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  • Norbert Gehrke

The Upside-Down World of Friction

This is Part III of our "In Search of Simplicity in Finance" Series. Please refer to Part I and Part II for further context.

Friction in Finance is generally considered a bad thing. You hear plenty of startups working on a "frictionless payments experience", for example. Initially, removing friction implies removing cash from the payments process. Once the payments process is digitalized, it is the number of clicks that, when reduced on the payments app or merchant website, removes friction. Less friction means less complexity, and since we are in search of simplicity in Finance, that can only be positive, right? Well, that is where things are starting to get complicated...


So the question we would like to ask ourselves is, "Is all friction bad?". Arguably, looking at the "Jobs to be done in Personal Finance" introduced in Part II, it is in the interest of our long-term financial well-being for the earning and saving/investing parts of our lives to be as frictionless as possible, while some slowing down of the decision-making process with regards to borrowing and spending might not be a bad thing at all.


Unfortunately, the reality we are facing today is quite the opposite. With the advent of credit cards, items purchased have been decoupled from the emotion of handing over physical cash, and shoppers can focus on the benefits of the purchase instead of the cost (which will only become apparent later on the credit card statement, commingled with many other purchases). Starting with Prelec & Simester in 2001, several studies have found a higher willingness-to-pay with credit cards, by up to 100% more in fact. Interestingly, one can flip this experience on its head as well and choose to pay in advance ("prospective accounting"), so that the consumption later can be enjoyed as if it was free.


This is all part of the consumption & debt economy we have created for ourselves. We do not need more consumption, nor do we need more debt, especially consumer debt. Again, the reality is that in addition to the highly valued startups that enable a frictionless payments experience ("Spend more!"), those startups that facilitate "buy now, pay later" ("Borrow more!") are not far behind - Swedish firm Klarna, for example is valued at USD 5.5bn. The world is upside-down, and detrimental to our financial well-being.


Not everyone is good at handling money prudently. Many live paycheck to paycheck. Leaving a lack of financial education to a side, the type of company mentioned above is a predator for those who are not financially literate. Thankfully, I would claim that I am relatively good at handling money - but I am terrible with chocolate. Leave a bar of chocolate next to me, and it will be gone in less than 15 minutes (and I am leaving a generous margin here). So my wife has come up with a simple method: whenever we happen to get into possession of a few bars, she will sequester them, and dole them out to me on a weekly schedule. So what is the equivalent of my wife for personal finance? It is an app like Squirrel, for example, which allows you to set up a budget and stick to it by safekeeping your money until you need it. So it would block your rent money - possibly by moving it to a different bank account that they maintain as a trustee - until releasing it for the day your actual rent becomes due. That is the type of friction in the spending process that is beneficial to financial health.


Let us talk briefly about the earning side. Without turning this piece into a full social critique, we would argue that there are several well-known startups that have based their business model entirely on subsidizing their product through venture capital, and worker exploitation by calling their employees anything but employees. In fact, they have just copied what many large corporation have perfected a long time ago through "loan workers" or "contractors". That would give us a red circle for the earnings side of things, where technology has not been to the workers' benefit. However, we do see a few interesting startups that focus on improving by financial health, for example by allowing the instant payment of wages once a shift has been completed, rather than on a weekly or monthly basis. While there is much more room for improvement, these glimmers of hope let us pick a yellow rating for the current earnings landscape.

If you liked this article, we invite you to give the eXponential Finance Podcast a try as well - you can find it on this site, or alternatively on Apple Podcasts, Spotify, Anchor, etc.

Please also follow eXponential Finance and Norbert Gehrke on LinkedIn.

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