expensive, increasingly capable and flexible mobile and other non-branch access. Acquire more attractive products faster from outside sources.

The dinosaurs were also big. They're extinct because they couldn't adapt, not because of government regulation. Megastores better managed than Sears and Circuit City aren't extinct, but neither have they beaten out smaller retailers who are astute in their management of locations, product lines, service and prices. Smaller banks and nonbanks will likewise continue to adapt and add value. 

Comments (2)
In banking, like all service industries, service with speed and smile will win. Too Big (to respond with speed and smile) may only be a disadvantage. The niche strategy has made many elephants 'dance' in the past.As of Dec, 2012, commercial and industrial loans constitute only about 15%, while Real estate loans and MBS constitute 50% of bank credit.Small businesses, the engine of economic growth in any economy, waits as a big opportunity for anyone who cares. Local contact and vicinity will win here.
Posted by Center for Safe and Sound Banking | Monday, February 04 2013 at 2:15PM ET
Couldn't agree more. What is more difficult is contending with the regulatory maze designed to protect the oligopolies from competition. So whilst Congress enacts laws designed to level the playing field, federal financial regulators do their best to ensure that the game is still stacked in favor of the Too Big To Behave Banks.
Posted by jim_wells | Tuesday, February 05 2013 at 5:24PM ET
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