Revenue Play

By Kenneth Cline

Mega-mergers have fared poorly of late. Dick Kovacevich aims to show Wells Fargo is different by generating real revenue growth.

The emerging view on big bank mergers is that they don't work. But Richard M. Kovacevich wants to prove the exception to this rule. The president and chief executive of Wells Fargo & Co. is determined to show that a union of two of the nation's largest banks can indeed generate improved revenue growth. Considering the poor showing of other recent big deals, this would be a tremendous achievement indeed.

So far, the November 1998 combination of Wells and Norwest Corp. has avoided the missteps that hobbled others. Unlike Bank One Corp. and First Union Corp., Wells has not damaged its credibility on Wall Street by repeatedly lowering its earnings projections. Nor has it faced the kind of investor skepticism that surrounds Bank of America Corp. and U.S. Bancorp.

Nevertheless, Kovacevich confronts a special challenge. Unlike some of his rivals, who can extract major cost savings from mergers within their own markets, Kovacevich did a long distance deal and thus is limited in his ability to realize efficiency gains. The only way he can justify this $32 billion transaction is by delivering extra revenue growth.

He is counting on cross-selling to help him succeed where others have failed. During the '90s, Kovacevich boosted Norwest's ratio of products sold per-customer to 4.6, twice the industry average. His audacious goal at Wells is to elevate the consolidated ratio, now at 3.4, up to eight. Such a dramatic surge in cross-selling is key to generating the revenue growth he needs to declare the Norwest/Wells merger a success.

There is disagreement, however, whether cross-selling is always a profitable activity. Beyond that, Kovacevich faces a number of challenges peculiar to the Norwest/Wells merger. To minimize integration problems, he opted for a cautious three-year systems conversion schedule, which remains two-thirds incomplete. The largest single piece, California, with its 1,200 branches and 3.5 million retail household customers, won't be done until yearend, which leaves Wells facing some huge operational uncertainties.

Nor has Kovacevich completed the cultural integration of Norwest and Wells, which operated under starkly different business models. Minneapolis-based Norwest, Kovacevich's former bank and the acquirer in this transaction, took a community bank approach focused on relationship selling. San Francisco-based Wells, by contrast, was known for its centralized, line-of-business structure and product sales orientation. Realistically, until these disparate models are reconciled, Kovacevich can't expect to see dramatic improvements.

The industry will be carefully watching. Kovacevich is known as a master marketer and motivator. Should this deal disappoint, given his stellar track record, it would call into question the whole concept of the financial services conglomerate.

One reason banks have undertaken big mergers is to provide the broadest possible array of products and services for their customers in order to wrest back market share from nonbank competitors. To date, however, few have capitalized effectively on their enormous resources. "Banks that have gotten bigger generally have not gotten better," says analyst Thomas K. Brown, CEO of money management firm Second Curve Capital in New York. "The challenge at Wells is to demonstrate growth within a massive franchise."

Though cognizant of the challenge, Kovacevich insists that his revenue-generating formula will work. The edifice of cross-selling must be built on a foundation of tremendous persistence and discipline, he says. "There are literally thousands of things we have to do right to get the revenue. This is not about strategy – it's about execution."

Tortoise and Hare

Kovacevich is on the hook to deliver. His targets call for at least 13% annual growth in earnings per-share, predicated on at least 10% revenue growth. Wells officially reported a 9% increase in revenues last year, to $16.8 billion, but Kovacevich admits the core rate fell closer to 7% after taking out one-time gains on items like branch divestitures. Given the ground the old Wells lost in 1997 and 1998, he says, reaching the 10% level will take a few more years. Right now, the company is relying heavily on venture capital gains to make its numbers.

That can't last forever. At some point, the deal flow generated by the high-tech sector will slow down and Wells will need to make up the difference in its vast retail operation (42% of earnings). That will depend on acquiring new customers and selling more products to each client.

Despite these pressures, Kovacevich is proceeding at an excruciatingly deliberate pace. He simply cannot afford to repeat the operational disasters that have destroyed other mergers. The old Wells' 1997 acquisition of First Interstate Bancorp, for example, was a textbook case of how not to do a bank merger.

By attempting an unrealistically ambitious timetable for converting systems – only eight months – Wells set itself up for massive customer defections as it lost track of critical account information. "We couldn't move the paper," recalls group executive vice president Terri A. Dial, a veteran of the old Wells who now runs the California branch system under Kovacevich. We couldn't process basic checks and deposits."

The debacle drove Wells into Norwest's embrace. Although the union was portrayed as a merger of equals and the Wells name is used for the combined entity, the dominant executives are Kovacevich and chief operating officer Leslie S. Biller, his long-time lieutenant from Norwest.

