FI Tip Sheet: The Innovator’s Dilemma

Over the past few years, I have seen significant change within the banking community — much of it defensive or in response to government intervention and oversight.  According to a white paper recently published by McLagan, “a great deal has been said about the excesses and errors of the past; however (sic), the current focus for banks, in particular, must be on the need to innovate or risk becoming stagnant and losing the ability to compete for exceptional talent.”  This morning’s column focuses on the “innovator’s dilemma,” vis-a-vis three questions.

Everything is AwesomeDo We Need Sustainable or Disruptive Technology ?

I have talked with a number of Chairmen and CEOs about their strategic plans that leverage financial technology to strengthen and/or differentiate their bank.  After one recent chat, I went to my bookshelf in search of Clayton Christensen’s “The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail.”  His book inspired today’s title — and fuels this first question.  Christensen writes about two types of technologies: sustaining and disruptive.  Sustaining technologies are those that improve product performance.  As he sees it, these are technologies that most large companies are familiar with; technologies that involve improving a product that has an established role in the market.  Most large companies are adept at turning sustaining technology challenges into achievements.  However, large companies have problems dealing with disruptive technologies — an observation that, in my view, does not bode well for many traditionally established banks.

“Discovering markets for emerging technologies inherently involves failure, and most individual decision makers find it very difficult to risk backing a project that might fail because the market is not there.”

While risk is inherent to banks of all sizes, taking chances on emerging technologies continues to challenge many officers and directors.  To this end, I thought about the themes explored in Christensen’s book after spending time in Microsoft’s New York City offices last week.  While there, I heard how big banks are generating revenues by acquiring new customers while retaining, up-selling and cross-selling to existing customers.  I left impressed by the various investments being made by the JP Morgans of the banking world, at least in terms of customer relationships and experience management along with analytics and core system modernization.  I do, however, wonder how any entrenched bank can realistically embrace something “uber-esque” (read: disruptive) that could truly transform the industry.

Do We Have the Staff We Need?

Consider the following question from the perspective of a relatively new hire: “I have a great idea for a product or service… who can I talk with?”  A few months ago, Stephen Steinour, the President & Chief Executive Officer at Huntington Bancshares, keynoted Bank Director’s annual Bank Executive & Board Compensation conference and addressed this very thing.  As he shared to an audience of his peers: “the things I assumed from my era of banking are no longer valid.”  Rather than tune out ideas from the field in favor of age and experience, he explained how his $56Bn+ institution re-focused on recruiting “the right” employees for the company they wanted (not necessarily what they had), with a particular emphasis on attracting the millennial generation into banking.  He admitted it’s a challenge heightened by public perception of the industry as one that “takes advantage of people and has benefited from government bailouts.”  Still, he made clear the team they are hiring for reflects a new cultural and staffing model designed to drive real, long-term change.  I wonder how many banks would (or could) be so bold?

Do We Have The Right Business Model?

I’ve heard it said that “forces of change” will compel banks to reinvent their business models.  Take the business model of core retail banking. According to a piece authored by McKinsey (Why U.S. Banks Need a New Business Model), over the past decade, banks continued to invest in branches as a response to free checking and to the rapid growth in consumer borrowing.  But regulations “undermining the assumptions behind free checking and a significant reduction in consumer borrowing have called into question the entire retail model.  In five years, branch banking will probably look fundamentally different as branch layouts, formats, and employee capabilities change.”  Now, I’m not sure banking’s overall business model needs a total overhaul; after all, it still comes back to relationships and reputations.  Nonetheless, many smaller banks appear ripe for a change.  And yes, the question of how they have structured their business is one some are beginning to explore.

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To comment on this piece, click on the green circle with the white plus sign on the bottom right.  Looking ahead, expect a daily post on About That Ratio next week.  I’ll be in Nashville at the Hermitage Hotel for Bank Director’s Bank Board Training Program.  Leading up to, and at, this educational event, I’ll provide an overview on the various issues being covered.  Namely, risk management and auditing issues, compensation, corporate governance, regulation and strategic planning.  Thanks for reading, and Aloha Friday!

The Buying and Selling of Banks

photo
I think I know what’s around the bend…

As we wind down the dog days of summer, I re-read my last eight posts before outlining this week’s piece.  By design, I placed a heavier emphasis on stories that related to building customer relationships and opportunities tied to organic growth rather than multi-national issues and regulatory reform.  To build off these ideas, I thought to share three pieces that address “what’s next” in the United States and Europe.  The first focuses on potential changes overseas; the second, on domestic mergers and acquisitions; to close, I share the thoughts of Wells Fargo’s CEO on the importance of community banks.

