01 June 2008 Features

 

Bright sparks

Tom Groenfeldt

Banks are not exactly leaders in innovation, but does that matter? Yes – banks risk losing market share, revenues and margins to non-traditional players or to rivals that embrace new business models and technology.

When BusinessWeek and the Boston Consulting Group compiled a list of the 25 most innovative companies in the world for 2007, the only bank on it was Citigroup, at Number 36. The list didn’t offer specific examples of Citi innovations which presumably could have included Special Investment Vehicles, or liquidity puts …

Does innovation matter in banking? Zubin Taraporevala and Marl Capossi of McKinsey & Co. suggest it does. Writing in BAI’s Banking Strategies publication, the consultants say that their firm’s study of US retail banks from 1999 to 2006 showed that 62% of their growth came from mergers and acquisitions, 54% from underlying market momentum while organic share growth actually contracted by 16%. Speakers at the BAI Retail Banking Conference routinely point out that bankers project their firms will grow faster than the overall market without offering any strategies to take business away from their competition. Meanwhile major assets like retirement funds continue to flow into mutual funds and other non-bank financial organisations.

McKinsey’s 2007 cross-industry customer satisfaction survey found that retail banking scores were stagnant. “Even airlines, not usually considered an example of good customer service, experienced a small year-over-year increase,” said Taraporevala and Capossi. The lack of innovation hurts bank stock prices – only 9% of the share price of U.S. bank stocks reflects future growth, compared to 74% for a biotech firm like Genentech and 69%for Apple, they said.

Among the innovators in banking they cite are PayPal, Intuit’s QuickBooks and ING Direct which has been a hit with Internet-savvy customers. Alenka Grealish, senior vice president at Celent, also cites ING Direct along with Mint, for on-line personal financial management and Wal-Mart, which plans 1,000 money centres by the end of this year. Meanwhile E*Trade added $8 billion in deposits last year and now ranks number 33 in the U.S. USAA, a non-bank financial firm that began serving the US military, has launched cheque deposit from home.

Banks risk gradually losing market share, revenues and margins to non-traditional players or to banks that move more swiftly to embrace new business models and technology.

McKinsey says that firms need a dedicated innovation group to succeed. One bank that has done just that is Lloyds TSB which has organised a London-based innovation group led by James Gardner.

The innovation group takes a portfolio approach to managing its work, he explains. “We have no shortage of ideas within Lloyds; the trick is to turn the ideas into something. We know how many ideas come in, how many emerge, and we measure how they work.”

He takes a very practical approach to the portfolio. While he is always looking for leaps in innovation, he knows they are rare and take time. “So we look for the leaps and pay the bill doing incremental improvements.”

To find opportunities for savings, his group looks for paper-intensive processes and activities around the bank where gaps between technologies still exist and staff are making do. An important part of innovation is looking at what the bank can stop doing, he adds. “It is typical to create a new product or service without looking at how you can turn off an old one.”

Because the innovation team relies on the organisation to help identify opportunities, it spends a great deal of effort communicating with the entire bank and educating staff on what the innovation group is doing.

“Ideas come in from all over,” says Gardner. “We might receive an idea from a branch and take it to the corporate office and see if they want to do it.” In evaluating ideas, the questions asked are: can we, should we, and when should we?

Gardner sees a banking world where innovation comes from activities inside, such as the decline of checks, and from outside, such as Zopa, the web-based person-to-person lending initiative.

“That’s extremely disruptive because it changes the model,” says Gardner. “In the past, people asked how to do banking better; now, from the outside, innovators are asking how to do it differently. Innovation is about taking what is not doing business as usual and making it business as usual.”

Innovation teams have to remember they play the role of a catalyst, but they don’t run the business, he adds. “We are about helping the business to change, but we are not the business. We are gunpowder but not the bullet.” Ideas developed by the group and approved are typically handed off to the bank’s strong architectural group.

“We don’t do delivery. Our ideas go into the standard architecture and design process which has about 200 people who consider every aspect of a system.”

Just over 18 months old, the innovation group still has a lot to learn, admits Gardner. “I expected resistance to change but we have found the bank has an enormous appetite for the work we are doing.”

Innovation isn’t just technology, but the two are closely intertwined. Part of what an innovation team does is look at new technological capabilities and then explore ways they could change banking. Gardner is paying close attention to social networking, for example.

Dermot Doherty, an industry solutions analyst at Microsoft who focuses on banking, is looking at the business drivers to see where technology can provide useful solutions. A key issue for banks is cost reduction, so they are looking at ways to encourage customers to use their low-cost channels, he says.

“Banks want to create straight-through-processing so a customer can initiate a transaction and it flows through the system faster, smarter and at a reduced cost.” If UK banks lose their case on the fairness of fees they have charged for overdrafts, they will have to go through their records for the last seven years and analyse their accounts to find cases where they owe refunds. Search technology such as Autonomy, or FAST, the Oslo-based company which Microsoft recently acquired, can help with that.

Doherty sees bank CIOs rethinking their core banking systems. They are reluctant to replace systems that have been developed over 35 years and run day-in and day-out without problems, he says. But the business needs a manufacturing engine which allows a bank to rapidly produce new products. So the challenge for banks is creating agility in a solution which wraps around the core banking system.

“Until banks can purchase a core application that will run on a resilient platform they will leverage the assets they have.”

He sees plenty of room to improve profitability measures. Very few banks can tell you how profitable an individual customer is, and many don’t know how profitable their products are. He recently participated in a study at one bank which discovered the marketing department had closed down its most profitable type of account.

Banks are tugged between what technology can change and what customers will accept, he adds. Bankers would love to get rid of saving passbooks but they know that would create dissatisfaction among some of their most profitable customers. In the 1990s, banks were talking about closing high street branches, but now they are keeping them open longer, increasing their branch visibility and turning to mobile banking for remote areas.

But that doesn’t mean internet access won’t change branches. Over the next two years Doherty expects to see banks making better use of customer information.

“In five years, the branch will still be there, but it won’t be quite as we know it. The branch will have smart ways to identify customers, perhaps with RFID. At the 10-year mark we will have had a generation change, so banks again will be thinking they can move more to internet banking.” He also expects continued growth in mobile tools for bank employees to have information at their fingertips when they work with customers, and for customers who can access their bank accounts from mobile phones.

As today’s young people move through the customer value management cycle, he says, they are going to be tech savvy and want to manage their money online faster and better than they can now.