The two are willing to take things slow in order to get it right. From start to finish, the systems conversion will take three years with the biggest chunk, California, left to the last. Kovacevich says he "doesn't understand the logic of trying to do it faster." But his approach goes against the grain of recent industry practice, which has been to engineer increasingly rapid integrations in deference to Wall Street.

As an out-of-market deal, Norwest/Wells would be expected to generate modest cost savings anyway. But revenue synergies provide the underlying rationale for Kovacevich says. "It was the differences between the two companies that provided the rationale for joining forces, not the similarities."

For that reason, Kovacevich has taken a "pick the best of each" approach to integration. Transition teams, composed of representatives from both sides, spent a year analyzing which systems and practices should be retained. Kovacevich admits that this method is difficult and slow but insists it's worthwhile. "It's a little like the race between the tortoise and the hare," he says. "It takes longer when you try to bring people together in a unified culture, but you win in the end."

Dueling Business Models

Much has been made of the cultural differences between the old Wells and the old Norwest. In shorthand form, this is usually described as a contrast between "high touch" (Norwest) and "high tech" (Wells). Kovacevich argues that the real difference is in business models.

Wells, predominately a California-based, urban-oriented bank before the First Interstate acquisition, employed a line-of-business organizational structure to deliver a streamlined product menu at the lowest possible cost. Its distribution system embodied one of the industry's most aggressive attempts to substitute alternative delivery (supermarket branches and ATMs) for more expensive full-service branches.

Norwest, by contrast, employed a decentralized (and more costly) community bank-style distribution system designed to serve customers within a relationship context. The underlying philosophy was account consolidation, or capturing as much of a customer's business as possible.

The Norwest relationship approach is unquestionably pervading the new Wells. Two of the five regional presidents in California are from Norwest. Although line-of-business structures are being retained for certain products, like small business loans and home equity lines, the retail branch system has adopted a more geography-centered organizational structure with a more diversified product menu. Customers of the old Wells, who were used to relying on that bank for a few basic services, like checking accounts and small business loans, will now be cross-sold insurance, mortgages and mutual funds.

This cross-selling process will be aided by the introduction of Norwest's computerized customer profiling system, which allows branch employees to engage in consultative selling with customers and refer them to specialists who handle nonbank products. Dial's employees are currently using a version of this program. But they will have to enter the information manually, on paper, until system conversions are completed.

Also coming to California by yearend is Norwest's portfolio management account, which captures on one statement a customer's banking, brokerage and trust relationships. Like the customer profiling system, this product will enable Wells employees to engage in Norwest-style relationship banking.

No Longer Lean

The downside is higher expenses. The old Wells was famous for its lean-and-mean cost structure, which helped make that institution one of the industry's most profitable in the mid-90s. Credit Suisse First Boston analyst Michael Mayo estimates the old Wells was 15% more efficient overall than Norwest.

But the spare staffing models at Wells also contributed to its failure to handle customer service problems during the integration of First Interstate. To repair some of that damage, Kovacevich added branches and put additional sales staff in existing branches. Dial, for example, has increased the sales staff in her California branches by an average of half a full-time employee per branch.

True to his concept of taking the best of both, Kovacevich is also trying to instill some Wells-style efficiency in the old Norwest branches. But doing this without harming cross-sell ratios will be a challenge. Wells' efficiency ratio meanwhile, which measures operating expense as a percentage of operating income, was hovering at 57% in the first quarter. Without committing itself to a timetable, the company has said it wants to get the ratio down to the mid- to low-50s.

Kovacevich himself is mindful of the need to control expenses. But his bias is clearly to focus on sales, noting that the efficiency ratio depends on the denominator (revenue) as well as the numerator (cost). "Improving your ratio on cost alone doesn't work over time," he says. "A better way to improve it is to grow revenues faster than expenses."

Meanwhile, down in the trenches, Wells managers are trying to reconcile the competing demands of sales gains and cost containment. "Having a strong sales culture, from my point of view, is not enough," Dial says. "You have to really manage the cost side of the equation. I'd argue there is some place in the middle where you lower your distribution cost by selling more on a per-square foot basis."

Like all the other challenges facing Wells, this will require effective execution on the front lines. There's always a point at which the top strategist must rely on his troops to implement the plan. The careful approach Kovacevich has taken to merging the two companies, his avoidance of demoralizing, slash-and-burn tactics, increases the likelihood that Wells employees will rally to the cause.

Kovacevich, in fact, identifies this as the major differentiating factor in banking today, now that products are commoditized and capital and technology can be accessed by all. "You gain competitive advantage," he says, "through your ability to implement."

Mr. Cline is senior editor of Banking Strategies.

Copyright © 2003 by Banking Strategies, published by BAI.

back to top