Business Model Optimization: Value Acceleration

Ernst & Webb co-founders Robert L. Ernst and Chuck R. Webb spoke with Bank Director about the value acceleration technique their firm employs to analyze mid-size banks’ operating models for maximum returns in today’s increasingly competitive environment.

Your firm uses a consulting technique called value acceleration when advising mid-size banks. Can you give a brief overview of value acceleration and its benefits?

Charles R.Webb: Value acceleration is an objective and critical analysis of a bank’s operating model and strategic plan.We ask: How does the bank make money? How does it allocate resources? Are these functions properly aligned?

These are critical times for banks. I was at Bank Director’s Acquire or Be Acquired conference in January and the overriding message was that 2007 will be a more competitive and more challenging year than 2006. I also attended the conference in 2006, and the message was that 2006 was going to be tougher than 2005. So that trend will continue to be driven by competition, not only from banks, but from all companies that deal with a bank’s customers.

In light of today’s increasingly competitive environment, it’s important to conduct a critical analysis of a bank’s operating model by taking a solid look at every detailed step, followed by a systematic review of the business plan. Such an engineering discipline takes each element of the plan and breaks it down to see where the bank is either spending or making money.

As a result, bankers gain a better understanding of how their business works. Open communication is also critical to the process, as is the need for every profit center and cost center to be represented. By doing so, you get everyone working together and you eliminate silos and parts of the business that are simply on the wrong axis. Once we evaluate a bank’s business model and break it down by revenue, expenses, leverage, and so on, we put together a peer group that includes direct competitors and out-of-market competitors with similar business models.We then mine the data to come up with a consensus of where the bank needs to be. On one side we have a position that says, “Here’s where we are.” On the other side we have a position that says, “Here’s where we want to be.”Then we identify the gaps and map how the bank can get from its current position to the desired position.

How critical is open dialogue among the bank’s leadership team, management, and the board to the success of analyzing the business plan?

Webb: It is absolutely essential.This entire process identifies changes that must take place so that gaps can be addressed, whether they be changes in personnel, processes, operating systems, or product lines. When there’s change, there’s typically human resistance. People won’t get on board until they are focused and see their fellow managers also having to make sacrifices. So communication is critical. One of our clients told us that the biggest takeaway from this process was the open communication it fostered, as well as the redefining of their corporate culture.

So why don’t more banks and financial institutions take this critical look at their performance level outside the merger and acquisition process?

Webb: Some do. Others haven’t been forced to or have yet to face the challenge. But the competitive business environment has changed that. Corporate governance has also increased the pressure on management, and directors are asking management, “Hey, what are we doing to improve?”

Do you think more and more companies are going to implement this type of internal assessment to survive in today’s competitive business world?

Webb: Yes. More and more companies are going to want to do this type of assessment.They must be committed to taking a critical look at how they do business.They must look at their people, their products, and their processes. Even though something was justified last year or last decade, is it still justified today? It’s very beneficial to have a systematic way to look at your profit model to say what works and what doesn’t.

Are directors kept in the loop as you go along the timeline and release various status reports, or are they just involved at the end point?

Webb: It depends on the bank’s particular situation. Some banks have a strong chief executive who doesn’t regularly report to the board on these matters.This is truly a management issue that doesn’t warrant considerable board involvement, but I would think directors would rest easier in their governance role if they knew their managers were following a disciplined approach to reassess how the bank operates. And, quite frankly, boards more and more are going into oversight mode and not micromanagement.

Where do banks start when implementing a long-term project such as a business evaluation?

Webb: Typically the directive comes from the CEO, who says,“We really have a need to make our business plan more dynamic.We need to increase our products and our fee income, and we must control costs.” If the revenue side stays flat, which is what many banks are currently experiencing, and the yield curve stays flat, there’s very little revenue growth.Thus with expenses going up 4% to 5% a year, the combination doesn’t lend itself to long-term independence.

So, where should banks begin?

