The year 2001 features a return to bank management’s emphasis on productivity and cost reduction as two critical measures for success. This time, however, managers have a chance to get it right.
All
too often past attempts at cost reduction have occurred without effective
linkage to bank strategy; in effect, cost reduction became the bank
strategy. In addition, those leading
the process have failed to assess the impact of cost reduction initiatives on
internal morale and revenue generation. Employee morale and enthusiasm suffers
as rumors abound and people fear the inevitable loss of jobs.
At
the same time revenue growth often begins to slip. Marketers are less focused
on selling a bank’s capabilities and customers often become increasingly
skeptical about whether the bank will offer the same level of service as in the
past. Their concern is heightened by competitor activities that often focus on
communicating that a bank is in the throes of an internal crisis.
Yes,
the net result of these cost reduction efforts has been a lower cost base at
least for a time. The more pertinent issues concern the cost of these efforts
to a bank’s future?
The
banking landscape is littered with banks that signed on with specialist
“consultants” for dramatic cost reduction initiatives that were packaged as
bank-wide reengineering. Compensation for many of those consultants was tied to
agreed upon cost take-outs. In some cases this may have encouraged supposedly
independent resources to suggest staffing cuts without focusing on the
strategic impact of their recommendations.
Many
of the banks that followed this type of bank-wide three-six month cost
reduction process have disappeared with most being purchased by other institutions.
Banks that fall into this category include Corestates, First Security, Michigan
National, Midlantic, Republic National, and Star Bank, among others. In many
cases cost reduction was a precursor to sale rather than renewal.
Lessons
from the past
Past efforts at reengineering often failed due to a number of factors ranging from over-ambition to failing to focus on growth opportunities:
Why
cost reduction has returned
The
banking industry faces a near-term growth squeeze on both the asset and
liability sides of the balance sheet. One approach management will use to
address that squeeze is to cut costs.
On
the asset side, a dip in consumer and business confidence may result in a
slowdown in quality lending opportunities.
Many banks are placing a greater emphasis on enforcing credit policies
and improving collection activities versus generating growth. These same banks are already seeing some
deterioration in new application credit scores and a decline in approvals; some
warning signs are beginning to show.
In
the small and middle commercial markets, many banks will reduce their appetite
for lending at least in part due to the need for increased reserves related to
marginal credits. At the same time, some of the most creditworthy borrowers
will rethink their capital and borrowing requirements in light of what they
view as an uncertain business environment. Small businesses in particular are
known for being conservative in softer economic times. Both lenders and
borrowers will become more conservative.
While
loan demand slows and credit quality slips, “free” demand deposits may also
become scarcer. We expect both
consumers and businesses to reduce their DDA levels and move an increased
percentage of balances to investment accounts.
Either the banks will in effect cannibalize their deposits by actively
selling sweep money market accounts or risk losing customers to the likes of
Merrill Lynch or Morgan Stanley.
While
deposit erosion is small and its growth is relatively slow, it represents one
of the greatest threats to bank health.
Year after year, many analysts have predicted a reduction in the
absolute level demand deposits. Yet, strong
economic growth combined with customer inertia has allowed banks to continue to
benefit from these profitable products.
Relatively
few senior managers view this more volatile economic environment as an
opportunity to reinvigorate their marketing efforts. For better or worse, within many banks the pendulum will be
swinging back from an emphasis on growth to an emphasis on safety. With that shift back to safety comes a reassessment
of the bank’s cost structure and activity focus.
Banks
seem particularly prone to applying what some might see as short-term fad
solutions to their long-term operating issues.
In recent years many “isms” and packaged solutions have been presented,
and for a time adopted, by bank executives.
Total quality management (TQM), reengineering, branding, customer
relationship management (CRM), the web, and, this year, Six Sigma have all been
promoted as Holy Grail-like answers to performance issues.
Each of the above concepts is valid and can provide substantial value to bank
management. None, however, is the
single, sole-source solution to business problems.
One
negative aspect of each of these solutions surfaces if managers pursue them
without a clear strategic context. For
example, as part of the bank-wide reengineering programs outlined above,
typically, the internal bank team and consultants created databases that
quantified the costs of various activities.
Project team leaders then assessed each item and determined what could
be changed or eliminated. These
processes usually did not address whether a bank should be in a specific
business in the first place or, conversely, whether a particular line of
business in fact merited increased investment because of its profit potential.
Cost
reduction cannot be effectively evaluated outside the context of a business’s
potential impact on the bottom line. In
recent history, First Union’s widely reported slashing of its branch personnel
cut costs but also destroyed customer value.
