Technology Spending Evades Cost Cutting

Although there's a consensus that the banking industry faces massive consolidation, spending on automation continues to grow, according to the American Banker's fifth annual technology survey.

The study, conducted with the consulting firm Ernst & Young, estimates that the banking industry will spend slightly more than $12 billion on hardware, software, and technical support staff in 1993, 7% more than in 1990.

No Cost Cutting Yet

While that rate of growth would be significantly lower than in previous years, it nevertheless indicates that significant cost cutting in technology areas is not yet on the drawing boards.

The study, based on data supplied by 57 of the 150 largest banking companies in technology spending, provides evidence that the industry has not yet come to grips with the fact that as the number of institutions shrinks and staffs are reduced, back offices will need at least as much surgery.

Nonbanks an Influence

Another factor that will force streamlined operations is competition from nonbank players. These rivals, most experts agree, are already more efficient, spending less on operations per dollar of revenue than banks do.

"Mutual funds can deliver their products to consumers at one-tenth the cost of a traditional bank-branch delivery system," said Robert B. Hedges Jr., vice president at the MAC Group, a bank consulting firm in Chicago. "That cost difference is not lost on customers."

Banks spent heavily in the 1980s on technology, yearning for lower operating costs and higher margins. During much of the decade, annual increases in data processing budgets were two to three times the rate of inflation.

The increases financed the explosion in electronic banking delivery mechanisms: automated teller machine networks, corporate cash management services, and sophisticated trust management systems.

To be sure, the survey provides evidence that spending on technology is slowing. Indeed, while there have been some successes, most banks have stopped looking to their systems for salvation.

Spending Surge Is Over

Taking inflation into account, technology spending will remain relatively flat over the next three years, the survey shows.

Furthermore, the recent rash of megamergers, which were announced since the survey was completed, figure to speed costcutting efforts.

Nevertheless, only a quarter of the banks responding to the survey said their technology budgets would decline by 1993, and even those institutions' cost-control strategies cannot be construed as drastic.

The most popular methods bankers cited for controlling expenses included hiring fewer consultants, reducing data processing staff, and relying on fewer application systems.

Long-term cost solutions such as consolidating or downsizing data centers were seen as less attractive.

Behind the Cost Trap

Banks have become high-cost producers for many of their product lines because they failed to recognize the risks of expansion during the 1980s, according to Lowell L. Bryan, a consultant with McKinsey & Co.

Banks "devoted most of their investments in computer systems, new branches, and staff to the common service of all customer segments - regardless of whether a segment made money or lost money," Mr. Bryan wrote in the May-June 1991 Harvard Business Review. "They didn't worry whether profitable products and services subsidized weaker ones."

A weak economy has left fewer cash cows to rely on. Ironically, some experts believe the big investments in technology during the previous decade also played a role in choking off profits.

"The wire transfer business is a classic example of how technology can turn a profitable service into a commodity," said Diogo Teixeira, a partner with Ernst & Young, who helped design the American Banker survey. "With funds transfer, the capacity of the industry grew as it has became more automated The result is the cost has gone down."

He said the average cost for a bank customer to perform a wire transfer was $15 in 1980; today it is $5. And while automation caused banks' cost per transaction to drop as well, technology lowered the barriers to providing the service. As more banks offered funds transfers - adding to available capacity - everyone's profit margins shrank.

Savvy Customers

If some bankers did not recognize that many of their products and services were turning into commodity businesses, customers quickly did.

"With so many suppliers of banking services, customers divide their business," said Richard L. Huber, the vice chairman responsible for corporate banking operations for Continental Bank Corp. in Chicago.

Mr. Huber said Continental has tried to stay away from competing purely as a low-cost supplier. "In cash management, which for us is the most operationally intensive business, it is essential to be a quality low-cost producer, and I really emphasize the word |quality,'" he said. "We think we can add value and can therefore charge a premium price, but that premium price cannot be too far above the plain-vanilla commodity provider."

Some bankers have come to play down the role of technology as the industry consolidates.

"The reason there's not a correlation of overcapacity in the marketplace to banks' computer capacity is because the computer itself is a relatively small component of the total cost structure," said O. Darwin Smith, president of NCNB Support Services, the operations arm of NCNB Corp. in Charlotte, N.C. "In terms of a pure cost-benefit analysis, there is a need to consolidate, to streamline, to simplify operations," he said.

First-Hand Experience

Mr. Smith can speak intimately about the issue: After NCNB acquired the assets of the failed First RepublicBank Corp. from the Federal Deposit Insurance Corp. in 1988, he spearheaded the back-office consolidation of the Texas unit.

Part of the streamlining effort will be to analyze how banks' back offices measure up to those of nonbank competitors.

"I think the more we do benchmarking, we should not be comparing ourselves to other banks, but to other industries," Mr. Smith said. "Historically, banks have operated under the concept of pooled costs, with the intent of lowering the average cost. We need to develop degrees of specialization, different approaches for different parts of the bank. In that way, banks can reduce costs and still provide better customer service."

Observers say this migration away from pooled cost accounting cannot take place without reform from Washington. "Costs of financial transactions of banks and insurance companies or mutual funds are not comparable," Mr. Teixeira said.

However, if the Treasury bill passes in its current form, banks' ability to enter new lines of business such as insurance and stock brokerage will force them to take a harder look at how their operations are organized. "If banks get new powers and disaggregate their front offices, it only seems to follow that they need to find a way to disaggregate the back office as well," Mr. Smith said.

Role of Mainframes

Despite predictions that cheap personal computers and high-powered desktop work stations will cause the demise of expensive, centralized mainframe computers, this year's survey found that banks will continue to rely heavily on these electronic behemoths for the foreseeable future. The number of mainframes will drop slightly over next three years, but these machines' overall capacity - as measured by processing power, on-line transactions, and storage capacity - will continue to mount over the same period.

Bankers say mainframes. even with their high cost per transaction compared with personal computers, will continue to play a dominant role. "I don't think the growth in mainframes and the growth in PCs [in banking] are at all mutually exclusive, but are in fact consistent," Mr. Smith said.

Mr. Huber said Continental was designing its technology around two concepts: a unified customer information file and distributed software controlled by individual business units.

"A customer data base is something that we and other banks believe has to be on a single or closely networked series of mainframes," he said. "On the front end - the applications - that adapts itself quite well to distributed processing."

Mr. Teixeira said that to fully appreciate how the consolidation of the industry will affect the back office, bankers need to better understand the cost of transactions and how it relates to customer profitability. They will also have to measure operational capacity for each line of business and the profit it generates.

The consultant concludes that sometimes the best-laid technology plans do not yield profits in a glutted market. "Often the best answer is to simply to withdraw from a business," he said.

PHOTO : How Banks Cut Costs

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