In the wake of a global pandemic, the deaths of George Floyd, Breonna Taylor, and many others, and an uncertain election season, we’re examining the role of trust in society and in business.
We the people are questioning whether we trust our friends to social distance, our employers and government to look out for our well-being, the police to administer justice, and plenty of other shifts that have taken place in 2020. With a renewed sense of vulnerability, it is natural to re-examine the role of trust. What does it mean to trust someone or something? How do people make the decision on whom to trust? What is having it worth? Should individuals have trust in businesses? And how can we look to harness trust more systematically in company building? We view trust as one of the most important assets in business today, yet one of the worst defined.
We’ve been watching the evolution of trust for a few years now. The following is a four-part series that consolidates some key insights from our work. Like most changes in economics, the presence of people talking about trust started as a slow and intermittent flow of insights — led by the likes of Rachel Bostman, Joe Gebbia, and Edelman PR. And now people talking about trust seem to be everywhere, all at once. The growing importance of trust was already happening, but COVID forced it front and center.
We leave it to you to handle social distancing judgment with your friends, but our goal with this series is to share what we’ve learned about the role of trust, how to build it, and how entrepreneurs and investors can harness it.
1. Trust is an Asset
If you lived in America in the 1950s, you and most people you knew, shared the same community banker. He (because it was almost always a ‘he’) had probably been your main contact since your first paycheck. You wouldn’t only see him at the bank, but out in the community. Perhaps your kids played on the same softball team, or you saw him on Sundays at church. The relationship would be professional, but also friendly, personal. When it came time to buy a house, take a business loan, make an investment decision, look for insurance, save for retirement, or perhaps even take a new job, you would trust your banker to offer sound professional advice — not just because he represented an august institution but because his personal relationship with you was riding on it.
Fast forward to today and this description is antiquated. In the 2000’s we substituted trust in individuals for the trust we have in institutions — we trust Bank of America more than Bill Banker. As banks consolidated, built global brands, and sold consumers on the advantages of scale (new financial products, national ATM networks, 24-hour service), customers rarely saw the same person twice, if they saw anyone at all. Individual trust fractured and institutional trust replaced it.
Then cracks in institutional trust began to form well before the digital acceleration brought about by the pandemic. They happened as the interests of institutions became misaligned with the interests of their customers. In pursuit of earnings growth within a mature industry, banks added lots of new fees — late, ATM, overdraft, low balance, interest rate adjustments, etc — that in some cases comprise up to 40% of the bank’s income. Fees drive profits for companies but are usually unanticipated by customers and generally come at the hardest times. Customers began to feel that the worse they do (e.g. pay more fees), the better their banks do. This misalignment has become increasingly visible through the transparency brought by online communities.
For many people, their trust in financial institutions broke wide open during the financial crisis of 2008. Big banks faced bankruptcy, and suddenly a bank vault felt much less safe. People discovered banks had their own best interests at heart, not their customers’ — and the two interests were further apart than customers had imagined. Wells Fargo is still embroiled in a scandal that it opened accounts and charged for services without customer authorization. Add in controversy more recently about the handling of the Paycheck Protection Program and others and the current level of distrust is pretty understandable.
According to Edelman’s 2020 trust barometer, financial services is the least trusted industry worldwide and has been for the last 8 years. Over 90% of Millennials distrust their bank. Customers now voice antipathy towards their bank with a common refrain: the times when I was most vulnerable (lost my job, had an unexpected expense, arrival of a new baby) were precisely the times when my bank tightened the screws. This significant loss of trust, across a huge industry, has created an enormous opportunity for value creation.
Consumer banking is an industry with commodity products built on top of the ultimate commodity — money. Most new entrants have sought to differentiate on the basis of product (clean new UX, robo-advisors) or pricing (high savings rates, zero cost trades). However, new product features are quickly copied by incumbents who have significantly lower costs of capital. So how do you attack an industry that is full of customer loathing, where trust in institutions has eroded, and where incumbents compete on economies of scale? Shift the basis of competition.
Trust is an asset. When built and nurtured, it forms the basis of nearly unassailable competitive advantage. Customers who trust not only stay, but they become advocates that accelerate growth, reinforce community, and deepen network effects. When companies tout brand value, what they really mean is they have built trust. Trust translates to a high barrier to entry, which in turn translates into economic value. We see this value measured in high revenue and cash flow multiples, with higher certainty of future cash flows, and in the difference between equity and asset value. We also see this economic value degrade when trust is violated and multiples compress while future financial performance weakens.
Trust as a Business Model
We understand intuitively that trust is a required concept in social relationships — we trust our family and friends. But more abstractly, trust is also the basis for all transactions. We trust that fiat currency is worth something, the mail will arrive every day, elections are fair, and doctors will correctly advise on the best course of treatment. Understanding trust, and how it is shifting, is a critical lens into the evolution of the global economy. Who we trust and why will direct the next wave of innovation, with significant derivative impacts. Technology is a key enabler of this next wave. It is creating the opportunity to build intimacy with customers — the type that a community banker once enjoyed in a one to one setting — but at scale.
