First of two parts

Wells Fargo was in an enviable position in early 2011. It had weathered the financial crisis better than most big banks; following its bargain-bin purchase of Wachovia, Wells was the nation's second-largest bank by market value.

In his annual shareholder letter that year, CEO John Stumpf boasted that the firm was coming off its second straight year of record profits.

He also heralded the bank's success in boosting its fabled cross-sell ratio, a measure of its sales to existing customers. Households that banked at Wells Fargo now had an average of 5.7 products with the company, up from 5.47 a year earlier. Stumpf argued that the firm's ability to cross-sell effectively represented a key edge over other banks.

"The bad news is it's hard to do," Stumpf wrote, referring to cross-selling. "The good news is it's hard to do, because once you build it, it's a competitive advantage that can't be copied."

This was a nimble turn of phrase, but it was not one that Stumpf had coined. Instead, it tracked almost word for word with a quote 10 years earlier by Stumpf's predecessor.

"The bad news is that this is hard to do," then-CEO Richard Kovacevich said in 2001, responding to an interviewer's question about cross-selling. "The good news is that this is hard to do."

By the time Kovacevich retired, he'd become an industry legend, in part because of his unflinching focus on sales to existing customers. When his hand-picked successor borrowed his words, it showed what a large shadow Kovacevich still cast over the company.

Today, Wells Fargo is enmeshed in a reputational crisis, following the discovery that thousands of employees opened as many as two million unauthorized customer accounts. What had been seen as a key strength at Wells Fargo — its proactive sales culture — has suddenly become a major weakness.

The scandal's central figure has been Stumpf, a mild-mannered Minnesota native who had few good answers during two contentious congressional hearings and later resigned.

But the individual most responsible for shaping the company's sales culture is Kovacevich, who took the helm in 1998 following the merger between Wells and Norwest, where he previously served as CEO.

It would not be fair to blame Kovacevich for the scandal — he retired as CEO nearly a decade ago. But a thorough understanding of what happened at Wells Fargo does require a close look back at his tenure as CEO.

Kovacevich was relentless in his pursuit of additional sales to existing customers. The sales targets he established were ambitious and perhaps unrealistic. He sent mixed messages about what should be the top priorities of consumer-facing employees. And his contention that rising sales volumes showed the company was doing right by its customers would be echoed by the next generation of leadership at Wells Fargo, even as evidence of widespread sales abuses mounted.

This article is based on interviews with numerous former Wells Fargo executives, in addition to a variety of documents that have long been part of the public record but merit reevaluation in light of the scandal at Wells. Kovacevich declined to be interviewed.

"You could see the fire burning in his eyes"

Wells Fargo, which was founded during the California Gold Rush of the 1850s, had seen better days by the late 1990s.

Just a few years earlier, a sale of the fabled bank would have been unthinkable. But a 1996 hostile takeover of First Interstate Bancorp, which owned banks in Washington, Oregon, Idaho, Utah, Nevada, Colorado and Montana, had not gone well.

Wells paid a high purchase price, and the deal included generous severance packages for senior managers at First Interstate. Hundreds of them left the combined company, and many customers also started looking for a new bank.

"They literally lost half of their business in states like Washington, Oregon, Idaho, Colorado and Utah," John Nelson, an executive who would later run the Colorado branches, told the Denver Post in 2000.

By 1998, the industry was in the midst of a mass wave of consolidation and Wells was seen as vulnerable.

In April, NationsBank and Bank of America announced they were merging to create the nation's first coast-to-coast bank, ratcheting up the pressure on other regionals to get bigger. Just two months later, Wells Fargo and Norwest struck a deal, and while it was billed as a merger of equals, there was little doubt that Norwest held the upper hand. Kovacevich became CEO of the combined company and his longtime deputy, Stumpf, would later become his successor. Meanwhile his counterpart at Wells Fargo, Paul Hazen, was gone less than three years after the merger closed.

Kovacevich was 54 years old when the merger was announced. A former college baseball pitcher, he had a toothy grin and graying temples. He also had ample charisma — and not just in comparison with stereotypically staid bankers.

During an earlier stint at Citibank, he'd dressed up in a New York Yankees uniform to give employees a pep talk at the start of a sales drive. Later in his career, he entertained bank staffers with his Mick Jagger impersonation.

Once the merger was complete, Kovacevich led a company that had $191 billion of assets, 2,860 branches across the West and the Midwest, and more than 90,000 employees. But the corporate culture at Wells East, which is what the old Norwest was initially called, immediately came into conflict with that of Wells West.

Wells West had been focused on cost-cutting, driven largely by automation. One former Norwest executive said in a recent interview that inside a branch in California, "There'd be more potted plants than there were bankers."

Norwest had taken the opposite approach. As Kovacevich described his philosophy during his tenure in Minneapolis, "The war we are in will be won on the field of revenue."

At Norwest, Kovacevich had pursued what was internally called the I-35 strategy, after the interstate highway that stretches from Duluth, Minn., to Laredo, Texas. Executives joked that if a town had two exits, Norwest would buy the local bank.

