You hear it all the time about financial services.The market is down, quarterly profits are down, and a major bank announces it will take out a billion dollars in costs by restructuring the business and reducing staff by 10,000 people.
The market loves these pronouncements. That billion-dollar cost cut is interpreted to mean that the bank will produce perhaps $400 million of new cash, which may turn into dividends or stock buy-backs. But in reality, such cuts simply return a bank to its status quo; and as the market or the economy rebounds, staff levels inch up and the bank's cost basis returns to previous levels.
For years,much of the financial services industry has responded to market cycles with short-term across the board cost cuts, often based on industry benchmarking, instead of creating permanent operating efficiencies that can ride out wide market swings. But there are forces at play that make a change in the industry's mindset an imperative:
- First, there is the growing burden of meeting regulatory requirements. One financial services leader complains his bank used to have 30 on-site auditors but is now required to have 180.The result? A major new permanent expense without revenue to offset it.
- Second, innovation in financial services is running low. No one is producing new ways to do mortgages, credit cards, or savings products. So new revenue streams for financial products just aren’t happening.
- Third, scale is no longer a major factor in competition. For example, an upstart enterprise in mortgage loans can produce the same level of profit as a mortgage megaplayer based on how well it manages efficiencies.
- Finally, there is this: The financial services industry is operating in an increasingly commoditized marketplace—one in which customer pricing and the quality of the customer experience are the only differentiators that matter.
Success—and in some cases, survival—in this environment means financial services organizations must abandon their reliance on short-term 'fixes' and create permanent efficiencies by reducing processing costs and increasing productivity in delivering services. But as one banker puts it,“We know how to cut costs like crazy but we don’t yet know how to engineer efficiencies." Well, for inspiration financial services executives need look no further than manufacturing and how successful manufacturers handle their supply chains.
Moving from Cost Cutting to Microeconomics
In manufacturing, knowing the "cost per unit" is part of the industry's DNA. Take the example of a pair of sneakers that costs $10 to produce. By understanding the cost of each element of the production process, including FTEs, a manufacturer can tinker with the components of his supply chain and use alternative delivery approaches to drive efficiency and productivity. Done correctly, the result is reduced cost and increased profit, at the same, or even higher levels of supply chain performance.
This kind of microeconomic thinking—breaking down major processes into units of work—is not common in financial services. Beyond monitoring high-level metrics like operating efficiency ratios, few financial services managers maintain the relentless focus on process productivity that manufacturing managers exercise. Rare is the financial services executive who knows how much it costs to resolve a credit card dispute or process a loan request, let alone whether those processes are efficient. It's not that financial services executives are out of touch with their business. It's that until now there has been no perceived value to the exercise.
But with so much at stake, financial services executives need to understand they can achieve the same long-term productivity improvements and cost efficiencies as manufacturers by looking at their processes as a series of supply chains—that is, by focusing on the microeconomics.
How does this work? Let's consider the operating efficiency of a bank's loan origination activities. At the branch level there is a cost for employees to help customers complete applications and send them to the bank's mid-office; and at the mid-office there is a cost for loan decisioning and another cost for onboarding, or booking, the asset. Once you have identified all of the process components and their costs, let's say the average cost to set up a loan is $80.
What you have created is a "unit of work"—one loan set up costs $80. And now that you understand the microeconomics, you can assess options to bring down the cost to, say, and $70. Can you do the work with fewer people or by setting up a Center of Excellence or a distributed center? Or should the focus be on modifying your work processes or adding automating technology? You can assess each option against your goal of reducing the unit of work cost.
Or consider post-trade processing in capital markets. Let's say that compared to an industry benchmark you're spending $70 million more than your competition. If you’re under pressure, your inclination might be to reduce headcount across the board. That will 'fix' the situation, but you still won't know where your excess spending is coming from—and that's the information you need to create sustainable improvements.
By delving into the microeconomics and examining the process components of each step in post-trade processing you might find, for example, that handling trade exceptions comprises an unusually high percentage of the work. So your job is to reduce the exceptions. Does your technology need upgrading? Do you need to modify your processes and redeploy FTEs to other activities? Should you switch to distributed execution and relocate it offshore? Each option gets assessed against the goal of reducing exceptions, which in turn will bring your costs in line.
Getting a Clear Picture
With these eventual alternatives in mind, where do you start? First, set aside what you think you know about your company’s operating efficiency ratio and, instead, delve into what’s driving your costs. While your costs, on their own, might give you a better feel for where the most impactful changes can occur, you'll want to look at why your costs have increased over time, especially relative to underlying transaction volumes. That way you can begin to identify trends and pinpoint causes. For example, maybe your personnel costs have escalated; or perhaps you aren’t processing as many transactions per labor hour as you used to.
With the big picture established, start establishing unit of work metrics for each of your major processes and their components. Distinguish between pure knowledge steps, such as assessing risk, and output steps, such as validating customer information—but remember that knowledge steps and process steps are typically connected. For example, making a decision on a loan is a knowledge step, but the process of deriving the information needed to make the decision consists of process steps that can be made more efficient.