Simplify to Succeed - IBM

IBM Business Consulting Services
Simplify to Succeed
Optimise the customer franchise and achieve
operational scale: Retail financial institutions in 2005
Futures Series

Rethinking the business model
Optimising the customer franchise
Maximising the breadth, depth and flexibility
of products and services
Optimising the scale and efficiency of
operations
Moving to a component-based business
model
Simplify to Succeed—Retail financial institutions in 2005
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This paper is part of IBM Business Consulting Services on-going
commitment to forward-looking industry and business points of view,
and our aim to help companies and industries Transform Futures.
table of contents

Retail financial services: ceaseless change
It has become commonplace that the retail financial services industry is in a ceaseless whirl of change.
The regulatory environment, competition from traditional and non-traditional players, the proliferation
of delivery channels, new technology and increased consumer expectations—all these are forcing retail
financial institutions (FIs) to innovate and adapt if they want to thrive and create shareholder value.
And they have risen to the challenge. Over recent years leading FIs have successfully introduced a host
of initiatives: new delivery channels, new management tools, new products and sources of revenue—
while also driving down costs and rewarding their shareholders.
But all this has absorbed a vast amount of investment—and used up much of the FIs’ capacity for
change. Moreover, IBM Business Consulting Services’ research shows that many institutions are
reaching the limit of their ability to extract further value from their customer franchise while simultaneously
increasing their flexibility and economies of scale: these two objectives are too much at odds
with each other.
However, we believe that this need not be an impasse. Many of the difficulties now facing large FIs
can be traced to years of making piecemeal modifications to their businesses, each of which may have
brought improvements but which, as a whole, have left them with complex business models that
constrain them when responding to fresh challenges. Typically, these consist of tightly integrated,
product-based units, which have robbed institutions of the flexibility needed to succeed in today’s
highly competitive and sophisticated markets.
The new challenge for FIs is to acquire a more flexible, customer-centric business model, while
simultaneously achieving economies of scale. Some FIs have already embarked on this transformation.
But change has to occur at all points of the value chain if this transformation is to succeed. We believe
that winning FIs of the future will be those which take on this challenge, and rethink their business
model, organisation, processes, technology, culture and performance measures in a fundamental way.
This paper presents our vision of tomorrow’s retail financial services sector, and describes the practical
steps that FIs will need to take if they are to succeed in it.
1

Simplify to Succeed—Retail financial institutions in 2005
2

Simplify to Succeed
2005: John Consumer gets the message
Breakfast in the Consumer household. John
boiled the kettle and reached for his favourite
packet of ground coffee. Empty. He’d have to
make do with instant: not the best start to his
day.
He sat down and picked up his mobile 3G
device. The overnight message from InsurBank
told him his net worth as of midnight: $37,321.
That was the total of his savings and
investments minus the home loan on their
apartment. It was slightly more than he
expected, but the statement showed he had
just been credited with the latest monthly
interest and dividends on his savings, which
InsurBank guaranteed would always be among
the market’s top decile.
John had some planning to do. He was off on
holiday with his family and needed travel
insurance (and it was his wife’s birthday today,
the message reminded him). Insurance was not
something that John cared to spend too much
time on, so he had subscribed to InsurBank’s
bundled family insurance cover. His car, house,
travel requirements, his life, even Rufus the
dog, were all on the same policy. However he
didn’t pay all year round; he just activated the
travel component when he needed it.
It was back in 2002 that John joined
InsurBank. At first he had been sceptical about
putting all his products with one provider. But
their style intrigued him, and the quality of
service was surprisingly good. He had also
despaired of his old bank: the 9:30 p.m.
customer satisfaction surveys, endless junk
mail and total failure to tell him that his life
insurance policy might not meet his needs!
The joy now was that all contact with the bank
happened when it suited him. Furthermore, all
communication channels showed his full
account details in real time, and in a consistent
format. Everyone he spoke to seemed to know
his history and preferences, and he could pick
up a conversation as if he had his own financial
adviser. As the years went by and the number
of financial products he needed increased, he
also began to tap into InsurBank’s financial
planning and inheritance services—and make
use of the discounted deals (holidays, theatre
tickets, etc.) offered by the network of
retailers that InsurBank had put together.
InsurBank also seemed to know about his
family and lifestyle. His daughter Sophia came
top of her class at technical college and they
gave her a loan to set up a small engineering
business. Another budding customer.
John sipped his coffee. It tasted dreadful. No
point in lingering. Anyhow, he had an
appointment at InsurBank’s local branch to
discuss which mutual funds might be suitable
for his next investments—they supplied a wide
range from a number of providers with proven
track records. He might also use an Internet
terminal in the branch to send flowers to his
wife. And they always had good coffee.
3

Simplify to Succeed—Retail financial institutions in 2005
2005: Another bad day at InflexiFinance
Pierre Grüman growled.
Another day, and more market punishment for
InflexiFinance, once his country’s leading retail
financial institution.
Life had seemed so rosy at the millennium.
InflexiFinance was the first FI to install
interactive TV banking. It also added insurance
brokering and asset management to its core
banking products to offer a complete wealth
management service to its customers. He was so
certain then that InflexiFinance would dominate
the market and reward its shareholders, as it
had done for years. But today, it was not he who
was being interviewed by CNN and CNBC, but
his bitter rival Marie Garcia, CEO of InsurBank.
Why was their P/E ratio 18 and his a mere 12.2?
He flicked on the television: There she was
again, beaming at the interviewer on the Finance
Channel.
It was back in 2002 that the two companies
started to pursue different strategies. While
InflexiFinance continued with its quest for size
and developing in-house capabilities for
everything, InsurBank announced that it was
going to focus on what it did best, and deal with
a select customer base. InsurBank formed a
distribution alliance with another of their rivals,
SmartCash, to sell each other’s products. The
idea of working with a competitor had seemed
ludicrous to Grüman: Why would SmartCash
want to help InsurBank? They would end up
fighting. But it now appeared that both
institutions had made considerable savings
through their joint venture, and had landed some
lucrative third-party partnership deals as well,
while maintaining their independence at the
front end.
4
Then there was InsurBank’s extraordinary
decision to move its back-office processes to
lower-cost countries in the Southern
Hemisphere. The political and economic
risks—to say nothing of the loss of control—
seemed absurd to Grüman. But InsurBank had
mitigated these risks by spreading the work
across South Asia and Latin America.
What’s more, Grüman’s master plan to create
a wealth management offering was not
delivering the goods. Although his CRM
systems had identified the mass affluent as a
potential market, InflexiFinance’s size and
complexity made them impossible to serve.
InsurBank, on the other hand, had reorganised
itself around its chosen customer
segments and had the flexibility to bundle
together the right products for them.
InsurBank now sold 4.3 products to each
customer against InflexiFinance’s 1.6.
Grüman looked up as InflexiFinance’s heads
of lending and insurance walked into his
office, arguing. There was no way they could
cross-sell their two sets of products to the
same customer because they couldn’t use the
same customer data. Furthermore, as their
salespeople’s pay was geared to sales
volumes rather than the overall customer
relationship, the two teams had little
incentive to help each other. He had
struggled, without success, to break down
these boundaries. How different it was at
InsurBank, where general managers served
customer segments and had incentives to
pass customers around the organisation.
Pierre Grüman tried to growl again but all he
could manage was a groan.

Rethinking the business model
The realities of today’s marketplace are that large institutions are trailing their smaller competitors in
value creation; business models are increasingly inflexible; barriers to growth via international
expansion remain; and technology continues to add complexity rather than simplifying.
In their drive to keep abreast of market developments, many FIs have ended up with inappropriate
business models—ones that are based around products or channels, and integrated from front-to-back
through the whole value chain. This has reduced their ability to optimise customer-facing activities to
serve evolving customer needs while simultaneously achieving economies of scale in order to maximise
long-term shareholder value. Today’s fast-moving markets require fundamental, not piecemeal change.
Large institutions are lagging behind their smaller competitors in value creation
FIs are confronting the challenges of today’s marketplace in a variety of ways: by restructuring, by
developing new products and raising service quality, by seeking scale, and by relentlessly driving costs
out of the business.
Return on Equity
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
Banking and Securities Insurance
Small Firms Medium Firms Large Firms
Banking and Securities
Small firms defined as firms with assets of $0 to $32b.
Medium firms defined as firms with assets of $32b to $128b.
Large firms defined as firms with assets of > $128b.
Insurance
Small firms defined as firms with premiums written of $0 to $250m.
Medium firms defined as firms with premiums written of $250m to $1.5n.
Large firms defined as firms with premiums written of > $1.5b.
Collected financial data from more than 5,000 financial institutions in Europe
and the U.S. Insurance figures are downward skewed as a result of outliers.
Data Source: IBM Business Consulting Services databases and Thomson
Financial, data reported on an entity basis for banking ratios, and insurance
expense ratios. Data sourced covers company performance from 1997 to
2000.
5
However, trends show that the larger
FIs are falling behind in the valuecreation
process. Apart from a
handful of industry leaders, most
large FIs are not matching the
profitability of their medium-sized
counterparts, nor are they generating
superior levels of shareholder value.
(See diagram.)
The incremental approach to
expansion has made business
models increasingly inflexible
The arrival of new entrants, new
delivery channels and new technologies
is driving change deep into the
financial services sector. But many FIs
react to these developments by
making incremental alterations and
additions to their businesses rather
than by addressing their fundamental
frameworks. Although this has
enabled them to move with the times,
the cumulative impact of change to
products, pricing and channels has
made their business models progressively
more complicated and less
flexible.
Most large FIs are
not matching the
profitability of their
medium-sized
counterparts, nor are
they generating
superior levels of
shareholder value.

