Patrick Hoare, Vanguard Consulting

I started working for The Leeds Permanent Building Society in 1992. It was a different time and now feels like a different world. I was happy in work, as pretty soon I’d learnt to deal with most of the customers’ requests on my own. We didn’t measure it, but I’d guess that 99% of customer demands were dealt with at the first point of contact; efficiency was high, costs were low and service was good. Low costs – now that was something that was measured.

In the early 1990s, the only measure I remember receiving attention was the cost : income ratio (cost per pound of revenue made) and, for those interested, we kept it below 40%; if memory serves, we got it down to 38.6% in 1993. This was an explicit drive for the whole company that everyone bought into, and we used it to rate ourselves against other banks and building societies.

From being the one explicit driver, the cost : income ratio has now disappeared from view into the notes at the back of the annual accounts. In 2014, KPMG reported cost:income ratios at five major banks of between 51 and 87%, with the depressing long-term trend set to continue. Between 2009 and 2014, the UK banks’ cost : income ratios deteriorated faster than in any other developed nation.

Patrick graph
KPMG 2015 ‘Banking results 2014: A paradox of forces’ April 2015, p11

How can this be when banks spend so much time, effort and, yes, money on controlling costs? What strategies are being put in place to bring about improvement, and is there any evidence that they work? Let’s look at some of them and the thinking they are based on.

1. Reduce costs by setting up ‘centres of excellence’ where roles are specialised and risk can be carefully managed and mitigated

The skills I used in 1992 have largely been transferred to remote service centres, ever bigger in size and smaller in numbers. This trend is based on a belief that economies of scale will reduce costs, a belief that has also led to service centres increasingly being outsourced and offshored. But we’re missing something here.

Something that used to involve one person (for instance agreeing and processing a secured loan) now requires input from up to 10 people, lengthening the time to complete the transaction and driving up customer frustration beyond recognition. The result is mushrooming failure demand (knock-on demand caused by the organisation doing something wrong or incompletely for the customer the first time), which is then dealt with by drafting in extra resources. Needless to say, the cost: income ratio soars. ‘Economies of scale thinking’ needs to be replaced by ‘economies of flow thinking’.

2. Drive change and cost control through central functions like IT

Large IT and change programmes designed to reduce long-term costs command huge budgets and are run by central teams remote from the reality of what happens on the front line. The programmes have plausible intentions, but 90% of IT projects fail to deliver. IT and change teams drain money and resource, while headcount is removed from a bemused and harassed front line. Since the initiatives are never used to study the system from a customer’s perspective, the real issues go unearthed and undealt with. In sum, the return from the massive IT spend is disappointing at best. Once again the current thinking – putting IT first as an instrument to drive change through to the customer – is exactly back-to-front, creating huge extra costs.

3. ‘We can drive improved performance by strengthening support functions’

IT and change programmes aside, I have seen a big increase in bank ‘support’ areas. Organisations have come to believe that the key to improvement is through performance management – managing people. Back in 1992, in an environment of low-cost : income ratios and flat-rate bonus schemes for all, six ‘personnel reps’ were sufficient for an entire company. Compare that to today’s small army of people dedicated to HR, performance management and bonus calculations. In some places, HR teams are outsourced and/or offshored and re-christened HR Direct. I see a similar growth in risk, audit and compliance teams, all adding substantial cost but no value. The problem is not the people, stupid; it’s the system!

4. Cost cutting by channel management

The thinking here is that moving customers to cheaper channels will reduce costs. If a transaction costs 67p online, £2.81 by phone and £9.50 face-to-face, pushing the online offering seems a plausible response. Yet it fails to take into account two things.

First, not all customers want to use online banking channels exclusively, and those that don’t will take their business elsewhere. Second, unless it is informed by understanding of demand and what matters to customers, the design of the banks’ internet offering is likely to be poor, meaning that frustrated customers have to visit the branches anyway to get what they require. Better to design against demand and free up customers to use the channel of their choice. Concentrate on creating value for customers, not cost per transaction.

