Brian Kenny: “Banker’s hours” is often said with a wink and a smile, a punchline that depicts an entire industry’s largess when it comes to customer service. It conjures up images of harried workers running to the bank to make their daily deposits before the gates are locked. Urban Dictionary defines banker's hours as working or being open for the shortest, and most inconvenient amount of time, and also includes a long lunch break and every possible holiday off.
The reputation was well deserved historically but in fairness the scant hours were a byproduct of the reams of paperwork that had to be done in order to process loan applications and tally deposits and withdrawals. Technology and the internet have changed all that. Today, you'll find banks open evenings and weekends with storefronts embedded in supermarkets and mall food courts. There are even banks that masquerade as high-end coffee shops with free Wi-Fi in an effort to draw in customers and create a convenient hassle-free experience that keeps them coming back. But in a world where 82 percent of 18-to-24-year-old smartphone owners use mobile banking exclusively, expanding hours and serving lattes may not be a winning strategy. So what's a bank to do? Today, we'll hear from professor Karen Mills about her case entitled, Eastern Bank; Innovating Through Eastern Labs. I'm your host, Brian Kenny, and you're listening to Cold Call.
Karen Mills is a senior fellow at Harvard Business School and Harvard Kennedy School. Prior to that she served in President Barack Obama's cabinet as the administrator of the US Small Business Administration, and she's about to release a new book called, FinTech, Small Business and the American Dream, I think that comes out this spring, Karen, is that right?
Karen Mills: Yes, it's coming out in March.
Kenny: Terrific. We look forward to seeing that but today we're going to get into some of the ideas that you talked about in the book. Thanks for joining us. This is your second time on Cold Call.
Mills: I'm delighted to be back.
Kenny: This case was terrific. Maybe you can start by telling us how the case begins. Who's the protagonist and what's on his mind?
Mills: Well, Eastern Bank has a great set of characters and it begins with Bob Rivers, who is the CEO. He has just come into that position. Bob started as a bank teller and worked his way up. He is a traditional banker. He wears the dark suit and the white shirt, but he thinks like an innovator. So when he comes to run Eastern Bank, it is a 200-year-old mutual. It was started in Salem, Massachusetts, really in the days of the witch trials and it started as a community bank, and it keeps all of that community-mindedness. Under Bob though, he realizes that innovation has come into banking and what he says is, "We have to disrupt ourselves. We can't just wait for the other forces to disrupt us."
He doesn't know how to do it. He takes his chief information officer, and they literally start walking around Kendall Square. They don't know who to connect with, so they finally connect with one of the innovation groups and they are asked, "Well, would you pay $20,000 to be a captain of innovation?" They say, "Of course," and in that process, they meet the entire Boston fintech community. A few months later, it turns out that there is a fintech that fails in Boston, but there's a very charismatic CEO named Dan O'Malley. So Bob Rivers picks up the phone and he calls his network from Kendall Square. He says, "Will you connect me to this person?" They get together and Bob convinces him to join the bank.
Now, Dan is willing to join because one of the reasons for his failure is it was his fintech was not developed inside a bank. It didn't understand how banks work, so Bob is the perfect host for this innovation. He wants to change. He sets up Eastern Labs, he puts it in the lobby of his bank in a glass box and he says to them, "Go ahead. I'm going to give you $4 million dollars a year," which by the way is one percent of the bank's income.
Kenny: As the case mentioned, Eastern Bank is the largest mutual bank, but compared to the Chase Manhattans of the world, this is a small outfit.
Mills: It's a regional bank. It had a leadership position since the recession in small business loans and SBA loans and Bob wanted to retain that position. He noticed that about 10 percent of his customers … were getting loans from some of these new fintech and online lenders. So Dan goes in and he creates a new product. It turns out to be quite successful, an internally developed online lending product. Instead of weeks and months of paperwork, as you described in your introduction, this turns around an answer in 30 seconds and the money can be in your account the next day.
Kenny: I want to go back to Dan and Bob for a second because as the case describes it, this is the odd couple. I mean you've talked about Bob dressing in his starched shirts and dark suits. Dan comes in wearing jeans and a flannel shirt, so this is the beginnings of what we see as two cultures coming together, and his move of putting Eastern Labs in the center of the workspace in a glass bowl as it were. That's a pretty bold thing for Bob to do.