Up to 70% of IT
spending by FIs goes
toward maintenance
and redevelopment.
Simplify to Succeed—Retail financial institutions in 2005
This can be seen in the fragmentation of their processes. For example, on the product delivery side,
they have tended to target one channel at a time (e.g., Internet or voice), leaving them with separate
channel silos, each with its own front-to-back operations for servicing, marketing and product design,
but with little lateral contact with other parts of the business. Similar structures have emerged in
manufacturing and operations, where business units have added new fulfilment processors incrementally.
So, while large FIs may have reached their desired operating scale, many have also lost the agility
of their smaller competitors.
From our extensive studies of performance improvement and cost reduction, we estimate that as much
as 60% to 80% of the functionality in silos may be redundant or duplicated in other parts of the
business. This weakens FIs’ performance and makes it harder for them to respond to fresh demands
for change.
Despite the reduction in barriers to cross-border commerce, hurdles to growth via
international expansion remain
As trade barriers fall through initiatives like NAFTA and the EU single market, FIs have sought
opportunities to expand beyond their domestic markets. But protective regulations and customs still
make it difficult for FIs, even world-class FIs, to establish themselves in other countries.
Cross-border differences in regulation and competition also influence the investment community’s view
of the balance of risk and reward in the financial service industry: Only the proven players tend to get
rewarded for taking the risk of moving abroad. Even for those FIs that have overcome the political,
financial and cultural differences, success is not guaranteed.
Nonetheless, the saturation of home markets creates pressure for international expansion, meaning
that new ways of addressing these hurdles need to be found.
Technology is making life more complex, not simpler
As technology opens up new ways of reaching customers, the strategic choices facing FIs become
steadily more complex: telephone, Internet, iDTV, 3G and PDA. And the channels that cannot be
supported by existing technology require the creation of more standalone applications.
Many FIs are also working with legacy systems that are expensive to maintain and hamper innovation.
Nor do their operations provide the advantages of straight-through processing: They often rely on
manual intervention. The cost in terms of inefficient business processes and volume of IT applications/
support can be huge.
Recent advances in integration middleware technology have provided some relief by making it possible
for FIs to move customer information across channels. But in many cases the technology has been laid
over flawed legacy architecture, and has merely created more duplication.
The cost of such an approach is reflected in our research, which shows that up to 70% of IT spending
by FIs goes toward maintenance and redevelopment. Furthermore, the problem seems to grow with
size: The largest banking institutions (with assets more than $60bn) spend 50% to 100% more on IT
relative to their smaller (under $2bn) counterparts. Despite this spend, virtually every business
manager in large FIs bemoans the organisation’s lack of speed and institutional inflexibility.
6

The vision of a component-based business
Today’s trends contain a clear message: The changes we are witnessing are not aberrations but
profound shifts in the nature of the market. This means that business as usual or even incremental
change cannot be an option for FIs that aim to create breakaway shareholder value. Instead, they point
to the need for a fresh approach.
In order to succeed, FIs need to redesign their business models so that they:
• Are capable of handling rapid change
• Possess both scale and flexibility
• Secure the long-term loyalty of the customer.
To achieve these often-conflicting goals, FIs should view their business not as an integrated whole but
as a federation of functions which collaborate to create value, and which can be added to or removed
from as necessary. This requires the business to be broken down into its component parts, each with a
high degree of autonomy but linked to the rest of the organisation through common messaging
standards, information systems and service agreements.
The FI value chain can be divided into three interconnected business areas—distribution, manufacturing
and operations—each focusing on one aspect of the value chain and optimised to achieve different
objectives.
The diagram on the following page illustrates the three layers.
• Distribution covers all customer-facing activities, including delivery channels, servicing, pricing,
cross-selling and marketing. It is organised around the customer meta-segments the FI has chosen to
target, and optimised to increase customer loyalty and share of wallet. All channels are supported by
a common infrastructure, which creates a single view of the customer and has a consistent look and
feel for the user.
• Manufacturing generates and assembles products and services in whatever form—and through
whichever channel—the market demands. Because many products are commoditised, FIs need to
achieve maximum re-use across manufacturing. To support ever-changing customer needs FIs should
have a full and flexible suite of products, which may involve sourcing products from external
providers. Manufacturing is optimised for both cost and flexibility.
• Operations focus on the essential business utilities, fulfilment processes and account transactions
(electronic payments, paper processing, customer data, etc.). Operations are optimised for cost
efficiency and economies of scale. This is achieved by automation, straight-through processing and
distribution of work to areas of lowest labour cost.
Each of these three business areas is broken down into building blocks or components which have
responsibility to deliver agreed service and cost levels. FIs manage each component separately and
strive to extract maximum value from that part of the business.
7
What is a
component?
A component is a
group of tightly
coupled business
activities supported
by appropriate
information
systems, processes,
organisation
structure and
performance
measures. Each
component serves a
unique purpose, and
collaborates with
other components
within the business
model, using agreed
cost and service
levels.

Simplify to Succeed—Retail financial institutions in 2005
Traditional Approach
Product Specific
Delivery
Marketing Sales
& Distribution
Product
Manufacture
Operations
Shared
Facilities
Component Model
Sub-Prime
Segment
Sub-Prime
Segment
Product
Silo 1
Mass Retail
Segment
Mass Affluent
Segment
Product
Silo 2
Private
Mass Retail
Banking
Segment
Segment
Mass Affluent
Ultra High
Segment
Net Worth
Segment
Distribution
Sector differentiated marketing, sales
and delivery
Parameterised Product Assembly
Manufacturing
Product options support and
Component based product manufacture
Low Cost, High Quality Servicing
Operations
Generalised operations and shared
facilities
Private
Banking
Segment
Ultra High
Net Worth
Segment
Product
Silo 3
Traditional approaches have attempted to create discrete product ‘silos’
- Systems and business processes are tightly coupled along the value
chain
- Capabilities are duplicated across silos
- Customers experience fragmented serivices
A component model provides business flexibility and process optimisation
- Distribution is tuned to the customer segment
- ‘Assembled’ product combinations re-use Manufacturing capabilities
regardless of sources
- Operations achieve enterprise-wide scale economies
8
To achieve the transition to a
component-based business model
(CBB model), FIs will have to
restructure their systems, processes,
organisational structures, culture and
performance measures in a fundamental
way. The traditional end-to-end
silos will have to be dismantled and
reassembled into a more flexible
componentised business architecture
supported by appropriate IT, processes,
performance measures and
organisational structures.
If the CBB model is to work, all its
parts must communicate and
collaborate seamlessly with each
other. This will also permit components
to be added or removed without
allowing complexity to creep into the
organisation. Consequently, this will
be one of the critical success factors
in unlocking the value of the CBB
model.
The value of the CBB model
At the heart of the CBB model lies the
ability to achieve the opposing
benefits of scale and flexibility while
simultaneously maximising long-term
customer loyalty and share of wallet.
The table below compares today’s
typical business models with what we
predict leading FIs of the future will
adopt.

Today’s typical models
Customers
• Customers are primarily targeted through
product silos. Customer segments are within
product silos.
• Customer data is collected but fragmented and
not available to drive real-time decisionmaking.
Distribution
• Channels are developed separately and ‘boltedon’
to the business model.
• Distribution is optimised for economies of
scale within product and business silos.
• Remuneration is based on volume and growth
metrics.
Product manufacturing
• Products are typically manufactured in silos
with little organisational flexibility.
• Products and services are developed to address
evolving needs as perceived by product/
business unit silo. A different or new product
option typically spawns a new product line.
Operations
• Operations are typically optimised at the
product or business unit level.
• Rigid organisational boundaries restrict ability
to outsource or to collaborate with other
entities.
• Operations are based in high-cost developed
economies, with traditional role-based
remuneration structures.
• Physical assets are owned by FI. Major political
hurdles to overcoming the costs associated
with physical branch space through divestiture.
Performance metrics and linkages
• Profitability measures are at the product/
business unit level and are geared to maximise
value of product/business unit silos.
• Performance metrics interaction is tightly
coupled between component parts of
product/business unit silos.
• Valuation is based on ‘assets in place’.
CBB model of the future
Customers
• Customers are targeted by segments. Products
and services are organised by segment.
• Customer data is integrated and drives eventbased
interaction at touch points.
Distribution
• Multiple channels are integrated seamlessly.
• Distribution is optimised to maximise customer
loyalty and lifetime value.
• Remuneration has customer satisfaction and
loyalty metrics baked in.
Product manufacturing
• Products are sourced from the most appropriate
manufacturer within or outside the
organisation.
• Products and services are either manufactured
or assembled to address customer segment
needs.
Operations
• Operations are optimised at the enterprise level.
• Transparent organisational boundaries enable FI
to outsource or collaborate to address changing
business conditions.
• Operation placement decisions reflect the
ability to leverage ‘wage arbitrage’
opportunities by migrating to lower cost
economies.
• Branch space can be franchised, and capital
management techniques are utilised
(e.g. property sale and leaseback).
Performance metrics and linkages
• Best in class economics and profitability
measures are at the component level, structured
to maximise value across all components.
• Rights, obligations, performance measures and
service level agreements are clearly articulated
at the component level.
• Valuation is based on profitability and high
growth options.
9

