Credit union industry, hotel rooms and gatekeepers

New thinking is scary, but old thinking is truly dangerous. Old thinking is safe; grounded in sensible logic that advises you to stick with what’s worked in the past. Historic business paradigms and pricing schemes that are the bread and butter of your revenue model are hard to give up.

History shows that major technology breakthroughs (e.g., the PC and the Internet) create the impetus for new business models, and it’s rare that existing companies are willing to cannibalize their income. Often a new company, with no existing stream of revenue to protect, introduces a new way to provide value and monetize the shift in power created by such breakthroughs. These revolutionary pricing models or customer acquisition systems shift the balance of power, and billions of dollars, away from established companies. The path is usually the same; incumbents cling to the past while the disrupters give away that service and instead charge for something new.

With 20/20 hindsight, we can point to hundreds of examples of disrupted businesses from the PC and Internet eras and criticize the impacted players that failed to see what is now obvious. But we also know that three current technology breakthroughs are happening as we speak; search, social media and mobile. We also know that in the not too distant future these important developments will impact other industries. Must we watch helplessly as a new wave of established companies suffer a predicable fate? Is our industry doomed for history to repeat while we take no action? In many ways it’s unavoidable as much as it is predicable. It’s easy to watch dispassionately how another industry is shaken to the core but be convinced it can’t happen to us. Even if you correctly fear the consequences of these shifts in power, and you rightly anticipate the changing business model paradigm, you’re often helpless to act because you’re in a fragmented market where you join thousands of your peers who may be dynamic leaders in our industry but we simple can’t move the needle on our own.

Many billions of dollars of investment capital is pouring into financial technology investing, and most are targeting disrupters; software players that directly market financial services to consumers versus business to business (B2B) software companies that offer white-label services under the financial institution’s brand. Examples of top funded companies include Acorns, Wealthfront, Betterment, Blender, Colu, Moula, Osper, Lending Club, Prosper, and many more. These companies and their venture investors are betting that a train wreck of disruption is arriving in the banking industry. Some leading banks and credit unions are attempting to answer the threat by hosting hackathons, participating in start-up incubators, and awarding prizes to software developers with exciting, new potential products or services. Most big banks with an innovation program work in isolation and the results are underwhelming. The number of truly game-changing new product innovations that have come out of banking in the past 25 years is minimal. Contrast that with the number of innovative products and services introduced by entrepreneurs. I can personally attest (as the co-founder of Digital Insight in 1995) to the real-world innovators dilemma that exists, and how most revolutionary companies could have only been created as a startup.

Let’s watch the train wreck as it’s happening in another industry sector with a number of daunting parallels to banking; hotel booking and distribution. There are 4.88M hotel rooms in the U.S. (over $115B in annual room revenue with 60% occupancy and $110 average daily room rate). In 2001 the vast majority of rooms were booked directly at a hotel (walk-in, call center reservation) and the rest were through intermediaries (travel agent, tour operator, online travel agency, known as OTA). Per a 2011 Oxford Economics Study, 1.4% of total room revenue was from Online Travel Agencies in 2001. It would be hard to find a respected industry expert or analyst that didn’t believe the mix would continue to shift in the future, along with the balance of power from hoteliers to online distribution agents. The percentage of online bookings from companies such as hotels.com predictably grew to 45% in 2015, representing over 15% of total industry room revenue.

Recently, Marriott and Starwood agreed to merge, creating the largest hotel operator in the world, with a combined market capitalization of $25B. Hilton is now the second largest chain with a $17B valuation, Intercontinental is $7.5B, Wyndham is $7B and Hyatt is $5B. These dominant hotel chains control 70% of the US hotel inventory and collectively have over $61B in market value as of February 8, 2016.

Conrad Hilton purchased his first hotel (The Mobley in Cisco, Texas) effectively launching Hilton Corp in 1919. Priceline, was founded in 1997, Expedia was founded in 1996 and they have a combined market cap of $59B.

Let this sink in. Demand did not shift (hotel room occupancy rates in the U.S. was 61% in 2005 and 65% in 2015). Supply did not materially change (the number of hotel rooms in the U.S. grew from 4.1M in 2000 to 4.9M in 2015, or 1.3% annually). No new competitive threat was introduced (unlike disruption in other industries; e.g. Amazon grew revenue from zero in the first half of 1994 to $107B in 2015, creating an equal revenue decline from traditional brick and mortar retailers, forcing several prominent chains into bankruptcy).

What shifted was the consumer experience for booking. The balance of power shifted from brand and operator to online marketing and customer acquisition agents, creating a new gatekeeper. This new intermediary between the guest and the hotel extracts between 15–30% of the total cost of the room. These OTA gatekeepers outspend hotels 2 to 1 in TV advertising and 4 to 1 in online search advertising. The model is very familiar and has been used by Uber, who charges drivers 20% of the total fare in exchange for marketing, lead generation, sales and payment processing.

These third party distribution channels have effectively created their own “soft brand” with features such as loyalty, social reviews and quality metrics, and substantial contribution in reservation automation. Their entry has led to price transparency, lower room rates, lower advance reservations (get lower rates if you wait, making it more difficult for hotels to forecast), and commoditization between hotel brands.

In order to make up for lost revenue, hotel operators invented new ways to charge customers to artificially lower the published room rate (such as resort fees and charging exorbitant rates for phone and internet access), further angering consumers (similar to how airlines introduced baggage fees), making the OTA look like the good guys. These intermediaries provide consumers what they want: greater choice, lower prices, price transparency, convenience, time savings, and better, more current travel information (independent ratings, reviews, location guides and travel tips).

