Increase Quality, Increase Velocity – in Finance

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Willie Sutton, a famous bank-robber during the mid-1900’s, was once asked why he robbed banks.  Willie responded, “Because that’s where the money is.”

Contrast that with a commercial on television I saw, several years ago (perhaps it was even in the 1990’s) from a major American bank.  The President of the bank was speaking to the camera and said, “Last year our bank processed over 10 billion checks accurately”.  He then immediately corrected himself and said, “Actually, our bank processed one check accurately last year and then repeated the process over 10 billion times”. I am sure he did not realize it at the time, but he was directly speaking of “velocity” of Lean and the “quality” of Six-Sigma.

What is remarkable is the transformation of “cold hard cash” having to be physically transferred when a transaction was made back in the mid-1900’s – to it all being bits of information exchanged from one financial institution’s computer to another’s as it is today.  Indeed, a bank-robber might well starve today on what they might steal, which is probably the main reason why there are so fewer bank robberies today than there used to be.

When people think of Continuous Improvement (Lean, Six-Sigma, Leadership, and the lot), they don’t usually think of the financial industry – except to believe it desperately needs a lot more improvement.  I mean, after all, how many of us hold our bank in high regard?  How many of us would consider ourselves “fans” of our own bank with whom we do business?

But in reality, financial institutions do an excellent job when it comes to high-volume transactional activity – an area in which they have invested mightily in automation.  For instance, in the last five (5) years, how many of us have had transactions gone awry?  Posted from, or to, the wrong account?  Or an occasion when the amount was wrong?  What was the source – the “root cause” – of the error?

Whether processing a credit-card charge, posting a payment, making a deposit, or processing a check – all of these activities are highly standardized, rigid and automated.  There is no room for error once the control and processes are within the system.  If there is an error, it is almost always at the point of entry or exit – when a human has the opportunity to engage.

As the transactions get more complex – with the number of variables and steps increasing as well as the level of risk – the processes become less standard, leading to less automation and an escalation of human involvement (labor).  These circumstances also result in an increase in exceptions with the result being that quality and efficiency suffers.

And we can witness this with our own life experiences.  The mundane transactions I described above occur without our giving them a second thought.  But let’s look at some of the more complex transactions, and what some of these increased complexities (and human involvement) might be;

  • Vehicle Loans:  Requires more paperwork to be examined and accepted than everyday personal banking activities – but the process is largely standardized due to the number of transactions of this sort.  Does the appraised value of the vehicle support the value of the loan being considered?  Is the title clear of liens?  How will the person taking the loan pay it back?
  • Home Loans:  Even more paperwork to be examined and accepted than in a vehicle loan.  There are all of the above requirements, plus the history of the property going all the way back to its discovery.  Who owned it from when to when?  Were all the loans throughout its history satisfied (could go back thousands of years).  Are there easements?  Did it pass an inspection?
  • Commercial Loans:  Now the evaluation process for the bank gets tricky and becomes labor-intensive.  What is the viability of the company and its long-term prognosis for success?  What is the value of a custom-built facility or a specialty apparatus to the marketplace beyond the company making the acquisition?  If the bank had to repossess, how much could they actually expect to get for the asset when sold?  And what about the inventory that is being “factored”?  Is it really worth what the company says its worth?  Is it even all there?

Each of the above transaction types are largely “commoditized transactions”.  Surely, a familiarity and relationship between the parties’ helps, but the only real difference from lender to lender is price and terms.  The result is that there is pressure on the “sell price”, and the resultant pressure on cost to deliver.

Mergers and Acquisitions – Where Cost Doesn’t Matter:

We read about it in the news, deals worth tons of money being struck over a Starbuck’s Triple Espresso Macchiato Wet and Whipless with Room in a Tall on a Leash.”  Just think of Facebook’s acquisition of Instagram for $1-Billion on April 9th, 2012 just a few short weeks before Facebook went public (May 18th, 2012) – this is nearly precisely how it occurred.

But that is just the announcement of a transaction in principle, the very beginning of the merger process – two business owners meeting and agreeing that a deal should be done and the rough parameters under which it will be ultimately consummated.  Since most deals, such as these, do get done once announced (especially when one of the parties is a publicly-traded entity), the news is usually celebrated with great fanfare.

