Intangible Assets: A Story of Asymmetric Warfare
Incumbents, Fintechs & Platforms Are Engaged In Asymmetric Warfare To Decide The Future Of Banking
In these early years of the 21st century, we are experiencing a Counter-Industrial Revolution. In the original industrial revolution, machinery, factories and mass production supplanted land as the principal asset (see our earlier commentary, The Counter-Industrial Revolution). Today’s revolution represents a move in the opposite direction, towards an intangible economy where physical assets have been replaced as the principal source of value creation by intangible assets – such as software, brands, customer relationships and ‘moats’ (to use Warren Buffett’s term). Studies show that the greatest part of an organization’s value is now likely to be its intangible assets; firms invest more in intangible assets than tangible assets; and both superior productivity and returns on capital are primarily attributable to intangible assets.1
In this series of papers, we focus on banking because it is one of the most intangible-intensive sectors, but you don’t need to be in financial services to draw useful conclusions about your own industry from our analysis. For banks, the rise of the intangible economy raises two key questions. First, how do banks generate value through intangible assets? And second, how will banking itself change in response to the distinct demands of an intangible economy?
Financial services is the second most intangible-intensive sector
When it comes to generating value from intangibles, banking is already highly intangible-intensive. In fact, intangible assets make up a larger share of investment in financial services than in any other sector apart from professional services, outweighing the investment in tangibles by a ratio of 2.3:1.2
Source: UK Office for National Statistics
Arguably, an underlying cause of the predominance of intangible assets is that financial services inherently contain an intangible aspect. Intangible factors such as trust, rights, time (and its impact on the value of money), security and transparency have always been fundamental to banking. Even the money used in daily transactions is at heart intangible: a piece of paper with the promise “to pay the bearer on demand …”.
The war of intangible assets is an asymmetric struggle that will decide who wins and who loses
In today’s digital age, you would be forgiven for thinking that by ‘intangible assets’ we mostly mean software. There’s no doubt that software is of critical importance, but banks hold a wide range of other intangibles: regulatory licences, customer relationships, data, trademarks and patents, and trained employees3. If you doubt the value of these ‘non-digital intangible assets’, ask a challenger bank that has built a next-generation banking platform but finds its growth constrained by:
- The time and expense entailed in obtaining banking licences
- A customer base that falls far short of the point where economies of scale kick in
- Limited brand recognition to attract new customers
- The loyalty that many customers show to their traditional bank, especially over where their salary is paid (and consequently where large under-exploited balances sit)
- Insufficient employee expertise in compliance and credit risk – skills that are essential if banks are to move into more complex (and profitable) banking products.
Of course, for incumbent banks the reverse is true. They are rich in non-digital intangibles but lack computer software – or rather, have the wrong computer software. Established banks have notional strengths in their data and customer base but until they are able to marshal them as assets, they remain underexploited, like chess pieces that are not on the table. Think how much banks could know about their customers and product profitability from countless years of financial history through several economic cycles, if only they were able to harness this data. It may even be that some of their most valuable assets are not considered to be assets at all. For instance, Google’s most valuable asset turned out to be the ‘data exhaust’ that was generated as a product of searches: “For example in addition to keywords, each Google search query produces a wake of collateral data such as the number and pattern of search terms, how a query is phrased, spelling, punctuation, dwell times, click patterns and location.”4 This data, which Google had been storing almost inadvertently, enabled the machine learning that drove its behavioural insights.
The global platforms (Google, Apple, Facebook and Amazon) have different strengths and weaknesses again. Their strong cards include customer bases counted in the billions, with concomitant frequency of touchpoints and screen time; huge amounts of data about customers, informed by not just demographics but also up-to-date circumstantial information (just got married, pregnant, thinking of moving house, recently laid off, looking to invest in a pension); and unrivalled depth of expertise in developing algorithms. On the other hand, they lack banking expertise, regulatory licenses and, though some of their software is highly pertinent (such as identity management and geolocation), they lack banking systems. (The Chinese platforms are of course already in a different position, having moved more decidedly into financial services.) The obvious strategy is to pick off areas of banking that have a low regulatory threshold and then partner to plug gaps, with both FinTechs and open-minded banks who have decided that if you can’t beat them then join them – and best do it first.
Intangible assets will be key in determining success in banking, as in all industries. The graph below illustrates the relative strengths and weaknesses of the intangible assets of the players in the banking sector. In considering this assessment, bear in mind the extent to which the shape of the battlefield can be rapidly altered through alliances with partners (‘Waterloo with the Prussians’ vs. ‘Waterloo without the Prussians’) and investments to transform the value of under-exploited assets such as data.
