Partnering with the Competition

About three years ago, the folks at Community First Bankshares, Inc. decided it was time to take action. With regulatory walls falling, rates on the Fargo, N.D.-based holding company’s saving accounts and CDs had a tough time stacking up against stock market returns.

To hang onto the hearts and wallets of customers, it was plain to David Groschong, executive vice president for financial services, that the $5.4 billion-asset company needed to offer them a way to buy mutual funds, annuities, and securities and help meet their financial planning needs.

The question was, how?

Creating the capabilities to offer those things in-house would be time-consuming and prohibitively expensiveu00e2u20ac”especially for a company devoted to using its capital for acquisitions. “There’s so much complexity coming out of a regulated banking environment that we didn’t see the value there,” Groschong recalls. “We concluded that we needed to partner with someone who had the expertise and could show us how to do this and help us to meet those needs.”

After researching and interviewing potential partners, Community First decided to form a strategic alliance with INVEST Financial Corp., a Tampa, Fla.-based wholesaler of investment products and financial planning services.

In exchange for about 20% of the revenues that sales of its line of mutual funds and other investment products churn, INVEST has trained and equipped representatives in all of Community First’s 145 banks to offer top-flight investment productsu00e2u20ac”and free financial planning servicesu00e2u20ac”to their customers. “They take a haircut on our income stream,” Groschong says. “But we think their infrastructure provides tremendous value.”

Indeed, in 1997 the partnership originated some $90 million in new investments, contributing about $3 million in fee income to Community First’s bottom line. Perhaps more significantly, 80% of that $90 million came from non-Community First relationships. “We got a big chunk of the [deposits] we lost back,” Groschong says.

The arrangement between Community First and INVEST is but one in a dazzling array of strategic alliances that have exploded across the industry landscape this decade, as banks and their partners seek to leverage each others’ capabilities and create “win-win” situations.

“Bankers today are looking for ways to offer more products and better serve their customers cost-effectively,” says Merwin Gackle, chairman and CEO of INVEST, which has relationships with 420 banks. “A strategic alliance oftentimes is a much better way to achieve those goals than trying to build and own [those capabilities] yourself.”

Changing landscape

This is not a fad. New technologies and deregulation have blurred the lines in the financial services arena, opening the doors to nonbank competitors and posing new challenges for capital-stretched banks. In response, they are turning to strategic alliances to minimize the costs and boost opportunities in the struggle for greater profitability.

“Five years ago, we pretty much did everything ourselves,” says David Campbell, executive vice president and head of strategic planning for Cleveland-based KeyCorp, which has entered into about 15 alliances in the past two years. “Today, with all the competitive pressures, you really have to decide what you’re going to focus your energies and capital on.

“We’re narrowing down the focus of the corporation’s activities to the things that really add value,” Campbell adds. “If we do something that really isn’t core to our business, and there’s someone else who can do it better and add that value, then we’ll work with them.”

A recent study by Andersen Consulting calls alliance formation “one of the dominant trends in the industry today,” noting that the average large bank is involved in three times more alliances todayu00e2u20ac”roughly 30u00e2u20ac”than it was a year earlier. It also found that many big banks expect to have at least 50 alliances by the year 2000, accounting for an astounding 50% of all revenues they produce.

Smaller banks also are jumping on board the alliance bandwagonu00e2u20ac”albeit at a slower clip than some of their larger brethren. But that, too, is expected to change.

“I don’t think that small banks are going to be able to make a living in the long-term by simply gathering deposits and making loans,” says Stephen Chryst, CEO of the $585 million Anchor Financial Corp. in Myrtle Beach, S.C. Anchor presently offers securities through an alliance with an Atlanta brokerage and is looking at adding insurance. “We’re going to have to offer other products, and I don’t think we can develop those things on our own. So we’re going to have to find alliances.”

Such thinking is typical. “Banks now recognize, without exception, that strategic alliances will become increasingly important in how they define their roles in the community and industry,” says John Weisel, a partner in Andersen’s financial services practice and author of the alliance study.

Beating the odds

Alliances are no walk in the park. It’s difficult to line up good partners, and even tougher to manage the ensuing relationship. Only 10% of all alliances considered by banks actually become reality, and fewer than 10% of those last longer than four years, Weisel notes.

“The skills that are required to create and maintain alliancesu00e2u20ac”how you screen opportunities to make sure they’re the right fit for your business strategy, how you value the relationships, how you structure and manage themu00e2u20ac”are still relatively new to the industry,” he says. “I think organizations will get smarter about strategic alliances, but it will take time.”

