The repeal of Glass-Steagall ushered in a spate of questions about the imminence of bank-insurance company consolidations.

However, industry representatives on both sides of the fence seem reluctant to discuss formal merger.

With good reason. At present, acquisition of banks by insurance companies and vice versa are problematic, because the preconditions for success are absent. Given some major corporate refurbishments, potential acquirers in either industry can satisfy these preconditions. But having satisfied them, many will conclude that they can do what they want without acquiring.

Most mergers in the financial services industry destroy shareholder value. Even those that appear to create value in the short run may end up weakening or at least handicapping the institution in the longer run.

For example, questions are being raised about even some of the more publicized "successful" bank mergers as it becomes clear that the demands of merger integration have so consumed the energies of bank personnel that they have fallen behind in product generation or acquiring needed new skill sets.

One key requirement for merger success is synergy. The merged entity must end up being worth more than the parties to the merger would have been worth had they remained independent. In practice, this means that the merged entity must generate enough extra revenue or cost economies to offset the acquisition premium.

What is the potential for doing so?

Most financial-institution mergers have been cost-driven: The attempt has been to co-opt the revenue stream of the acquired institution and reproduce it at a lower cost. But the capacity to do this tends to be industry-specific.

For example, a bank can sometimes trim huge gobs of costs by eliminating the neighboring branches of a cross-town bank acquiree. But it has much less chance of doing so with a cross-town insurance acquiree, and vice versa.

Mergers of banks and insurance companies may conceivably yield some economies in operations and systems. But not many, since a number of technologies are dedicated to particular tasks and cannot be extended to dissimilar or cross-product applications without costly modifications.

The likelihood of appreciably increasing revenue is even more doubtful.

Why would the addition of a bank to an insurance company generate more revenue than the parties to the combination could have produced on their own? An obvious answer is by improving cross-sales.

But, on average, insurance companies are very poor at cross-selling. In fact, one large and representative insurer reports that its policyholders purchase an average of only 1.2 products - that is, little more than one policy per customer.

A number of banks boast somewhat higher ratios. Often, however, they would have done better by not making these sales, because they consist largely of deposit products that are especially high-cost in relation to revenues - for example, IRAs or short-term CDs. Thus while revenues go up, costs increase enough to render the sales insufficiently profitable.

If the two parties to prospective mergers cannot cross-sell well in isolation, is it likely that they will be able to do any better in combination?

Both parties are handicapped by their legacy status. They are product-oriented rather than customer-oriented. They have antediluvian basic distribution systems.

And they have problems using their customer data effectively. Both are short of people skilled in extracting patterns from available information. Even more important, they lack an institutional environment that stresses the key importance of this task and is pledged to use whatever resources are needed to nurture and expand it.

Perhaps most important, they lack key implementation skills in marketing. Bluntly put, they simply can't execute.

The handicapped status of the two intermediaries is not lost on the marketplace, which typically pays much less for a dollar of their earnings than it does for an equivalent dollar of, say, packaged goods, drug, or hotel earnings.

The chief reason is profit sustainability. The marketplace, being forward-looking, fears that bank and insurer legacy problems will make it difficult to stanch the exodus of customers, much less secure a larger share of their wallets. It has fewer qualms about industries less encumbered by caretaker traditions.

To change the minds of investors, banks and insurers must bend every organizational resource toward using information about the customer (in legacy databases) and, more importantly, information from the customer (as gleaned from imaginative use of the Web) to create and efficiently provide services that the customer values and that in turn will augment the value of the service provider.

Traditionally, both intermediary types have used whatever information resources they had to bombard the customer with a group of unorganized product offerings from disparate parts by the organization, each of which had its own proverbial ax to grind. But what most customers require (and will value) is a dispassionate and comprehensive analysis of their life situations and how these situations should translate into a set of relevant financial products and services.

In the classic taxonomy made famous by the old Citibank, customers need transactions, credit, investments, insurance - and financial planning to determine the resources to be assigned to each of the four product categories at any given stage of life. The financial institution that can integrate and continuously refine this five-part package will build the kind of customer loyalty that is eventually productive of high profits.

Thus far, however, no institution, be it bank or insurer, seems capable of meeting these requirements, though Citigroup may come closest.

The institutional type that succeeds in providing what is needed will enjoy a much higher market multiple than is now obtainable. It will then have the currency with which to merge profitably. But somewhat paradoxically, the fact that it can buy will, in all likelihood, make it unnecessary to do so.

Such a position signifies that the institution has become a respected financial problem solver, objectively serving the needs of selected customer segments. The profit in this relationship stems from the quality of the solution; it does not stem from the products that help to implement the solution. These are mere commodities, ubiquitously available in any marketplace around the world.

Thus the solution provider should have no particular need to have an ownership interest in the product provider, and will probably consider merger only if a property becomes available at the equivalent of a distress price.

It will, of course, always be willing to consider the purchase of the customer list of a less advanced institution. However, given the new technology, it is very possible that a good solution provider - by definition a savvy user of the Internet - can amass these customers via Web encounters, either initiated by the customers or through the use of carefully crafted, proactive e-mails.

Merging to acquire customer lists may shortly become a thing of the past, or a practice that will re-emerge only if acquisition premiums tumble drastically from today's elevated levels.

Assuming more reasonable premium levels, companies that toy with the notion of acquiring will need to run through the following prescriptive checklist:

  • What, strategically, do we expect to derive from the proposed merger? Increased revenues? Bigger share of customers' wallets? More varied menu of products? More distribution outlets? Internet leadership? Reduced cost per unit sold?
  • How exactly will the proposed merger contribute to these strategic objectives?
  • Are there alternative, less costly ways to achieve these objectives? If there aren't, do we have the execution and integration capabilities needed to merge successfully?
  • Will the merger create enough "hidden" costs (diversion of time from customer contact, new product introduction, and employee training and development) to undermine its hoped-for benefits?

Companies that can answer these questions thoroughly and objectively stand the best chance of coming to rational decisions and thereby avoiding potential disaster. Let us never forget that in financial services a high proportion of those who merge inadvisedly are themselves merged out of existence shortly thereafter.


Mr. Kocjan and Mr. LaPorta are principals of Deloitte Consulting, in New York.

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