Mills: Yes, and it had the repercussions you would expect. One of the things that happens is that Dan wants to do what we call test and iterate. He wants to sort of see if his ideas are going to fly. So he says, "Let's do a test where we take everybody who applies and we approve them." And the traditional lender says to him, "Wait a minute, you want me to open my window and just throw money out, tax-guaranteed money, out the window to just anybody?" And Dan says, "Yes, I want to see if my value proposition, my customer value proposition of a fast turnaround on this loan, works." And, of course, they do it and it does work.
Kenny: But everybody's trying to do their job here, right? Because the question that the CFO at Eastern Banks asks is a serious question. They are responsible, they have a fiduciary obligation to make sure that these funds are dispersed in a way that's responsible and to people that can pay the loans back. So this has got to be a pretty unsettling proposition that Dan has made for the bank to do.
Mills: Yes. And this is one of the reasons why innovation has come slowly to banks and to lending. This is a risk-averse, highly regulated industry.
Kenny: I would love to hear how you look at this advent of fintech and the questions that it raises more broadly about who owns the data. Who's making sure that people's information is protected? Who's making sure that the government loans are backed and those kinds of things?
Mills: Fintech, and particularly small-business-lending fintech, is one of the most exciting transformation stories out there right now because banking to small business turns out to be critical to a really important part of the economy. Half the people who work in this country own or work for a small business. So it's sort of an underappreciated economic driver, and when credit is not available to small businesses, as we saw in the great recession, we lose jobs. It's very important to have a well-functioning credit market.
What happened in the recovery is that banks, who had been very damaged, really pulled back from small business lending, particularly the smallest loans, maybe a $50,000 or $100,000 loan just wasn't profitable for a bank. The increase in regulatory burden made them turn away and small businesses kept getting turned away from small loans. Enter the new online lenders.
“Fintech, and particularly small-business-lending fintech, is one of the most exciting transformation stories out there … because banking to small business turns out to be critical to a really important part of the economy.”
So in 2012, you had OnDeck, Cabbage, and a series of new lenders who had these algorithms and sucked up all kinds of data that had never been used in underwriting. Now, you would have thought that David would then kill Goliath—that all the dinosaurs, i.e. the banks, would be disrupted. The story was not quite that simple. What happened was the online lenders kind of stumbled because they hadn't really anticipated all of the difficulty in acquiring customers and they had very expensive capital. The banks roared back in; and they had their own customers and they had low-cost capital in the form of deposits. So back to the story of Eastern.
Eastern is this 200-year-old dinosaur bank, and they start an innovative product that creates the same customer experience (as its fintech rivals), and they don't have to go searching for customers. They can just email their customers and say, "You are pre-approved." They spun off this product into its own company, Numerated. (A full-disclosure, I'm an investor in Numerated. I'm also a venture capitalist.) It has an operation That is trying to sell that software to all the other community banks. fintech had to step back and say, "Wait a minute, do we really have competitive advantage?" So that was phase one of the transformation. Now we are in phase two where another set of competitors have come in. Think Amazon, PayPal, Square, the new technology companies.
Kenny: They know a lot about us, don't they?
Mills: They have the data. It turns out that the really transformative thing in fintech is access to data in pipes, in APIs, that were never before available. So this API transition has really changed the game; it brings a whole set of new opportunities for banks and for fintech and for people who are going to provide the piping. This one company I love called Plaid provides all this information and allows it to be used to assess your credit in minutes in much more robust ways.
Kenny: It sounds like fintech organizations and traditional banks kind of need each other, that there's a symbiotic relationship that's forming. But am I wrong in thinking that the better the fintech companies get at mining the data and learning from it, the less they'll need the banks. Are the banks working themselves out of a job here?
Mills: It’s a really great question. And this is kind of where the competitive battle is taking place, but you could also argue that fintech companies are working their way out of a job. Because what happens when the banks, with their armies of technologists, when they get the right people inside, as Bob Rivers actually was able to do with Dan, and they create their own algorithms, do they really need the fintech companies? So now we come back to the question of who has the competitive advantage? Is it Amazon, which knows more than anybody else about its small-business sellers? But if all this information is available in these open pipes, the advantage goes to the person who provides the best customer service and understands their small-business client.