For bank boards and managements, the trend demands some long-term strategic thinking about where the company is headed and how a partner might help achieve those goals.

Alliances can work wonders at expanding a bank’s line of products or services, or its back-office capabilities, without building in-house or acquiring other companies. But they also can be costly and time consuming to create and manage. Furthermore, they often require giving up at least some control, exposing your customer base to someone else, or working closely with someone whose goals and values probably aren’t totally aligned with your own.

David Ernst, a senior consultant and alliance expert for McKinsey & Co., says that most alliances fail because partners’ strategies and expectations “aren’t compatible from the outset, or they change over time.”

In 1994, First Bank System, Inc. (now U.S. Bancorp) abruptly halted a pilot alliance that placed financial planners from American Express Financial Advisors in several First Bank branches. “We decided, frankly, that we didn’t want to share the pie with [American Express],” said then-vice chairman William Farley of First Bank’s decision. “It’s our relationship, our customer… That’s what the others who come in and sell want a piece of.”

The level of failures proves that alliances remain something of a hit-and-miss proposition. Something that makes sense intuitively might not bear fruit. But those committed to partnering say you’ve got to continue plugging.

In 1996, KeyCorp entered an alliance with Office Max to place small-business-related banking services in some of the retailer’s Copy Max locations. The program, once hailed as promising, is not being expanded. “It was not a home run in consumers’ eyes,” Campbell concedes. “But you can’t expect to hit a home run every time.”

Even profitable partnerships can be difficult to maintain, because companies “underestimate the amount of time and resources required to manage them effectively,” Ernst says.

An alluring option

Despite the challenges, alliances have exploded across many industries in recent years, as companies look to leverage their own core competencies and better use their capital by sharing both risks and rewards with someone else.

“Companies in all fields are asking, ‘How can I get more leverage from my intangible assetsu00e2u20ac”my brand, my technology, my customer relationships, my skills,’” says Ernst. “Increasingly, they’re concluding that a partnership is the best way to do that.”

Banking has been relatively slow on the uptake. It’s not that alliances are new to the industry. Indeed, many community banks have plenty of alliance experience. Traditional correspondent banking and the outsourcing of basic backroom functions are two examples of what Weisel refers to as “traditional alliances.”

But until recently, banking, with its relationship focus and heavy regulatory burdens, has been more or less immune to the partnership phenomenon that has gripped other industries.

Now the industry is making up for lost groundu00e2u20ac”fast. Weisel says that banks entered more alliances in the last half of 1997 than they did in the previous six years. In the fourth quarter, he estimates, about 400 new bank alliances were launched.

Scratch the surface of virtually any well-run bank today, and you’ll find themu00e2u20ac”joint ventures; marketing, distribution and licensing agreements; cobranding deals; outsourcing arrangementsu00e2u20ac”with technology companies, airlines, retailers, nonbank financial services providers, and even other banks.

Many alliances are aimed at enhancing revenues by boosting product offerings, access to customers, or frontline technological abilities. Others are focused more on keeping backroom costs down.

Weisel breaks them down into three broad categories: traditional alliances, such as correspondent banking; “core capture” alliances, aimed at boosting the level of service and efficiency provided to current customers; and “specialist expansion” alliancesu00e2u20ac”partnering with nonbanks that offer related products or services to expand the overall customer base.

On the access frontu00e2u20ac”part of the “specialist expansion” movementu00e2u20ac”they run the gamut, from Wells Fargo & Co.’s agreement to sell medical savings accounts to members of the National Federation of Independent Business, to TCF Financial Corp.’s long-standing supermarket banking presence or the placement of ATMs at gas stations.

“Supermarkets have always cashed more checks than banks, and they get really intense about finding the absolute best retail space around,” notes TCF’s chairman and CEO, William Cooper. The Minneapolis-based banking company has about 60 supermarket branches in six states. “Capitalizing on that expertise is a natural for us,” he says.

Similar alliances can be found on the business banking side. KeyCorp is among the growing ranks of banks that are forging partnerships with foreign banksu00e2u20ac”it has one alliance each in Europe and Asia. And both PNC Bank Corp. and First Chicago NBD have formalized ties with investment banks to beef up their corporate finance abilities.

