The Shape of Banks to Come
“Why will you refuse to listen to reason? I had hoped to find in you – as being a man of sense and an accomplished mathematician – a fit apostle for the Gospel of the Three Dimensions, which I am allowed to preach once only in a thousand years.”
…says the Sphere to the Square in “Flatland”, by Edwin A. Abbot
Outsourcing has been defined as, “to send out work to an outside provider or manufacturer in order to cut costs.1“ The term has only recently made it into dictionaries – a regrettable development for the lexicographer because it is already coming to the end of its useful life.
Not only has outsourcing become politically charged, but it also carries with it too much explanatory overhead – it just takes too much time for people to explain to one another what it means to them.
More fundamentally, the term itself and the concepts that surround it do not get to the heart of the matter, particularly when we are thinking about how financial institutions should configure themselves to cope with an uncertain future.
In an often heard line of argument we hear of the various pressures that assail financial institutions, leading to the inescapable conclusion that banks need to focus on core activities, outsource the rest, or face diminishing competitiveness against more pro-active peers.
One problem with this train of thought is that very often the characterisation of the market environment is just not dramatic enough. We can nonchalantly list the forces acting on financial institutions – shareholder expectations, client demands, regulatory changes, industry developments, technological changes, etc – without getting a sense of the truly brutal implications on the bank.
The other problem with the common outsourcing argument is that it can often lead to very wrong conclusions. The market is so unforgiving to the unwary institution that we cannot afford to work with half-right outsourcing terminology to reach half-right solutions. Financial institutions should reach for a new conceptual toolkit to think about the future and find ways to bank outside the box.
The following diagram shows an idealised financial institution in three dimensions. Every firm has a given set of products that they sell to a given set of clients in different markets. It is these two dimensions that establish the bank’s revenue earning opportunity.
The bank’s efforts to sell X products to Y markets are supported by a given infrastructure – by this we mean human and technological components synchronised into structured business processes. In this dark dimension lies the bank’s fixed cost base.
This is a view of any financial institution that helps us think well beyond the outsourcing paradigm. The question is not the classic ‘what are my core and non-core activities?’ but the new ‘what is the shape of my bank now, and what do I want it to be in the future?’ This is not outsourcing – this is re-dimensioning.
The general problem for any financial institution is to find a way of growing the revenue opportunity without a proportional increase in the cost base. The last thing that any firm wants is to grow its revenue opportunity by a square, but find the cost base increasing by a cube.
In the following sections we look at each of the three axes in turn and discuss completely new ways for banks to transcend current boundaries through re-dimensioning.
Every financial institution has product gaps. In the past banks have typically filled these gaps by building their own product very often based on a vendor package. Time and time again banks have found this a direct route to a bloated fixed cost base.
The re-dimensioning solution is to scan the market for the best product provider in the field and ask them to supply a white-labelled service offering – their product folded into your brand experience. There is a world of difference between buying an application and buying a fully-fledged product, a difference expressed in speed to market, development costs and ongoing product profitability.
| Product Extension | Case Study |
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Problem
Solution
Benefits
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Opportunities exist for financial institutions to extend their product portfolio with already established products from other banks, including: cash management, trade finance, securities services, FX and treasury product sets. This is hardly an exhaustive list – the possibilities extend across products oriented to both wholesale and retail clients.
A financial institution seeking revenue opportunities without an attendant increase in fixed costs would do well to extend the product portfolio in this way rather than build from the ground up.
Banks will find willing partners in this product extension exercise among those financial institutions with market leading offerings aimed at largely different target markets. Product re-dimensioning is a win-win solution for both partners – new revenue for one party and a contribution towards fixed costs for the other.
There have been far too many unfortunate instances of financial institutions pulling out of markets because they have built up a fixed cost base that overwhelms the business that has been generated. More poignant and tragic still is the case of the bank that has once pulled out of a market but is drawn by macro-economic developments or its own client base to re-enter.
The traditional market entry strategy for a bank is to build branches from scratch. A number of vendors offer solutions that give the impression of an easy implementation. But anyone who has been involved in the building of a new branch knows that ‘plug and play’ just does not apply to complex banking systems.