Webb: Initially, management recognizes a need to take a critical look at the business.They sit down with senior officers and go through this approach as it relates to their people, products, and platform.Then they put together a team of about 18 or 20 key people. With our clients, we start with a pro forma general outline–whether it’s for a retail group, mortgage group, or back office–that can be tailored to their situation.We go through every line and every function in each department. Then we go back to the larger group and share our findings and discuss the exceptions.

Why did you begin working with mid-size banks?

Webb: Bob Ernst and I are longtime bankers, and we saw a void in the marketplace for this type of analysis. We brought in three engineers with MBAs who aren’t bankers, but who are process and product people, to work with us, and we’ve taken tools that have been used in the manufacturing sector, applying them to a service business. We’re finding that the service environment lends itself very well to these engineering tools.

You mentioned competition, not only from other banks, but from other types of companies. Could you elaborate on how the current environment is creating challenges for banking?

The competition is there, and banks must keep up.They’re trying to get deposit dollars.They’re trying to get loan dollars.They are competing for investment dollars and wealth management assets.

A measured evaluation of how financial institutions are conducting their business is just one of the steps that’s going to make people more efficient. It’s going to make them more profitoriented. You need to make a minimum base return on profit to stay in business and to stay economically relevant.

Do you typically go back and do a follow-up assessment?

Our project managers stay in touch with their clients on a quarterly basis. When quarterly earnings reports are released, we watch how our clients are doing and go back to consult with them if asked.We will also insert ourselves into the process if we think there’s a glitch.We’re fortunate in that we have very good communication with our clients, and due to the size of our staff, we are able to stay in touch with all of our clients at least quarterly.

Robert L. Ernst: We also put together quarterly report cards where we look at past clients’ progress. It’s really gratifying because the banks that have clearly followed the road map we provided typically report annualized results that are much higher than what they experienced in prior quarters.

How important is open dialogue with a bank’s leadership team?

Ernst: It’s very important because in today’s highly regulated environment, they need to find a business partner with whom to bounce ideas.We end up being the sounding board that pushes back. Many people have said to us, “We like the fact that you don’t tell us what we want to hear.You tell us what we need to hear.” It’s vitally important to be on top of every issue. So therefore, oftentimes companies need that sounding board, they need individuals who are going to back away from the forest, take a good look at the trees, and give them a better view of what the current situation looks like.

As part of a value-accelerating process, you talk about product bundling. Can you give a specific example of this?

Ernst: When most financial institutions promote a product, they advertise a single service and fail to advertise those I call tagalong products. For example, if I’m advertising a checking account and I want to encourage direct deposit so that I eliminate the depository item coming across the window, I include direct deposit, a credit card, an ATM card, and automated bill pay. Instead of focusing on just one product, I bundle four products, each with individual incremental value.With ties to four products, there’s less than a 40% chance of losing that customer. So product bundling involves understanding a customer’s profile and putting those products directly in front of the customer.

Webb: When financial institutions bundle products, two significant things occur. One, they experience more revenue growth, and two, they have a much better chance of retaining that customer–and customer retention is key to holding down your costs, long term. So product bundling works on the top line as well as the bottom line.

What makes your method of consulting different?

Webb: Bob and I have put together a unique team of seasoned bankers and engineers who are also experienced businesspeople.We use a very disciplined approach in looking at how banks run their business, and how their profit model is broken down. Up to that point, we’re probably the same as most other consultants or their own internal management. But here’s where we’re different.We use very disciplined, documented approaches–the zero-based budgeting, justifying everything from the ground up–to illustrate the bank’s current status.Then we look at the metrics to see where the bank needs to be for good returns on its investment and what it needs to be market competitive, and we build a bridge to close those gaps.We track the bank’s progress and make it available online so other people can track it, too. It’s a full-time job for us, whereas if you’re in corporate management, you’ve got your bank to run at the same time.

Ernst: Some consultants don’t tie all the threads of an operating model together, but we use a very holistic approach.We really believe you cannot fragment changes in a successful operating model.You must tie all the pieces together. Webb: Our approach couples people skills with technology. In summary, we are building our firm on experience, focus, and speed, while constantly striving for increased client performance.

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