New-tech firms play clever game in taking on entrenched institutions and shaking up incumbents

There is a saying in Silicon Valley that "software is eating the world". Attributed to the Californian entrepreneur-turned-investor Marc Andreessen, it describes a phenomenon in which traditional industries are increasingly being taken over by software and online operation.

"We are in the middle of a dramatic and broad technological and economic shift in which software companies are poised to take over large swathes of the economy," he wrote in the Wall Street Journal two years ago.

Machines have been replacing human workers since the Industrial Revolution. What's different this time is that the replacement is happening beyond manufacturing, in service industries like education and retail. And instead of machines, it is software, often aided by the Internet, that is nudging out humans.

In the past 20 years or so, technology innovation, including development tools, network technology, and artificial intelligence, has been so efficacious that no industry is immune any more.

The latest example in this evolution is taking place in China, in the finance sector. Following Alipay's entry into personal finance, other Chinese Internet juggernauts have rushed to introduce their own financial services. The new wealth management site of China's dominant search engine Baidu was so popular that its servers had difficulty accommodating online visitors - and it is no stranger to handling heavy Internet traffic.

Unlike some of the more conservative and slow-moving industries such as education, the world of finance has been rather open to technological innovation. Machine-controlled trading algorithms have long been a major player on Wall Street, beating human brokers with their speed and precision, and giving rise to successful "quant funds" like Renaissance Technologies. Financial institutions, with their generous budgets, eagerly seek every advantage and are often early adopters of new technology.

With Alipay and Baidu's latest movement, the direction has been reversed. Instead of well-endowed financial institutions adopting the latest technology, it is technology companies, especially Internet companies, that are making a foray into finance.

At the moment, the likes of Baidu are mostly staying on the retail side of the business. They are not peddling their own financial products, but are leveraging their huge traffic and partnering with traditional financial institutions.

Seen in this light, this latest development may come across as less groundbreaking than it initially appears. But this is not to say that it does not present a significant step. As is often the case when the Internet gets involved in an industry, inevitably more transparency and tougher competition soon follow.

A case in point is the movie rental business after Netflix came onto the scene. Netflix, riding on consumers' adoption of the Internet and DVD, fought a head-to-head battle with incumbent player Blockbuster for the online movie rental business. Although Blockbuster had the brand and a well-financed team, it eventually lost out to the upstart.

After a race to cut rental fees and improve service between the two companies, movie viewers were the ultimate beneficiaries. Limited selections and late fees became a thing of the past. Blockbuster has gone bust, while Netflix continues apace with its strong tech expertise and customer service culture and now dominates the new Internet video-on-demand market.

A similar scenario may not be far from the minds of Internet company executives, as they made the decision to expand into finance. The first ones to feel the pressure will be retail banks and retail brokerage firms. Like Blockbuster, they have enjoyed comfortable profit levels due to their entrenched offline presence. The Internet promises to be a game changer, with no cost to set up retail outlets and virtually unlimited capacity to serve customers. Internet companies also come with a culture of excellent customer service and transaction speed.

As has happened in industry after industry, the entrance of Internet players will shake up incumbent ones, many of which cannot adapt fast enough and become easy pickings. If past examples are any indicator, the ambitions of these new players will hardly stop at taking over retail. Is it possible that after gaining an initial foothold in the financial industry they could expand into the core business of designing their own financial products?

That may seem rather removed from their current expertise, but it is happened in other fields. Again, take the case of Netflix, which started out as an online video rental company. It financed the hit US TV drama series House of Cards, entering the turf of original content production.

Technology companies have a history of gaining entry to well-guarded traditional industries from unexpected directions. Who is to say that Baidu will not, after learning the ropes of its new venture, come up with innovative financial products of its own? It probably is in a better position to do so, with its access to vast amounts of data, and advanced analytical tools.

Indeed, Baidu may well be on its way to such a future. In November, Baidu Jinrong (Baidu Finance) debuted after months of trials. This new service offers search facilities in credit card and loan services. It is a natural extension of Baidu's core competency, but at the same time reveals the Internet company's ambition in the financial services industry.

Baidu's CEO Robin Li made it abundantly clear in the recent quarterly meeting that incorporating financial services into the Baidu product family is a key step in its overall strategy.

How things will play out is anybody's guess. Besides market forces, there is considerable regulatory uncertainty surrounding this development. Financial services is regarded as a sector vital to a country's economic well-being and is heavily scrutinized. Any changes are likely to be introduced in tentative baby steps. But it is hard to imagine such a lucrative and important industry remaining unaffected by the Internet. At the same time, the Internet companies, pressed to seek new revenue streams, will surely push hard to get in on the action.

After some initial experimenting, with the authorities keeping a close watch, appropriate regulations will probably be introduced, ensuring fair play and market stability, but also probably acknowledging the rightful places of the new players. In the past, they have proven to be a positive force, bringing new ideas and rejuvenating stagnant markets.

This could well be what China needs. In many ways the sectors in China are less developed than their Western counterparts. Ironically, it also makes it possible for new entrants to take advantage of the latest technology without having to deal with legacy issues.

Taobao is wildly more successful in China than its counterpart eBay is in the US, precisely because offline retail was less well developed in China, giving Taobao a vacuum that it was only too happy to fill. Similarly, with China's underdeveloped financial services industry, Internet finance has a bigger shoe to fill here than elsewhere.

The author is an independent commentator in Beijing. Contact the writer at fengwriting@gmail.com. The views do not necessarily reflect those of China Daily.

(China Daily European Weekly 01/10/2014 page11)