For example, nearly all of us were raised with the simple axiom that stranger = danger. A decade ago, very few people would have been comfortable sleeping in a stranger’s apartment or riding in the back of their Honda Accord. So, what changed? Technology enabled us to not only conquer fear but also a common social bias. A common (though clearly flawed) heuristic for building trust is similarity — demographic, geographic, beliefs, behaviors, etc. The closer someone is to you, the more you are likely to trust them. We trusted our community banker. But technology allows us to intentionally design for trust in new and novel ways. Airbnb demonstrated it can replace the deeply rooted social bias of similarity by introducing transparency and reputation built on reviews. Through innovative product design, Airbnb encouraged both guests and hosts to leave accurate reviews. They found that once a host has received more than ten reviews, her reputation becomes more important than similarity for a guest making a decision about where to stay. Today, we’ve entered a new era where we are trusting a distributed network. Many people have called the rise of companies such as Airbnb and Uber the sharing economy. More fundamentally, it is an evolution in trust away from institutions and towards community.
Nextdoor is a clear example of enabling the community. They built a platform based on address verified identities where users can talk to their neighbors in trusted ways previously reserved for small towns — but Nextdoor did it at scale. The design of the platform enabled new behaviors for many. Users have to use their real names and take the “Good Neighbor Pledge.” They created community guidelines for behavior and have local monitors with on the ground context manage those communities. Users can sell furniture, ask for recommendations, or borrow a cup of sugar. Since the beginning of the year, the platform has seen a 7x increase in members joining groups — a clear expression of a new desire to connect locally during the pandemic. They even started a “Help map” with neighbors offering to pick up groceries or check in on others in times of need. Nextdoor has turned “strangers” into potential friends.
Insurance is another consumer category that struggles with trust. The industry is huge, 11% of GDP and 12 of the Fortune 100 are insurance companies with an average age of 125 years. Nearly all of them are using broker-based distribution. Perhaps the most troubling facet of insurance is that customers don’t trust the companies and vice versa. 25% of Americans say that it’s fine to embellish insurance claims. Why does insurance seem to bring out the devil in people? Distrust is baked into the business model. Insurance companies and their customers are fighting over the same coin. But the companies have more information, understand every detail in the policy, and hold the money. The less that is paid in claims, the greater the profits. It shouldn’t make sense that Warren Buffet can build the Berkshire empire (and profits) based on the float baked into the business model. Certainly, that can’t align with end customers’ interests. Lemonade set out to change this by creating a business model that is trusting and trustworthy. They charge a flat fee of 25% and buy reinsurance to protect from higher than expected claims while committing to give back any excess profits. The model is set up to bring honesty back — changing behavior — and to both price and operate differently due to lower fraud. The model is reminiscent of the initial intent of many mutual companies, much of which was lost. Since 1930, over 300 mutual life insurance companies have demutualized.
Trust Creates New Markets
When people are faced with something new or different, they feel vulnerable and often reticent to proceed. Yet, once they discover the risk assessment they held of potential outcomes is no longer valid, behavior shifts. We swipe our credit cards and enter the digits into online websites. We share personal details of our lives on global social platforms and let other people pick out our groceries. It took a leap of faith, of trust, to change behavior, but once the trust leap occurs there is no going back.
How do new behaviors enabled by new forms of trust unlock new markets? When Airbnb started, the service appealed to a narrow segment of the population — most of whom would be comfortable staying in hostels. The hospitality industry was big, but this was a small niche. Through product innovation, Airbnb built a network of trust that made staying with a host comfortable, and indeed preferable, to a much, much larger segment of the market. This trust was tested when COVID led to a near-global halt in travel in early 2020. China was an early indicator, then Europe was hit hard, and by March millions of guests had canceled over $1 billion of bookings. Airbnb decided to side with health and safety and overrode the host cancellation policies in order to refund guests. Many hosts were hit hard, alongside small businesses across the country and around the world. As the lockdowns began to be relaxed around the world, people still wanted to travel, just in different ways than they had previously — more local, longer stays, private spaces. Airbnb worked closely with its hosts to come back and in the process, has opened yet another segment of new customers and deepened the trust built into the network. Notably, this trust extends to new products, as Airbnb has shown with the rapid growth of virtual experiences — creating a new extension of their mission to provide belonging and connection.
Existing companies and established business models have a particularly hard time competing and adjusting to a world of new behaviors. They have different economic incentives (fees, retail locations, debt service commitments, public market reporting expectations) that limit adaptation. To continue the sharing economy analogy, analysts often repeat the idea that the largest hospitality and transportation companies, Airbnb and Uber, don’t own their assets. What enabled them to be asset-light is the ability to enable trust to shift from being centralized around institutions to being distributed to the edge.
Because the role of trust is widely misunderstood, it is undervalued. Financial markets continue to rely on economic metrics in a world that assumes scarce capital, leading to short-term optimization and efficiency gains in a zero-sum market. It is hard to measure the Return on Investment (ROI) of an investment in trust and it can take years to actuate change. Trust is rarely included as a KPI for managers and it isn’t a direct part of calculating a Discounted Cash Flow (DCF) valuation. By establishing a shared vocabulary of trust, we can begin to measure and manage for it and reap the benefits of unlocking new markets.
Part II of the Trust series tackles how to systematically define and identify trust in a company.