Financial Transparency: Banks Can’t Ignore IT Cost in Their Profitability Reporting

Financial Transparency: Banks Can’t Ignore IT Cost in Their Profitability Reporting

Business-intelligence2

There are still a few bankers who can recall a time before immediate access to data, real time transactions and 24/7 service. This was a time when banks would often ignore the impact of shared services and IT on their profitability and performance measurement.

In the early days of my banking career, I managed a large consumer lending office in the branch network of mid-size regional bank.  In those days you predominately operated on an island, with the autonomy to make decisions, but with limited information that was dated by at least 24 hours, if not a week or a month.  Waiting for the courier to arrive with those green bar reports to learn what happened yesterday or last week, left you disconnected from the IT and operations organization.

However, being disconnected also meant that you could not be held accountable for the spend of those organizations.  Service allocations were typically a single line item in your “below the line” indirect expenses that were not included in the performance review of your organization.  Today that paradigm has shifted, and shared services and IT are very much a part of how banks deliver products and services to their customers.

Over the past twenty years or so banks have invested considerable time and effort to centralize and automate as many functions as possible, however, many organizations continue to live in the past and separate front and back office expenses. This distinction is increasingly less meaningful if bankers want to understand the true profitability of various organizations, customers and products.  Bank management must understand the impact that technology expense is having on their profitability.

Since 2008 the banking industry has focused on cost management and slashed their operating budgets. Many banks have searched for efficiencies through automation, consolidating operations and branch rationalization initiatives.  Particularly the retail bank, what was once a decentralized organization is evolving into a more homogeneous and consolidated environment.  To support this evolution, improved cost information is driving better management reporting to understand the organization’s dimensional profitability.

For the last few years automation and development of alternative delivery channels have become a primary focus of most banks placing the spotlight squarely on IT.  Worldwide in 2014, banks are expected to spend over $215 billion on their IT organizations, which is approximately half of all IT spending in the financial services sector.  In the US, while most areas in the bank are still looking for areas to reduce spend, the IT budget is expected to grow by and annual rate of 4.2% to 5.0% over the next three years.  Most banks are expecting to see a continued increase in their operating budgets to keep pace with the increased demands for alternative delivery channels.  The American Banker projects the top areas of IT spending in the near future, will focus on; online Banking and Mobile Payments, Marketing Analytics and Data Management and the continued integration of delivery channels across the banking platform.   This data leads to two indisputable conclusions regarding bank profitability:

  • Technology will continue to grow as a percentage of total organizational spend and will be a strategic leader for banks.
  • Bank management will have to understand the impact of technology spend on the profitability of their customers and products to make informed tactical and strategic decisions.

Alternative delivery channels are increasingly critical to account acquisition and servicing, and the role of the branch will continue to evolve based on this shift.  Financial data from the technology organization will have to be translated into meaningful financial information for both the technology group and the business owners.  The CIO and the CFO must cooperate in driving change that will provide both sides with the financial information they need, the right methodology to deliver that information and the toolset to support this transformation.  The production cost of IT should be driven to application cost pools based on the consumption of IT resources by the applications supported.  Customer facing application costs can be driven directly to product profitability through a transactional unit cost based on customer usage.  Service and core application costs can be driven to the owning business units and embedded in their profitability reporting.

The profitability system should also provide the ability to track costs back from the end point to the originating organization, providing the financial transparency that most organizations are striving to obtain. Understanding IT costs and aligning them appropriately is increasingly important as banks continue to struggle with tactical and strategic decisions about how to efficiently use their delivery channels.

IT spend required to support the increased automation of processes and delivery channels are by nature larger in scale, longer term, and often less flexible than traditional resources. Banks can’t install and uninstall systems nearly as quickly as they can increase or reduce tellers, sales force, or back office personnel. Understanding excess capacity, step functions of investments, and fixed vs. variable expenses are more important than ever as the supporting infrastructure of banking shifts towards IT.

While banks have made a considerable investment in understanding the various dimensions of profitability, many have been unable or unwilling to invest the time and effort to understand IT cost.  With the growth and importance of IT to the organization this will not be a sustainable approach for banks.  Technology is clearly a part of the cost equation that must be measured and analyzed to understand bank profitability, and it can no longer be ignored.

Activity Based Costing: Below-the-Line becomes top of mind for cost improvement

Activity Based Costing: Below-the-Line becomes top of mind for cost improvement

TechnologyCostsCompanies interested in improving overall margins are now focusing on below-the-line cost efficiency as a means for cost improvement. Also referred to as shared services or overhead costs, these “allocated” costs represent a growing share of the overall expense base. For years, the process of simply allocating these costs to the revenue generating functions of the business has been ignored as an uncontrollable cost of doing business. Companies are now realizing benefits of conducting cost studies on back office functions and billing internal organizations based on these services.

