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An atypical test for spotting financial system failure

In nature, the Asian Giant Hornet is a predator that feeds off bees with the goal of obtaining the honey bee larvae. One of these hornets can kill as many as 40 honey bees per minute. It takes only a small amount of these hornets a scant few hours to exterminate the entire population of a 30,000-member hive, leaving a trail of severed insect heads and limbs, effectively destroying their food supply. Without the natural barriers of distance and geography, hornets would wipe out the entire bee species.

Many areas of the business world demonstrate a similar “win at all costs” business model even if it goes so far as to destroy their customer base.

The core premise of the Hornet Nest Theory is that wherever this is allowed to happen, it is a clear sign of system failure.

Getting Stung

Recently I was on a trip to Phoenix to attend a National Speakers Association Convention. While driving back to where I was staying I was unknowingly stung by one of their photo radar cameras and issued a speeding ticket for $182 for going a mere 12 mph over the speed limit on the Interstate.

It gets better. The ticket arrived a full six weeks after the violation. Up to that point, I had no indication that I had exceeded the speed limit.  I was far more concerned about “where I was going” in an unfamiliar city than “how I was driving”.

The notion of traffic tickets being used to promote safer driving habits was totally abolished from the equation by the sheer length of time between infraction and receipt of ticket. To me this was nothing more than a government sanctioned money-spinning operation split between the local government and the company that installed the radar cameras.

Understand that I’m not saying I didn’t exceed the speed limit, only that the legal violation seemed only distantly tangential to the rights it granted them to fleece my pocketbook.

Much like walking too close to a hornet’s nest, I was stung, and don’t plan to go back.

Regardless of their self-justifying posturing promoting a so called safer society, as a consumer, I’ve chosen to stay away from that particular hornet’s nest. I was planning on attending a second conference in Phoenix in November, but I’ve now decided not to go. The “Big Brother” style speeding ticket was the deciding factor.

I am using this example to illustrate the fact that government and private enterprise are concurrently competing directly for the same consumer dollars. Because of the extra penalties levied by insurance companies, court costs, and others (my rental car company tacked on an additional $10 fine), the issuing of one questionably-intentioned traffic ticket can result in a significant blast zone with long-term consequences and ramifications.

While I haven’t found any studies on it, I feel confident that cities who aggressively enforce traffic violations and other petty enforcements are the same communities where businesses struggle. Aggressive enforcement of any kind scares people. Would-be customers have a long memory and will travel considerable distances to avoid getting stung.

The Hornet Nest Theory

The Hornet Nest Theory, simply stated, is that people tend to stay away from places where they get stung. If they don’t or can’t stay away there is something clearly wrong with the system that governs it.

The late Citi Group Chairman Walter Wriston stated that capital, when freed to travel at the speed of light, “will go to where it is wanted and will stay where it is well-treated.”

Any municipality that develops the moniker of “speed-trap city” is putting their local businesses at a distinct competitive disadvantage. Each consumer represents a self-guided revenue stream, and given the freedom to self-direct, their decisions will be heavily influenced by ”where their money is wanted and where they feel well-treated”.

It is basic human nature to avoid the horrors of any hornet nest.

But the Hornet Nest Theory applies to far more than just a few ticket-happy municipalities. It applies to virtually all aspects of business.

Consumers and their money flow to businesses that make them feel welcome and give them great value.

System Failure

One area that best demonstrates a Hornet Nest system failure is the seemingly masochistic relationship that banks and credit card companies have with their customers.

These financial institutions are notorious for repeatedly stinging their customers with a plethora of fees and penalties to the point of cannibalizing entire bank accounts, effectively killing their base of customers.

Why then don’t customers flee from this kind of hornet-stinging customer abuse? The answer is simple. They feel trapped! With the heavy handed influence of credit bureaus and the rigid requirements for opening a new bank account, many are left with no other options. They either endure the financial pain of the hornet stings or go without, and the “go without” lifestyle is far less appealing.

From a business standpoint, it easy to understand why companies want to make it difficult for customers to leave. As an example, phone companies insist on two-year contracts to offset contract incentives, such as free phones, and to minimize churn. Real estate brokers often insert penalties and other encumbrances into their contracts to ensure that buyers won’t walk away from a deal.

It’s also easy to understand why companies will finesse their penalties and fees to a point where it becomes a major source of income. Rest assured, customer loss is closely monitored, so they are keenly aware when the pain threshold has been pushed too far.

In the financial world, penalties and fees are an effective way to circumvent usury laws and boost the bottom line. Often times this can amount to double, triple, and even quadruple the rates normally allowed by law.

For certain, banks and credit cards are not the only industries creating win-lose relationships with their customers. Pawn shops, payday loan services, rent-to-own, and check cashing services are just a few of the many players who work on this lopsided end of the customer relationship spectrum.

Customer Abuse

During the past few months, credit card companies have become increasingly blatant in their treatment of longstanding customers. Most have increased interest rates to the current maximum of 29%. In less than a week, five credit card companies sent us letters saying they were raising rates, sometimes as much as doubling, our previous interest rates. For people like us who routinely make payments on time, they’ve resorted to other tactics such as changing the due date for payments to five days earlier than the previous due date. Late payments not only trigger a penalty, but also gives these hornets an excuse to ratchet interest rates to the legal maximum.

Credit card companies are currently waging an all out war against “shallow pocketed” individuals, and this includes most of us. Anyone who cannot instantly pay off their remaining balance is subject to attack. Consumers simply have no recourse other than to pay the exorbitant amounts or file bankruptcy.