It is a strategic decision for a bank to enter a new market – a decision clouded by assumptions about the infrastructure that will be required on the ground, and by bad market exit experiences. But still the need remains to grow the franchise – what is a bank to do?
| Market Extension | Case Study |
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Solution
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The market re-dimensioning solution is to find a financial institution already operating successfully in the market you are interested in and leverage their existing infrastructure.
The Mobile Virtual Network Operator (MVNO) model pioneered by Virgin Mobile is coming to banking. Over time there will be a range of financial institutions who can enable other banks to make use of their core capabilities to provide entirely new market extension possibilities. For example, with a virtual banking platform available, banks in the EU will see a range of strategic options to use their existing domestic banking licences to passport into new EU markets, with the rapidly growing accession countries a particular area of interest.
Transcending market boundaries through re-dimensioning gives all banks a new strategic framework to use when deciding whether or not – and how – to enter a market. This will lead to new growth possibilities, and hopefully to far fewer examples of banks closing down branches in frontier economies.
The previous two dimensions – product and market – focused on new revenue generating possibilities. Only now do we turn to the cost dimension that is the pre-occupation of the outsourcing discussion, but which in reality is only one component of the more general, more powerful re-dimensioning framework.
Banks will have an ever growing range of options available to them as a partner grid comes online. A growing number of financial institutions will enable parts of their processing capabilities for use by other banks. This development will be much facilitated by SWIFTNet, which may become a standard mechanism for linking elements that remain in house (eg the general ledger) with elements provided by other banks (eg the payments system and clearing interfaces).
| Infrastucture Contraction | Case Study |
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Problem
Solution
Benefits
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The partner grid will be much more than hardware and software – operational capabilities will be tied into the network so that business processes will be available on the network, not just computing power.
The emerging partner grid will enable every bank to re-dimension their existing cost base. Banks will be able to gouge out portions of the fixed cost base until it comes to resemble Swiss cheese.
None of these re-dimensioning possibilities will be available to banks without work on the part of the suppliers. The suppliers will be financial institutions and their partner vendors. Some of the minimum requirements will be:
Enabling a financial institution to offer these kinds of new options is like building a cycle path alongside a road. There is a part of the road for the financial institution’s own use, and another part for use by other banks. This analogy points out a few key challenges – it is more expensive to build a road with a cycle lane, and sometimes it is physically impossible to add one to an existing road because it is already too narrow.
The most important insight for would-be suppliers of re-dimensioning solutions is to make sure the cycle lane is planned in from the start.
This may add cost, complexity and time to projects, but the approach will give some financial institutions the ability to offer re-dimensioning solutions to clients, and this is a major strategic opportunity.
Financial institutions should take a fresh look at the future with the new set of re-dimensioning options in mind. Banks should keep a running list of:
The re-dimensioning challenge for banks is to clearly articulate these areas of opportunity and find creative new ways to tackle them.
Leveraging the products, market coverage and infrastructures of other financial institutions gives banks re-dimensioning possibilities in each of these areas, while assuaging regulator concerns about traditional outsourcing to non-regulated entities. This will take banks beyond the limiting outsourcing thought process and provide a much more powerful way to confront a brutal market environment.
Financial institutions need to transcend the outsourcing terminology in over-use today and enter into a more fundamental, strategic discussion about the shape of the bank. New possibilities existing to grow revenue without a proportionate increase in fixed cost because:
What is the shape of banks to come? In form they will come to resemble less the bulky cubes of old fashioned TVs and more the sleek lines of modern plasma screens. They will extend along product and market dimensions without a proportional increase in fixed costs, becoming ever thinner, but ever brighter. They will generate cubes of performance for squares of expense.
The three dimensions that we have discussed – product, market and infrastructure – are axes of possibility. If financial institutions take on the re-dimensioning challenge, if suppliers step up to the plate and if banks can act as partners in execution while remaining independent in terms of origination, then we really will be banking outside the box. With that done, we can begin to explore the fourth dimension and those beyond it in the quest for the perfectly formed bank…
“Yet I exist in the hope that these memoirs, in some manner, I know not how, may find their way to the minds of humanity in Some Dimension, and may stir up a race of rebels who shall refuse to be confined to limited Dimensionality.”
…lament of the incarcerated Square in ‘Flatland’ by Edwin A. Abbott
1The American Heritage® Dictionary of the English Language, Fourth EditionCopyright © 2000 by Houghton Mifflin Company.