Armada’s 2020 release of Acumen Cost Analytics has several new features for visualizing Cost Fact data from the modeling application. With the cost decomposition tree visualization, users can now navigate and analyze the source of costs from anywhere in the model with complete transparency and traceability back to the source center and GL expense account.
See the new feature in action here – Cost Decomposition Tree video
I recently had the pleasure of accompanying my daughters to a lecture given by Scott and Mark Kelly, the twin brothers who both led inspiring careers as astronauts. They emphasized that we should do things not because they are easy, but because they are hard. Their great advice was simple. When you find something that motivates you, to accomplish something meaningful, do a few basic things. 1. Have a goal, 2. Have a plan. 3. Focus on what you can control.
What does that have to do with technology costs? As it has with so many things, technology is transforming the banking industry. Paper checks are becoming relics, channel preferences (both the customer’s and the provider’s) are evolving, self-service is in high demand by some customers and being imposed on others, economic activity is migrating away from cash transactions, and a tremendous amount of data regarding customer behavior is being collected, analyzed and acted upon. Technology is also a contributing factor to the continued M&A activity throughout the industry. Economies of scale are increasingly critical. Many institutions have experienced (or soon will) one or more mergers. Combining entities inevitably brings significant change. In fact, change resulting in efficiency is usually the point. Dealing with the combination of technologically driven change and M&A activity is the managerial equivalent of hunkering through a hurricane during an earthquake. Understanding costs can be hard and financial institutions better be motivated to do so.
Managers who are serious about strategic cost management know Activity Based Costing methodology can offer shelter by providing valuable information about the nature of your costs and high potential savings opportunities. Whether your company is embarking on an ABC implementation or utilizing an existing one it’s time to take a fresh look at your costing methodology and ask the challenging question, do we have the transparency we need to successfully manage our IT costs? Building that transparency and understanding should be your goal.
When companies first implement costing methodologies, they often focus on the non-IT costs and defer a deep dive on the IT costs for some later date which often never comes. There’s a failure to launch. Why is that? There are many reasons. Managers tend to have a strong understanding of their direct expenses (resources) and how they are used. They tend to spend a large portion of their time managing people. So when it comes to completing cost studies for non-IT groups, they are focused on and comfortable with capturing the activities that people do. They can reasonably associate those costs with particular products or customers. Once that is done, it’s not hard to start digging into the ABC results and start identifying opportunities. This is the easy part. But what about the IT costs?
Unlike the cost of personnel resources which are easily identified (in the general ledger, job class salary midpoints, etc.), capturing the cost of particular IT resources requires some work. The costs of PC support and the like are reasonably straight forward, but what about the dozens or hundreds of systems and applications they provide, how much does each one cost? Once we know that, how can we reasonably assign the costs to the appropriate products and customers? The IT folks have to model the costs of their resources (storage, processing, programing, maintenance, licenses, etc.) just to estimate the cost of each application they provide. Once the inventory of IT applications and their costs is complete, work can begin on assigning the IT application costs to products and customers. People with the knowledge to make informed judgements about how particular applications enable activities or support products/customers are harder to come by. Often there is not one person who has the knowledge to accurately assign the cost of a given IT application; a combination of IT and business folks are required. Multiply that complication by many dozens of applications and the task of assigning the costs of IT resources can seem daunting. Last but not least, companies implementing strategic cost management are usually doing so as a response to urgent pressure. Managers are often tasked with identifying cost savings opportunities with quick paybacks and create savings to, at a minimum, self-fund the costing project. That’s not great incentive to put the deeper effort into the IT costing. They want to get started on the most visible and obvious savings initiatives.
So is your strategic cost management effort doomed to provide less value than it could or in fact should? For some companies, yes. They may get stuck doing the easy part over and over. Change is hard. Others will find the motivation to do the hard thing. Break the project down into manageable pieces, and make a plan.
The incentives to make the effort are crystal clear. Technology is uprooting processes and driving change in the cost structure of financial institutions. Processes that were labor intensive have likely been impacted by automation in some way. New processes are emerging, some are fully automated. Many redundant systems and applications survive the merger process or even organic growth. You can’t control the industry dynamics but you can control the investment you make in your costing methodology and the quality of your costing information. IT costs as a percentage of total costs are substantial and growing. They are fertile ground for strategic cost savings which are there for the taking. Take the Kelly brothers advice and do the hard thing. Have a goal, make a plan, and focus on what you can control. Get motivated to upgrade your IT costing methodology now. After all, it’s not rocket science.
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.
Companies 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 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.
Over the last decade, corporate scandals, failures, and the great recession, the CFO function of organizations has evolved beyond the corporate persona as number crunchers and budget cops, and has been invited to the strategy table. Not just as integrity champion or implementer of corporate controls and governance, but it was finally understood that finance is the universal language of business. Since that time, Finance departments globally became the cornerstone of corporate initiatives, large projects, and strategic decision making. The role of the Chief Financial Officer became the chief ‘go to’ officer for everything from Information Technology transformation to back office operations, taking on roles traditionally occupied by CIO’s and COO’s, even becoming heir apparent for replacing CEO’s in many major corporations.
Financial Transparency: Full & Accurate Disclosure
However, there are seasons in life both personally and professionally and while the spotlight has shined on finance professionals for several years, a backlash is beginning. At the core of this backlash is the same concept that brought the focus to finance as a strategic partner—Financial Transparency. In the wake of the implementation of controls, regulatory reporting, and systems to ensure transparency, the perception of finance is slowly reverting back to the number crunching budget cop persona of the past almost as though someone finally had the time to look up the definition of the now corporate buzzword of “transparency.” Transparency, as it relates to financial transparency, is defined as, “the full, accurate, and timely disclosure of information.” Business managers are now asking Finance for needed information, or to clarify the credibility of the information, but choosing to interpret, analyze and make business decisions independent of Finance’s support. Too often now, presentations and proposals to executive management lack independent review from Finance, while the presenter still emphasizes that ‘Finance provided the numbers’, giving them a Teflon covering in case the proposed action fails.
In order to avoid slipping back in to the corporate dark ages, Finance needs to proactively restore relevance to their craft. Moving beyond transparency and the simple disclosure of information, Finance must drive performance improvements and empower themselves to be the corporate steward before the next crisis arises.
Moving Beyond Transparency: Measuring Your Readiness
The following factors can determine your readiness to move beyond transparency:
Kevlar over Teflon – True leaders are those who would rather challenge what needs to change and face the firing squad than to remain silent and slowly die inside. Corporate America needs more professionals willing to put on Kevlar to champion change, and less professionals managing with a ‘no stick’ policy in an effort to keep their jobs.
Insight over Information – The amount of information available electronically is doubling every 12 months, so the adage of information is “power no longer applies.” Information is a commodity; the ability to transform information into insight is what makes Finance professionals valuable.
Performance over Politics – It no longer matters ‘who you know’ or even ‘what you know’ in your climb up the corporate ladder. Success today is defined simply by what you can make happen. Performance pays, and your ability to execute strategic initiatives that have a positive financial impact will move Finance professionals beyond transparency.