No one disputes that the world of financial services is changing. But when pressed to describe how the new world will look, most analysis begins to dry up. Boards and managers meet to set direction in strategy, often sketching a high-level vision of the future. But the one person who might help most with creating a transformation to the future is perhaps the most conservative member of the management team: the chief financial officer.
The CFO is the person who prepares the numbers, builds the ALM models and enhances the analysis of business as we know it today. What better person to construct tomorrow's business model?
The ultimate job of the CFO is to conserve the value of the institution, to guarantee its on-going financial viability. If the current economics are changing, what numbers should we look to? Where is the real value in our business today? Is it the assets on the balance sheet-or somewhere else?
An economist from the Dallas Federal Reserve Bank who spoke at Callahan's Financial Strategies Conference in January recorded the tremendous success of the economy since 1991. "We have created over 15 million additional jobs, a rate of 190,000 a month for the last seven years," he said.
But this total is a net amount, for there have been an estimated 25 million jobs eliminated and 40 million new positions created by the forces of competitive change. The rate of business failure has almost doubled. A growing economy includes both a destructive process of doing away with the old as well as bringing in the new.
Consultant Peter Drucker has made the observation that if innovation can change the cost structure of an industry by at least 30%, then competition can cause up to 50% of the firms to be gone within 10 years.
Financial services is essentially an information business. The transfer of information via networks is the revolution caused by the Internet. Although estimates vary, there is little dispute that Internet home banking costs only a fraction of other ways of conducting transactions.
The Destruction/Reconstruction of the Discount Brokerage Business
One example of this cost revolution is in discount brokerage. In just two years the average cost of a trade on-line via a discount broker fell from over $50 to just $16. Thirty-five firms now offer on-line trading. Yet the market share of on-line sales is still a fraction of the $14.5 billion brokerage business.
Some estimates of the marginal cost of on-line trading are as low as $2-3 dollar per trade. With investment information readily available on-line as well, what is the future of the full service broker? Certainly additional ways must be found to enhance their value if live brokers are to remain in business.
A Hard Look at the Numbers
The first requirement for any significant change is "brutal honesty", the ability to see the world as it currently stands. We need to look outside the way we learned to do business. A model from the outside is necessary to replace the current one.
Credit union members already tell us that our traditional products and services are not the cornerstone of their financial lives. Insured deposits have grown less than 1% since 1989. Since 1981 when the IRS gave 401(k)s the green light, the amount in these pretax retirement savings plans has grown from $55 billion in 1984 to $1 trillion in 1997. These funds come off the top of the employees' paycheck and are almost totally invested outside insured financial institutions.
In addition, economies of scale have made many credit unions merely pass-through lenders in the mortgage business. Credit union auto lending, which makes up almost 35% of credit unions' loans, is constantly threatened by leasing alternatives and bundled pricing deals at the dealers.
Apart from these specific competitive threats, the collection of personal credit information and demographics in the information age means that the essential business information used by the credit union to evaluate members for product and market initiatives is widely available. Credit unions no longer have the inside position on information about their members.
Accordingly, I see a new business model already available. The transformation necessary is from a "funds-on-deposit" relationship with the member to one based on "assets under management," one by which the vast majority of member balances reside off the balance sheet.
Quantify the Model
Again by looking at the external environment, it is possible to construct the kinds of financial revenues and costs associated with new services. The economics of mutual funds, discount brokerage and other services are available.
The key variables of such new services, such as growth rates, capital requirements, cost assumptions, balances per member and distribution options, are radically different from the traditional credit union experience.
As part of this model, changes must be made in the way we think about and manage costs. Internal analysis in credit unions has focused on improving the understanding of product costs or household and member profitability. Invariably the results demonstrate that 20% of the members "account for" 80% of the net income.
The dilemma with these models is that while revenue can be fairly accurately assigned, the concept of fully allocated costs is much fuzzier. In the new models of financial services, the concept is more marginal cash outlays, rather than cost allocation. In essence, the credit union becomes a single cost center with the primary goal of driving revenue.
Understanding the environment and the new economics will suggest new ways to think about the future. Some initiatives are as simple as stopping certain activities, such as opening new branches. Others may be more consequential, such as the necessity to partner in the cyber world of financial services.
The chief financial officer is often the person closest to areas of change. The CFO reports the jump in bankruptcies or the rise in shares or the drop in auto loans. Often expense cuts rely on the CFO's suggestions.
What could be more important than reinventing, not just tinkering, with the financial model as we know it today? If we are to create and move to a new business model, what better place to look for innovation than to the CFO?