(1) “What’s next for the restructuring of Europe’s banks,” a question that parallels many conversations taking place within boardrooms, think tanks, government offices and media rooms across the U.S.  Penned by members of the financial services team at McKinsey, this op-ed shows how Europe’s banks, like their U.S. counterparts, have had to re-evaluate their short and long-term prospects based on stagnant economic conditions.  Many “continue to face pressure from difficult funding conditions, a transition to higher costs of capital, changing regulations and tighter capital requirements.”  The authors make a case that many “need to shed capital-intensive operations and simplify businesses to compete more profitably in fewer market segments.”  All told, this report claims Europe’s banks are “considering the sale of up to 725 business lines across various business segments and geographies.”  If true, this might result in greater numbers of strategic mergers of like-sized banks.  Do you agree that this story sounds eerily familiar to the one playing out here in the States?

(2) Staying closer to home, bankers and advisers alike debate how quickly consolidation will play out in the coming years.  Personally, I see it taking place over a longer period than some might forecast.  To this point, I think I have a friend in Raymond James’ Anthony Polini (their Managing Director of Equity Research).  Anthony shared his perspectives with an audience of CEOs, Chairmen and board members at Bank Director’s Acquire or Be Acquired conference this January.  There, he opined that industry consolidation “is inevitable” as banks come to grips with new regulations, lower growth rates, higher capital/reserve requirements and lower long-term margins/returns.

Earlier this week, he penned a mid-year report that builds on those ideas.  He lays out how “the current slow growth environment fosters M&A as a quicker means for balance sheet growth and to achieve operating efficiencies in this revenue-challenged environment.”  In his team’s estimation, meaningful industry consolidation takes place over the next 5 to 10 years rather than a large wave that occurs over just a few.  This belies his belief that banks are “sold and not bought.”

Using this logic, coupled with an improving (albeit slowly) economy, modestly better asset quality and shades of loan growth, he believes “an M&A target’s view of franchise value will remain above that of potential acquirers. Put another way… expect the disconnect between buyers’ and sellers’ expectations to remain wide but slowly move closer to equilibrium over time.”

(3) Not to be lost amid this consolidation talk is a perspective from John Stumpf, the chairman and chief executive of Wells Fargo, as to why “Community Banks Are Vital to Our Way of Life.”  In his words

“…we need well-managed, well-regulated banks of all sizes—large and small—to meet our nation’s diverse financial needs, and we need public policies that don’t unintentionally damage the very financial ecosystem they should keep healthy. “

He continues that “almost 95% of all U.S. banks are community banks. They provide nearly half of all small loans to U.S. businesses and farms. In one out of five U.S. counties, community banks are the only banking option for local residents and businesses. Many small towns… would have little access to banks, and the services they provide, without our system of community banks.”  Significant words from one of banking’s biggest voices.  Not the first time he’s shared this opinion, and hopefully, not the last.

Aloha Friday!

Back in the Saddle

A summer vacation sunset
A summer vacation sunset

It’s been a few weeks since I last shared what I’ve heard, learned or discussed on this site. Yes, vacation treated me well. But I’m excited to get back into the swing of things and especially pleased to welcome two new people to the Bank Director team: Katy Prejeant and Jake Massey. Both can be followed on Twitter @BankDirectorAE and @WJ_Massey. As always, what follows are three things that relate to bank executives and boards that caught my eye and/or ear this week.

(1) Drive a few hours west of our Nashville offices and you can find Memphis-based Mercer Capital. The advisory firm assists banks, thrifts and credit unions with “corporate valuation requirements and transactional services.” Each month, their Bank Watch newsletter pulls together a series of articles from around the web. From stress testing to Basel III, ESOPs to a Midwestern public bank peer report, there are some interesting reads this month. But one that caught my eye wasn’t in their report – it can be found on their main site. It’s a white paper on Creating the Potential for Shared Upside. Authored by Jeff Davis (a speaker at last year’s Acquire or Be Acquired conference), the piece reviews various financial issues arising when community banks merge or sell to a larger, public institution. With many anticipating an upswing in M&A deals in the second half of 2013, it is an interesting perspective to consider.

(2) In past posts, I have noted how the banking industry is a mature one. That is, where competing on price with the BofA’s of the world may best be seen as a fool’s errand. Nonetheless, McKinsey’s classic article on “Setting Value, Not Price” should be a must read this week. While not specific to the financial space, they lay out a reality where ”people buy products and services not on price alone but on customer value: the relationship between costs and benefits.” Although this trade-off has long been recognized as critical for marketing, this month’s “Insights & Publications” shows that businesses frequently get their price–benefit position wrong. They wrote in 1997 that “value” may be one of the most overused and misused terms in marketing and pricing. If you’re game, drop me a line below and let me know if you agree this is still the case.

