Insight No.36 : Apr 2012 : What's Coming Around the Corner?Shortening a Bank's Financial Supply Chainby Paul Freeman

According to the definition in Wikipedia, a supply chain is "a system of organizations, people, technology, activities, information and resources involved in moving a product or service from supplier to a customer." Whether the end product has a physical manifestation, such as a pair of shoes, or non-physical, as in the case of financial services, managing the supply chain is often the difference between profit and loss.

Since the 2008 crisis financial institutions have had a laser focus on reducing the costs of producing their products and services. Clients are demanding improved services at reduced prices and lower risk products. This is putting real pressure on banks' operating margins. Historically, internal technology and operations have grown fat and expensive because products commanded significant margins and high profitability. Now process efficiency is one of the major topics on any executive's agenda.

This re-engineering of the product production process is requiring banks to think very differently about how they might manage their business. Pcubed has found that many are now re-evaluating the entire stream of work they perform and discovering that they don't necessarily have to occupy such a large stretch of that supply chain.

If you were to envisage a horizontal line representing the supply chain making up a bank's product delivery operations, most have traditionally managed a very big piece of that chain and were reluctant to go outside for services. Now we're hearing them say that they're willing to consider commoditizing more of the supply chain, having segments delivered by third parties, and taking a less conservative approach to offshoring and/or outsourcing than would have been the norm five years ago.

The result will be that banks occupy a much smaller piece of that end-to-end stream of work. They'll put a great amount of energy into converting what has traditionally been a relatively high fixed cost supply chain to a much more variable, fluid, and flexible model.

What this effectively amounts to is an increased appetite for taking risks along that supply chain as a tradeoff for lower cost. For example, I'm hearing more bank leaders say something to the effect of: "Historically, we felt we had to own all of risk management and to have that sitting right alongside our core operation in a higher cost location. That's no longer desirable because it's not affordable. Plus, the competition is all changing, so I have to match the competition."

How a Bank Streamlines its Financial Supply Chain

To illustrate what I'm talking about, let's look at the activities related to risk management. In the past, it wouldn't have been unusual for the bank to maintain all of its risk management services in a high-cost center. That work would have been internally controlled and managed. When Western banks began to use India-based service providers, the jobs would have consisted primarily of relatively low-level commoditized tasks. The bank would pick the "location du jour" and send the reconciliation there - Chennai this year, Shanghai next. Goals focused on meeting cost reduction targets, so pricing was the main driver for decision making.

Now banks are increasingly pushing middle- or higher-level tasks out to third-party providers and feeling far less pressure to "own" those processes. They're also redefining what the offshoring strategy should be and coming around to the notion that it really means "rightshoring" - that the absolutely essential functions are handled by the onshore high cost locations. Nearshore, offshore, and far-offshore locations can do the remainder, defined by the cost operating in those locations and the risk of the processes they're delivering.

What used to be considered "cheap" locations aren't viewed that way anymore. As more and more companies piled into India, Singapore, the Philippines, and China, the usual demand-supply curve kicked in, so they're no longer quite as attractive low cost locations as they used to be.

Nowadays service providers might be located in Eastern Europe instead of Asia, places that are within a three- or four-hour flight for Europeans or less than a day for Americans. That way, when headquarters needs to bring staff into the center, there isn't that two- or three-day delay. There are definite cost advantages at these locations compared to keeping the business in Western Europe or the United States.

The real shift here is the move to a true strategy versus a year-on-year cost play. Banks that get this right and have the fortitude to stick to the strategy will have a sustainable supply chain with all the attributes necessary to compete in today's environment.

Besides business process activities, banks are also reconsidering how they deliver their technology stacks. No longer are they compelled to own the entire IT operation. They've begun to take the view that managing data centers and owning the real estate those data centers occupy is expensive. Likewise with other aspects of the infrastructure - storage, networks and other hardware components. Large third-party suppliers such as IBM and HP (with its EDS business) can offer real benefits of scale. Increasingly, banks are inclined to take up more and more of these services.