If you can’t beat ’em…

Enhancing product offerings, as Community First has done with INVEST, is more along the “core capture” lines. Increasingly, banks are allying with insurance companies and investment firms that appear at first glance to be competitors. One notable example: KeyCorp and First Union Corp. now offer Charles Schwab & Co.’s One Source investment product, wrapped with their own in-house offerings.

“It would take years and tens of millions of dollars to come anywhere close to replicating what Schwab already has,” KeyCorp’s Campbell says. “They look like a competitor. But we were able to leverage the power of their name, and the complexity and beauty of their products, in a way that enables us to retain customers.”

This “if you can’t beat ’em, join ’em” thinking is a driving force behind many product partnerships, as banks seek to preserve customer relationships. Alliances also are being employed to cut the high costs of investing in new, but important, frontline technologies, such as Internet banking or customer kiosks, where providers can leverage their own economies of scale.

Ohio’s Huntington Bancshares did this when it cut a deal with Security First Technologies to provide software and technology for Internet transactions. Scores of small banks are working with local tech companies to establish Web sites.

On the backroom side, alliances are quickly coming to dominate areas such as payments, check clearing, and data processing, where technological advances make it prohibitively expensive to keep up. In the past year, for instance, both Firstar Corp. and KeyCorp established equity joint ventures with Nova Corp., the transaction processor, to handle their bankcard payments.

More ambitious are ventures like Integrion Financial Networku00e2u20ac”an alliance of 17 banks, IBM Corp., and Visa USA aimed at creating the industry standard for electronic commerce transactionsu00e2u20ac”in which multiple banks are joining hands to confront perceived threats to the industry’s control of payment or currency systems. (See sidebar.)

These are but a few examples among an ever-growing list of partnerships engulfing the banking industry. Truth be told, you’d need a long scorecard, with lots of crisscrossing lines, to keep the whole trend straight.

Management miasma

If it’s confusing to contemplate, it can be flat-out daunting to manage. Given the complexities, larger banks appear to have the upper hand in the partnership game. Many have begun to build standardized alliance policies and procedures, develop firmwide alliance databases, and assign managers dedicated to overseeing alliances.

But McKinsey’s Ernst says that only a handful of firms are truly up to snuff on alliance managementu00e2u20ac”most of them technology giants, such as Hewlett Packard or Xerox.

Smaller banks, he adds, can enter into a limited number of partnerships without an infrastructure, as long as they think carefully about what they hope to gain from an alliance.

Bank managers and boards considering entering strategic alliances need to ask themselves some blunt questions and be up front about their expectations to negotiate a deal that makes sense in the context of the institution’s overall goals. You need to have a vision of how the alliance will work, what benefits it will bring, and how success will be gauged.

“The most important thing is, do your homework during the courting process,” says KeyCorp’s Campbell. “It’s all about personalities and cultures. You need to understand very clearly the people you’re going to be working with, and whether the organizations’ cultures can mesh.”

He recommends getting to know the management of the prospective partnersu00e2u20ac”their approaches to issues like quality control and assessment, whether you like them and can work with them, how they envision the alliance, and what they hope to get from it.

“It’s kind of like peeling an onion,” Campbell explains. “Sometimes you take off the first layer, and your eyes aren’t watering. But then you take off the second layer, and you’re crying so hard you can’t see the onion any more.

“If that happens, it’s not worth pursuing,” he adds.

The notion of corporate culture clashes gets a lot of attention. Andersen’s Weisel calls it “the hardest part for companies to get their arms around” and a prime source of alliance failures.

But Ernst, who has spent more than a decade studying and advising on alliances in various industries, says that differences in individual corporate cultures are overblown as a cause of alliance failure.

Rather, he says, incompatible goals and strategies are the chief reason for alliance failures. “Almost every alliance, whether it succeeds or not, has a culture clash. The successful ones are able to overcome it.”

Interestingly, it may be better to jump into the alliance frayu00e2u20ac”even with the risks of failureu00e2u20ac”than to hold back entirely. The liability for directors may actually come from not actively pursuing an alliance, according to Weisel. He says if a bank decides to pursue something in-house that could have been done better and/or cheaper with a partner, then the board may have to answer for it.

“As a director, you should be encouraging management to think about partnerships, because you often can get access to markets or expertise that can help expand the business at a much lower cost than if the bank did it on its own,” he says. “If you’re not advising your company to look at the alliance option, you may not be fulfilling your fiduciary responsibility to shareholders.”