Simplify to Succeed—Retail financial institutions in 2005
Making the change
The CBB model represents a change in the way FIs are structured and managed. Migrating to such a
framework will pose different challenges and opportunities to each institution. Clearly, the pace and
extent to which any individual FI can make the journey will be dictated by its starting point. While FIs
may choose to execute aspects of the CBB model in order to obtain the full benefit of this framework,
FIs will need to execute change across the breadth of their business, rather than just strive for success
in one component.
Many FIs already have their hands full with existing initiatives and will be wondering how they can
manage even more change. However, we believe that intensifying competition and the shift toward
global markets means that the time to address the strategic business framework is now. For FIs which
accept this challenge, we set out in the following three chapters the required reforms to the distribution,
product manufacturing and operational parts of the value chain. The final chapter outlines key
points in the people and cultural change agenda and summarises the proposed actions for FIs.
10

Optimising the customer franchise
Change means adaptation. While FIs have made progress in creating value out of new delivery
channels and tools such as customer relationship management (CRM), significant opportunities still
exist to realise a fuller return on this investment.
Customer loyalty is falling
As customers have become more aware of their financial services needs, they have also become more
willing to shop around for the best deals. This is leading to a marked decline in customer loyalty. While
customers seldom desert their traditional suppliers totally, they increasingly look elsewhere for their
new banking, insurance and investment needs. This shift toward multiple providers is costing FIs
valuable incremental business and threatening their share of wallet.
In some cases, FIs are actually being pressed to give their customers greater freedom. In the UK, a new
industry standard requires banks to enable customers to change their current accounts within nine
working days, or pay a penalty.
New entrants have also sharpened customer expectations. In the U.S., websites such as Quicken.com
have made it easier for consumers to shop around: People can search for credit cards using criteria
such as introductory APR, rewards and annual fees.
FIs have had mixed success at exploiting their brands
Established players are failing to exploit their brand potential to the full. Most FIs rely on traditional
values for their image, and rarely differentiate their brands across their markets. Those organisations
that have attempted brand differentiation have taken various approaches, from creating wholly new
brands to combining all into a single global brand. Examples of the first include the off-beat brands
used by UK banks to attract younger customers: The credit card Goldfish, for example, has attracted
1m customers in five years, and the online bank Cahoot attracted 300,000 customers since its launch
in June 2000. 1
The second category includes a small number of FIs that have successfully extended their brands, e.g.,
ING with its launch of ING Direct in distinctive corporate colouring, and Citibank, which has managed
to give its brand mass appeal in the U.S., while making it upmarket in Europe. There is a third category
of retail FIs which have created multiple brands, e.g., in the UK, the Royal Bank of Scotland has its own
brands for retail banking (Royal Bank of Scotland, NatWest, Ulster Bank), private banking (Coutts) and
insurance (Direct Line, Privilege).
Regardless, FIs have low brand recognition: No retail financial service brand features in the world’s top
ten brands. Only Citibank and American Express make it to the top twenty. 2
On the other hand, new entrants, be they supermarkets or car manufacturers, have been very successful
at extending their brands into financial services. In the UK, Sainsbury’s, the supermarket chain,
opened a bank in February 1997: It now has 1.25m customers with more than £2bn in deposits. 3 In
Italy, the Fiat automobile group has laid out a diversification strategy which includes insurance in
partnership with Toro Assicurazioni. 4 In Japan, the retailer Ito Yokado started IY Bank, with services
now available at more than 1,000 ATMs in its 7/11 stores. IY Bank has also started to sell loan and
insurance products through this channel.
11
Distribution
Manufacturing
Operations
Established players
are failing to exploit
their brand potential
to the full.

Simplify to Succeed—Retail financial institutions in 2005
Investment by FIs to meet customer needs has enjoyed only limited success
To date, few FIs have successfully moved from a product or channel focus to one that looks at the
customer. CRM tools have been used to create mass-market solutions without developing the skills to
make better use of customer data or gain a fuller understanding of customer needs.
Large-scale CRM initiatives have also proved difficult to implement due to a lack of institutional
commitment or resistance to what is frequently a major change programme. Some FIs have tried to get
around internal hurdles by making appointments such as Head of Mass Affluent to address customer
segments individually. Others have sought to create greater autonomy lower down the command chain,
at customer relationship or branch level. But resistance to these moves can be strong.
Other problems have also slowed the momentum of change, such as working with unclean data or
failing to understand data protection regulations. Few FIs have seen radical improvements in cross-sell,
servicing and share of wallet from their often-significant investments in CRM.
Few FIs have achieved true multichannel capability
FIs are striving to reach the point where the full customer relationship can be managed on a multichannel
basis. This involves a substantial investment to shift delivery technology from a channel-specific to
a channel-agnostic basis. However, the transition is impeded by the fact that too much technology is
embedded in each individual channel.
The rigidity of individual channels is preventing common processes from being implemented to create a
single customer view and open up cross-selling opportunities. Furthermore, the cost of servicing
customers continues to increase despite the proliferation of lower-cost distribution channels because
rising transaction volumes are cancelling out any savings.
In the meantime, many FIs are seeing their brand value eroded by indifferent service.
The vision of the retail customer
Who are the retail customers of 2005?
Regardless of which market segment they belong to, customers will:
• Be mobile–aware that they can change providers easily to meet their requirements
Expect a high level of service, and be turned off when it is poor
Expect to communicate with their FIs through the channels they choose, and receive a consistent
service
Be unimpressed by poor attempts at product and service innovation
Be intolerant of CRM hard-sell practices
Expect fair value and transparent charging based on the entire relationship
Migrate toward brands with whose values they identify
Be prepared to reduce the number of providers they use
12

Successful FIs will radically redesign the customer-facing parts of the value chain. Servicing, crossselling,
pricing and associated processes, technology, organisation structures and performance
measures will be reconfigured to strengthen customer loyalty and increase share of wallet. FIs will
have to learn how to make every customer relationship profitable.
FIs will reorganise their customer-facing operations around customer segments
By 2005, FIs will be switching the focus of their retail operations from products to customer segments,
by which we mean broad meta-segments rather than the micro-segments used for marketing purposes.
Each segment will be founded on a strong understanding of customer behaviour and lifetime value, and
each will be built around an appropriate mix of channels and products.
In 2001, FleetBoston began to reorganise its retail bank by shifting from a product-centred to a
customer-centred business model. Its customer segments include Affluent Banking, Investment
Oriented Banking, Consumer Banking and Community Banking. Other institutions, including Bank of
America and JP Morgan Chase, are pursuing similar initiatives. 5
Technology will also allow FIs to create a single operational view of the customer by pulling together all
the details of the relationship. This will allow the FI to service customers through any channel at any
time, and provide them with a seamless view of their accounts in real time. This will open up opportunities
to tailor products and services much more closely to individual requirements, and introduce
bundled product pricing.
By 2005, the dominant organising
principle will be customer segment rather
than product or channel.
The five customer meta-segments will be:
•sub-prime
•mass retail
•affluent
•high net worth
•ultra high net worth
Understanding the lifestyle needs of the
customer will be key to a successful
retailing strategy
FIs will make large strides toward understanding
their customers’ behaviour, and this will enable
them to pursue lifestyle customer strategies—ones
driven not by events but by values. This might be
through the psychographic approach, which uses
drivers such as age, education, travel or spending
patterns to determine a person’s lifestyle, and
hence the appetite for particular financial
products and services.
Some FIs will place authority further down the structure to allow the customer focus to be developed at
the point of contact. There will also be a move to price at the level of the customer or household rather
than the product or account, using sophisticated pricing algorithms.
Capital One in the U.S. has built a significant capability in predictive modelling and decision science.
This has helped it micro-segment its customer base. As a result, Capital One has a markedly better
customer retention and risk management record than its competitors—and one of the lowest loan loss
rates in the industry. This has fed through to the bottom line with exceptional earnings growth. 6
“The concept of retail client is too wide.”
Julio López
BBVA
13
By 2005, leading FIs
will move to customer
level pricing.
Early adopters will
generate substantial
long-term
customer loyalty,
forcing other FIs to
follow suit.