But what really set Norwest apart was its CEO's intense focus on sales — or more specifically, sales to current customers. Kovacevich knew that it cost a bank much less to sell an additional product to an existing customer than it did to sell the same product to a new one, and Norwest tried to figure out the best ways to act upon that insight.

Kovacevich was nicknamed "King of the Cross-Sell," and he frequently held forth about the merits of his sales strategy.

"It was all he wanted to talk about," said Devon Kinkead, a bank marketing consultant who recalled a meeting with Kovacevich. "You could see the fire burning in his eyes."

Kovacevich declined to respond to various comments made by some of his former colleagues. But in an email, he said the following about his tenure at the bank: "I believe almost everything, but not all, you have been told here is incorrect...or at a minimum conveys the wrong impression."

The merger was sold to Wall Street partly on the promise that Wells East would raise the cross-sell ratio at Wells West. But the reality was different, according to a former Wells West executive.

"It was pretty dramatically different, believe me," this executive said of the cultural divide.

The two companies used different methods for calculating their cross-selling ratios, the former executive said. Once the firms were integrated, "It became clear that Wells Fargo's cross-sell ratio was actually higher than Norwest's, if you counted products the same way," he said.

The former executive characterized that anecdote as an example of how Norwest's culture emphasized form over substance.

By 1999, the amount of profit that each Wells Fargo salesperson generated daily was being tracked in California, as the company sought to build a stronger sales orientation in the nation's largest state.

"Letting an employee know how much in incremental profits he or she generated for the company is the biggest driver of increasing cross-sell," one Wells executive said at the time.

The new Wells Fargo retained the iconic stagecoach branding, and the company's headquarters stayed in San Francisco. But Norwest's culture won out.

'Going for Gr-eight'

Kovacevich had two main audiences for his cross-selling mantra — investors and employees — and he understood how to speak to both groups.

First, he needed to convince investors that Wells Fargo was better than the rest of the banking industry at cross-selling, so that they would be willing to pay a premium for the company's stock.

Wall Street was initially skeptical. After all, the banking industry had never been known for its sales prowess. Inside of banks, different business lines were often run in separate siloes. Many old-school bankers did not see themselves as salespeople.

"I never heard of a retailer who didn't want customers coming to their store," Kovacevich told the New York Times in 1993. "Yet you often hear bankers complain about people who waste their time, ask too many questions and get the carpet dirty."

But by the mid-1990s, the industry was starting to change. Cross-selling was the new buzzword, and Kovacevich was its loudest champion. "He was thought of as a leader," said Darryl Demos, an executive vice president at Novantas.

Over time Kovacevich's message — we're different from other banks - gained traction on Wall Street.

Parts of the CEO's pitch had a linguistic gloss, like his insistence on referring to branches as "stores." But his argument also had a quantifiable aspect in the company's vaunted cross-selling ratio.

In retrospect, Wells Fargo's cross-selling ratio had a couple of glaring problems. The ratio did not account for a product's profitability; sales of money-losing products were counted the same as lucrative sales. In addition, exactly how the metric was calculated was opaque, which made it difficult to compare Wells' ratio with those of other banks.

"I don't know why they touted it," said one former Wells Fargo executive.

This source said that the company used to count a checking account with a debit card, overdraft protection, direct deposit, and an automatic bill payment as five separate sales.

"I wouldn't call that five sales. I'd call it one sale," the former executive said.

A Wells Fargo spokesman declined to comment on the specific products that the company used to include in the cross-sell ratio, but said that the metric has consistently been focused on products that generate revenue or have the potential to do so.

One benefit of the cross-sell ratio was that it was easy for investors to understand. The number climbed throughout Kovacevich's tenure at Wells Fargo.

In 1998 Wells reported 3.2 products per retail banking household. By 2001, the number had risen to 3.8 products. By 2006, it was 5.2.

During a recent congressional hearing, Stumpf was lambasted for the jocular rationale behind the company's sales goal of eight products per household — "Eight rhymes with great." But it was actually during his predecessor's tenure that the company first cited the number eight as its goal. "Shooting for Six! Going for Gr-eight!" read one corporate document from 2006.

Kovacevich's emphasis on cross-selling was widely thought to be a key reason why the company's stock traded at a higher premium than other banks.

The second audience for Kovacevich's sales message was Wells Fargo's own employees; after all, he was relying on tens of thousands of bankers to do all of the selling.

It helped that Kovacevich had a genuine way with people. One former Norwest executive recalled talking to bank employees in numerous states after joining the company during the 1990s. Workers at all levels of the firm — even secretaries and janitors — gave a consistently positive message about the CEO. "He cared about all of his employees," this former executive said.

During multi-day conferences for employees who were identified as top performers, Kovacevich put on lighthearted performances that helped endear him to the rank and file. He once played one of the seven dwarfs — the dwarf whose last name was hard to pronounce.

"For four or five days you'd take an organization chart and flip it upside down," Leslie Biller, a longtime Kovacevich deputy, told American Banker in 2003. "You'd recognize employees, make them feel special — and they'd go home fanatics."

