With high-speed change dominating the worlds of technology and financial services, and with interstate banking now a reality, many bank CEOs and directors are nervously asking the question, "Will I be able to stay independent through the next wave of industry restructuring?"

The question that community bankers should be asking is, "Based on shareholder and customer expectations, do you deserve to stay independent?" Although answering this question requires a thorough strategic and financial analysis of your bank, we recommend two important litmus tests that will gauge a bank's overall ability to remain independent. These tests center around the following questions:

Are your resources allocated appropriately to customer-driven functions?

Are you using your independence effectively to mitigate an acquirer's premium for consolidation?

Allocate Costs Appropriately.

Recent analyses of bank acquisitions estimate the realized cost savings at levels between 15% and 30%. In many cases, this number runs as high as 50%. With ample overcapacity in the banking and thrift industries, acquirers are finding opportunities to cut costs in redundant areas such as operations, MIS, loan servicing, human resources, marketing, accounting, audit, and, most assuredly, senior management.

How can these acquirers eliminate these costs so easily? Simply because the traditional model for banking no longer makes economic sense. To understand this issue, we often ask bankers to create a pie chart that summarizes where total expenses and/or fixed salary dollars are allocated in their organizations. Many institutions are startled to discover that operations and administrative functions consume one-third to one-half of a bank's total resources. For an acquirer with idle capacity, most of this excess cost can be lopped off immediately.

Now think how these cost dynamics translate into takeover premium. If a large bank can take over a midsize bank earning a 50 basis point ROA and can quickly cut the bank's 4% overhead ratio in half, the acquiring bank's after-tax return would jump to 1.6% on the franchise. It is these type of dynamics that are driving premiums for healthy banks in the range of 2.0 to 2.5 times book value or greater. Without strong earnings growth on the horizon, it is difficult for even the most loyal board of directors to turn down these lucrative offers.

A small midsize bank should also compare its current cost structure to what it would look like if their bank were to be acquired and consolidated into a larger bank. Often times, the difference is dramatic. While a bank would be very hard pressed to make its cost structure as lean as if it were part of a larger institution, these "post-acquisition" levels can serve as valuable benchmarks for all banks to target.

How can a small to midsize bank possibly organize itself to be more efficient than the scale-driven larger banks? The answer lies in the new technologies, business processes, and organizational cultures that are emerging in our information based economy. To take advantage of these new strategies, banks will need to:

* Build an information technology infrastructure that allows the bank to share information across the organization and tap into external products and services that compliment the bank's core business activities. This will allow small banks to offer a broad array of financial products and services without having to produce and service the products in-house.

* Increase the technical knowledge of all employees. The cost efficiencies required to stay independent will require not only technology, but skilled "power users" behind each workstation.

* Flatten the organization, positioning the majority of employees in direct customer contact roles. The community bank of the future will have very little need for middle managers or administrative staff. In fact, the majority of job titles within the organization should be either "relationship manager" or "customer service representative." Most individuals within the bank will have a broad knowledge of all bank products and operations.

Like the minimills that revolutionized the steel industry or the microbrewers that are rapidly expanding market share, community banks have the opportunity to be unique, customer-driven alternatives to the scale- driven national banks. But this differentiation will not be ensured by merely being small and friendly. It will require each community bank to select a viable strategic niche and to improve the delivery of products and services with new information technologies. Community banks that survive will become offensive versus defensive in their technology strategies. New PC, client/server, and data base technologies will give small banks the opportunity to assume this role.

Leverage Independence.

Certainly, a community bank's ability to remain independent will not hinge on cost efficiencies alone. In fact, unfettered cost cutting by the large banks will present community banks with one of their greatest opportunities to steal market share.

However, a community bank's autonomy must translate into real differences in the eyes of the customer. From a strategy perspective, community banks need to ask themselves:

* Are we more responsive to and involved with our local communities than our larger competitors?

* Are we building customer loyalty by being more responsive in the way we do business, or do we basically emulate our larger competitors?

* Are we using our knowledge of the local marketplace to underwrite risk better than our larger competitors?

* Have we chosen lending niches that require local market knowledge and specialized skills, or are we fighting a losing battle in commodity businesses?

* Are we taking advantage of the flexibility we have to react quickly to new customer, geographic, and product opportunities?

* Are we rapidly adapting new technologies in our organization that our competitors are unable to implement as quickly with their large scale operations?

Unless community banks can redefine their cost structures and actively leverage their independence to differentiate themselves competitively, the premium for selling the organization may prove too tempting for a bank CEO or board of directors. Management can only make a viable case for continued independence to their directors if they have a clear strategic direction, a keen focus on cost efficiencies and service quality through technology, and a strong commitment to earnings growth that will outweigh the attractiveness of the cash in the hand today.

Marilyn R. Seyman is president and CEO of M ONE Inc., Phoenix, and Steven P. Williams is managing director.

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