Sometimes, the deals are not made in a friendly fashion over coffee.  Sometimes, the party that is wanting to acquire will call the (publicly-traded) party which is the target of the acquisition and simply inform them of their intent.  Then things can get very complicated.

Are there other serious bidders?  Such was the case with RJR Nabisco which pit a Leveraged Buy-Out from Kohlberg Kravis Roberts (KKR) against a Leveraged Management Buy-Out (made famous by the book and movie “Barbarians at the Gate”).  In the end, KKR won.

Are governments wanting to get involved?  This recently occurred with General Electric’s (GE) acquisition of Alstom.  In this case, there was a feigned attempt from Siemen’s to get involved in the deal as a spoiler, but it was the French Government, citing “national interests” (which is code for “cash to France”) that was the real hurdle that needed overcoming.  Once GE agreed to pay the government of France, all the “national interests” issues were resolved.

Whether over coffee or uninvited, most business leaders are highly motivated to get deals done.  After all, the executive leadership (and the shareholders) are usually going to make a “metric shit-ton” of money when the deal is completed.

But these transactions are very complex and require a lot of highly specialized (and expensive) experts (on both sides of the transaction) to ensure that the accuracy of the transaction and its intent is (and remains) a reality.  And although almost all deals have similar considerations, the nature of the deals is such that each one is a “one-off” and do not easily or obviously lend themselves to streamlining.

Some pre-merger activities of note (Bowne, now itself acquired by RR Donnelley in 2010, created a great “M&A Handbook” for reference);

  • Terms of the Deal;  What’s it going to take for both parties to be satisfied
  • Non-Disclosure Agreements;  Everyone is going to “open their Kimono”, and neither parties wants the private inner-workings and strategies of their organization to be made public.
  • Employment Agreements;  After the deal is done, some people are going to stay and others are not.  For those who are going to stay, there has to be a position and a compensation-package agreed.  For those who are going to go, there has to be adequate compensation to keep them quiet about the proprietary information they possess (and also not to go to, or become, a competitor).
  • Due Diligence;  Each side has to ensure that the other is representing itself accurately and that there are no post-merger risks that are not properly accounted or undisclosed.  Each of the parties must consider any regulatory issues that might be relevant to the deal.
  • Definitive Acquisition Agreement;  The formal terms and conditions of the deal, beyond the “cup of coffee”, must be decided and agreed.
  • Indemnifications and Warranties;  Defines what happens if things agreed are not as they were represented.  Who is responsible, under what circumstances, and to what extent.

But the fun does not stop after the deal is done.  The companies still have to make it work and this is certainly not a given.  The business-world is littered with the carcasses of failed Mergers & Acquisition activities.  In fact, the majority of acquisitions fail outright or fail to meet the expectations set at the closing of the deal – as opposed to the minority that meet or exceed.

One needs look no further than the acquisition in 1998 of Chrysler by Daimler-Benz.  Hailed as a “merger of equals” when it happened, it was obvious from the get-go that Daimler-Benz was the “more equal” – the acquirer – and Chrysler was definitely the acquired.  The running joke at the time was that the new company name was to be “Daimler-Chrysler”, but in German, the “Chrysler” is silent.  The eventuality was that Daimler realized the incompatibilities were insurmountable on its own and sold a majority of its stake in Chrysler to Cerberus Capital Management (eventually, Daimler would write-off its remaining investment stake).

Although it speaks only to the business and financial aspects of post-merger activity and ignores culture and the leveraging of synergies, an excellent “Post-Acquisition Handbook” by Baker-McKenzie can be found here for your reference.

Cost is what you pay, value is what you get.

In addition to the uniqueness and complexities involved in the transaction, there is no real motivation to cut costs.  The motivation lies in accelerating the process (and the pocketing of the rewards).  And if that costs more, so be it (so long as it does not negatively impact the rewards).  In the example of Facebook and Instagram for instance, the $1-Billion became $715-Million by the time the deal was done because of the drop in the price of Facebook shares (which were the bulk of the payment of the acquisition price).

The “bottom-line” – consider if you will:  You are told you are going to get $1m (usually more like $50m+) at the end of a process.  And you have in yourself the power to accelerate that process at considerable cost, but not coming out of your $1m.  Remembering that time is the enemy in these deals, would you spend other people’s money to get yours?

