The fundamental changes in the structure of the financial services industry affect the profitability dynamics of financial institutions. New paradigms for profitability have emerged:

Low-cost producers. Nationwide megabanks are currently forming, most recently with the BankAmerica/Continental merger, creating a new class of low-cost producers. Within these companies, and other niche players, cost is king.

Being a low-cost producer and passing part of the savings along to the customer is the competitive advantage on which the low-cost producers are trading.

Their profitability is cost-driven, and supports focus on volume-sensitive businesses with a high fixed-cost component, such as investment management, domestic and global custody, mutual funds, credit card processing, securitization, data processing, and operational processes, including check processing.

Where service is king. These are the super community banks and market niche players that use relationship orientation and service superiority as the competitive advantage. In super community banks, profitability is revenue-driven, not cost-driven.

While there are cost implications to the strategy and strategic cost reduction is an essential component to an effective competitive posture, it is revenue enhancement that makes super community banks successful.

They have a strong franchise which they leverage with a broad product line and high cross-selling and customer retention ratios.

Community banks. This third emerging segment has been there all along. It includes not only commercial banks, but also many thrifts which selected community banking as their transition strategy into the next century.

The business of community banking is margin-driven. Both asset mix and the liability mix are key to the success of community banks, since they cannot generate economies of scale on their own, and their profitability is so heavily reliant on margin management rather than fee income.

At the same time, community banks still need to manage their efficiency ratios and internal cost structure to maintain their competitive position.

While too small to produce economies of scale, community banks can piggy-back on others' economies by renting data processing, trust services, internal and external audit, mutual funds, etc.

Outsourcing these services or renting them from someone else permits community banks to access economies of scale which are not associated with their specific asset size and, therefore, make size transparent.

Low-cost producers, for which sustainable cost savings are the key to success, often use downsizing and organizational flattening as important tools for cost management. They continuously watch their cost performance in an effort to lower per unit costs.

Companies such as Nations-Bank, Wells Fargo and Mellon are examples of low-cost producers which pay extraordinary attention to every element of their cost structure.

Super community banks, on the other hand, cannot afford to reduce service levels in the interest of cost efficiencies. They must grapple with tradeoffs between elements such as standardization and customization, centralization and decentralization, or the slash-and-burn organization relative to the humane company.

Since employee retention is important to their success, they are hard-pressed to maximize head-count efficiency with layoffs without hurting the organization spirit.

Therefore, cost reduction in super community banks is better achieved through reengineering, using distribution concepts such as the hub-and-spoke approach, and applying technology as a cost-reduction tool rather than through harsher measures.

In addition, super community banks emphasize revenue-driven profitability by expanding fee income and their product line and by focusing on relationship profitability, thereby reducing the need for extreme cost management measures.

Creative Growth

Community banks too small to create their own economies of scale can achieve it through creative growth in order to remain competitive in the restructuring industry.

Vendor partnerships and cooperatives, buying consortia, and joint ventures among community banks are among the methods which make the individual bank size transparent and permit even small institutions to acess scale-sensitive businesses and technology.

Candidates for cooperatives and joint ventures range from compliance and CRA-related activities to securitization, loan servicing, data processing, and loan participation syndicates.

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