Banking in an intangible economy
In every sector, it will be essential to ask how customer wants, needs, processes and behaviours will be different in an intangible economy because this is where space will open up for new products and services. In banking, this question will be all the more important because banking is by its nature a services function that exists only to enable others’ ambitions and desires. Inevitably, therefore, as the economy becomes more intangible, banking products and services must change.
For example, trade finance (one of the oldest banking functions) is bound to change when what is imported/exported is increasingly intangible or, when tangible, wrapped in intangibles such as rights, patents, software, etc. Likewise, trade finance must be transformed with the arrival of the ‘internet of things’, when most manufactured ‘things’ have a digital manifestation – an intangible asset that sits alongside the physical asset and can transmit, receive and act upon the information.
When it comes to lending, fundamental practices (such as assessing the ability to pay and taking collateral as security against default) will be required to change when the most valuable assets that firms possess are intangible. This is because intangible assets have distinct characteristics. As Haskel and Westlake explain in ‘Capitalism without Capital’5, key characteristics include:
- Scalability. As opposed to physical assets that are consumed and wear out, intangibles are scaleable – think Google, with its data and algorithms. How do you assess future cash flows from an asset that may increase in value over time?
- Synergies. Much of the value of intangible assets come through synergies with other intangibles. For instance, with platforms, customers draw in other customers and partners, and additional customers bring more data to refine algorithms. These synergies between intangible assets create self-reinforcing loops. But how do you value an asset whose value is not inherent, but depends on how it is brought into play and combined with other intangibles? Or an asset that has high value when times are good but little or no value when times are bad?
- ‘Sunken-ness’. Whereas tangible assets can be sold or repurposed, intangibles are more sunk – it is impossible to sell software that is specific to a business or training that resides in your people. How do you lend to a customer whose principal assets cannot be used as meaningful collateral?
Moreover, it is inevitable that, as banking responds to the growing intangibility of its customers’ assets and operations, ‘financial architecture’ (which includes financial contracts, banks, markets, and monetary and legal systems) will likewise evolve to be still more intangible. We can expect the trend towards intangibility to also apply to underpin analytical techniques, since banking is not only about financial architecture: “Finance is also a system of analysis that incorporates counting; recording; algorithmic calculation; and advanced mathematical methods, such as calculus and probability theory”.6 Indeed, since its inception, banking has been on a path towards progressive intangibility, as this series illustrates:
- Money: Gold and silver coins, banknotes, cryptocurrencies
- Saving: Deposits, interest, bonds, synthetic products
- Banks: Branches, digital banking, cashless society
In conclusion …
As the intangible economy increasingly takes root, banks will need to re-align their products and services to the needs of their customers, whose assets and operations will become more and more intangible. At the same time, banks will have to re-think their competitive strategies to exploit the intangible assets that they possess or can acquire through partnering, and to parry the attacks of competitors who hold asymmetric assets. Although the financial services sector is already intangible-intensive, a deeper investment in intangibles is inevitable as financial architecture and financial analysis continue their progression towards intangibility.
In future articles, we will examine in more depth the strategies through which banks can create value from their critical assets – both digital assets such as scalable digital operations, digital platforms, data, algorithms and digital assets that can be monetized in their own right; and non-digital assets such as customers, partners, trust and transparency.
1 Susana Ferreira and Kirk Hamilton, ‘Comprehensive Wealth, Intangible Capital, and Development’, World Bank Policy Research Working Paper 5452, 2010; Carol Corrado and Charles Hulten, ‘How do you measure a technological revolution?’, American Economic Review, 2010; Meghana Ayyagari, Asli Demirguc-Kunt and Vojislav Maksimovic, ‘Who are America’s Star Firms?’, World Bank Policy Research Working Paper 8534, 2018; Nicolas Crouzet and Janice Eberly, ‘Intangibles, Investment, and Efficiency’, AEA Papers and Proceedings 108, 2018
2 Experimental estimates of investment in intangible assets in the UK: 2016 http://www.ons.gov.uk/economy/economicoutputandproductivity/productivitymeasures/articles/experimentalestimatesofinvestmentinintangibleassetsintheuk2015/2016
3 Balance sheets often include ‘goodwill’ – an accounting treatment where the cost of acquiring a company exceeds the fair market value of the assets and the additional amount is capitalized as ‘goodwill’.
4 Shoshana Zuboff, ‘The Age of Surveillance Capitalism: The Fight for a Human Future at the New Frontier of Power’, Profile Books, 2019
5 Jonathan Haskel and Stian Westlake, ‘Capitalism without Capital: The Rise of the Intangible Economy’, Princeton University Press, 2017
6 William Goetzmann, ‘Money Changes Everything: How Finance Made Civilization Possible’, Princeton University Press, 2016