The March 5 edition of the American Banker reported on a study of community bank spending on technology. While nearly all respondents reported they believe technology is necessary to stay competitive, only 7% said they will spend more than $250,000 on new technology. Should the difference between belief and behavior be of concern? Not necessarily.

Wharton's research on technology spending in retail banking systems suggests that most banks are not getting what they pay for with their investments in technology. In fact, there is a significant gap between the functionality they buy and what users believe they have.

Although bank technology spending is at record levels, much of the spending may be wasted. Neither research nor experience suggests that spending more on technology in turn leads to a better-functioning franchise. In fact, Wharton's research shows that small banks may be better off not spending on technology if the capabilities cannot be used to create perceived and real value for customers, to enhance market position, or to strengthen market penetration and revenues from customer households.

Smaller banks have unique challenges in designing technology strategies. Access to powerful technological solutions is available to banks of virtually any size, and technology is cheaper. The art and science of technology investment, however, require close alignment of strategy, expected volume, process design, and human resource practices. In our sample of smaller banks, those with high technology investment and functionality were not necessarily more efficient. Rather, banks with low functionality evenly matched to sales levels and customer expectations were more efficient than banks that spend more but capture a smaller share of accounts.

How do smart bankers make the right choices for their technology budget?

First, they start with the bank's strategy and objectives for differentiation. In short, how does the bank create brand value and quality in its markets? Positioning choices should drive the operating and performance challenges technology must address.

If Bank A's strategy is to deliver low-cost, meat-and-potatoes products with high personal service, technology investments should center on basic operating efficiency - doing it right every time and at a low cost. Bank B intends to position itself as "high value-added" in terms of product design, delivery flexibility, and financial information. Technology must provide product development flexibility, individualized relationship packaging and pricing options, and board access to customer information from the bank's various applications systems.

Different strategies require very different technology choices. The point is, without a well-defined brand differentiation plan, technology spending leads to greater expense, not franchise enhancement. Banks should choose not to spend on technology rather than waste scarce resources on functionality of transitory value.

The second challenge is the trade-off between efficient processes and differentiating product design and delivery. Few banks can afford to endow every product with the same level of value-added features. Segmentation priorities should help technology decisions. Services that may not build brand value but are necessary to compete should be delivered at the lowest possible cost and with well-defined quality expectations. Added-value features should be reserved for the products and delivery options that clearly distinguish the bank from its competitors.

Once product and delivery choices are defined, sales and service processes can be mapped and fitted to the bank's "strategic templates" for efficiency and value-added requirements. Process maps and strategic preferences become the basis for the bank's technology architecture and platform specifications. Once the specifications are defined, the bank must address classic "make or buy" decisions regarding the technology itself.

Next week: Should community banks "make or buy" technology?

Ms. McClave is managing director of the Wharton Financial Institutions Center at the University of Pennsylvania.

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