Customers who stroll into a Portland, Ore.-based Umpqua Bank branch can hoist a mug of gourmet coffee and then relax in the comfy lobby while checking their e-mail (via free Wi-Fi) before attending an evening yoga class. The vibe is so relaxing that visitors might easily forget that a nasty sub-prime mortgage crisis is roiling most retail banks and the financial services industry as a whole. Once the credit crisis recedes, banks like Umpqua that compete based on the experiences and products they target to specific customer segments will be better positioned to triumph in an extremely competitive marketplace. At that point, the industry's competitive zeal is expected to more closely resemble the cutthroat dynamic of retail rather than the easy-money era the banking sector enjoyed in the past two decades. That period, until about late 2004, was defined by an extremely beneficial yield curve, vigorous deposit growth, excellent credit performance and, of course, hefty profits.
The credit crisis is largely the result of risks taken since late 2004 in an effort to extend the industry's highly profitable two-decade run (with several minor exceptions, including two brief and mild recessions). "What we're seeing now is essentially the blowback from an 18-month period of everyone trying to stay at the party too long," explains Michael Poulos, Oliver Wyman managing director and head of the firm's financial services in North America.
"That's going to work itself out eventually: we'll have our hangover, and then we'll be done. … When it is over, it's going to be much tougher to make money in financial services than it has been for the last 20 years."
That's because the factors that drove both the long boom and the current bust will still exist. Bain & Company partner Phil Davis, a member of the firm's global financial services practice, notes that net interest margin—the difference between what banks receive from borrowers in interest and the interest banks pay borrowers—has been declining for several years. Furthermore, new competitors are crowding retail banking, securities firms and insurance.
"Banks are going to have to find ways to adapt to this new environment," Poulos says.
Those adaptations will require cost cutting, stronger technical and analytical capabilities, enhanced customer experience management capabilities and, of course, plenty of insight, advice and practical, hands-on work from financial services consultants.
Struggling Like its 1989
In the near term, financial services clients may want to hold off on the caffeine as their stomachs adjust to the turbulence. The Dow Jones U.S. Banks index was down more than 22 percent in 2007 compared to the previous year. Valuations in the financial services sector as a whole declined nearly 15 percent. And defaults on sub-prime mortgages appeared to be spreading to prime mortgages and even auto loans, which saw a delinquency rate increase from August 2007 to September 2007 by the largest amount in eight-plus years, according to Lehman Brothers research.
The credit crunch also claimed the top executives of at least two financial services giants, Citigroup and Merrill Lynch.
At the start of 2007, the industry was largely focused on three objectives: growing revenue, becoming more efficient and, says Deloitte Consulting's John Kocjan, "trying to achieve both of those goals without blowing the place up."
"Unfortunately, they weren't able to avoid blowing something up," adds Kocjan, who heads the firm's financial services practice and its financial services strategy.
For financial services veterans, the current situation has a familiar feel to it. "The last time my gut felt this way was '89 and '90," notes Sean Culbert, IBM Global Services business transformation consultant. "That's when the banking sector contracted significantly in the wake of the savings and loan scandal."
A Bull Run in Cost Reduction
The industry's current struggles have sparked a significant shift in focus—from preventative challenges to remediation challenges—that directly affects many consulting engagements, Culbert says.
"Companies are looking backward at events that occurred to determine what the root cause is and how the problems can be fixed," he explains. Helping financial services clients on that score marks a major change from the strategic consulting of the past, where the emphasis was on "selling more, safer," delivered during the last five years.
After identifying root causes—which usually boil down to some combination of erroneous data, incorrect business assumptions and risk indicators, or to information system problems—financial services firms are looking for guidance on how to cut costs.
"Many large financial institutions will have to continue to restructure their cost base," says Kocjan, who identifies organizational rationalization and simplification, business process redesign, technology rationalization, real estate and infrastructure rationalization and procurement streamlining as key focus areas. "Companies are looking for more aggressive ways to think about enterprise cost reduction," he adds. "In some cases, it almost enters crisis-management mode."
Yet, Kocjan and other consultants helping their clients "rationalize" also emphasize that cost-reduction requires a surgeon's touch: many parts of financial services organizations require additional investment.
| Searching for New Expertise Financial services consultants say their clients need help cutting costs, generating more revenue from new and existing sources, and preparing for a much more competitive environment. It also helps to understand what expertise financial services firms are seeking from another service, their executive-search firms. Global Managing Director Rob Grandy leads Korn/Ferry International's financial markets practice, and he's noticed several shifts in preferences during recent months, including the following:
A much greater focus on "infrastructure searches," which include positions related to risk management, compliance (e.g., chief compliance officers) and back-office technology (CIOs). "Some firms will reduce their staffs dramatically, but they may also struggle to keep their top producers," Grandy says. "Not everybody is affected the same way by this crisis. Some people are skating through pretty much untouched and able to build. Others are getting crushed. The real question is, 'How do you split up the bonus money to ensure that you keep your best producers?'" —E.K. |
"It is very much akin to the pendulum that moves according to market forces—normally the IT investment pendulum maintains relative equilibrium with a balance between the two general areas of growth and revenue generation vs. cost containment and increasing efficiency," explains Pierre Nanterme, Accenture financial services operating group chief executive officer. "Right now, market forces are moving it toward the 'operational,' 'focus on costs' or 'increase efficiency' end of the spectrum."
As financial services firms reduce headcount in some areas, they will likely find they need to hire—or source—in others, such as collections and workout professionals. "There's a finite amount of workout resources out there," Kocjan notes. "And everybody will begin to look for those resources at the same time."