While congress is currently making noise about curbing this kind of excessive behavior, any actions they take will come far too late to prevent the “hornet nest” carnage currently being left in the wake of these attacks.

Probable Futures

Clearly what seems to be missing from the current equation is any kind of checks and balance system. So the question remains, how do we create a system that allows for the free flow of customers and their money to places, as Walter Wriston suggests, ”where their money is wanted and where they feel it is well-treated”.

As a futurist my work involves looking at system failures and the resulting breaking points. Left unimpeded, any win-lose system such as this will result in an industry that will inevitably self-destructs.

These are the all-important breaking points that will force us to go a new direction. When the pendulum swings one way, it will invariably swing back. So what are some likely scenarios?

In our rapidly morphing business world, change is being driven by three primary disruptive forces – disruptive public policy, disruptive business methodologies, and disruptive technology. Here are four possible scenarios that may trigger major changes.

Scenario #1 – Redirecting the Revenue Streams from Penalties – (Disruptive public policy)

Currently the law allows for individual bank and credit card companies to act as the judge, jury, and executioner for each “customer violation”.

What if the companies that imposed the penalties were no longer able to receive any benefit from them? What if the revenue streams from penalties and fees were redirected to another entity such as a credit reporting agency, conflict-resolution company, or governmental regulatory body.

One can easily imagine that if the U.S. House & Senate Banking Committees legislated this one simple rule change stating that companies could no longer received any direct benefit from their penalties or fees that the fees and penalties would instantly begin to evaporate.

Scenario #2 – No-Bounce Bank Account – (Disruptive business methodology)

Moore’s Law has dramatically changed the timing of transactions. Transaction technology has continued to speed up and the traditional time float has been squashed to zero. We have entered an era of real-time transactions. And along with real-time transactions comes other opportunities less obvious to financial communities whose thinking has been based on established linear ways of doing business.

Our primary tool for conducting financial transactions in the future will inevitably be convenient handheld devices such as the iPhone, the PRE, Android, or Blackberry. We will not only use them to make payments and deposits, but also have a running account balance available at any given moment. The devices will be equipped with multiple layers of security, such as biometric scanners, to insure every transaction is safe.

When the time float is reduced to zero and risks of transaction failures are all but eliminated, a natural progression points to a disruptive business model I refer to as the “no-bounce bank account.” Financial institutions, including banks and credit cards, have long been criticized for the excessive penalty fees they charge for overdrafts, late fees, and over limit fees. With real-time transactions, a renegade banking company could quickly differentiate themselves by introducing a no-penalty consumer-friendly bank account and establish an entirely new standard for the industry.

This type of service could greatly increase a bank’s customer base to include many of the un-banked and under-banked opening entirely new markets for banking services.

Scenario #3 – Bank-on-a-Chip – (Disruptive technology)

Currently banks serve as intermediaries. They are the in-between institution governing our access to money and managing the distribution of it.

At the heart of the banking industry lies a payment system that has been difficult to design around. Bank accounts serve as the central repository for personal wealth and offer a convenient way to issue payments.

Beyond our paper-based currency, the entire monetary system operates as nothing more than digital bits and bytes. Where we store our own bits and bytes should be up to us. So the logical question to ask is, “What if the money wasn’t stored in a bank, but rather on a chip, a chip that we control with multiple backup systems that talk to a central controller to insure system integrity? And continuing with this line of thinking, what if the payments could be made directly from person to person with no bank involvement?”

Current efforts in developing peer-to-peer payment systems are leading us towards this kind of “no-bank banking concept”.

Yes, there would indeed have to be a trusted institution in the background to insure the integrity of the system, but it could conceivably be something other than a typical banking operation. If, for example, Google and Wal-Mart were to team up and offer “no-bank bank accounts” and deposits were privately insured and considered safe by the consumer, the migration of customers would be swift, and millions of traditional bank accounts may well evaporate over night.

The primary motivation behind this movement is once again the feeling by customers that their money is no longer “well-treated”.

Scenario #4 – Foreign Competition

In a recent survey we asked the question, “If one of the following organizations began issuing their own currency, which one would you trust the most?” The question was followed by a list of 15 organizations including Visa, Harvard University, Llyods of London, Apple Computers, the State of California and several more. It was interesting to see that the two that rose to the top were Google and Wal-Mart, viewed in this context to be America’s most trusted brands.

Since it is becoming increasingly unnecessary for customers to live in close proximity to their bank, an obvious question to ask is, “Will foreign banks be able to make a serious play for U.S. customers.” It is true that Swiss and European banks have a long history of serving American customers but this is still a tiny percentage of the market.

Perhaps a better way to ask this question would be, ”Can any foreign bank garner sufficient trust to seriously compete for a large-scale migration of U.S. customers?”  The answer that we give today will most certainly shift along with technology and the political landscape.

To make serious inroads, a foreign competitor will need to offer a substantially better alternative to the current U.S. based companies.

Final Thoughts

Shown in this light the Hornet Nest Theory becomes a valuable tool for spotting potential weaknesses and failure points in our current skewed systems. Done correctly, a well-executed structure for the banking system could dramatically improve the economy. Money would flow more efficiently with less friction to contend with.

Realizing that we will never be able to create the absolute perfect system and that the human element is equally as difficult to design for as around we are left knowing that people are both the greatest problem and the greatest solution. However, whenever the imbalance is great enough, people are driven to action, and in this environment the actions will happen swiftly. So just how close to the nest are we?