By 2005, a couple of
non-traditional
financial service
providers will
make significant
forays into retail
financial services on
the back of their
brand and service
differentiation.
Simplify to Succeed—Retail financial institutions in 2005
“HSBC is increasingly aligning management competencies along customer segments. Our product
departments have been combined into broad customer needs areas, e.g., long-term saving and
investing, protecting your lifestyle. Combining this with segmentation of our customers into lifestyle
segments has given us a platform for further customer driven development.”
Tony Ashford
General Manager, Personal Banking
HSBC
“For most financial institutions, CRM is not so much an analytical as an operational challenge:
making customer information available to all.”
Michael Koutstaal
Programme Director
Retail (Netherlands)
ING
“Customer segmentation… will be enriched by customer needs and customer potential.”
Christian Poirier
Senior Executive Vice President
Strategy and Marketing Division
Retail Banking
Société Générale
“AXA believes that the key differentiator from a customer perspective will be the individualisation
of the offer.”
Jean-Laurent Granier
Market Director
AXA France
By 2005, quality of service will
be the competitive frontier
The neutral-to-negative perception
that today’s consumer has of FIs
leaves service quality wide open as a
competitive feature. This will change
as FIs strive to have best-in-class
products and processes, and refine
their product ranges and pricing.
Structural change in the industry will
also reinforce the emphasis on service
quality: The focus on the customer will
put a premium on service, as will the
growing interest in meeting a
customer’s overall needs.
By 2005, leading FIs will be categorising their
customers by lifestyle
14
Lifestyle
2000-3 Event-Based
1990s Product Channel

“FIs that are successful at delivering service quality will benefit through greater customer loyalty
and wallet share, and by getting the customer relationship on to a complete, lifetime basis.”
“Service is the key to differentiation.”
Christian Poirier
Senior Executive Vice President
Strategy and Marketing Division
Retail Banking
Société Générale
“Qualitative criteria, for example service quality, will be of great importance in employee bonus
calculations.”
Mariano Pérez Claver
Caja Madrid
Successful multichannel approaches will differentiate between type of customer and
sales function
By adopting sophisticated pricing strategies, FIs will be able to encourage customers to move to the
most appropriate and profitable distribution channels.
A physical presence will be essential to success: The move to the future is not about eliminating the
physical side of distribution and moving to a Web-based approach. People continue to seek personal
interaction, especially for advice-based products.
The use of physical branches will continue, but these will be more tightly integrated into the multichannel
approach, working side by side with mobile agents and other outlets. Their role will also become
more sales-oriented; for example, they will make greater use of customer value metrics.
“At a localised level, branch managers with their own P&L have the autonomy to fashion the
customer experience according to segments using centralised knowledge management and
process tools, while complying to formal centralised Nordea ethics and standards.”
Lars G Nordström
Member of Group Executive Management
Nordea
“ABN Amro is going to concentrate the knowledge for personal advice in only 80 branches,
as part of a multichannel Service Concept.”
Dolf Collee
Member of the Managing Board
ABN Amro
15
By 2005, leading FIs
will successfully
move to a channel
agnostic model for
distribution leading
to increased differentiation
in competitive
positioning.

By 2005, two or three
FIs will be achieving
a global brand.
Simplify to Succeed—Retail financial institutions in 2005
Brand positioning will play an increasing role in the success of FIs and new entrants
Brand positioning and the ability to follow through with the promised array of products, services and
prices will be a major contributor to success in the age of the consumer. Brand will also determine the
strength of opportunities to form alliances with partners within and outside the finance sector, and
beyond the domestic market.
“We are Nordic and local.”
“We have just one brand (except for the very high end of private banking). However, each brand
can have a different meaning in each country. For example, in Sweden, we have a reputation as a
high-tech self-service organisation but we are considered more traditional in Denmark.”
Lars G Nordström
Member of Group Executive Management
Nordea
“Brand is crucial to the general banking proposition and has the potential to be a key
differentiator in the market.”
Tony Ashford
General Manager Personal Banking
HSBC
Non-financial concerns will continue to exploit their brands to gain entry into the financial service
market. The Automobile Association, the UK’s leading roadside vehicle recovery group, entered
financial services by providing an insurance service, first for autos, later for homes and their contents. 7
Recently, the organisation has expanded further by introducing car loans.
16

Priority actions for tomorrow’s leaders
Rapidly migrate to a customer segment model for the customer-facing parts of your
business
• Recognise that the purpose of distribution is to maximise the lifetime value of every customer
relationship rather than strive for product economies of scale.
• Identify customer segments that have good growth prospects, and realign management
responsibility accordingly.
• Begin with the customer segment that promises the greatest economic value.
• Make investments in technology and processes to ensure the success of the customer meta-segment
model, especially in the high-volume parts of the business.
• A multistage approach is critical to success. Use the economic value released from small initial
investments to fund further initiatives. Achieving the single operational view of the customer at all
touchpoints and in real time is a requirement.
• Be aware that the migration may result in the loss of customers in the short term, unless executed
flawlessly. This risk will be outweighed by the long-term benefits of a more focused relationship.
Build and reward loyalty to extract the fullest value from the customer
The key to unlocking the full value of the customer lies in developing the relationship rather than
seeking quick sales.
• Tailor products, services, pricing and channels to each customer’s lifestyle. To do this, create a
complete view of the customer across the enterprise and bring it to bear at all touchpoints. Launch a
programme to systematically clean up and consolidate data. In doing so, ensure everyone understands
data protection regulations.
• Realise that customer service is an under-explored competitive dynamic, and will be key to strengthening
customer loyalty.
• Move from the traditional pricing model based on product/service to one based on the customer or
household to strengthen customer loyalty. Reward customers for consolidating their relationship.
This can be done through superior price points, improved and personalised service levels, or loyalty
reward and point schemes.
• Train customers to use the most appropriate channel to handle each of their needs. This involves
putting high touch ahead of high tech to proactively influence and reinforce customer behaviour.
• Start adding value now, based on the entire customer relationship, as margins will start to
disappear.
17

Simplify to Succeed—Retail financial institutions in 2005
Make CRM a long-term philosophy
Active customer relationship management is the key to generating long-term customer value. But this
requires a conscious move away from the traditional sales and marketing mentality.
• Anticipate that your programme will last two to three years. CRM implementation is part of a major
change programme that requires changes to processes, performance measures, organisational
structures and technology.
• Create a learning organisation.
• Improve sales skills at all customer touchpoints to encourage more proactive handling of data and
customers.
• Encourage a sales mentality at branch level and make sure that staff employ customer value.
• Address the structural, reward mechanisms and performance metrics to avoid investments in
technology that do not deliver shareholder value.
18

Maximising the breadth, depth and
flexibility of products and services
Although FIs are investing in product systems to increase their range and flexibility, they need to do
more to address the full product and service needs of their target customer segments. The extent to
which FIs are meeting their customers’ needs differs by geography. In the U.S., few providers have yet
developed an effective suite of products and services, while in Europe many FIs offer a wide range of
products but struggle to cross-sell effectively.
Many products have become commodities
The market for retail financial services is becoming increasingly commoditised as new channels erode
entry barriers, facilitate quick and easy comparison-shopping, and increase ability to migrate accounts
between FIs.
In the UK, new banks like Cahoot and Egg have offered zero-interest introductory rates on credit cards.
Other institutions have segmented their markets to beat down prices for selected customers. The UK
online insurer Esure, for example, has been quoting 30% off motor insurance for safe drivers.
This has given fast followers an edge over first movers. In the UK, Virgin launched the first “netted”
mortgage through its One Account (an account which offsets the mortgage loan with the borrower’s
savings). The initial uptake was low, but then players such as the Woolwich, IF and First Direct
launched their own versions. In the U.S., the first mover in online banking, Wingspan Bank, secured
225,000 customers but could not then cover the cost of servicing them, and collapsed. 8
According to a report published in the Harvard Business Review based on data from more than 1,000
companies, first movers gain a sales advantage but incur a large cost disadvantage. Measured by
return on investment, first movers lag later entrants by approximately 4%. 9
Product assembly is not yet a core competency
Many FIs still address the evolving needs of their customers by making incremental changes to their
systems to add products and services. Where they cannot supply the product, they source it from
outside and deliver it on an undifferentiated basis. This approach has made it hard for FIs to assemble
suites of financial services that truly address their customers’ needs. Furthermore, they still price at
the level of the product rather than the product bundle or the customer.
Despite their considerable investments, FIs have enjoyed only mixed success in cross-selling products
and services. The average number of products sold to one customer in the UK is 1.8, though in France,
where bundled account offerings are more commonplace, it is closer to five. An example is Société
Générale’s Jazz account, where customers take out an average of three to four products around the
current account, including credit and debit cards, and protection insurance.
In some countries, the trend toward sourcing from multiple providers, or open-product architecture,
forces the need for products to be best of breed to find a market. This has also highlighted the
importance of skill in product assembly.
19
Distribution
Manufacturing
Operations

