Exploring customer market share dynamics of UK retail banks emerging from their adoption of sustainable business models

Abstract

Digital challenger banks in the UK retail banking industry have caused unprecedented Personal Current Account (PCA) market share changes at the cost of traditional banks. This loss in competitive position prompted traditional bank managers to reconsider the way they operate, resulting in the commoditization of digital services till date. Now, the industry is faced with another potentially disruptive strategic innovation: sustainable business models. Adopting such a business model is, however, a complex decision for bank managers, as they need to ensure that the resources and capabilities of their bank align in an optimal manner to achieve competitive advantage. On the one hand, there is evidence in favor of sustainable business models as they have been associated with lower bank risk, better (financial) performance, and higher stakeholder value. In addition, consumers and policymakers increasingly expect UK retail banks to adopt a sustainable business model. On the other hand, there are also many uncertainties regarding the disruptive potential of sustainable business models - in part because there is no insight on how consumers might respond. Bank managers are thus faced with a dilemma on whether to change their business model at the cost of existing revenue for potential future profit.

In this study, we aimed to address these latter risks by providing insights into the mechanisms that underlie changes in the PCA market shares of UK retail banks and investigating what the future composition of the UK retail banking industry might entail when banks adopt sustainable business models. The UK retail banking industry is, however, a complex, open, uncertain, and dynamic multi-actor system in which the competitive position of banks depends on the strategic decisions of themselves and their competitors. As a consequence, there are many plausible future states of the system that can only be explored by the quantitative simulation of banks’ interactions. Previous literature advising bank managers on the adoption of sustainable business models fail to do so.

Due to the lack of detailed data on the consumer response to sustainable business models, however, we could not employ existing market share models that generally rely on the statistical analysis of this detailed (time-series) data. As such, we developed a novel simulation model that used the language of game theory in the context of agent-based modeling (ABM) to understand the complexity of customer market share dynamics. Specifically, the model simulated the consumer choice of bank behavior in response to the strategical decision-making of 20 banks on a variety of topics (e.g., sustainability, digital capabilities) during a seven-year time period. Consequent to being the first model of its kind that allows the study of the disruptive potential of a strategic innovation, we note that the model is unique in its ability to (i) simulate the endogenous decision-making by the banks under study in response to the evolving state of the system, (ii) simultaneously include (potentially) competitive effects (i.e., customer switching volumes) and (potentially) market-expansive effects (i.e., PCA market growth), and (iii) systematically address system uncertainties.

Using exploratory modeling of 12,000 alternative future scenarios, we show that PCA market shares are quite robust (i.e., between 0.5-2% decrease) to different factors such as the customer switching volume, PCA market growth, consumer choice of bank behavior, and different types of sustainable banking implementation strategies (e.g. being a leader or follower). As to the mechanisms that do underlie the marginal changes in the market shares of UK retail banks, we identify a role for improved digital capabilities of mid-tier banks resulting in an improved competitive position of these banks. In addition, smaller specialized banks in the UK may capture some market share, but this growth is limited as serving more customer segments is associated with less overall satisfaction and a consequent potential decrease in market share. This trade-off means that the organic growth of smaller banks in the UK retail banking industry is limited. We furthermore show that low PCA market growth, low consumer preference towards banks’ sustainable operations, and moderate to high consumer preference towards banks’ service quality and digital services significantly contribute to limiting the market share decrease of big 4 banks to max. 0.7%. Finally, we also show that PCA market pressure is not sufficient for all UK retail banks to adopt a sustainable business model. As such, we conclude that sustainable business models are not directly associated with PCA market share dynamics and that they have a minimal disruptive potential.

While numerical inaccuracy limits confidence in the simulation model outputs, the findings of this study can be used to draw general policy directions for UK regulators and bank managers.
To regulators:
• Focus on increasing competition through unique new entrants, as increased switching volumes currently have little effect on dynamics in customer market shares due to too little competitive differentiation between retail banks;
• Introduce additional incentives for retail banks to adopt sustainable business models, as PCA market pressure alone is insufficient to introduce a sustainability transition in the UK retail banking industry within the next seven years;
• Facilitate consistent data collection on a number of bank KPIs and make this data publicly available to aid future research onto the competitive positions of banks by both regulators and the private sector.
To bank managers:
• Do not focus on building customer market share, as one will likely capture customers that open a secondary (or even tertiary) account which is often operated with a very low margin (if not at a loss);
• Redefine how the customer value proposition is designed, as sustainable business models might have non-tangible side effects such as more loyal and less price-sensitive customers;
• Set up specialized PCA products to focus on an underserved small customer segment to avoid competing with the bulk of PCA providers;
• Use monetary incentives to compensate for a lacking performance on sustainability, digital capabilities, or service quality, as these incentives effectively dampen the dynamics in customer market shares;
• To mid-tier managers, investigate the potential to capture market share, as this study indicates that a potential upswing in mid-tier market share is possible.

Finally, we urge bank managers to consider the ecological consequences of sustainable business models when designing their policies. Precisely because there is no direct link between sustainable business models and customer market share, one can adopt such a business model without fearing the competitive position. The plausibility of irreversible climate change does mean that investment in measures for dealing with these circumstances, and not just greenwashing, should be taken sooner rather than later. Future work should focus on facilitating such multi-objective decision-making for bank managers by extending the model KPIs (e.g., consumer deposits, sustainability metrics) and by improving the model structure to increase numerical accuracy.