Smarter Choices

By John R. Engen

Tight budgets are pressuring banks to develop more effective ways of evaluating information technology projects.

Banks that binged on technology spending during the '90s Internet boom now are thrust into an era of austerity, and some experts estimate that spending for new projects has been cut in half. Whether retrenchment leads to better investment decisions remains to be seen.

This slowdown reflects both the dot-com crash of 2000 and the economic doldrums that beset the national economy in 2001. Lending woes, gyrating net-interest margins and stagnating fee income have pressured banks to ax discretionary spending. Strategic technology projects, with their uncertain payoffs, present a tempting target.

Properly focused, such cost-cutting could do the industry some good. It's now generally conceded that banks lost financial discipline in the latter '90s. In too many cases, institutions plowed money into technologies, such as wireless banking, on a "me-too" basis, rather than in response to customer demand or profit potential.

Today, the emphasis is on projects that provide a realistic prospect of financial return, or at least a selective enhancement of customer service. "We're moving into a more mature place, where we can be more discerning and demanding in our judgment of the value generated by new applications," says Lawrence Baxter, executive vice president of e-commerce for Wachovia Corp. in Charlotte.

But the new spending environment also exposes a key vulnerability. Most banks lack the metrics, reporting processes, governance structures and other tools needed to effectively assess the value of current technology projects, let alone support the kind of predictive modeling required to pick the winners from among the dozens of newer initiatives vying for suddenly scarce resources. This represents a serious threat to the industry's profitability, considering that large banks devote as much as 20% of their noninterest expense to technology expenditures.

Recognizing the problem, institutions such as Wachovia, Wells Fargo & Co., Bank of America Corp., and Mellon Financial Corp. have devoted years of effort and millions of dollars to developing more effective project prioritization techniques. The approaches vary, but the general thrust is to ascertain how specific initiatives fit into the bank's big-picture strategy and meet the needs of discrete customer segments.

Doing this well requires scientific metrics, such as control group comparisons and balanced scorecards. It also requires organizational structures that can simultaneously support and rein in business-line initiatives, while providing adequate review and oversight of projects. "Each initiative needs to be examined line-by-line," Baxter says. "It's deep-down, detailed work."

While it's hard to tell how successful individual institutions have been, the prioritization effort itself is clearly worthwhile. For all its excesses, the technology revolution of the past decade underscored the power of well-targeted strategic technologies to provide crucial differentiation in a mostly commoditized industry.

Banks that can funnel scarce resources to projects with the best long-term prospects could gain a considerable competitive advantage, both in terms of the effectiveness of the projects themselves, and also the money saved for other uses. That could prove to be a key performance differentiator in the years to come.

"We're at an inflection point, where banks with the right capabilities can separate themselves from the pack," says Cathy Graeber, a San Francisco-based senior analyst for Forrester Research Inc.

Swinging Pendulum

For most institutions, financial and non-financial, technology spending is not a spigot that can be abruptly turned on and off. Banks must continue spending money to maintain their networks and systems, address security and compliance issues and complete ongoing projects that are still deemed worthwhile.

Celent Communications estimates IT spending by U.S. banks will actually rise 4% this year, to more than $34 billion, although this represents a sharp drop from the 10%-plus annual increases typical of the late '90s. According to Celent, which is based in Cambridge, Mass., 90% of this money will go toward maintenance rather than new projects.

Along these same lines, John Weisel, a New York-based partner for Accenture, a strategic consulting firm, estimates that spending on new strategic initiatives has declined from 30% of the typical large bank's IT budget in 1998 to between 10% and 15% today. "The pendulum has swung. We're seeing all of our clients dramatically reducing their discretionary technology investments," Weisel says.

Wachovia, for example, suspended plans to launch retail wireless banking. Wireless was once seen as an exciting new channel for distributing financial services, but a lack of customer interest and technical problems involving standards and devices have dimmed its prospects. According to TowerGroup, fewer than 20,000 customers in North America regularly use wireless banking services. "There's no longer the sense that these things have to be done immediately or we'll lose customers," Baxter says.