CEO Chryst notes that Anchor has burned through three alliance partners on the securities front in three years, due to disagreements or consolidation. He has become frustrated with the commission-driven nature of his partners’ business and his inability to “personalize” the products to meet his company’s identity goals. “That’s why the big banks are buying their own firms. So they can have control,” he says.

For smaller companies, however, that’s not an optionu00e2u20ac”which is why alliances are exploding.

Community First conducted due diligence on several investment companies before opening negotiations with INVEST. It looked at the companies’ track records and product offerings and concluded that INVEST’s screening process provided the kind of high-quality investment opportunities that it felt comfortable offering its customers.

This may be especially important in a relationship business like banking: If customers get burned by a product that’s sold out of your bank, they’ll likely blame you, not the partner.

Coming to terms

If you’re confident that you’ve found a potential partner, negotiations come next. “We say, ‘This is where we are, and this is what we’re trying to do. How can you help us?’” explains Groschong, who oversees several alliances for Community First.

Many alliance partners have boilerplate contracts that they’ll try to offer. Those can serve as a good starting point. But a bank that knows what it wants can negotiate modifications to meet specific needs.

And while there are a plethora of investment bankers, lawyers, and consultants available to offer advisement during this period, only a small amount of banks use such advisors.

“Executives are extremely interested in the topic, and they tend to go it alone,” Weisel says.

Expect those negotiations to take timeu00e2u20ac”many last a year or moreu00e2u20ac”and don’t be surprised if you encounter some disagreements. “If you get married to someone without having an argument and knowing you can resolve it, the marriage might not be very good during rocky times,” KeyCorp’s Campbell says.

Also understand that strategic alliances aren’t zero-sum games, where partners are competitors. No self-respecting company is going to ally with you if they’re not getting something out of it, too. Indeed, uneven alliances, where one side feels taken advantage of, probably won’t succeed.

“You need to create, as much as possible, a ‘win-win’ situation, with clear decision-making authority and the resources needed to launch the alliance properly,” Ernst advises.

Groschong is a firm believer that banks, as controllers of the distribution system, are well positioned to shape product-based contracts to their liking. “We have the customers and the trust. If [a partner] doesn’t acknowledge that, they’re probably not going to be a good fit for us,” he says. “They have to be open-minded to our needs and buy into where we’re headed.”

This is crucial. If you don’t know what you want out of an alliance, then you’re not going to get it. Laying out firm expectations and an agreed-upon way to measure whether those goals are met rank among the biggest challenges for alliance partners. “At the end of the day, it has to be based on the value created for shareholders,” Weisel says. “But most organizations really struggle with the specifics.”

The criteria will vary by company. But they can give directors a way to keep tabs on the alliance’s progress. In return, the board needs to provide both the support and tools to give the venture a fighting chance.

How to demonstrate that commitment? Make the alliance the responsibility of a senior executiveu00e2u20ac”preferably the same person who negotiated the deal. “That’s a best-practice,” Weisel says. “The notion that ‘if you kill it, you eat it.’”

You also might want to consider tying some of the manager’s compensation to the alliance’s performance. “Actions speak loudest,” attests INVEST’s Gackle. With alliances that involve selling new products, “people have to be compensated well for meeting customer needs.”

Once an alliance is started, be patient. Many might not show results for a year or more, as programs are instituted and employees trained. If success comesu00e2u20ac”even in small amountsu00e2u20ac””champion it across the organization” to build morale and support, Weisel recommends.

But remember, continuing communication between partners may be the most important ingredient for success. Groschong points to an alliance Community First had with an insurer that provided credit insurance for its borrowers but didn’t provide the kind of comprehensive service and tracking the bank demanded. “They didn’t support the program or provide reports to let us know where we were,” he recalls. The relationship was terminated.

Ultimately, the toughest issue of all may be control. Banks have a history of running their own shows. Splitting, or even conceding, decision-making power with a partner may be tough to swallow.

“Industries that are heavily focused on risk management and without a history of alliances often have a challenge adjusting to the alliance mindset,” Ernst says.

But KeyCorp’s Campbell, who negotiated his company’s joint venture with Novau00e2u20ac”the technology firm owns 51%u00e2u20ac”says that such worries can be addressed during negotiations. “You can mitigate the risks through the policies and monitoring you institute at the beginning.

“A lot of people get into trouble in alliances because they don’t think out a couple of years about what it will be like to manage the relationship,” Campbell adds. “If you are thoughtful at the outset, it should work.”