IT Cost Recovery leads the way
Trends in aggressive cost management of back office functions began with the rising costs of IT departments. The proliferation of technology throughout the enterprise resulted in rising costs with minimal transparency into the causal drivers of IT expenditures. Traditional allocations provided no capabilities for management to gain insights and take the necessary actions to reduce consumption of IT resources. Success in developing more sophisticated chargeback processes based on usage brought managers from across the enterprise into a more productive, even collaborative dialog around IT cost control. Now, the methodology is gaining momentum across all shared services and back office operations departments, providing a Profit and Loss (P&L) reporting view to managing non-revenue generating business units.

Activity Based Costing is key
These efforts can be complex and the corporate politics involved can be treacherous. Few finance functions are as contentious as the assignment of costs to managers that do not directly control the budget. Successful adoption requires a fair and consistent methodology that provides credible and actionable information. Activity based costing provides the best approach to accurately provide cost transparency to management. Activity based costing lost ground in the ‘90s as a methodology, due to manually intensive data collection and implementation complexity. The emergence of big data, improved technology, and increased demand for cost analytics have given new life to the method. Implementations are taking weeks instead of months and providing immediate cost savings, often self-funding the project investment.

Costs are the most controllable part of the profit equation
Today, companies are able to leverage advanced cost modeling systems to provide detailed cost analytics that not only provide insights into the drivers of profitability in their business, but also identify and eliminate unnecessary costs. With increased regulations, competitive markets, and economic uncertainty decreasing top line revenue growth, below the line cost improvements can drive much needed bottom line results.

If you are interested in learning more about Cost Modeling or Strategic Cost Management, contact Armada Consulting here.

Armada Consulting Announces Cost Management Benchmark Survey Findings

Armada Consulting Announces Cost Management Benchmark Survey Findings

Armada Consulting Announces Cost Management Benchmark Survey Findings

DOC-150x150Armada Consulting is pleased to announce the completion of the inaugural Cost Management Benchmark survey for Financial Services companies.  The survey achieved the objective of providing current information on the state of cost management in Financial Services companies representing a cross section of participants including commercial banks, community banks and credit unions.

Participants ranged in size from well over a Trillion in assets to under $300 million.  Regardless of asset size, respondents were fairly advanced in cost analytics with the vast majority rating their capabilities as intermediate or advanced. Despite the respondents being fairly advanced, the vast majority at best had only doubled their investment to date in cost analytics.

We believe Strategic Cost Management is one of the most controllable components of the profitability equation for many industries and survey results suggest many Financial Services companies are challenged to deliver an effective return on investment for their efforts. The survey also confirmed that a successful Cost Analytics framework is one that drives business value and is highly correlated with unit cost methodology, capacity analysis and a standard management reporting approach.  The integration of cost management information into the reporting and planning process was also a strong contributing factor to the success of the overall performance management effort.

The survey confirmed our belief that a successful Cost Analytics framework is not correlated to size of cost analytics investment, use of a dedicated system or asset size of the institution.  Shared Services and IT chargeback mechanisms also contributed to a successful Cost Analytics framework for the majority of companies surveyed.

Many industry contacts and a majority of the respondents indicated an interest in more detailed cost management benchmarking efforts leveraging a standardized approach. Branch economics were the most desired topic for potential further benchmarking efforts along with IT cost transparency and shared services.  Armada Consulting will continue our effort to be a premier provider of Strategic Cost Management solutions by expanding our Financial Services research and potentially leveraging our experience across other service oriented industries.

If you have any questions or if you are interested in participating in current or future survey efforts please contact me at Brad.Anderson@Armadaconsulting.com.

Convenience Is Key to Increasing Bank Profits in 2013

Convenience Is Key to Increasing Bank Profits in 2013

Adapted from the American Banker 1/3/13
by Brad Anderson 

Have you ever caught yourself paying a $3 ATM fee to avoid driving across town to your own bank’s ATM? Add up the value of your time, gasoline costs, the need to complete a necessary task and it’s easy to justify that $3.

Convenience is king for many of today’s consumers, and banks should adjust to this changing behavior. Customers are flocking to online, mobile and ATM banking like never before. By the end of 2013, the Federal Reserve expects 42% of bank customers to use their smartphones for banking. Rapidly changing technology and demographics are going to accelerate these trends.