He also points to a unique customer-experience consulting opportunity in collections. "Clients need to develop better early warning capabilities so they can more accurately differentiate between borrowers who represent a serious risk and borrowers who are merely late payers," he says. "That way, they can avoid spending too much money and energy collecting from sloppy payers."
And, Kocjan adds, collection functions can bring to bear more enhanced consultative skills while working with at-risk borrowers to ensure that their institutions are repaid first, before competing institutions.
Helping clients understand how they arrived at their current challenges represents the sort of self-reflection consultants ought to encourage in less turbulent periods as well, Nanterme says. "The exercise of 'lessons learned' cannot be initiated only during or after adverse circumstances—though it might seem more apparent to conduct such an exploration when losses are incurred," he adds. "It should be a regularly utilized management and growth tool. That said, the times we are now in demand an exhaustive examination of how companies can better manage their risk portfolio."
Getting Customers Experienced
An increasingly important way for financial services firms to address future competitive risks is by focusing on customer experience. Umpqua's upscale coffee clutch and free Wi-Fi approach to customer experience management in its branches and online, notes Davis of Bain, reflects the sort of innovation more retail banks should consider.
"The emphasis on retail banking used to be on the banking, but it's quickly shifting to an emphasis on retail," Davis explains. "We are advising clients to recreate the traditional branch in new ways, such as a light retail approach."
Consider the cellular phone stores that occupy nearly every form of retail property in the U.S. These small stores are convenient as well as easy and cost-efficient to set up and tear down. But Davis says most consumer banks are not familiar with this approach and other concepts that have flourished in the retail sector for several years.
"Traditional retailers have a much stronger sense of who their customers are and what their needs are," he adds. "They have a sense of what lifestyle their customer leads and what role they have in improving that lifestyle."
Retail banks have paid lip service to their customers' lifestyle, but very few have woven those considerations into effective strategies. Try to think of the last time you stepped foot into a consumer bank branch that didn't remind you of, well, every other consumer bank branch. Umpqua is an exception, and its innovative approach extends beyond bricks and mortar. The "UmpquaLife" page on its Web site directs customers to different life milestones and products that complement those particular life stages rather simply pitching products. More of those customer experience considerations are needed within all customer segments, financial services experts emphasize. With baby boomers on the verge of retirement, a more tech-savvy generation is about to become an important customer segment.
And these younger consumers, notes Bruce Temkin, vice president and principal analyst, customer experience with Forrester Research, "are adopting new models of behavior like social computing that are shifting how they interact with all sorts of institutions" and how they share information. "This information includes consumers' assessments and recommendations of financial services firms and products," Temkin adds. "So financial institutions need to deal with consumers who are telling each other about their experiences, which creates both 'hyper-informed' and 'hyper-misinformed' consumers."
As baby boomers age, their banking and financial services needs change. "The baby boomers have been in peak earning years, so everything in financial services—not just in banking but also in the investment businesses and even the insurance business—has been about accumulating assets," Poulos says. "As the population gets older… people will need to draw down those assets. All financial institutions, including banks, will need to help people think about how to do so in the most optimal way."
Few financial institutions appear prepared on that score; most compensation structures are based on the size of assets under management, and relatively few products (beyond reverse mortgages and annuities) exist to meet this need. "There are many opportunities out there to essentially re-orient your thinking as a financial institution around the needs of your customer in a different life stage," Poulos says.
Outside Help Needed
Before some of the largest financial services firms can conduct this sort of reorientation, they will need to familiarize orient themselves with new executive leadership. While the leadership turnover may not have a significant impact on most consulting relationships in the industry, the trickle-down implications of well-documented succession planning problems suggest a need for leadership development services. The specifications firms are seeking in their top executives (see Searching for New Expertise on Page 36) also reflect mindset challenges consultants should note.
The critical specs that led Citigroup to hire its new CEO, Vikram Pandit, in December included oversight, cost-containment, team-building and risk management capabilities, according to The Wall Street Journal. Had the search been conducted more than a year ago, its likely those qualities would have taken a distant back seat to a candidate's production track record.
"Within most financial services companies, promotions usually focused within the producer ranks," according to Rob Grandy, Korn/Ferry International global managing director who leads the firm's financial markets practice. "Those are the people who traditionally moved management and leadership positions in the firms … The spoils basically go to the biggest producers."
That tendency may have contributed to the industry's recent risk-management and succession-planning problems. Since top producers were rewarded with promotions, many financial services firms invested less time and energy in management development and training than other industries. Korn/Ferry's Grandy reports that his firm uses its leadership assessment methodology—a process designed to identify leadership qualities best suited for particular executive levels within organizations—on roughly 30 percent of the financials services executive searches it conducts. Yet, the firm uses the same leadership assessment methodology on well over half of the searches it conducts in all other industries.
"It's clear that the [financial services] industry is using less leadership assessment and development work than companies in other industries," Grandy says.
Boards of directors demanding better succession planning capabilities represent one more worry for already stressed executive teams. Soothing their nerves will require much more than yoga classes and comfy bank lobbies.
The consulting firms that succeed in the newly competitive industry that emerges post credit crisis recedes will need to collaborate more with their retail colleagues, deliver services with practical impact and convince clients that they can help them succeed without the safety nets that previously cushioned the industry from some competitive challenges.
"You can't just put your bank on auto-pilot and expect to make profits any more," Poulos adds. "But the field is wide open. And we see huge opportunities for companies that get it right and huge downsides for companies that get it wrong."
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