As bank executive teams set their budgets for next year, a key question is how to optimize expenditures and investments in the face of tight market conditions. What is the best way to nurture near-term performance without compromising the future?
Increasingly, the answer depends on careful tradeoffs among the major functional areas of the bank, with the goal of optimizing performance in each local market within the network footprint. But that requirement exposes a weakness in traditional planning, which splinters decision-making among various central teams.
Under the budgeting approach commonly used today, the bank starts with top-down performance targets – revenues, expenses, profitability and efficiency. Bottom-up plans are then developed by function (branches, small business, product lines, marketing, virtual channels, etc.) to meet those requirements, with only loose coordination in how decisions and resources are applied in local markets.
Distortions quickly surface amid negotiations to make everything fit. Line units are pushed into commitments they may not know how to meet. Critical long-term investments in technology development and branch refurbishment get deferred as resources are diverted to near-term priorities, such as marketing spend in support of sales. Inevitably, various local markets wind up over- or under-nourished.
While banks long have contended with such frictions, the complication now is that the market is much less forgiving. Factors that formerly floated the budget – strong margins and loan demand; extensive leveraging of the branch network for sales – now are in retreat. There is a critical need to plug leakages in revenues and resources while franchises are repositioned for multi-channel competition, including web and mobile.
In these lean times, a different planning and management approach is needed. Performance priorities in local markets now must firmly guide a tighter collective effort by the functional areas of the bank. This entails setting individualized performance objectives – revenue, expense, investment – for each market within the franchise footprint, considering local opportunity, positioning and the competition.
New leadership will be required, with the functional heads working as a team to triage the markets. Some locales with little upside should be reconfigured to improve efficiency. Others with good growth potential and competitive stance should be built out to acquire new customers. Elsewhere resources should be scaled back, either because of poor position or thin local competition.
Such priorities should be crafted and implemented via a consistent planning tool, as embodied in market playbooks. Because banking is such a local business, there is no other way to manage though the extreme profit pressures of today’s environment. Unless there is a shared view of prioritization, functional heads are likely to average across markets and in essence scatter their shot.
The Flaw of Standardization
Banking has always been a local business, won or lost locally. Consumers and small businesses do not drive across states, counties, or even cities to do their banking. Instead they typically bank where they live, work or shop. This implies an ongoing need for locally-tailored banking networks, services and performance strategies.
But standardization has worked against that priority as countless local banks have been subsumed into regional, super-regional and national networks. Along with scale economies, consolidation had the benefit of simplifying network management and ensuring consistency of delivery. Yet it carried side effects as well. As the functional areas of super-sized banks gained scale and influence, it became more difficult to coordinate their efforts, creating powerful internal conflicts in bank management.
Indeed, the very process of budgeting by function leads to unforeseen consequences. Product groups look individually for pricing opportunities to widen spread. Each regional sales unit demands equal support (such as marketing spend) to reach its goals, forcing an ineffective spread of resources across geographies. Expenses termed “deferrable” are withdrawn from budgets, crimping the developmental work often needed to confront the technology-based disruptions besetting the marketplace.
A frequent result is that the bank retreats into its advantaged markets, investing where there is immediate gain, and parcels the remaining resources across the other markets in a politically negotiated “fair” allocation. This in essence doubles down on the few main markets and starves the rest.
Such imbalances tended to get covered up in a pre-recession economy where margins, fee revenues and loan demand were riding high. Now they are contributing to a slow bleeding of the franchise. Yet in today’s management approach, there is no forum in which these issues are systematically detected and addressed.
Portfolio of Markets
It is time to return to market-based planning and management, not in the traditional portfolio-of-community-banks approach with autonomous local leadership, but rather with a portfolio of markets to be managed by a cross-functional senior management team.
The logic is simple. Instead of planning by function across markets, the team needs to lay plans by market across functions, based on assessments of short- and long-term potential in each locale. It is a different approach, requiring market reconnaissance and financial planning support that may not yet exist within the bank.