So where do the opportunities for improvement exist?  And, perhaps more importantly, where in the business are they likely to actually occur and have the largest impact?

I believe we can all agree, at this point, that what is important to Mergers & Acquisitions, what is “value in the eyes of the customer”, is velocity of throughput – and not cost.  So any improvement in the processes would be measured in terms of increasing the speed of delivery with any subsequent increase in cost being (willingly) borne by one or both of the parties.  But considering that the deals are “one-offs”, that standards beyond “checklists” do not really exist, and the security requirements of the information being passed between the parties (and not leaking out beyond those directly involved); one can reasonably expect the scope of improvements to be incremental and not transformational.

So that leaves the emphasis of applying Continuous Improvement efforts for banks and financial institutions, including the leveraging of the tools and methodologies of Lean and Six-Sigma, in the activities surrounding “personal banking” and other high-volume activities.

Consider, if you will, the cost of money (the “raw materials” of finance and banking).  The Federal Reserve Bank’s Funds Rate is currently 0.25% – has been for some time and is projected to continue to be such for some time into the future.  In addition, the average interest paid on personal savings accounts and “Certificates of Deposit” (other sources of “raw material”) are in the neighborhood of 1.00%.

Then consider the interest rates charged for revenue-generating transactions; a new car loan can be obtained for between 3.00% and 4.00%, and home loans for 3.10% (15-Year Fixed) or 4.00% (30-Year Fixed).  A “profit margin” of 2% to 3% on deployed capital is thread-bare (especially considering the indirect servicing burdens of bad-debt, infrastructure, and compliance).  In fact, the only “shining light” for banks is in the margins realized on the interest charged on unsecured personal credit (credit cards), which can be in excess of 21%.

But there is a magnitude in volume of these types of transactions, and they all follow the same process (with very, if any, exceptions).  Thus leveraging the benefits of economies of scale and lending themselves to automation (eliminating labor costs) result in considerable benefit to the bank and (most of the time) to the customer as well.

There is “on-line banking”, which is gradually replacing the writing of checks or a visit to the bank (which has already all but disappeared in Europe).  Almost every vendor takes credit-cards or debit-cards, and there are Automated Teller Machines (ATM’s) almost everywhere a person might go (except, based on experience, certain islands or ports in Greece – so stock-up on cash if you intend to go there).

And if a customer has questions or a problem, the banks have implemented increasingly sophisticated “telephony trees”, where an automated system answers the call and the caller is prompted with a series of questions intended to guide the caller to the answers they seek.  Some more robust trees will also provide computer-generated answers to some routine questions such as; account balance, last charges, next payment date and amount due, etc…

Recently, Citibank changed its credit-card fraud detection system (I know, since I have one).  If a charge is suspected of being fraudulent, I get an SMS on my mobile detailing the charge and asking me to return a “0” if the charge is valid and a “1” if it is otherwise.  There is no credit-card number (or part) that is transmitted.  Real-time, secure – saves everyone time and money.

There has been an enormous amount of transformation in the banking industry in the past 20 years.  Some improvements have reduced the costs to deliver financial services while simultaneously increasing the velocity of providing the services and their accuracy; such as leveraging the technologies related to the internet and telephony.  And some of these same improvements have led to their being exploited for nefarious activities and a lessening of ability to engage should a need arise that is outside the system.

The challenge to the future will be:  How much non-value-add-costs will banks pursue to eliminate?  How much accurate and secure acceleration will customers want (but still have the ability for a human to engage when the situation is “outside operational parameters”)?  And how much of all of this are governments willing to allow?

By Joseph F Paris Jr

Photo of XONITEK's Joseph Paris

Paris is the Founder and Chairman of the XONITEK Group of Companies; an international management consultancy firm specializing in all disciplines related to Operational Excellence, the continuous and deliberate improvement of company performance AND the circumstances of those who work there – to pursue “Operational Excellence by Design” and not by coincidence. 

He is also the Founder of the Operational Excellence Society, with hundreds of members and several Chapters located around the world, as well as the Owner of the Operational Excellence Group on Linked-In, with over 40,000 members.

Connect with him on LinkedIn

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