As FIs expand the
array of products
and services they
offer, the management
of wealth will
become the mantra.
Simplify to Succeed—Retail financial institutions in 2005
The vision for product manufacturing and assembly
The ability to assemble the right products and services at the right price and satisfy the full financial
needs of their customers will separate winning FIs from the rest.
As FIs expand the array of products and services they offer, the management of wealth will become the
mantra.
Wealth management will provide the philosophy that replaces the product-based view of the customer
with an all-embracing lifestyle perspective. It has three components:
• Wealth creation, which enhances the customer’s wealth capabilities (e.g., checking account,
mortgages, short-term investments, short-term debt)
• Wealth preservation, which covers the longer term (savings, investment, life and property and
casualty (P&C, non-life) insurance, and retirement planning)
• Wealth transfer, which looks beyond the individuals’ needs to the needs of those around them
(inheritance planning, children’s education, trusts)
Wealth management will define the way each customer is addressed. In turn, the customer will want
the best value across the full range of services, rather than just product-by-product. FIs adopting this
approach will gain an increasing proportion of their revenues from advisory and fee-based services.
Although many FIs will target the mass affluent to achieve these goals, there is value to be mined from
other market segments, such as mass retail and even the unbanked.
“A universal bank… must be able to deliver value to all segments in a profitable manner.”
Jose Antonio Fernández Rivero
BBVA
“The goal is to have a broad vision of the customer… to collect wealth information.”
Nicholas Schimel, Commercial Director
AGF Vie
“Wealth management implies all asset classes and all stages of the wealth cycle—from wealth
creation through wealth management, enhancement and distribution. To our selected target
clients we aim to deliver against this goal, recognising that each client’s needs are specific
and unique.”
Investec Private Bank
20

More FIs will build sources of revenue outside their traditional markets
Competition in the commoditised financial service market will drive FIs to look for new sources of
revenue. By 2005, they will be wrapping a wide range of services around their core products; their
customer acquisition and retention strategies will increasingly be based on lifestyle propositions; and
they will be expanding relationships with other service providers such as cars, home services and travel.
Those FIs which are good at understanding what their customers want will prove the most attractive
partners for these service providers. FIs which successfully create new income streams will also be
rewarded by the stock market.
Some FIs have already begun to expand their revenue streams in this way. For example, motor insurers
diversified relatively easily into breakdown recovery. But Direct Line, the UK telephone and Internet
insurer, took this a step further and set up jamjar.com to sell cars and motoring accessories on the
Internet. The business was established in July 2000. By the end of 2001 it had tens of thousands of
customers. 10
Core competencies can be diversified into new market opportunities
Countrywide Credit: value in diversification
In order to improve its profitability and reduce its exposure to the cyclical mortgage business,
Countrywide Credit, a large U.S.-based mortgage lender, transformed itself into a diversified
provider of mortgage and home-related financial services.
Since 1992, Countrywide has introduced new products and services which build on its core
competency in the mortgage market. These have included home loans for the sub-prime
market, home equity loans, home-buying services, and a range of insurance products: credit
life, homeowner, auto, and life and disability insurance.
At the same time, Countrywide has begun to sub-service other players in the market, thereby
stabilising its revenue streams. This has led to significant cost improvements, and earned it a
reputation as a best-of-breed processor. Countrywide offers some of these services to
companies in Europe, and is planning to expand its markets further. In addition, Countrywide
has capitalised on its new skills by selling technology and consulting services.
As a result of these changes, Countrywide now obtains over 30% of its revenues from outside
the core mortgage business, and its results have been rewarded in the capital markets.
Goldman Sachs is predicting 46% growth in EPS for 2002, making it a leader in the sector.
Source: Countrywide Home Loans Inc., http://www.countrywide.com/, “Specialty Finance: Mortgage Finance,”
November 6, 2001
21
By 2005, leading FIs
will be achieving
50% of new revenue
growth from nontraditional
products
and services.

By 2005, at least one
major insurer in each
of the market territories
will have withdrawn
completely
from the customer
sphere into a purely
manufacturing role.
Simplify to Succeed—Retail financial institutions in 2005
Product sourcing and assembly will become a core competency
In order to become their customers’ primary financial provider, FIs will have to be able to supply
packages of products and services that satisfy their full needs. This will put a premium on the ability to
either manufacture in-house or source externally all the necessary package components.
The product assembly function will therefore grow rapidly in importance. Those involved in this function
will need to have a good understanding of basic product types, plus specific features such as tax
efficiency so that they can put compelling value propositions to their customers.
Some organisations may not be able to compete in the customer-facing end of the business, and will
instead become product suppliers with a purely manufacturing role. Given the present pattern of
customer touchpoints, retail banks are more likely to succeed at the front end because of their more
regular contact with the customer, while insurance and investment management firms, which deal with
customers less directly and frequently, will deploy their skills in manufacturing.
Alliances can generate benefits for both sides–in revenue gains as well as cost savings
How Barclays and Legal & General teamed up on distribution
In January 2001, the UK retail bank Barclays announced an exclusive distribution deal with the
long-term savings and protection insurer Legal & General under which Barclays would sell Legal
& General branded life insurance, pension (including stakeholder pension) and investment
products through its UK distribution network.
The alliance drew together Legal & General’s highly regarded brand, manufacturing, service and
administration expertise, and Barclays’ extensive customer base and distribution capability.
Through the joint venture, both companies have achieved significant economies of scale, and
hugely increased business volume. Barclays, which is now Legal & General’s largest distributor,
is aiming to double its sales of long-term savings, protection and investment products by 2004,
while reducing costs by £70m a year from the end of 2002. In early 2002 Legal & General
reported a 27% growth in new business. The alliance has also provided significant opportunities
for expansion, particularly in the new stakeholder pension market for small and medium-sized
enterprises.
Barclays has now moved out of insurance manufacturing entirely. Barclays Life and Barclays
Funds ceased to recruit new customers and transferred administration of their businesses to
Legal & General, which now looks after existing customers.
Source: Legal & General Assurance Society Ltd., http://www.legal-and-general.co.uk/, company press release,
January 16, 2001, and new business results, January 24, 2002
22

Priority actions for tomorrow’s leaders
Broaden the range of products and services to embrace the entire spectrum of
customer needs
• Recognise that the game is not just about manufacturing and distributing financial services, but
identifying and meeting the full needs of the customer.
• Source some products from other suppliers and/or assemble with those manufactured in-house in
order to deliver the full spectrum of products. Note that acquiring the mindset to assemble products
and services regardless of where they are manufactured will pose challenges.
• Actively seek partnership and co-branding arrangements to supply additional products. Recognise
that in some markets you need to pursue co-branding opportunities aggressively to avoid being
locked out by faster-acting rivals.
Explore opportunities to supply products and services outside traditional financial
service boundaries
• Provide products and services that deepen customer relationships, without necessarily investing in
the manufacture and/or servicing of those products.
• Leverage the insights gained about the customer’s lifestyle and financial needs to offer an increasing
range of non-traditional products targeted to address their unique circumstances to strengthen
the customer relationship.
• Ensure that extensions into non-traditional products are structured on a variable cost, learn fast, fail
early basis.
• Avoid conflict between brand values.
Learn the skills of product assembly
• Assess the advantages of “white-labelling” versus external product sourcing (own-brand versus
established brand). This will differ by market sector and offering.
• Acquire the skills to find appropriate partners and providers. Learn to manage the balance between
in-house and externally sourced products.
• Develop standardised features for open products to allow for a wide choice (e.g., for transparent
investment “wrapper” products, decide what the basic product features should be, and then go to a
range of suppliers for the investment funds).
• Develop customer analytics to select the most appropriate products, financial and non-financial, for
each customer. Extend the analytics from verticals like credit cards and life insurance to embrace the
entire suite of financial products and services.
“The goal is to leverage scale, by maximising return from investments in product manufacturing,
and minimising product unit cost.”
Dr. Gerhard O. Lohmann
Head of Strategy & Projects
Corporate & Retail Banking Division
Credit Suisse
23