This is a key shift in attitude. During the last decade, the large banks particularly tended to view technology development as a competitive race. Institutions were willing to spend money on projects that lacked any clear path to earning a return out of a fear that competitors would dominate that space in the future. Today, Wachovia is devoting its discretionary dollars to services for which it perceives tangible customer demand, such as check imaging and electronic bill pay.

Still, many banks need to improve their technology-decision frameworks. "Good project prioritization requires a lot of connecting the dots, and most banks haven't quite figured out how to do that effectively," says Bill Bradway, president of Meridien Research. The Newton, Mass.-based research firm recently identified the improvement of IT investment metrics as the most important strategic initiative for retail banks this year.

The need for this is reinforced by a recent Forrester Research study in which 63% of large banks surveyed conceded that the metrics they use to measure the profitability of Internet ventures were either somewhat or completely ineffective.

Lacking precise metrics, many banks rely on "soft" measures to drive their decision-making, such as customer satisfaction surveys or online traffic measurements. While good to know, such feedback by itself says little about an initiative's ability to achieve bigger corporate profit objectives such as customer retention or acquisition, revenue growth or cost reductions.

Wachovia's Baxter, for example, says he's convinced e-billing is a winning technology because the relatively affluent customers who use it "are every banker's dream." Yet, he also admits that no identifiable return on investment can be charted for this service.

Maintenance Mode

Unable to accurately track the efficacy of their spending and identify the projects that matter, a few banks have responded to the recent technology downturn with what Weisel calls a "slash-and-burn, stop-all-spending" approach, particularly to things Internet-related.

While investments by North American institutions in Web technologies will rise 19% this year, to $630 million, most of that will go to basic upgrades and maintenance, according to Jim Eckenrode, group director of consumer banking research for Needham, Mass.-based TowerGroup. Although a few areas, such as small business services, continue to garner investment dollars, the money going to electronic bill presentment and payment, account aggregation and certain wealth-management tools has slowed to a trickle, Eckenrode adds. "The industry is in a maintenance mode."

The Internet's loss is the branch system's gain, as bankers re-orient their focus from technological advances to improving service where it counts the most. TowerGroup predicts that branch technology spending in North America will increase 9% this year, to $3.7 billion, which comprises 39% of the total IT spending for retail delivery channels.

Some of this is playing catch-up following a decade of neglect. Eckenrode notes that most branch systems are based on IBM Corp.'s OS/2 operating system, an outmoded product that will be phased out by IBM over the next five years. That will force most banks that haven't already done so to migrate to either Linux or Microsoft Corp.'s Windows NT.

Other areas likely to receive modest boosts in spending, according to researchers, are those that fit into the industry's current theme of maximizing established customer relationships. These include: customer-relationship management software; multi-channel integration systems; and some wealth-management applications. Projects aimed at upgrading call centers to interact more effectively with other channels, and thus boost sales effectiveness, are likewise moving higher on the priority ladder, as are those aimed at enhancing privacy, risk management and security.

The slowdown in overall technology spending, meanwhile, has accelerated outsourcing, which shifts some of the development expense and risk to third parties, albeit with loss of control and customization. U.S. banks already devote 12% of their delivery channel IT expenditures to outsourcing arrangements, and TowerGroup projects such outlays will grow by 20% a year through 2005.

Picking the Winners

Still, it's not assured that bankers are spending their tech dollars more wisely now than in the past. Absent hard metrics and an effective prioritization schematic, investment choices can be unduly influenced by internal politics or competitor moves. "If you don't have the right metrics or structures to make good decisions, it can quickly wind up being a free-for-all," says Forrester's Graeber.

Determined to avoid that outcome, a few institutions have established rigorous prioritization procedures. While the specific approaches vary, these banks say they're now better able to track the financial benefits of strategic technology efforts and distinguish winning initiatives from the losers.

By necessity, such prioritization begins at the top, with clearly identified financial goals. Senior managers establish broad, quantifiable objectives for their technologies — such as growing revenue or lowering service costs — and then rally the troops around those goals.