How and why did hotel operators allow this to happen? We know what they wanted; higher occupancy, higher average daily room rates, brand loyalty, and ability to up-sell other hotel services (such as bar / restaurant).

Cindy Estis Green and Mark V. Lomann published a report in 2012 that summarized the industry threat (An AH&LA and STR Special Report. Distribution Channel Analysis: A Guide for Hotels); “Power is in the hands of the gatekeepers who control consumer access, and many are vying for that position. This doesn’t bode well for a fragmented industry such as lodging. There are many powerful online media interests that are well positioned to control the traffic leading to the demand for hotel rooms. They have deep pockets, centralized product and marketing strategies. To compete effectively and retain control of pricing, inventory, and brand value, the industry has to make a substantial commitment to manage a burgeoning array of transactional and marketing channels and harness its customer relationships, the asset it controls best, more effectively than any third party intermediary. Three greatest emerging trends are; search, social media, mobile. Greatest threat to business in next 2–3 years; Google, Facebook and Apple.”

In spite of decades of time advantage, valuable customer records and control over a customer experience that can never go ‘digital’, hoteliers gave away their customer relationships, allowing these new gatekeepers.

Other participants in the travel industry also faced threats and opportunities. Consumer-focused offline travel agents were not able to make the transition to online (travel agent retail locations are down from 34,000 in mid-nineties to 13,000 in 2012). Airlines leveraged two key pieces of data; travel dates and destination city, to tap into hotel inventory and car rentals by offering bookings via their own branded online and mobile experience. They provide a valuable customer experience, using their data to act as gatekeeper in order to generate ancillary income.

What about the banking industry? Simply replace the words lodging with banking, hotel rooms with banking services, and the threats are the same; disintermediation (inviting gatekeepers), shifting economic model (from interchange to leveraging consumer demand and data), fragmented industry, and powerful new market entrants (Apple, Google, Facebook) in an industry that is increasingly going digital. Consumers would much prefer to have banks provide the plumbing and have their favorite mobile interface handle the user experience.

We can also draw powerful corollaries between hotel inventory and the payments industry. The shift for online commerce started twenty years ago but is still in its infancy (according to the St. Louis Fed, e-commerce accounted for $87B in online sales in Q3 2015, or 7.4% of total retail sales in the U.S.). The shift for offline commerce (in-store retailing) is just beginning and the winners have the potential to create trillions of dollars of value each year. Consumers will continue to buy gas, food, clothes etc. in brick and mortar stores, but the way they find, compare and pay for these goods and services has already started to change significantly due to search, mobile and social media capabilities. How will the power shift for the banking industry? What’s the role of current payments industry forces?

Total payments interchange is estimated to be $60B each year, shared by several layers of intermediaries who move information and money from the bank of the consumer to the bank of the merchant. As this dated business model continues to decline, leading banks like Chase are accelerating the decline in payment processing fees by leading the shift in power to enabling commerce in their own branded mobile payment system (via Chase Pay, anticipated to debut later in 2016). Chase Pay has partnered with several companies, including LevelUp and Merchant Customer Exchange (MCX), to offer over-the-top settlement services. This means that merchants are able to pay significantly less for ‘on-us’ Chase payment transactions, where payment is initiated via mobile, with zero fraud liability. Chase understand that their customer relationships, their consumer payment and past consumption data, and their position as gatekeeper based on their banking relationships is the true value in payments.

The power will not be in the hands of the retailers, but will be with the consumer. Let’s look at merchant funded offers networks (card linked offers, group buying sites, coupons, and other incentive systems). Once a hotel chain partners with an OTA, the power shift has occurred and now that chain has opened a new customer acquisition channel. The chain (e.g., Hyatt and Hilton) will provide their inventory to every other OTA (e.g., hotels.com and Expedia) and create a ‘jump ball’ whereby whoever books the room gets the commission. For merchants, providing consumer savings and incentives via card-linked offers or merchant funded rewards works the same way. If a big box chain makes pricing and other incentives available to consumers, they will make the offer available to all shopping apps that enable discovery, search, comparison, purchase and rewards. The mobile device and software platform that presents the offer and provides the best consumer value and experience will win.

Financial institutions have significantly more consumption and demographic data then other industries. Financial institutions are currently gatekeepers in the card issuance and card acceptance model, and have the opportunity to become the gatekeeper in the future data and customer purchase model.

Fortunately for credit unions, a visionary group of 38 credit unions and CU service organizations understood the risks associated with in-action, along with the opportunities that exist in this rapidly changing space, and founded and invested in CU Wallet in 2013. As a CUSO, CU Wallet collaborated to create a platform to provide credit unions with an alternative to inviting new gatekeepers into our industry. The first product, introduced in January 2016 for a handful of progressive credit unions, provides a credit union branded mobile app with in-store payment capabilities and a merchant funded offers network. It’s not often that credit unions are able to beat big banks like Chase to market with innovative new services, but thanks to a group of investors and subscribers, in partnership with entrepreneurial leadership, new thinking is being applied to ensure our industry’s success.

 

Paul Fiore

Paul Fiore

Paul Fiore is a fintech entrepreneur, founder of Digital Insight and CU Wallet. He presently is an advisor to multiple fintechs. Details