There still is a need to define top-down corporate performance objectives. But plans will no longer be refined primarily by tweaking line items on balance sheet and income statements. Instead, the new cross-functional team needs to translate top-level performance requirements into first-cut expectations for each locale (e.g., new accounts, cross-sell, spread, fees and expenses).
This responsibility critically depends on skillful triaging of markets (Figure 1). In particular the team needs to work through four major steps:
1) Assess each market’s competitive position and potential. This includes reviewing the bank’s footprint and brand equity relative to others; the state of the current franchise (customer segments served, cross-sell success); market potential (growth vs. lagging, wealth/affluent, small business, etc.); and the headroom available to the bank.
2) Assess the market structure and likely competitor actions. Most of the time competitors act rationally; but sometimes irrationally. Depending on a market’s structure, the team can handicap where competitors are going to be in terms of share growth, pricing and market expansion, especially given the trends of the prior year. Such insight alerts the team to likely price competition and/or competitive marketing spend in a given locale, and helps to determine the tactics available for the bank.
3) Define winning strategies by market. In a market where the bank is dominant, for example, the objective may be to “thin” the network while gaining share, which would imply an overarching need to gain further share-of-wallet among its customers. In other markets, the key objective might be to gain new-to-the-bank customers.
4) Classify markets into playbooks and triage. Typically a bank would have four to six different strategies that could be applied as needed to various markets. The bank then needs to classify each market (“optimize”, “invest”, “harvest”, etc.) and set appropriate local positions (price, marketing, branching, staffing, etc.) for each play.
After classifying the markets, the team needs to “roll up” the individual local plans into the functional units – revenues, expenses and investments. At this point, the composite undoubtedly will not work. This where trade-offs are made – marketing, pricing, staffing, branches, technology investments, etc. – to arrive at a workable plan.
This process strives to create a winning plan for high-potential markets and a harvest-like plan for markets with less upside. Such a program is necessary to ensure that the healthiest parts of the franchise continue to prosper; the markets with potential receive appropriate investment; and developmental resources are freed up from markets either with little potential or little competition. This provides the best approach to profitability with the least harm to the franchise.
One additional benefit of this approach is that it can be used quarterly to assess progress and adjust plans. Assuming business is better than expected, the prioritization points to the markets which are “next on the list” for investments. If business is worse, it provides a cross-functional view of cost-cut potential, market by market.
A major first step is to form a cross-functional team that includes the heads of the significant business and functional divisions (i.e. product, marketing, branches, staffing and technology). The objective is to provide a forum where these senior executives can trade resources – not within their particular functions (which they do already) but across functions, according to the agreed-upon priorities of the market triage.
There is ample precedent for this sort of collaboration in other industries. In the auto business, each new model is jointly developed by various teams from design, marketing, engineering, manufacturing and finance. In consumer electronics, particularly hand-held devices, collaboration (case, screen, battery, circuitry, software) is essential.
Of course, a local banking market is not an object created from scratch. But each one is still a distinct entity requiring ongoing refinement and renewal. No longer can this be done by making tradeoffs within discrete business silos. Instead, the bank must learn to make savvy tradeoffs among the silos. Decisions must be made systematically according to an agreed-upon process. Otherwise the budget will be sub-optimized.
The analytical spine will be supplied by a set of “market playbooks,” designed to solve for a central strategy executed locally. Playbooks draw on a multi-faceted analysis of growth and cost drivers in each market to set priorities and allocate resources. (Editor’s Note: See companion article, “Market Playbooks: The New Paradigm for Performance Optimization”).
\We anticipate that the banking industry, particularly the retail sector, will have to endure several more years of tight conditions. Only by viewing the business as a portfolio of markets, with varying strategies and tactics by market, can a bank make the rational business decisions needed to preserve and grow the franchise in a period of scarcity.
Rick Spitler is Co-CEO and Managing Director in the New York headquarters of Novantas Inc., a management consultancy. He can be reached at firstname.lastname@example.org.