Learning Lessons from the Other Industries

In the area of physical supply chain for goods such as printed matter, furniture - whatever the product - banks are figuring out that just-in-time provisioning can be handed over to a third-party that stores stock in its own warehouses and delivers it to the bank's premises at the exact moment it will be consumed. This is the same technique that supermarket chains and retailers, particularly in the United States, were actually doing way back in the 1980s. In other words, banks are finally learning from other industries and playing catch-up. I've had many conversations with senior leaders in banks saying they realize that they're not very good at this stuff and they can learn from the exemplars in manufacturing, which have really refined how to manage the whole production process.

Whereas 10 years ago a financial institution would have occupied higher cost locations for 70 or 80 percent of its supply chain operations, now those activities will make up perhaps only 20 percent. That's a dramatic shift. And that's when other types of challenges begin to surface. Suddenly banks will have to focus on collaborative management of multiple suppliers or multiple locations feeding into their supply chains.

While the banks are just waking up to this, the same shift occurred long ago in the automotive and broader manufacturing segments, both of which also face low-margin, highly competitive, and challenging environments. The tide has turned, and, frankly, it's never going back. Suddenly banks are scrambling to understand how to manage the supply chain in this way and looking for insight from other industries that have already paved the way.

There's an inherent risk of moving to these new operating models because the organization is being dissected into process components, as it were. In many cases we're finding that some of those processes are just plain broken and have to be fixed before they're handed over to providers outside of company walls. As ever, if you don't fix broken processes first, what you'll end up with is something that tends to get more broken down the line and significantly more expensive as a result.

The complexity of shifting the financial supply chain is compounded by the introduction of products that exploit technology, such as the use of mobile apps to deliver services. Banks are finding that they need to set up partnerships with companies that don't necessarily have a known track record in any industry because they're so new and untested. How those partnerships are structured and how that work is managed are critical to success to project success.

Also banks are under the microscope from all financial services regulators. These new supply chains face as much scrutiny as any part of a bank's operations. Therefore, in order to earn the necessary regulatory approvals for the shifts in production being contemplated today, it's essential to have a clear strategy, properly planned transformation programs, and focused management attention.

The Biggest Challenge in Fixing the Financial Supply Chain

Perhaps the biggest challenge banks face in transforming themselves into lean and nimble operations is to understand the cultural shift required within the organization and also to be prepared to come to terms with the marriage of multiple company cultures - their own plus those of their partners. It's a shock sometimes to discover that others, such as service providers, don't do essential work in the same way you do. It's hardly ever the underlying technology or design elements that delay progress in a transformation initiative; those are understood fairly quickly by participants. It's the business change elements that turn out to be the most complex.

What we've seen fairly often is that the organization isn't sufficiently "joined up." Activities take place within one silo and then get handed off to the next one. Streamlining those segments across the entire operation gets stalled because there are missing links - white spaces between one silo and another, due to a lack of communication and stakeholder management.

We recommend evaluating the entire supply chain as it works today and figuring out what needs to be addressed in order to create a horizontally integrated organization. The starting point usually involves diagnosing what's in place today, figuring out where you want to be in, say, two years' time, and then coming up with a map for crossing that chasm, which typically means fixing poor processes. Only once those repairs are made will the company be ready to take on the bigger challenges in financial supply chain reorganization, such as moving work to new locations or handing it off to third parties.

Once the bank understands its end-to-end processes in macro terms, its leaders can have the informed conversations about the movement of information and data through the supply chain and how to create synergies and generate profit in combining those activities into a single masterful workflow.

Paul Freeman is a Managing Director for Pcubed, leading the Financial Services practice. He is an experienced CFO and CIO and has led finance and technology organisations in several organisations, including Lehman Brothers, Dresdner Kleinwort Benson, and Barclays Capital. Contact Paul at paul.freeman@pcubed.co.uk.