The productivity conundrum

Nine reasons why UK retail financial services

is becoming less productive

“Productivity growth is the only sustainable source of real income

growth in the long term”

Office of Budget Responsibility Economic and Fiscal Outlook

December 2013

The Bank of England is bemused

• are firms hoarding labour?

• why is labour not being reallocated to more productive uses?

• is output being measured properly?

• are staff over-qualified for assigned tasks?

• are share buy-backs hampering investment?

• are firms focusing on M&A rather than organic growth or innovation?

• manufacturing is now just 15% of GDP

• improving productivity in service sector is very important

• but why has it been so difficult?

The UK economy is increasingly service-oriented

Financial services productivity is stalled

• revenues have been broadly flat…

• further increasing the need for improved cost effectiveness

• but not much progress has been made in doing things better (as distinct from doing fewer things)

• growth businesses have typically not reaped economies of scale

"In the first half of 2013, the average cost-to-income ratio of a group of 30 of the largest US and European banks was 60 per cent - the same as it was in the first half of 2011. More than that, it is the same as it was 10 years ago, despite all those promises to keep tight control of costs" FT Lex, 22 September 2013

The state of play in ten institutions Firm 1 Increasing revenue while reducing headcount

Taking smaller, quicker steps; more agile decision-making Firm 2 Major impact of risk management on performance Firm 3 Restructuring; systems consolidation & de-duplication

Centrally-driven transformation eats all change capacity Firm 4 Strategy: low cost manufacturer distributing via intermediaries Firm 5 Cross-skilling to increase agility and flexibility

Cultural change & employee involvement; professionalising Ops Managing the interdependence of product & process

Firm 6 Sub-scale legacy products; difficult to justify automating Cost not the only factor: is the customer getting what they want?

Firm 7 Struggling with systems migration & cost reduction Firm 8 Resolving regulatory issues Firm 9 People & cultural factors seen as very significant

Organisational clutter: impact of regulatory/ HR requirements Firm 10 New Target Operating Model & other major change in hand

Why has productivity growth stalled in UK retail financial institutions?

1: Post-2008, retail financial services has been rebuilding

• retail banks – balance sheet repair and

divestments, with NIM under huge pressure and growing fee intolerance

• retail investments – recovering asset valuations,

but “net new” asset flows non-existent except for a few dominant firms

• protection insurers: – not massively impacted by

2008 meltdown, but facing continuing pricing pressures

Productivity and cost improvement have not been seen as priority tasks

Many players are hoping that “something will turn up” to rescue their current business model….

… and that the recovering economy, in combination with their marketing initiatives, will somehow restore revenue growth

2. Non-discretionary projects have crowded out productivity improvement…. • “we’re doing it because we have to”

• some recent examples: – Retail Distribution Review: cost to industry £500m?

– Client Assets: CASS requirements: cost £000m?

– Mortgage Market Review: impact on cost per sale?

– IT upgrades: dealing with the legacy of Windows XP

– post-merger migrations from multiple systems to new platforms

• the business cases for non-discretionary projects promise mainly cosmetic commercial benefits

…. and other projects with worthwhile business cases get crowded out

3. The industry’s previous track record on productivity is unconvincing

• end-to-end process re-engineering in RBS and Lloyds

• botched system replacements and IT outages

• channel diversification (telephony, web) cost-additive rather than substitutive: customer intimacy damaged

• economies of scale hard to capture: costs have tracked revenue growth (or worse)

• Lean/ Six Sigma initiatives have lacked traction

• continuing concern about uncertainty and deliverability of change

4. Improvement techniques from manufacturing don’t transfer easily

• it’s harder to improve service productivity • some options:

– get the customer to do the work (check-in/ check-out) – eliminate the task (direct debits?) – automate (online checks with reference databases)

• but how can the productivity of a haircut be improved?

• service innovations are less patentable • reverse engineering of service innovations is easier • typically, service sector spends less on R&D • in services, organisational capital (skills, processes,

culture) is a more sustainable source of differentiation

5. Incentives are blunt at the sharp end

• top management trumpets performance ambitions…

• while operational management keep their heads down

• within the line management hierarchy there is risk-aversion, a depressed appetite for change, job insecurity

• perceived penalties for failure are stronger than rewards for successfully implementing change

• few firms are investing in effective management practices for productivity improvement

• ….. but as yet, few firms have gone to the wall (or have been allowed to)

6. The cost of quality is unsustainable

Organisations incur three types of quality cost. In retail financial services these types of cost are increasing rather than being effectively managed…

• prevention: – training and competence regimes

– anti-money-laundering and identity checks for customers and staff

– risk management, authority levels and decision referrals

• inspection: – controls, internal audit and double-keying

• failure: – complaints, compensation and redress

– rework, errors & omissions and manual interventions for exceptions

Do extra security checks at the airport improve productivity?

7. Doing fewer things is not the same as doing things better

• “cost-cutting” is not the same as productivity improvement

• industries which sustain productivity growth do so through relentless, incremental change

• difficult to maintain focus on continuous improvement

• attention deficit syndrome:

– CEOs focus on grand, announceable initiatives; and then move on

8. New business models are more productive

• incumbents suffer constraints on agility: – organisational clutter & legacy

– slow decision-making

– latency of outsourcing and external contracts

• are incumbent organisations becoming too complex to manage?

• the threat of irrelevancy: – mobile payments

– peer-to-peer lending

– DIY investing

Productivity growth in US retail derives almost wholly from reallocation from one business to another. Within-store productivity growth is extremely slow

Chad Syverson

National Bureau of Economic Research

http://www.nber.org/papers/w15712

9. Organisational capital can become baggage

• required strategic competence: – the ability to create &

sustain improvements

• intangible assets can act as a brake on innovation – vested interests resist

change

• organisations need to be “good at” what the market requires today, not yesterday

Organisational capabilities: what you are “good at” Assemblies and combinations of underlying skills, processes, systems, structures…. …. which enable value to be provided to a customer or user

Some remedies

• set a target for “whole firm” productivity – the total value created, compared with the total resources

used

• collaborate – “it’s about people, process and technology all combined” – cross-industry initiatives (faster payments, electronic

messaging) have had massive success

• understand and exploit “what you’re good at” – access missing capabilities through partnerships

• de-scale and de-risk technological change – rapid, relay-race innovation

• … or accept defeat, and go and found a start-up