Something extraordinary - perhaps revolutionary - is happening in the financial industry.
In the past 12 months, accounts of megamergers and acquisitions have dominated the news. But the defining moment was the April announcement of the colossal Citicorp-Travelers deal. Completed last month, the merger formed a single global entity to sell consumers not only banking services but also insurance and investment services.
The strategy of creating a financial services supermarket to offer one- stop shopping is not new.
Throughout the 1990s the industry has undergone a steady transformation, driven by market liberalization and advances in technology. Many European companies have embraced the concept of bancassurance - combining bank, insurance, and investment banking operations under a single roof.
But Citigroup's integrated model, with its massive size and global scale, clearly signals a new era in retail financial services. What's more, it provides a glimpse of the future of global finance.
What the Citigroup model shows is the convergence of financial services, that is, the deterioration of the arbitrary distinctions separating different types of financial products and services-banking, securities, and insurance-as well as the providers of these once-discrete products and services.
Driving the convergence phenomenon are a number of powerful market forces: The changing demographic mix of retail financial services consumers today; new competition for retail deposits; relaxed regulatory restrictions; market globalization; and the increasing use of alternative distribution channels such as the Internet and toll-free phone numbers.
But these drivers are not the bottom-line reason for convergence.
The impetus behind financial industry convergence, and behind the new integrated model, is the pressure to find growth through new markets and revenue streams. And this is especially true for traditional banking companies, which perhaps are more affected by convergence-operationally, structurally, and technologically-than insurance companies and securities firms are.
Banking has changed irrevocably. In the past few decades, banks' overall share of available deposits has dropped dramatically, as rate-sensitive consumers opt to invest their savings in mutual funds and annuities run by investment houses and insurance firms.
For banks, moving to the new integrated model provides a way to keep funds from walking out the door. And the model is built on a diversified portfolio, which improves a bank's risk management position.
But as a strategy, the integrated model is more offensive than defensive.
The aim is to accelerate growth by cross-selling, in effect building a single retail franchise that offers every conceivable financial product: traditional banking, credit, transaction processing, foreign exchange, insurance, annuity, mutual funds, and so on. The idea is to gain the maximum amount of "wallet share" from every customer, especially the profitable ones.
For companies employing the convergence strategy, the central issue is the degree to which operations are integrated. And the degree of integration hinges on two critical areas: integration of the customer interface and integration of the systems infrastructure.
The success of a converged company depends in large measure on how well it structures, operates, and integrates its various business and product lines-in short, on how much it behaves in an integrated fashion.
The operational model of a converged player will depend upon its strategic intent and desired market position. Four core operational models demonstrate the various levels at which companies function in an integrated manner.
Under this model, the company supplements its core business line by obtaining products and services from third-party providers and uses its own distribution channel to deliver these products and services.
This model allows the company to offer its retail customers a full portfolio of services while leveraging its own distribution systems to keep control of the all-important customer interface.
The company is thereby able to concentrate on making the most-effective use of its distribution channel and on maintaining strong relationships with its customers.
As the least-integrated operational model, the distribution channel model represents the low-risk approach to entering new markets and capturing additional wallet share of customers. This is because the company does not own the new services and thus avoids the necessary investment in proprietary business lines.
Experience has taught us that lack of ownership can prove to be a double-edged sword. While the company avoids the investment, it must rely on the third party's integrity and dedication to the goals. Additionally, lack of ownership may prohibit the customization of products or services to best meet the needs of customers.
This model assumes a more formal relationship between the company and its various third-party providers.
While the same benefits can be derived from this model as from the distribution channel model, the company can to a large degree solve the problems inherent to a lack of product and service ownership by means of a formalized exclusive partnership.
In this model, greater integration allows for more sharing of customer information and intellectual capital. Products and services can be co- developed and customized.
Of course, the disadvantages of the integrated alliance model are the same as those attending any alliance or partnership. Potential conflicts of interest concerning strategy and accountability are inevitable.
The success of the model relies upon the ability of all parties to integrate their market strategies and successfully work together for the benefit of the entire partnership.
Unlike the previous two examples, in the holding company model the financial institution owns all business and product lines.
As in any of today's financial services conglomerates, individual subsidiaries in the holding company model operate in a vacuum, concentrating on their particular lines of business and serving their traditional market segments, without integration with their fellow subsidiaries. Each has its own profit and loss statement and is responsible for its own systems.
Because the holding company model is highly diversified, with a hand in every sector of the financial services market, it offers a significant advantage by limiting risk.
There are inherent difficulties, however. The lack of integration, from both a customer service and systems perspective, does not encourage a portfolio-management approach. Also, the corporation may ultimately suffer from trying to be all things to all people.
Additionally, because each subsidiary is responsible for its systems and product development, none benefits from any enterprisewide core competencies.
In essence, the holding company model lacks synergy, and the limited integration of each subsidiary means that the potential cost savings from leveraging economies of scale and centralizing core functions are lost.
Perhaps more critical is the weak portfolio-management ability. Even the model's key advantage-that each subsidiary is a product or service specialist-is diminished by the limited portfolio approach And more important, the enterprise suffers from the lack of a single point of contact for customers.
In the highly converged model, the company owns divisions that operate under the traditional organizational structure. However, these divisions' operations and infrastructure are integrated, thus enabling a single market-facing brand to offer customers a full portfolio of financial products and services.
The highly converged model is the ideal in the converged financial industry. Different business lines are integrated, allowing the company to fully realize the competitive advantages of enterprise synergy and portfolio management. Instead of multiple stand-alone systems, the infrastructure is fully integrated, driven by a unified customer data base that provides service representatives with immediate access to a customer's complete relationship with the company.
The challenge faced by companies building the highly converged model is the complexity of achieving and managing total integration. Bringing together disparate systems is an exceedingly difficult task, and the risk of service disruption during system migrations is ever-present. Building a unified customer data base takes time and constant vigilance.
Moreover, while the idea of cross-selling is brilliant in its simplicity, its execution is neither simple nor easy. Employees skilled in a single competency or specialty will need to be retrained to cross-sell services smartly, and sales incentives will need to be put in place. Retail banking generalists will soon be in great demand, and they too will demand to be appropriately compensated for their skills. Add to this the inevitable clash of egos, personalities, and corporate cultures, and the difficulties inherent in the highly converged model increase exponentially.
Of course, the four core operational models are just that: models. As companies redefine themselves and formulate strategies to meet the demands of a converged marketplace, we will likely see the advent of hybrid companies, reflecting varying degrees of product and service ownership, organizational and technical integration, and convergence behavior.
But the most successful financial services firms, and the leaders of the global commerce in the future, will be those that move closest to the integrated business model.