It is a much-ballyhooed principle among managers of U.S. financial institutions - particularly merging financial institutions - that consolidation can translate into substantial cost savings.

Their premise is that, as redundant operations and data processing systems are eliminated and staffing levels reduced, the savings go right to the bottom line.

When two banks merge, the potential for significant cost reductions is greater still, largely through an infusion of technology for unifying their operations to serve a broader market.

Or so the theory goes.

Unimpressive Record

Today, the landscape is littered with banks in the process of combining operations. And yet - if we exempt for the moment the merging banks that are surrendering their technology resources wholesale to third-party outsourcers - the industry's record on upgrading and consolidating critical technologies is less than impressive.

As I see it, much of the U.S. banking community is missing the boat by not pushing consolidation to its full operational potential. Consolidation is the ideal platform for retooling infrastructures of merging banks to meet the changing markets of the '90s.

Computer technology, applied both to front-line information management functions and back-office operations, is the primary engine behind advances in banking productivity and customer service standards.

By making reengineering the keystone in any consolidation initiative, bankers can ensure that their core systems - those based both on technology and on human resources - contribute a full share to the success of the business.

Whether bank executives acknowledge it or not, information technology has become a vital tool for achieving strategic advantages in an increasingly competitive industry.

Defensive Consolidations

The last few years have seen the merger and acquisition impulse, in the '80s a springboard to franchise expansion and revenue growth, become a largely defensive strategy.

Today, proposed mergers are most often touted as means to reduce operating expenses by eliminating redundant operations and resources, generally in marketing, back-office, branch, and information technology functions.

Merger proponents point to such measures as closing branches, back offices, and data centers, as well as adjusting staffing levels at acquired banks, as the direct and obvious routes to lower costs.

They are right. Carefully managed consolidations can significantly reduce staff-related expenses, most often through impressive reductions in data processing and back-office operations.

In successive acquisitions, for example, Fleet Financial Group has cut costs more than 80% in data processing functions. For back-office operations like check processing, which are transaction based and repetitive, we generally achieve reductions in the 35% to 45% range.

Halving Operating Costs

Our current consolidation effort, focusing on the newly acquired Bank of New England, will halve annual expenses for bank operations and data processing. The reduction from $180 million to $90 million will have taken 18 months when it is completed this December.

Fleet's numbers accurately represent the financial returns that consolidation can earn for the bank willing to carry it out comprehensively.

What's more, as other banks that have consolidated effectively know well, the advantages are not merely fiscal. In fact, the scope of the financial return depends directly on the degree to which consolidation adopts appropriate technologies.

For example, reducing the number of operations centers at a geographically dispersed bank makes sense today only because of recent refinements in technologies for high - volume data transmission across extensive networks.

Similarly, developments in optical imaging and automated teller machine design have made it possible to improve service and add products without jeopardizing a bank's business imperative to handle customer and interbank transactions with maximum speed.

My point is that reengineering in the context of consolidation not only eliminates redundancies but also should innovate. The results are improved service, better banking products, and a strengthened competitive position - and lower costs to boot.

Four Obstacles

Except for a few leading examples, however, little evidence of successful, in-house, technology-driven consolidations at U.S. banks.

I see four phenomena in particular working against widespread application of the consolidation-reengineering strategy:

* Senior management's reluctance to champion consolidation. Some bank officials, although convinced of the validity of the approach, are hesitating to push hard on technology consolidations (or are following through only half-heartedly) because executing the strategy entails unpleasant realities.

For instance, they have little training or inclination to handle the downsizing that tends to accompany consolidations.

Historically, bankers have been conditioned to deal more naturally with long-term business relationships in their communities than to reengineer product distribution systems or to make tough business decisions that result in painfully visible job losses.

* The outsourcing option. Here, a bank in effect delegates a consolidation initiative - in fact, much or all of its information technology operations - to a third-party contractor who can realize reasonable (although rarely maximal) cost savings.

The problem is that the outsourcer has no incentive to create strategic advantages. Outsourcing may be the most evident manifestation today of the impulse to consolidate, and it may indeed make sense for smaller banks to outsource technology functions.

But for multibank holding companies, large-scale outsourcing squanders opportunities to build strategic advantages and cut cost.

On the other hand, outsourcing can be a most convenient means for senior managers to dodge the community outcry likely to ensue if they themselves lay off employees and close facilities.

* The legislative roadblock. Some commentators see federal and state regulation as the villain prohibiting homogenous and obviously redundant banking operations from consolidating fully.

There is more than a kernel of truth in this assertion; no other enterprise within the borders of a given state is required to operate substantially independently of its parent company and affiliates and to maintain a separate board, management team, and operational infrastructure.

Still, regulations that preclude full legal consolidation don't entirely rule out consolidating systems and operational resources, even across state lines.

By standardizing products and centralizing systems and back-office operations as much as possible under current rules, banks are cutting expenses and improving their competitive positions, though not optimally.

* Operating management's territorial instincts. Many local bank executives see consolidation as a threat to their influence in corporate operations.

Others resist standardizing products because they mistakenly believe it will dilute service and responsiveness to customers. Yet systems standardization does not imply insensitivity to local prerogatives and markets. Current technology fully supports product options within a franchisewide infrastructure.

Personal Leadership

What can we do to make technology-driven consolidations work for us?

For one thing, bank executives must accustom themselves to spending as much time in the back offices and technology centers as they do in pursuing new business.

And they must take responsibility for managing the painful side effects of consolidation, particularly layoffs.

Bankers simply have to exercise personal leadership, which involves planning, sensitivity, and even generosity; it is not a duty appropriate for surrender to an outsourcer.

Legislators and regulators should also recognize that allowing banks to operate more efficiently advances their goal of ensuring safety and soundness in the industry.

Eliminating the structural inefficiencies imposed by, for example, restrictions on interstate branching would encourage multistate banks to revamp their vital operations for an increasingly competitive world market.

Strategic Potential

Consolidation without bank-wide reengineering is a half measure that fails to acknowledge technology's strategic potential to reduce expenses, enhance customer service, and increase earnings.

Rather than ignore the reality that most banking operations and products are technology-dependent, senior management would do well to take the initiative in understanding and adopting the consolidating technologies that can help revitalize our ailing industry.

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