For financial services companies, the transition to mobile and online banking is a paradox. To stay competitive, they know they need to offer popular online conveniences, such as depositing a check with a smartphone from any location. They also know every time a customer doesn’t enter a bricks-and-mortar bank branch to make a deposit, they may be missing a face-to-face sales opportunity.

A decade ago, new bank branches were popping up on corners seemingly overnight. This trend was driven by customers choosing banks based on location. But the Internet is changing the traditional model. Customers are now able to choose a provider based on their product needs, and this may or may not be their local branch. Many banking products and services are commodities and, thus, customer behaviors are driven increasingly by price and convenience.

Because of dwindling foot traffic in bank lobbies, the leaders in banking are closing more and more branches every day. Branch economics are expected to be a major focus for banks and other financial services companies in the years to come, especially in light of the Fed’s announcement that low interest rates will continue into 2015. Sales and asset origination opportunities for many institutions will likely not return to levels seen prior to the financial crisis until then.

Additionally, you’re seeing more prepaid debit cards. Customers like them as an alternative to checking accounts and credit cards and banks like them because they can charge transactions fees that they can’t with a regular debit card. This trend will also allow some non-traditional players to enter the banking marketplace. The recent partnership between American Express and Walmart is only one example.

What does this mean for banks? In an increasingly competitive marketplace, they must continue to innovate to compete in the new online banking market and properly engage and build loyalty among customers.

Using data collected from debit and credit cards transactions, banks can better target customers and sell them financial services products that are customized based on the particular customer need.

Based on the earlier ATM example, it would seem that banks could capitalize on customers who are willing to pay for convenience. Other tactics include image-enabled ATMs, automatic bill pay, online and mobile bank services and large ATM networks.

However, banks must set prices accurately because customers generally hate fees. Last year, when several large banks tried adding debit card fees to non-ATM transactions, customer backlash caused many banks to abandon the idea. Also adding to the challenge is the fact that banks are generally not very well perceived by customers for service and value.

With all these innovations becoming available, it’s important that we put ourselves in the shoes of the bank customer. What do they value most? Is it personal service? Security? Convenience? Chances are it’s all of the above.

In this changing landscape in banking, it’s important to realize our own preferences as consumers can help shape the products offered at financial institutions. It also will be increasingly important to understand the economics of those products and services to price them appropriately.

Armada Upgrades Cost Modeling Software: Acumen 2.0

Acumen 2.0 News

BROKEN ARROW – Over the past two decades, banks have taken measures to ensure they remain profitable while responding to increasingly changing market conditions, said Scott Wise, CEO of Armada Consulting.

Rising costs and falling margins are driving the demand for more detailed cost information, said Wise, partner at Broken Arrow-based Armada. The cost management company provides insight on company costs and how to maximize profits.

In November, Armada Consulting released its Acumen 2.0, a cost modeling software that is an upgrade to its cost analytics software, Wise said.

“The upgrade delivers improved performance management by delivering strategic cost management capabilities to their clients,” Wise said this week. “The latest release allows users to model costs in less time.”

Armada has 10 employees in Broken Arrow and offices in North Carolina, Atlanta and Philadelphia, Wise said. The company is poised to double the number of employees by next summer.

Wise launched Armada as a consulting company in 2002. In 2008, the economy collapsed and Wise shuttered the company. He reopened its doors this year and said he expects to see Armada earn $1.6 million.

“We finished the first version of Acumen in 2008,” Wise said.

Now, with the latest version, Wise and Armada are looking to license the software.

“We relaunched the first of the year,” Wise said. “Right now our business is 90/10 consulting and licensing and we are working toward 60/40 consulting to licensing ratio.”

The Acumen software helps banks identify obstacles to profitability and tells them where to save money, Wise said.

“Banks need to get a better handle on where expenses are and how they line up with their revenue sources,” he said. “Banks have to examine – given the regulatory environment – the products they offer customers and decide which work and which do not.”

Armada is not the only player in the market segment, Wise said.

“To the big players, this cost analysis niche is too narrow and is just another side business for their all-around data mining,” he said. “We separate ourselves by our ability to focus on the cost management.”

The latest Acumen provides clients with a deeper set of cost analytics to drive improvements, establish cost controls and better understand the economics of their business, Wise said.

“For many banks, it is difficult for them to understand their costs – when you look at the diversity of the main bank and their branches – it can be difficult to line up costs with the customer segments and the many variables,” he said.

The goal, Wise said, is to take Acumen and apply it to other industries.

“This release of Acumen represents collaboration with our clients as they provided great feedback and recommended enhancements for improving the product while implementing the software,” Wise said.

Cost management is becoming more relevant, he said.

Press Release found on The Journal Record
December 5, 2012 

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.