Distribution
Manufacturing
Operations
Simplify to Succeed—Retail financial institutions in 2005
Optimising the scale and efficiency of
operations
While FIs are achieving economies of scale, their progress is slowing down. A step change is called for
if FIs are to reach their ambitious shareholder value objectives.
Opportunities for easy cost reduction are over in many domestic markets
The first phase of cost reduction, which focused on cutting employee numbers and centralising
processes and other initiatives like outsourcing, is over. Most of the significant players, particularly on
the banking side, are now at scale within their territories, meaning that they have few obvious routes
to cut costs further.
Many FIs are also understandably anxious about cost-saving measures such as outsourcing because of
the loss of control at the client interface or the difficulty of managing third-party agreements. Regulators
in some countries require FIs to duplicate outsourced functions internally, which adds to costs.
Regardless of the product areas of focus, large FIs consistently lag medium-sized FIs in the management
of costs relative to income levels.
The benefits of consolidation
are dwindling
Mergers and takeovers have enabled
some FIs to achieve greater scope and
scale, and reduce costs. Through its
$30bn acquisition of NatWest in
March 2000, Royal Bank of Scotland
expects to save more than $2bn a
year by 2004 by absorbing NatWest’s
operations into its own platforms. 11
However consolidation will not
provide the solution in every market
and situation. In general, mergers
have failed to deliver the promised
shareholder value benefits. 12 The
recent trend toward pricing takeovers
on asset cost alone, without any
premium, also highlights the market’s
view that combinations do not
necessarily create new value.
Furthermore, while scope for
Cost Income Ratios
80%
70%
60%
50%
40%
30%
20%
10%
0%
Expense Ratio
Expense Ratio
Life Insurance Non-Life
Insurance
Operating Cost/
Operating Income
Banking &
Securities
Small Firms Medium Firms Large Firms
Data Source: IBM Business Consulting Services databases and Thomson
Financial, data reported on an entity basis for Banking ratios, and insurance
expense ratios.
Data sourced covers company performance from 1997 to 2000.
Collected financial data from more than 5,000 financial institutions in Europe
and the U.S.
24

consolidation still exists in the U.S. and some Asia-Pacific markets, Europe is coming close to saturation
in some countries. Recent merger attempts like Lloyds TSB’s bid for Abbey National in the UK and
the combination of SEB and FSB in Sweden were blocked on competition grounds. 13 This means that FIs
are increasingly having to look abroad, or to strategic partners, for expansion.
Despite the growth of cross-border commerce, big hurdles to international expansion
still exist
One strategic option for FIs is international expansion on the back of moves to reduce trade barriers,
such as NAFTA and the EU single market. However, protective national regulations and customs still
make it difficult even for world-class FIs to establish themselves in other countries.
Where European FIs have decided to list on U.S. exchanges to internationalise their shareholder bases,
they have also undergone profound cultural changes. For example, French finance group AXA has
decided that all internal meetings and board papers should be in English. Furthermore, the valuation
yardsticks used by different capital markets are becoming increasingly common, and this is driving
convergence in performance measures like cost/income ratios. As a result, many European FIs are
finding that hurdle rates for investment and expansion are rising and becoming more transparent.
Cross-border differences in regulation and competition still influence the investment community’s view
of the balance of risk and reward in the financial services industry: Only the proven players tend to get
rewarded.
The vision for operations
Considerable opportunities exist to transform the operations of FIs in a radical way, and these will
bring substantial rewards to those which are prepared to act boldly. The challenge is to optimise
operations both internally and through combinations with other institutions, including competitors to
achieve economies of scale in operations. This drive will also lead to the emergence of new specialised
institutions and the migration of work across geographic boundaries.
The value of achieving scale in processing will be twofold:
• Owners of the processor will increase revenue and shareholder value.
• Small to mid-sized players which have access to a best-in-class provider will rapidly improve their
operating costs and product service.
Operations will be configured around three processing layers:
• Service representatives who will support customer-facing staff and assist in first-level contact with
the customer
• Complex processing units requiring specialist knowledge
• High-volume processing units which are automated
25
Cross-border differences
in regulation
and competition still
influence the investment
community’s
view of the balance
of risk and reward in
the financial services
industry.

By 2005, there may
be only two or three
major, fully integrated,
global
financial services
providers that
continue to pursue
such a strategy.
Simplify to Succeed—Retail financial institutions in 2005
FIs will need to break up the value chain and optimise each component
A bold approach will be needed to break the business model up into its operational component parts,
and optimise each of them individually.
This can be done in various ways. Some components can be treated internally by giving them incentives
to become best of class. Others can be optimised by linking them collaboratively with external
operations, including those of competitors, to achieve quality or scale objectives. Others still can be
migrated to lower-cost economies. The very best can even be spun off into markets which will put a
higher value on them than on the parent (the P/E ratio of service providers like State Street is 22 to
25 compared to a banking average of 12 to 15). Those components that cannot deliver full value will
have to be pruned, and the services outsourced.
These techniques are already being widely applied. In the UK, Barclays and Lloyds TSB have established
a joint venture to process cheques, with Unisys as a joint partner. 14 In the U.S., the fund
management group Vanguard has used collaboration to achieve the lowest costs in its sector: It
outsources the actual management of funds to Wellington Management and Bernstein, and maintains
control of all other functions, focusing on brand and customers.
The benefits of these creative approaches can be realised at many levels: organisational, customer and
shareholder. Moreover FIs which adopt them are able to cut their operating costs and increase their
capital flexibility without reducing their channel or sales capacities. For example, in the UK Abbey
National has optimised its branch network assets by franchising a number of them to employees.
FIs which have concerns about outsourcing may choose the alternative route of setting up joint
ventures to attain similar benefits. This will also be the case in countries where there are no opportunities
for outsourcing.
Branch franchising as a way of creating new value
Abbey National: coffee and franchises
In late 1999, the UK retail bank, Abbey National, announced the launch of a branch franchising
scheme which gives employees greater control over their branch space in return for greater
accountability on the returns the branch generates. Under the scheme, the franchisees are given
ownership of the local market, including staffing, marketing, campaigns, incentives and opening
hours. They are rewarded for sales and service, less costs incurred, and the reward itself is
dependent on centralised credit and sales quality control, as well as brand, customer and employee
satisfaction, and regulatory performance.
As part of the scheme, Abbey National announced a deal with Costa Coffee to install cafes in its
branches. In August 2000, the first branch opened in Barnet, North London. The branch was
completely refurbished to create space for a 40-seat café, as well as a Technology Assist Area
where Abbey National’s Internet and digital TV banking services can be demonstrated and used by
customers. The bank is aiming to have 50 Costa branches by the end of 2002.
To date, the franchised branches have delivered a sales uplift of 17%, and improved both
customer and employee satisfaction levels. Abbey National says that by generating income from
its branches, it is helping to guarantee their future.
Source: The Abbey National Group, http://www.abbeynational.plc.uk/, analyst presentation, June 2001, and
press release, August 1, 2001
26

Collaboration with financial institutions and non-industry players will become the
norm rather than the exception
The new marketplace will be dominated by collaborations and alliances—among financial service
competitors, technology companies and non-traditional financial service providers. We will also see the
emergence of coopetition—cooperative ventures between competitors to gain advantage in a particular
area.
“Collaborative ventures are the preferred way forward. In this way you retain the benefits of cost
reduction while at the same time not losing control of the organisation.”
Director of a major North American financial institution
“Collaboration will add the most value in distribution channels, as people begin to share routes to
market.”
Anne Gunther
Chief Executive
Standard Life Bank
“The more pan-European an organisation is, the more difficult it can be to get buy-in from
individual country stakeholders about a major centralised outsourcing programme.”
Lars G Nordström
Member of Group Executive Management
Nordea
Embracing coopetition to slash costs and strengthen revenue
German mortgage marriage
In November 2001, Deutsche Bank, Dresdner Bank and Commerzbank announced a cost-cutting
merger of their mortgage banking (“hypo”) operations. The merged unit, combining Deutsche’s
Eurohypo, Dresdner’s Deutsche Hyp and Commerzbank’s Rheinhyp, will be known as Eurohypo.
This has created Germany’s biggest property lender with assets of about E237bn and an
estimated 25% domestic market share.
The banks took a combined one-off restructuring charge of E125m and shed 800 jobs. But they
expect their combined operation to save E120m ($108m) a year from 2004, and to start growing
earnings from that date. Total savings will amount to 28% of the combined cost base.
The merger was driven by mounting pressure for consolidation among Germany’s mortgage banks.
These have been suffering from shrinking margins and heavy loan losses due to large scale
lending in eastern Germany in the early 1990s.
Deutsche Bank and Commerzbank each have a 35% stake in the venture, and Dresdner 30%.
While all three shareholders are expected to hold onto their stakes in the medium term, a sale or
a flotation of Eurohypo may be an option in a few years’ time.
Source: Financial Times, http://ft.com/, November 7, 2001, “Germany: Companies and finance Europe - Leap in
earnings for German property bank”
27
By 2005, as
componentisation
takes hold, collaboration
will become
part of the armoury
of every FI.

