The latest fashion in management consulting is to portray the corporate future as either draconian cost restructuring or competitive extinction.

True, excess capacity and new, more intense forms of competition in banking increase the penalties of inefficiency. Excess costs probably are widespread, while "process reengineering" with new information technologies enables much higher efficiency levels.

Yet much of the supposed benefit of restructuring is likely to prove illusory. Financial analysts and other observers are justifiable skeptical of these programs. Cost reduction can be, and often is, misguided and excessive.

Cost reduction alone is not a strategic response to banking's new technological and market environment. It may actually distract from addressing critical strategic issues. Misdirection is inevitable without substantial progress in resolving those issues. Most restructuring programs, moreover, rely on misleading measures of corporate financial performance.

Beyond Benefits

Decision criteria incorporating those measures ultimately subvert the most fundamental of all corporate objectives -- promoting shareholder values. Worse, they encourage extending restructuring well beyond any possible benefits.

A test is whether restructuring reflects a viable strategy. In a vigorously competitive environment, promoting shareholder value must be the paramount strategic objective. The alternative is a hostile environment for capital, eroding capacity for survival.

A common presumption is that higher earnings from cost reductions increase shareholder values, presupposing the strategic legitimacy of earnings goals.

Actually, reliance on earnings criteria in banking systematically subverts shareholder objectives and long-term prospects.

Many executives and consultants miss this point, failing to understand the limitations of the accounting conventions underlying those earnings criteria. However convenient, conventional accounting measures are inappropriate for internal bank decision-making.

Faulty Decision Criteria

The priorities governing public accounting are inconsistent with providing information bearing directly on shareholder value. Relying on that information therefore cannot promote shareholder objectives. Accounting's chief objective is assuring reliability in public financial statements.

Financial reports should be unbiased, objective, and verifiable by other accountants. Next in priority is the consistency of information -- similar financial circumstances should imply similar financial results. Lowest in priority, and usually submerged by the others, is relevance to enterprise (shareholder) values.

The historical-cost convention, while promoting accounting reliability, has special implications in service businesses such as banking. It requires reporting investment in banking relationships -- the source of most bank premium value -- as current expense, excluding it from balance sheet recognition.

A consequence is widespread failure to apply investment criteria in decisions and strategies affecting banking relationships.

Lacking foundation in shareholder value objectives, management decisions and corporate strategies become misguided, haphazard, and riskier.

Incentives to Underinvest

Moreover, as relationship investment reduces reported earnings, incentives to underinvest in banking relationships are pervasive, particularly if earnings are weak. Earnings pressures often extend to cutting replacement investment, potentially forfeiting the future to "window-dress" the present.

Recognition that value ultimately arises from future cash flows is insufficient, as is also recognition of differences between earnings and net cash flows.

Earnings and cash flows do tend toward convergence in the long run, but that convergence does not mean that increasing near-term earnings promotes shareholder values.

As preoccupation with reported earnings distorts investment decisions and increases risks, impairment of shareholder values must result, reducing the levels at which any convergence occurs. Boosts to earnings, and any increases in stock prices that result, are often only transitory.

Strategic Failures

Viable strategies certainly do not involve betting corporate futures on perverse objectives. Yet, are bankers even addressing critical strategic issues? Major cost restructuring has dramatic appeal by appearing to confront the failure head-on.

It may actually "put the cart before the horse" by deferring or avoiding development of long-term strategies. To the dismay of the investment community and many bank customers, bankers often simply follow the lead of other bankers -- a pattern that easily becomes more circular than enlightening.

Cost restructuring only focuses on one aspect of the economic problem -- how to produce and deliver goods and services. It does not address the more strategic issues what and for whom. To what extent can bankers possibly determine how they will produce before determining what and for whom?

Banking's primary challenge is redefining, or "reinventing" itself. Its competitiveness has traditionally been tempered by inertia in banking relationships whose nexus is transaction deposits -- a service substantially insulated from nonbank sources of competition.

Homogeneity inhibits competitive initiatives -- responses by rivals quickly eliminate any advantages thus obtained. A weak competitive climate nurtures pervasive inefficiency and ineffectual decisions.

However, new and often unfamiliar sources and dimensions of competition, coupled with more demanding customers, threaten those traditional foundations.

Before determining strategic directions, bankers must come to grips with the transformation of their business from intermediation to services.

It requires a new focus on markets and customers. Consider just a few of the dimensions of strategic choice that threaten banking's traditional homogenity:

* "Full service" or specialization in services.

* "Commodity services" or customization of services.

* Broadly defined markets or customer specialization and targeting.

* Direct marketing or local sales representation

* Remote or local delivery of serices

* Outsourcing or internal production

Each dimension represents opportunities for banks to differentiate themselves from rivals. Differentiation invites competitive initiative and innovation.

This proliferation of strategic opportunities has only become possible with new information and communications technologies.

It is difficult to imagine how a bank can proceed very far in cutting costs before deciding where it can best position itself.

How should bankers develop strategies appropriate for their future? If they accept that proposition that their paramount responsibility is to promote shareholder value, an initial step is to adopt decision criteria that relate individual decisions to that objective.

Taking that step requires recognizing the underlying sources of value in banking.

As in other service businesses, an important component of that value consists of customer relationships. Customer relationships result from investment in their development. Product, pricing, and marketing decisions and strategies thus represent investment decisions to which capital budgeting principles apply.

Reconfiguring banking to the emerging financial environment will require substantial new investment in market research, information files, and above all else, in developing customer relationships.

An obvious cause for concern is that myopic preoccupation with costs and earnings deters and misdirects such investment. Many "costs" actually need realocation, and not cutting.

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