5. ‘We need help – we can’t do this for ourselves’

As a consultant myself, I’m flabbergasted at the number of consultants employed by the banks these days. Some of the big consultancy firms have had teams in some banks for years. What is the return on these contracts? The justification must be that it will save money in the long-term – but is that really happening? With a different level of thinking, banks can learn to study their systems from a customer’s perspective and unlock massive potential for themselves, at the same time-saving a huge bill from the men and women in sharp suits – a double benefit.

6. Increase revenue by selling more products

What about increasing revenue while reducing costs? The preferred strategy in banking has been to increase marketing budgets to build better products which will bring in more customers. This done, the next stage is to incentivise staff to sell more of these products, the primary aim being to increase product holding per customer – for example, if the holding is currently 1.3 products per customer, the goal is to increase it to 2.5. Customer Relationship Management tools are then acquired at large expense to prompt colleagues to push products to customers, turning off many while persuading politer ones to accept the products only to regret it afterwards. Or ‘project teams are established to work with ‘Products’ to dream up ‘the best offering in the marketplace’. In my experience, this tends to be people swapping amazing ideas against a backdrop of wanting to at least match what their competitors are offering.

So, what’s the impact here? Once again, the key point is that decisions are made away from the front line. Analysis usually reveals that customers want products that work, rather than sing, dance and salute. Then, there’s the cost of incentivising people to sell the products. Banks are currently taking a hit of £40 billion – yes, that’s right, £40 billion – in compensation and fines for the mis-selling of endowments, personal pension schemes and PPI. After the endowment fiasco of the 1990s, you might think the banks had taken on board the dangers of incentivising people to meet sales targets, but experience suggests otherwise. Fines and costs of mis-selling packaged bank accounts are just starting. There are other hidden costs. Many ‘sold’ products are never used. In one study I carried out, 54% of new accounts opened in one of the major banks were never funded – so all the work selling the accounts and providing cards, PINs and statements to fill them was money tipped straight down the drain.

The startling upshot of all this? Overall, the major banks show a 227% increase in costs between 2000 and 2012. Meanwhile the cost : income ratio, at best stable, for most banks continues on its merry upward trend.

And, it’s set to get worse.

I recently had the dubious pleasure of spending six weeks with a project team tasked with the digitization of a bank. The top line was this. A team of 45 was put together in London, more than half of them external consultants and most of the remainder bank colleagues from areas such as ‘change’, ‘compliance’ and ‘risk’. The two token frontline colleagues were largely marginalised. We were asked to imagine customer journeys using personas, dream up what a perfect journey would look like and then play that journey out in front of ‘live’ customers (paid to come in and answer loaded questions). The ‘creative’ consultants drew up storyboards and imagined how a customer could walk past a bank and be sent a phone alert telling them about the latest products available online, while a business case was drawn up to show how many frontline staff could be culled on the back of these great ideas. So, huge costs and no study or understanding of demand or how the current system works for customers.

Doesn’t anyone care about profit?

When I began work in 1992, I had no targets and I worked with a set of principles based around ‘Customer First’. Morale and customer advocacy were high; staff turnover, fines, complaints and cost : income ratios low. Since that time, the drive for standardisation and centralised control and a fierce focus on reducing costs has perversely driven up costs inexorably. My conclusion: instead of worrying about costs, volumes of customers and market share, banks need to move back to a focus on the measure that says it all: the cost : income ratio.

The past 20 years have seen a wholesale destruction of banking morale, reputation and cost : income ratios. In the next 20 years that needs to be reversed by a return to customer-shaped profit centres where potential and innovation are unlocked, central support is available on a subservient ‘pull’ basis and the system is governed by principles and measures related to customer purpose. Using the right principles alongside 21st century technical and other advancements, properly employed, makes a return to cost : income ratios of 38.6, or perhaps even lower, entirely feasible. What’s needed to achieve them is not transformation through large investment programmes, but a change in management thinking. Are the banks prepared to embrace it?

This article appears in Edition One of The Vanguard Periodical: The Vanguard Method in Financial Services. Ask for your FREE hard copy or PDF.