I make a prediction in the book, which I'm going to preview here. I think that there will be a new category of competitors, which are online small-business banks focused on the products and services that small businesses need. If you think about small-business banking, it's really a weak cousin of consumer banking and consumer banking is just much easier because if you have five or 10 data points, you can tell whether a consumer should get a mortgage. Not so with small businesses, they suffer from two difficulties. The first is information opacity. It's really hard to know if a small business is really making money and sometimes they don't even know themselves. And the second thing is heterogeneity. All the small businesses are different. So if you're very good at lending to restaurants, you might not be good at lending to steel suppliers.
So how do you overcome that? One of the things that I think might happen is that online competitors will become specialized in different small business verticals and all the information they are sucking up will be provided to small businesses as a cash flow dashboard. We call this small business utopia. Imagine you're a small business owner today. Today, you have to open QuickBooks and then you open your Square account and then you open your bank account and then you open your Turbo Tax account and you're supposed to, in your head, create that Excel spreadsheet cash flow that tells you if you even need a bank loan, you're going to run out of money. You're supposed to do that mentally. Well, the technology exists today to bring all that information together in a way that is valuable to small businesses. That tells them, "Next month it's going to be a time you're building inventory and you probably need a working capital line. Press here, you are pre-approved for $10,000 dollars," and that integration of the access to credit and the intelligence, I think will be the wave of the future.
“I think that there will be a new category of competitors, which are online small-business banks focused on the products and services that small businesses need.”
Kenny: So you've got sort of an ecosystem forming where you've got the Amazons and others that have all the data, but their job then is to package that up in a way that the banks can access it easily. And then the bank's job is to really enhance that customer relationship by packaging that information in a way that the business owner can make sense out of it and being able to anticipate what their needs are going to be.
Mills: Right now it's a free for all. In the UK, we see some challenger banks coming out with just this model of the small business online bank. So I would say it's a drama and we don't know the conclusion yet, but the players are lining up. And I would say this is one of the most interesting industry evolutions that you're going to see with the technological transformation and a real disruption.
Kenny: The case gets into the fact that even though Eastern and Bob and his team really invested in this and wanted it to be successful, and it was … Numerated wasn't a tremendously profitable thing in terms of the overall portfolio of the Eastern Bank. Is small business on the rise?
Mills: Well, small business is a critical part of the economy. And it is definitely a critical part of many banks’ business like Eastern. But one of the things we ask in the case is, was Eastern Labs a huge success, or was it a $12 million, three year mistake? The students have a good time arguing both sides. On the one hand, Eastern Banks is now an innovator. It's known for innovation, it's creating a whole atmosphere where people learned how to test and iterate and they have a successful online product. On the other hand, they spun off their technology and now it's available to others even including competitors to use and they only own 25 percent of the new company, which is not maybe the best return on their $12 million dollars.
One of the reasons we teach Eastern Bank [to first-year MBA students] is it gives us a chance to talk about intrapreneurship—how you create innovation and change in a large organization. We have some great people who have worked on that here at HBS, Michael Tushman. We teach about his ambidextrous organization and how, on the one hand, you have to separate out the innovators from the traditional organization or the traditional organization will kill the innovation. But the trick is to have a successful transformation, you have to reintegrate that innovation back into the core business. And I would say from this case they're still working on that.
Kenny: So there could be a B case, is what you're telling me.
Mills: Absolutely.
Kenny: We'll keep an eye out for that. Thank you so much, Karen, for joining us today.
Mills: Thank you.
Kenny: If you enjoyed this episode of Cold Call, you should check out our other podcasts. After Hours features Harvard Business School faculty dishing on the latest happenings of the crossroads of business and culture, and Managing the Future of Work features experts discussing how to survive and thrive in the age of artificial intelligence and learning machines. Subscribe to these and others on Apple Podcasts or wherever you listen. I'm your host Brian Kenny, and you've been listening to Cold Call, an official podcast of Harvard Business School.
Transcript edited for length and clarity. Interview recorded on November 28, 2918.