A major change will
be needed for FIs to
face up to the risks in
moving jobs offshore.
But the success
of early adopters will
force the hand of
others.
Simplify to Succeed—Retail financial institutions in 2005
Collaboration will address a range of issues, from very localised ones such as the use of branch space,
to grander ones such as rationalising operations across sectors and attaining global economies of
scale.
Collaboration on new technologies is underway. In Denmark, Nordea, Danske Bank and the local bank
associations have been working on a system to make micro-payments on the Internet. This will initially
be open to all Danish banks, but will soon be exported to the rest of Scandinavia. 15
Collaboration enables market-leading improvements
Symcor: streamlining the back office
In Canada, financial services firms were searching for new cost efficiencies as an alternative to
mergers. In the core function of document processing and print systems, they were unable to
reduce unit costs and increase efficiency without a significant investment in new technology. To
address this, in August 1996, Bank of Montreal, Royal Bank of Canada and the Toronto Dominion
Bank set up a joint venture, Symcor Services Inc.
Symcor was a fusion of three components: the considerable document-processing experience of
the three banks, the scale of the three organisations, and investment in the most advanced
document processing technology available.
The company is now achieving cost savings by combining resources and optimising efficiencies.
Nineteen document processing centres were reduced to nine. Common platforms and standard
service offerings were developed, resulting in 222 major co-locations or consolidations and the
movement of equipment, people and departments. By standardising processes, Symcor was also
able to achieve significant long-term efficiency gains.
Through their alliance, the three banks have created the largest item processing and customer
communication company in Canada. Symcor is now beginning to provide fulfilment services to
other industry players, and is seeking further acquisitions and partnerships to extend its reach.
Source: Symcor Inc., http://www.symcorinc.ca/english/index.html
The migration of work to lower-cost economies will accelerate
Operations and support will move to low-cost regions, driven by wage arbitrage and backed by
guaranteed service level agreements. Leading FIs now view offshoring, or global sourcing, as a key
element in their globalisation strategy. GE Capital, for example, has 7,000 people in Delhi in functions
including call centre, claims processing, credit card processing and accounting.
By 2005, a typical FI’s high volume processing and customer contact operations will be dispersed
around the globe, offering 24/7 support. Firms which have transferred operations offshore report that
they have not only achieved lower costs, but also higher levels of service than on the domestic market.
IBM Business Consulting Services’s “Best Practices of Leaders in Offshoring” survey showed that firms
28

have made savings averaging 40% to
50%, despite having to invest more
heavily in programme and risk
management. More importantly, 68%
of respondents also reported
improvements in quality.
The choice of offshore location will be
dictated both by cost and local
employment practices, which can in
some cases be restrictive. However
the growth of the global market and
trans-national competition will erode
these differences over time. Regulatory
and financial reporting considerations
will also play a part in the
decision to go offshore, as will the
emergence of new technologies such
as paper imaging and electronic
signatures.
Operational Processors are more highly valued
than the FIs they serve
P/E Ratio
30
25
20
15
10
5
0
Operational
Processors
Banking
Sector
Average
Insurance
Sector
Average
Operations processors include Fiserv, First Data Corporation, Jack Henry and
Associates, Total System Services.
Banking sector average taken from estimates published in the following Goldman
Sachs research reports: Appelbaum, L. E. et al, "Banks: Regional, United States",
April 8, 2002, Leadem, S. R. et al. "Banks, Europe", March 12, 2002.
Insurance sector average taken from estimates published in the following Goldman
Sachs research reports: Zief, J. H. et al, "Weekly insurance wrap-up", April 5, 2002
European ratios calculated using data from Burden, R. et al, "Insurance, Europe"
January 9, 2002.
New competitors will appear in
financial service functions
As FIs break up the operations chain, operational processors will appear to focus on particular parts of
it, such as mortgage servicing, claims management and cheque processing.
Some of these will emerge out of existing FIs which decide to spin successful operations off into
separate entities. Some of them will be new players which spring up to take advantage of areas of the
market where established players have little core competency or competitive advantage. Only the
largest financial institutions will be able to compete with these low-cost operations, which may not be
financial service institutions at all but utilities which are able to leverage their processing strengths.
Deriving value from one segment within the value chain—from traditional providers and
29
By 2005, two or
three FIs will move
into the operational
processing space
and create dramatic
shareholder value.

Simplify to Succeed—Retail financial institutions in 2005
new entrants
State Street: Finding the golden link in the value chain
State Street Corporation, one of the world’s top specialists in serving the management and
administration needs of institutional investors, is a leader in the custody business and a global
servicer of financial assets.
State Street gained a market-leading position by processing value-added, decision-oriented
information for the investment management business. More recently, it attained a leading
position in the development and use of investment management technology. Today, State Street
reconciles and analyses information across a wide range of disparate corporate systems. Its
service offerings include securities processing, multi-currency accounting, record-keeping,
performance and analytics measurement, global securities lending, and daily pricing.
Furthermore, State Street has leveraged its expertise in the development of financial service IT to
become a leader in investment management itself. Using automated processes, it implements
investment strategies for institutional investors. State Street currently has $775bn of assets
under management, making it the third-largest money manager in the U.S., and it is a leader in
the international index fund business.
State Street’s financial performance is one of the strongest and most consistent of all U.S. bank
holding companies. As it limits its traditional bank lending activities, the loan portfolio accounts
for only 8% of total assets compared with the average of 40%. State Street’s EPS has grown by
17% a year over the past 10 years. It has achieved a P/E ratio of 28 and an ROE of 18%.
Source: State Street Corporation, http://www.statestreet.com/
30

Third-party providers can become market leaders through unbeatable cost of service
Credit cards: processing for profit
First Data Corporation (FDC) and TSS are leaders in the global credit card processing industry.
The companies initially built up their market share by offering basic credit card processing to
small financial institutions which lacked the means to do it themselves. This enabled them to
acquire operating scale and processing knowledge. They then moved to provide services to
retail stores wishing to create affinity cards, including Sears Roebuck which is now the fifthlargest
credit card issuer in the U.S..
Today, the two firms are responsible for the majority of U.S. credit card transactions, and are
expanding abroad, building new capabilities for processing debit cards in Europe. Their services
have also enabled other providers to open up new markets, for example, in sectors such as high
credit risk where low-cost processing is key.
FDC and TSS have reaped the financial rewards of their strategy. Both have an ROE of over
20%. FDC has a P/E ratio consistently over 25, and TSS of 40.
Source: TowerGroup, “Off-the-Shelf Credit Card Processing Software: Post Shakeout Market Share Analysis,”
June 1, 1999
Creating value from a manufacturing function
Irish Life goes to Italy
In 1998, the Dublin-based life insurer Irish Life and Permanent launched IPSI, a separate
business within its retail division. IPSI provides a wide range of products and services for
companies wishing to expand existing life assurance operations or establish new ones.
IPSI offers fund, policy and corporate services, ranging from contract acceptance, issue and
maintenance, the management of external fund managers, to product development support and
management information. From a ‘menu’ of services, clients choose those that they wish to
outsource to IPSI, and these are then tailored to requirements. All work is conducted through
IPSI’s offices in Dublin.
IPSI launched its services in the Italian market, targeting subsidiaries of large financial services
groups. To date, its clients include Banca Monte dei Paschi di Siena, Arca Vita, La Fondiaria and
Banca Sella. IPSI is now moving beyond Italy. A recent acquisition was Inora Life, a new life
company set up in Dublin by Société Générale. During 2000, IPSI issued more than 50,000
policies with a value of 228m Euros APE (annual premium equivalent).
Note: Annual premium equivalent is an income measure used in the life assurance industry, and
is the sum of all annual premiums, plus one tenth of single premiums.
Source: Irish Life & Permanent plc, http://www.irishlife.ie/
31

Simplify to Succeed—Retail financial institutions in 2005
Technology will increasingly be a critical factor in moving toward the CBB model
Moving to the CBB model requires system structures to be redefined significantly. Nevertheless, this
approach is made possible by new technology that allows this migration to happen in stages with
economic benefit unlocked at each stage funding future stages.
Central to this approach is alignment to a message-enabled component architecture. Each component
serves a unique purpose, and collaborates by means of a common messaging standard.
To move to this architecture, existing systems need to be re-aligned and possibly augmented with new
facilities to match component boundaries, dividing, extending and retracting their scope as necessary.
To support the common messaging system, all facilities will need to be wrapped with a suitable
message interpretation layer. Using new EAI- and XML-based technologies; the systems in the highopportunity
areas of the business can be aligned to the component view incrementally.
In Japan, Shinsei Bank (the surviving entity of the Long Term Credit Bank, now owned by foreign
investors) deployed one of the first integrated Windows-based systems across its website and all its
branches, ATMs and call centres. The bank believes it has reduced retail IT costs by more than 70% in
doing so. It also believes that, as a mid-sized player, it will outperform larger local competitors thanks
to lower IT costs, a componentised and outsourcing business philosophy and an integrated approach to
clients across all its product offerings.
Priority actions for tomorrow’s leaders
Drive component owners to be best in class
• Complete the centralisation and industrialisation of common activities by componentising them.
• Align measures of performance and reward to motivate component owners to maximise revenue and
cost efficiency.
• Strive for best-in-class economics in each component. Recognise that best performance will be
achieved in many components by collaborating, co-sourcing and outsourcing.
• Leverage your best-in-class components by exploring the option of floating them off. If you do not
have best-in-class components, explore options for outsourcing. Define rights, obligations, performance
measures and service level agreements at the component level. Changing organisational
boundaries before you componentise your business model will create significant problems. Several
FIs are paying the penalty for not first agreeing rights, obligations and service level agreements for
components before outsourcing.
• Understand the network dynamics that the CBB model creates when componentising the business
model.
• Learn how to manage service level agreements, including interdependency and ownership issues.
32

