Cost Management: Recent Federal Action Makes Understanding Branch Economics Critical

With the recent announcement from the Federal Reserve of a continued environment of low interest rates into 2015, the question of branch economics will continue to be a major focus for many financial service companies. We believe the announcement confirms our view on the sluggishness of the recovery and also the challenges in the business environment for the near future. Historically, low interest rates and slow asset growth will come together to stress the economics of many branch distribution networks.

A few larger financial service companies are utilizing the branch network in an attempt to deliver on the promise of a financial supermarket. The success of many is up for debate, but the diversification of products and services will help support branch economics. The challenge for many mid-size and smaller institutions that lack diversification is that the branch network has primarily become a mechanism for gathering and servicing deposits.

Because of this, the potential for an extended period of low rates could disproportionally impact many of the mid-size and smaller retail oriented financial services companies. Many distribution networks were expanded in a very different environment of strong asset origination and more appealing deposit economics. We believe sales and asset origination opportunities for many institutions will not return to levels seen prior to the financial crisis.

Understanding economic profitability supported by strategic cost management will be increasingly important in deducing how products and services are consumed, how they are delivered in branches, and by various distribution channels. This will assist companies to more effectively align financial and human capital to business lines, products, and customer segments with the highest risk adjusted returns. Improved performance management will also assist with the rationalization of delivery networks and the appropriate pricing of products and services.

Strategic cost management provides a framework to understand overall capacity and how to more effectively utilize available capacity. Strategic cost management also provides additional insight on how to more intelligently grow or how to reduce capacity as needed in order to better align with the needs of your current and future customer base.

With the economic and rate environment far from certain, strategic cost management also enables an organization to model various scenarios. This prospective modeling capability combined with a more granular economic view of historical results will be essential for creating opportunities moving forward.

Cost Management: to Build or not to Build, That is the Question

In our focus of assisting companies to make better business decisions, it has become apparent that every few years the focus in financial services is centered on the merits of branches as effective sales and service platforms. In our experience, this same discussion around the seemingly constant expansion of financial services stores (branches) could easily be applied as well to various retail businesses and service industries which have a real or perceived need for a physical presence.

As technology and consumer preferences also continue to evolve, we believe one should question the economics and need for an aggressive physical expansion strategy across these varying industries. This analysis can be just as insightful for a retail, healthcare and higher education facility as it is for the neighborhood branch of a financial services company.

It is easy to understand the historical focus on expanding physical presence to drive revenue growth. For most of our collective career experience, this strategy has worked quite well in an environment of declining cost of capital, ample credit, and favorable borrowing costs. Our view is that we are experiencing a paradigm shift in the global economy that will result in higher costs to build (higher cost of capital/borrowing costs) and operate physical locations, coupled with a difficult environment to generate much in the way of pricing power.

Many financial services companies are in the eye of the coming storm with vast physical distribution networks and increasingly scarce revenue growth opportunities. We believe strategic cost management is a necessary capability to not only weather the storm, but to prosper. It will be increasingly important to understand how customers are consuming products and services by various distribution mechanisms. Strategic uses of more effective management information include how to allocate financial and human capital to business lines, products and customer segments with the highest return. More tactical benefits include rationalization of the branch delivery network and appropriately pricing products and services.

Strategic cost management provides a framework to understand overall capacity and how to more effectively utilize available capacity. Strategic cost management also provides additional insight on how to more intelligently grow or reduce capacity as needed to better align with the needs of your customer base. We feel many of the benefits of strategic cost management are applicable to understanding not only the recent question of branch strategy in financial services, but highly valuable in your business as well.