(3) Spend any time talking with a bank’s CEO, and keeping pace with technology (and by extension, technology risk management) is sure to come up in a discussion that involves improving their business, brand and reputation. According to a new “FS Viewpoints” published by PwC, financial institutions have, for too long, “viewed technology risk management as a defensive tactic or regulatory compliance activity.” Based on the consultancy’s observations, “existing approaches to technology risk management often provide limited value to the business.” They see a real opportunity to leverage technology risk management to provide strategic business value. This piece shows how leading institutions are shifting their focus on risk management, moving from a fragmented and reactive compliance approach to a more balanced, business-aligned, risk-based strategy.
Aloha Friday!

Before I pack my bags

DC food trucks got some business...
By staying local, a few DC food trucks picked up extra business this week…

For the first time in nearly two months, I did not leave the friendly confines of Washington, D.C. for work.  Next week, AA gets my business back with a trip to San Francisco — followed by one the following week to Chicago and the next, to New York and Nashville.  Yes, I anticipate sharing a number of stories in the weeks ahead, but these three had me excited to post today.  As always, my #FridayFollow-inspired post on things I heard, learned or discussed that relate to financial organizations.

(1) File this one under “things that make you go hmmm.”  Earlier this week, the American Banker published an interesting piece entitled “Fed Reveals Secret Lessons of Successful Small Banks.”  As I’ve written in multiple M&A-focused posts, many investment banks  predicted a wave of consolidation among community banks after the financial crisis hit while positing that financial institutions need at least $1 billion of assets to compete/remain relevant.  This piece, however, cites recent St. Louis Fed research that shows the asset range with the most “thrivers” — the term the StL Fed used to describe remarkable banks — was $100 million to $300 million.  As the American Banker notes, much of the research stemming from the crisis focused on the mistakes banks had made, so the St. Louis Fed decided to take the opposite approach.  If you have a subscription to AB, their recap is worth a read.

(2) Disruptive technologies were front & center a few weeks ago in New Orleans at our annual Growth Conference.  Yesterday afternoon, McKinsey put out “Disruptive technologies: Advances that will transform life, business, and the global economy.”  While not specific to our industry, the fact that the “mobile internet” placed first should reinforce the conversations taking place in bank boardrooms today.  According to the authors, 4.3 billion people are yet to be connected to the Internet, with many expected to first engage through mobile devices.  Considering the six-fold growth in sales of smartphones and tablets since launch of iPhone in 2007, well, you can see why I’m bullish on banks getting social and enhancing their mobile offerings ASAP.

(3) Finally, for those quants looking for a good, non-Krugman economics piece, look no further than the NY Times’s “Economix” blog.  The most recent post: How a Big-Bank Failure Could Unfold.  In the piece, the authors consider what could happen if there were a hypothetical problem at a major international financial conglomerate such as Deutsche Bank or Citigroup.  As they note, “defenders of big banks are adamant that we have fixed the problem of too big to fail.”  This entry considers the alternative.  So for those with a desire to stay up late during this Memorial Day three-day weekend?  This might be a read for you.

Aloha Friday!

Its Aloha Friday

Cherry blossoms in DC
An example of organic growth in Chevy Chase D.C.

Earlier this week, as part of Bank Director’s annual Bank Chairman/CEO Peer Exchange, I was lucky enough to spend time with key leaders from 40+ community banks averaging nearly $900M in asset size. As I reflect on various growth-focused conversations I had with CEOs of NASDAQ-listed banks, I think I’ve found a common thread. Each person runs an institution profitable enough to make acquisitions — all while maintaining adequate capital ratios.  The interesting part (for me at least) concerns the strategies these executives set to build their brand and tactics put in place to “organically” grow their franchise.  As our industry continues to rally back from the past few years of pessimism, it really is fun to hear success stories.  So what follows are three thoughts from this week that builds on my time at the Four Seasons in Chicago.

  • While M&A offers immediate growth to the acquirer, I’m hearing that “stocking the bank for talent” is a real long-term challenge. While a bank’s CEO and Chairman must work even more closely to drive bottom line performance while enhancing shareholder value, I left Chicago convinced this team must more aggressively identify — and groom — the next generation of bank leadership. Without the big banks providing management training like they once did (an unintended pipeline of talent for community banks), its time to get creative. For example, while most at our event appreciate the need to get mobile, few community banks have the senior strategist on hand to do so right now. While that opens the door to outside advisors to support an institution, it does present longer term dangers as customers expect access to their banks sans branch or ATM use.
  • Keeping on the tech-to-grow theme, I read an interesting “big data,” bank-specific piece by McKinsey on my way home to D.C.  Personally, I’ve been interested in the various tools and tactics banks employ to analyze their massive amounts of data to detect/prevent fraud, devise customer loyalty plans and proactively approach consumers. This overview, complete with video, touch on these points and show how some are using big data and analytics to sharpen risk assessment and drive revenue.

Aloha Friday to all, especially my niece and sister-in-law on their birthdays.