The net result was that the bank then had to reinvest (and rehire) to
try to rebuild its positive customer experience.
Some
areas such as small business and wealth management groups generate the type of
outsized returns that a bank wants to preserve and grow rather than risk losing. Cost reduction programs that cause these
efforts to be scaled back can be harmful to the overall health and future of
the bank.
What makes a cost reduction program successful? Our experience is that three factors lead to success:
Senior management shows commitment and communicates honestly to bank employees throughout the process. Senior management must leverage the credibility it has already established with its employees to get staff to rally around this effort. If that credibility does not exist prior to initiating this effort, employees will tend to drag their feet and look at the process with skepticism. Some may have the attitude, “This too shall pass.”
Management
tailors programs to the bank’s culture. Cost
reduction programs may try to squeeze a bank’s culture into a consultant’s
template. Clearly, that is a
mistake. The consultant’s role is one
of thought-leader and process-creator.
At the same time, tailoring the process to a bank has to be a key
priority for management.
From
the first day of the project, management puts strong emphasis on
implementation. Projects rely on strong
internal working teams not only to generate ideas but also to lead
implementation and create corporate-wide buy-in. Implementation is where theory becomes reality. Critical comments from participants in earlier
programs underscore its importance:
·
“Some
of us are skeptical that we will achieve the cost take-outs that we projected;
there may not be the will.”
·
“The
idea was great; don’t ask me how the hell we’ll do it.”
·
“The
consultants who lead the reengineering project left before we began to
implement; now what?”
FIC’s
experience is that the most successful players are those that follow a cost
minimization approach all the time, rather than just in time of crisis. Further, their corporate strategy follows a
path that maximizes efficiencies.
Knowing who your customer is and being able to articulate the
product/services that you wish to provide contributes to an optimal cost
structure as well as strong growth.
Focus
on key market segments and product capabilities. For too long banks have tried to be all things to all
people. Product proliferation and an
eagerness to serve all customer segments with a similar level of service have
caused many customers to view one bank as similar to another. Non-banks and niche banks have seen customer
interest and stock prices rise in response to their product/customer segment
focus.
Cost
reduction exercises are an excellent opportunity to frankly assess from which
markets and/or products the bank generates the most and least economic
value. Segmentation is critical to
establishing core competencies and leveraging those to selected markets. Where does the bank want to play? Where can it not afford to operate because
of existing inefficiencies or inadequate resources?
Strong
credit and operation discipline. Banks that
regularly allow exceptions to policies typically find themselves with higher
credit losses and increased operational expense. While exceptions are
appropriate for the right customer, frequent policy breeches undermine
discipline and increase costs.
Performing an internal operational review can uncover the cost of
exceptions and operational miscues and highlight procedural gaps that need to
be addressed.
Distribution
systems tailored to customer requirements. The
past year has demonstrated that the Internet will not result in the wholesale
closure of branches. In fact, at this
point online access appears to be an additional cost of doing business rather
than a way of significantly reducing delivery costs or increasing
revenues. Nonetheless, banks can take
advantage of online, telephone, and other non-branch channels by influencing
customers to select them versus entering a branch or contacting an RM. This can be accomplished by effectively
communicating their convenience and other benefits to customers as well as by
selectively implementing a pricing structure that provides some economic
incentive to users.
Cost
management as an ongoing day-to day discipline. Management of one past client pursued a cost reduction program
while maintaining its corporate jet and apartment. Two points: 1) sacrifices need to be shared and 2) eliminating a
cost is not an issue if the expenditure has not been made in the first
place. Question proposed expenditures,
particularly those that are related to the corporate ego rather than the
customer.
Incentive
compensation based on profit. One old
truth is that people do what they are paid to do. Yet most banks remain wary of
encouraging incentive compensation, putting caps on specific bonus-driving
activities or limiting overall incentives. The leading non-banks seldom follow
that path, paying their employees more for selling the most profitable
products. For example, one investment bank wished to limit the number of small
loans that its brokers generated. Its
solution: brokers could bring in any size loan but below a certain threshold
they would not be compensated for it.
The net result: few small loans.
Cost
reduction and growth are interconnected. We believe
that cost reduction and revenue growth are opposite sides of the same
coin. Pursuing cost reduction without a
clear growth path minimizes the impact of a cost-based exercise. Focusing on revenue alone without
consideration of cost ignores the importance of segmentation as well as
corporate culture on the bottom line.
Nonetheless, this will be a cost-focused year and for good reason. Those using the cost lever as a tool to position themselves for the future will survive and flourish. Those viewing cost reduction as an end in itself may see their franchise eroded and their future placed in doubt.