Take advantage of wage arbitrage opportunities in lower-cost economies
The migration of commodity activities to lower-cost economies is accelerating and FIs must aggressively
pursue this opportunity to reduce costs.
• Understand local social and employment cultures to ease the transition.
• Consider adjusting onshore employee remuneration to reward skills rather than role.
• Conduct a pilot. If successful, consider migrating a larger process. Success factors and overheads in
an offshore facility are different from one onshore.
• Create accountability for the migration offshore through senior management support.
• Migrate personnel who are replaced by offshore service providers to other jobs including the
management of the offshore relationship to reduce morale problems.
• Leave some facilities onshore as offshore facilities may pose political risks.
• Exclude processes that might be fully automated or transferred to a self-service process driven by
the customer.
Make the culture of operations become more entrepreneurial
• Ensure that quality is not damaged when migrating to the component model by rigorously implementing
service level agreements and adopting process improvement tools such as six sigma.
• Appoint managers with entrepreneurial skills as operational component owners. Create career paths
that enable such managers to become best in class in their area.
• Monitor service quality unfailingly. Service quality problems can plague poorly managed transformations
of operational processes.
• Realign reward mechanisms early on to ensure success both for the component owners and the users
of their services.
• Address cultural issues when splitting off components as separate entities.
Ensure your programme has top-level sponsorship and that the sponsors accept that
this is a long-term change exercise
• Business and component owners must understand the critical role that technology plays in the
migration to the CBB model.
• Recognise that most of the enterprise’s economic value and intellectual capital is locked up in the
legacy systems that have been built up over the years. Re-directing these assets to support the CBB
model will unlock more economic value than investments in new technology.
• Ruthlessly outsource those parts of the technology infrastructure that are commodity services.
33

The flexibility of the
CBB model depends
on creating flexible
people.
Simplify to Succeed—Retail financial institutions in 2005
• Develop an end-state architecture for your business and technology as a priority. Advance toward it
as economic value is created. Recognise that this is a multi-stage journey. Recognise that emerging
technologies have a role to play, particularly in establishing ‘digital connectivity’ between business
components.
• Hold component business unit owners responsible for technology changes. Align technology
resources and component owners to avoid conflict, and ensure that reward mechanisms for technologists
are influenced by component owners.
• Do not lose sight of how the technology achieves your business objectives. If you focus only on what
new functionality is achieving you will end up with a technology infrastructure that limits the
benefits of the CBB model.
• Train staff to see the personal value in moving to the new world. For example, new career paths will
be created as business units advance from being pure support functions to becoming standalone
businesses.
• Design HR policies that encourage team behaviour. The intellectual power of the staff needs to be
made a corporate rather than just a personal asset. The flexibility of the CBB model depends on
creating flexible people.
• Continually communicate the end-state vision and openly reward successes on the journey.
• Implement people development plans and put in place mechanisms to transfer experience from one
component to another.
34

Moving to a component-based business
model
The management challenge
Making the move to the CBB model will require a new set of management skills and tools. Managers
need to:
• Create new performance measures. For customer-facing functions these will include long-term
customer loyalty and share-of-wallet metrics. Owners of manufacturing components will be measured
on their ability to create products internally or source them outside, and then assemble them
so that they successfully address customer needs. At the operations end, component owners will be
assessed on their ability to achieve best-in-class efficiencies at agreed service levels.
• Appoint entrepreneurial managers to lead components or groups of components. The ability to work
collaboratively both within the organisation and with others will become a key skill for these
managers.
• Ensure that senior executives are skilled at managing the entire portfolio of components while
retaining the ability to enter and exit areas of opportunity.
• Structure measurement systems and service level agreements not only for activities and processes
within the organisation, but also for those that will be executed by external parties.
• Develop third-party relationships to achieve mutually beneficial outcomes rather than conflicting
goals.
• Do not underestimate the amount of training and re-tooling that will be required to get managers
across to the CBB model.
• Align compensation schemes and performance metrics with the new model as a first priority.
• Recognise that cultural change will represent one of the greatest challenges to a successful
transition to the CBB model.
35

Simplify to Succeed—Retail financial institutions in 2005
Think big, start small and act fast
The migration to a CBB model is a multi-stage journey. The migration must take advantage of initiatives
that may already be underway to reduce costs, increase flexibility and achieve scale. Begin by
proving the power of the CBB model in one part of the value chain and use the lessons learned there to
drive change through the rest of the organisation. Migrating to the CBB model requires both the break
up of the existing integrated business model and the networking of the new components that are
created.
The high-level route map to the CBB model can be summarised as follows.
1. Rapidly migrate to a customer segment model for the customer-facing aspects of your business,
and provide a differentiated service to each segment.
2. Assess your competitive position in each component of your business model and accept that
collaboration will become the norm in many parts of the value chain.
3. Broaden your range of products and services to meet the full spectrum of customer needs, from
wealth creation through to wealth preservation and transfer. This may necessitate forming
strategic alliances and co-branding products.
4. Force operational component owners to become best in class. Where this can be achieved with an
in-house unit, seek opportunities to spin it out as a standalone business and create a new source of
revenue. Where in-house units cannot be best in class, outsource to achieve economies of scale.
5. Develop new management competencies and measurement techniques to ensure the success of the
CBB model.
6. Communicate your intentions clearly to the outside world and explain how the move toward a CBB
model will improve revenues, cut costs and make better use of capital.
7. Align your IT portfolio and architecture with your business architecture. Ensure that the transformation
is business-driven and has tight linkages to IT.
Undertaking these changes will enable John Consumer to get the message and will make Pierre
Grüman a feted CEO of InflexiFinance.
36

Sources
1 The Abbey National Group, http://www.abbeynational.plc.uk/
2 Business Week, August 6, 2001 http://www.businessweek.com/, “The Best Global Brands”, by
Gerry Khermouch, Stanley Holmes and Moon Ihlwan
3 J Sainsbury plc, http://www.j-sainsbury.co.uk/index.cfm
4 La Stampa (Italy) February 22, 2002
5 FleetBoston Financial Corporation, http://www.fleet.com/home.asp, Investor Relations Section,
Salomon Smith Barney Financial Services Conference, January 30th 2002
6 Societe Generale Group, http://www.socgen.com/en/html/index_en.htm
7 The Automobile Association Limited, http://www.theaa.com/
8 Chicago Sun-Times , 6/29/01, “Bank One unplugs Web bank, Folds Internet-only Wingspan into
main online service”, by Scott Silvestri
9Harvard Business Review, Reprint F0109A, “First Mover Disadvantage,” by William Building and
Marcus Christen
10 The Goldman Sachs Group Inc., http://www.gs.com/, “Mortgage Finance: Mortgage Banking,”
October 4, 2000
11 The Royal Bank of Scotland Group, http://www.royalbankscot.co.uk/, Analyst presentations
12 Harvard Business Review, January 9, 2001, “How To Ruin a Merger,” by Kristen Donahue
13 FöreningsSparbanken AB, http://www.foreningssparbanken.se/, Announcement, September 19,
2001
14 Unisys Corporation, http://www.unisys.com/, press release, December 7, 2001
15 Nordea AB, http://www.nordea.com/
37

Simplify to Succeed—Retail financial institutions in 2005
About the Authors
Shanker Ramamurthy
Shanker Ramamurthy is a New York-based Strategic Change Solutions consultant in IBM Business
Consulting Services Financial Services practice. He has more than 16 years of consulting experience
and has worked with financial institutions in more than 20 countries in North America, Europe and the
Asia-Pacific region.
Michael Robinson
Michael Robinson is a Strategic Change Solutions partner in IBM Business Consulting Services
Financial Services practice based in London. He is a lead practitioner in the delivery of strategic
transformation work for established financial institutions and new entrants. He has performed work
across the UK and Europe,and has more than 15 years experience as a financial services consultant.
Contributors
Julie Asfahl, Kathleen DeGood, Jack Diggle, Dan Golosovker, John Hallsworth, Ramesh Nair,
Muriel Oatham, Guy Rackham.
Special thanks to our many research participants for their valuable insights, and to David Lascelles
for his editorial expertise
Editorial Board
Mark Austen, Thomas Barrett, Saul Berman, Pedro Castañeda, Glenn Finch, Robert Gould,
Angus JS Hislop, Charles Leedman, Salomon Mizrahi, Tom Murnane, Patrick Morrison, Alex Owen,
Erik Van Der Zee.
38

About IBM Business Consulting Services
IBM Business Consulting Services (ibm.com/services) is one of the world’s leading providers of
management consulting and technology services to many of the largest and most successful organizations,
across a wide range of industries. With offices in 160 countries, IBM Business Consulting
Services helps clients solve their business issues, exploiting world-class technology for improved
business performance.
39

Simplify to Succeed—Retail financial institutions in 2005

To learn more about our global Financial Services practice, please visit
http://www.ibm.com/services/strategy/industries/banking.html
or contact an IBM Business Consulting Services representative.
please contact
Authors:
Shanker Ramamurthy—New York
Partner, Financial Services Practice
+1 646 598 3000
Michael S. Robinson—London
Partner, Financial Services Practice
+44 (0)20 7583 5000
Simplify to Succeed Marketing
insights@us.ibm.com

Simplify to Succeed—Retail financial institutions in 2005
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