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.
I was sitting in a prospective client meeting not long ago discussing their current monthly cost modeling process. The client described the roles and responsibilities of each financial analyst. The analysts were heavily involved with their business partner to update the model drivers, volumes, and expenses, using excel spreadsheets as their collection tool.
The conversation then switched to how the analysts get collected data in and out of their cost modeling tool. The analysts had to consolidate their excel spreadsheets and send them to an IT analyst. The IT analyst had total responsibility of loading the data, running the tool, and extracting the data from the tool for validation by analysts. The process could run within a day but most often it was a two to three day exercise. Depending on when the financial analyst started working with their business partners it could take anywhere between 3 days and 2 weeks to communicate the impact of changes made in their excel spreadsheet back to their partners. It didn’t matter if the change was a minor adjustment to a percentage or a major overhaul of an operations groups, it could take weeks to fully understand the impact to service or product costs and rates.
It made me reflect over my career and how cost modeling has changed, or more importantly hasn’t. My first major cost modeling project was 10 years ago. That client had a single modeler/financial analyst responsible for consolidating every individual model for her colleagues. She aggregated all of the data in an access database and loaded it to a consolidated master model. It could take upwards of three weeks for her to report back the impact of any individual modeler’s changes to data.
Looking at the time required to report back the impact of modeling changes you would think these examples are outliers. You might assume they aren’t or weren’t using the latest tools and best practices. Maybe they’re just inefficient. Unfortunately, scenarios like these are more the norm than the exception. These organizations operate similarly to the majority of clients Armada has worked with over the last 10 years and work with currently.
I would have hoped that advancements in technology and the roll out of new cost modeling applications from SAS, Oracle, Acorn, and others, that the pace would have quickened. I would have hoped that financial analysts would possess the tools they need to make changes and report the impact of those changes in a matter of hours not days.
Somehow the industry has adopted the belief that running cost modeling applications, getting data in and out, and reporting is the responsibility of IT. That an advanced technical skill set is needed. That understanding and writing query languages is required. This acceptance has led to building large teams around technology. Too often, many companies have as many resources running the application as are analyzing the data coming out of the application. Instead of using the wealth of information cost models provide, they spend time maintaining production environments.
It is time for all of this madness to stop. It is time to empower financial analysts with the tools they need to build, update, maintain, and report on their cost model without complete reliance on an IT counterpart.
As the Product Manager for Armada’s cost modeling tool, Acumen, I have made it my mission to create a tool with the Financial Analyst in mind. Every enhancement and release of Acumen is focused around one primary objective, the user experience. Specifically, can a finance user do everything they need within Acumen? Do they have the ability to make changes, load bulk data, and get results without having to know SQL and without ever leaving Acumen? All while still providing a tool that can be scripted by IT to run a minimal touch production cycle.
We know when a model is in a production cycle that a significant portion of the hierarchies, drivers, volumes, etc. should be loaded systemically without manual touches from a financial analyst. By allowing organizations access to Acumen’s table structure we give them the ability to create ETL process to load all that data.
In our next major release of Acumen, we are integrating it with Aegis, Armada’s data manager and monitoring tool. Aegis will allow both finance and IT users to script loads from data sources without ever leaving Acumen. We have built a tool that provides the best of both worlds.
By allowing Finance analysts to manage the modeling process and data organizations can focus on what is important, driving business value from the modeling data.
Analysis conducted on the Top 100 US Credit Unions revealed an $820 Million cost improvement opportunity for more than 40 institutions. The study was based on 2014 annual credit union call reporting data across the Top 100 Credit Unions based on asset size. Total Non-Interest Expenses for these institutions were over $11 billion dollars and represent the normal operating costs to serve Credit Union members excluding interest expense and provisions for loan losses.
The average Non Interest Expense incurred per member for these institutions was $375 per member, with over 40% of the Credit Unions exceeding that average. If each of these institutions reduced their respective cost per member to the average it would save over $820 million in Non-Interest Expenses. Scott Wise, CEO of Armada Consulting commented, “What the analysis demonstrates is the fact that Credit Unions can yield a significant return on investment on cost management programs”.
The disparity of cost per member data across diverse organization sizes in terms of Assets and Employee base indicates a need for improved cost analytics in the industry. Commercial banks have invested heavily in cost and profitability analytics programs to uncover improvement opportunities for several years, while Credit Unions have lagged other Financials Service institutions in deployment. But, as this segment of Financial Services grows, so does the demand for deeper analytics to identify cost takeout opportunities. These savings are much needed to meet growing competitive and regulatory threats facing Credit Unions today.
3 ways improved Cost Analytics can accelerate cost reductions
Channel Cost Rationalization
Branch costs represent a significant portion of Non-Interest Expenses incurred to service members, with declining volumes due to expanding delivery channels. Understanding specific unit costs for transactions conducted in the branch compared to alternative channel offerings enables management to make strategic decisions regarding channel rationalization and accelerate customer migration to more cost efficient delivery channels.
Cost of Excess Capacity
Few can argue that despite continued draconian reductions in staff there is still a substantial savings to be gained from identifying and eliminating costs of excess labor capacity. However, a more creative solution would be to identify the costs of excess labor capacity in a very targeted manner, and then redeploying those resources for more strategic member acquisition functions thus reducing an organizations Cost Per Member rate from both sides of the equation.
Back Office Efficiency
Non-customer value added activities in the back office related to regulatory requirements, fraud, and exception processing, continue to stress back office expense budgets. Improved cost analytics can provide deeper insights into activity and process costs to serve members and help eliminate unnecessary costs relation to exception processing. Integrating a Strategic Cost Management program can provide the necessary cost analytics to improve even the best continuous process improvement initiatives.
Armada releases their newest version of Acumen Cost Analytics for 2015. The latest version includes the following enhancements:
New features for consolidated reporting across multiple periods and scenarios
Enhanced documentation management features to handle Regulatory Cost Transfer audits
Improved handling of period specific attributes and dimensions
Better user interface for model creation and maintenance
Micah Campbell, Acumen Product Manager says “The improvements made in our latest release make Acumen Cost Analytics one of the most powerful, user friendly activity based cost modeling applications on the market “.
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.