'A lost customer is lost revenue'

For all of Kovacevich's focus on cross-selling, he seems to have been aware of the perils of taking the strategy too far.

The pitfalls would not necessarily entail sales-motivated employees opening phony accounts. Rather, there was a fear inside the company that pushy salespeople might chase away good customers.

"We cannot provide average service and expect to achieve superior financial performance," Kovacevich wrote in the company's 2000 annual report. "A lost customer is lost revenue."

Wells Fargo faced a tricky calculus. On one hand, cross-selling tended to be quite profitable. On the other hand, overly aggressive salespeople were likely to turn people off.

That tension is inherent in the business model of any sales-oriented company. But inside of Wells, the consistent message was that sales and service go hand in hand.

To make that idea credible, Wells employees needed to understand what was happening in its customers' lives. So the company set goals for the number of times employees were to speak with customers, according to one former Kovacevich deputy, who left the company in the early 2000s. During those conversations, the employees asked questions related to the customers' financial needs.

"Ideally, only after you get the answer to all these questions will you be ready to offer a set of recommendations," this former executive said. "I can't tell you that it happened 100% of the time, but that was the approach."

This philosophy helps to explain some of the company's internal terminology. Cross-selling was sometimes described as "needs-based selling." Employees spoke about "solutions," rather than "sales."

"Each banker needed to come up with a minimum of eight solutions a day," Yesenia Guitron, a former branch worker in St. Helena, Calif., told the Napa Valley Register in October.

The implication of that language is that when Wells Fargo sold a product, it was solving a problem in a customer's life. But it is not clear how often that theory tracked reality, even during the Kovacevich era.

In the early 2000s, the firm consistently lagged other banks in scores from the American Customer Satisfaction Index, which is based on thousands of consumer surveys.

The low scores preceded the Norwest merger, but they continued after the integration was completed. In 2003, Wells scored 68 in the customer satisfaction index, well below the banking industry average of 75.

Those subpar results would have come as no surprise to critics of the cross-selling strategy.

"Cross-selling is the epitome of a corporate-centered, self-centered approach to doing the business, not a client-centered approach," former Merrill Lynch President Herb Allison told American Banker prior to his death in 2013.

After the Norwest merger, Wells Fargo hired the Gallup Organization to conduct random surveys of customers when they transacted in branches, according to Jay Freeman, a former Wells executive. The survey was aimed at evaluating the quality of the customer experience, he said.

"Over time, these survey results were given significant weight in the incentive compensation strategy," Freeman said in an email. "Every team member in every branch had a stake in the outcome. By 2012, no amount of selling could offset a poor customer experience score in the branch incentive plan."

Still, when Kovacevich retired as the bank's CEO, Wells Fargo's customer satisfaction ratings had fallen even further behind the rest of the banking industry. In 2007, the San Francisco bank scored 69 in the American Customer Satisfaction Index, compared with an industry-wide score of 78.

'Vision and Values'

Before the fake account scandal surfaced, and even since then, Wells executives have often spoken admiringly about the company's "vision and values."

Carrie Tolstedt, who until recently ran the bank's retail banking division, was once quoted praising then-CEO Stumpf as "a master modeler of the 'vision and values.'"

Stumpf himself told Congress this fall: "Of course we've made mistakes. Not everybody lives up to our vision and values."

And Mary Mack, who succeeded Tolstedt as the head of community banking, said recently: "The sales practices issues identified in the settlement are unacceptable and were never consistent with the true vision and values of the company."

They were all referring to "The Vision and Values of Wells Fargo," a document that aims to describe the company's culture and is one of the enduring legacies of the Kovacevich era.

The pamphlet was first printed in 1993, when Kovacevich was at Norwest. Early editions were titled "Sharing the Vision, Living the Values." Over the years, the document took on a totemic quality inside the company.

The year before Kovacevich retired, Wells Fargo published the 2006 edition of "Vision and Values." Its cover featured a photo of the CEO in a jacket and a red tie, flanked by four younger colleagues. Everyone was smiling.

On page eight, the document stated: "If we do what's right for the customer, then it will be right for Wells Fargo. We focus not on products but on customer needs."

But then came a numerical goal that was, at the very least, in tension with what had come before: "We expect to sell at least one more product to every customer every year."

The 40-page booklet was full of these sorts of mixed messages.

On one hand, selling products that are not in customers' best long-term interests is contrary to the company's vision and values, the document stated. On the other hand, if the CEO had to choose only one goal for Wells Fargo, he said it would be double-digit revenue growth.

"When customers vote with their pocket books, we know we're doing something right," Kovacevich wrote, explaining why he saw double-digit revenue growth as the company's most important goal. "When customers rave about our service, they'll give us more of their business, increasing revenue. They'll refer new customers to us. They won't leave us. They'll stay with us forever."

Those sentiments would later be articulated by Wells Fargo's new leaders, as they insisted there was nothing wrong with the firm's sales culture.

Next: The torch is passed to John Stumpf and Carrie Tolstedt, and they push Wells Fargo's cross-selling strategy beyond the limits of effectiveness.

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