At Wells Fargo, for example, CEO Richard Kovacevich is keenly intent on boosting sales throughout the organization, so he ensures that technology spending is aligned with that effort. "If a project doesn't support one of his objectives, it doesn't get funded," says Kevin Dabney, executive vice president of Wells Fargo Services Group, the San Francisco-based holding company's in-house technology and operations unit. One example: building a common architecture that will allow different business units and channels to share customer information more easily.

Just as strategy itself is best set at the enterprise level, so too is the implementation of some initiatives. Multi-channel integration, single Web sign-ons, check imaging and customer relationship management are among the projects typically managed and financed centrally, either because the benefits are widespread, or because they're too costly for one unit to bear.

Where measurement and prioritization efforts face their stiffest challenge is at the business-line level. Most banks allocate technology resources, based largely on revenues or profits generated, to business units to allow them to pursue initiatives that can improve their competitiveness. "The only reason we have technology is to enable a line-of-business strategy," says Allan Woods, chief information officer for Pittsburgh-based Mellon.

The trick is to serve the competitive needs of the business line, while ensuring that initiatives are consistent with broader organizational goals. Initiatives must also be compatible with the bank's technical architecture, and scalable to meet the future needs of other business units.

At Mellon, the business line heads sit down with Woods' IT department at the beginning of each budget cycle to assess the "financial justification" of individual projects. What emerges is a wish list of projects, ranked by potential ROI, that is reviewed once a month. "It's in priority order, so if revenues in that unit decline during the year, they can cut from the bottom of the list," Woods explains. "They're the ones making the final decision."

Likewise at Wachovia, initiatives backed by individual units must run a gauntlet of review committees, and are subjected to a balanced scorecard, which weighs such factors as scalability and customer profitability and satisfaction to gauge business cases, predicted payback periods, and ROIs.

Weighing such factors can nix projects that a business line considers crucial to success, testing the effectiveness of an organization's dispute-resolution capabilities. When Baxter's group recently vetoed a "quick one-off" initiative, in favor of moving slower to find a more-scalable solution, the business manager argued strongly that the technology was needed to compete with rivals. A debate ensued, and eventually the dispute rose to Baxter's desk, where, after a series of discussions, he signed off on the project. "That business manager is the one who understands the business, not me," Baxter says now.

Most banks have similar appeal procedures in place, and often the buck stops at the CIO level. On bigger, more costly projects, the final decision can come from even higher up the corporate ladder.

Defusing Politics

While some flexibility is important to building support and trust, too much delegation of authority can be a bad thing. At many banks, the business line that "hollers loud enough or has the best connections can get its way, even if its project doesn't fit the firm-wide vision," says Celent president Octavio Marenzi.

One of the major problems with many recent bank CRM programs, for instance, is that multiple silos have pushed through their own projects. Since true CRM entails a full view of the customer relationship, competing initiatives — often based on different vendor solutions — can set back the institution as a whole.

Good measurement and scientific processes can defuse some of this political tension and produce better decisions. Bank of America has adopted the Six Sigma program, which employs statistical modeling to reduce waste. "We make business decisions based on data, not intuition," says John Rosenfeld, the Charlotte-based company's consumer e-commerce executive.

Rosenfeld's group employs a shadow profit-and-loss statement to gauge the bottom-line potential of current and future initiatives. Proposed projects are vetted and reviewed monthly by a committee that includes representatives from key business lines, customer segments and the e-commerce division. That team assigns scores to proposals based on enterprise priorities, such as profit potential; limiting attrition; growing customer usage and revenue impact; and making the service easier for mainstream customers to use. Those scores are then weighted and aggregated to produce a single score, which is compared with competing proposals.

Lending added credibility to Bank of America's efforts is its use of control groups to measure the economic value of initiatives. Two years ago, the company began studying the behaviors of 300,000 customers, comparing two closely-matched groups of customers exhibiting the same age, income and product-usage characteristics. The only difference: one group banked online, while the other didn't.

From that research, the bank determined, for example, that customers who use electronic bill payment and presentment had a 75% lower attrition rate than offline customers, made 34% fewer calls to a call center, had 28% higher deposit balances and loan balances that were 23% higher than offline customers. That data, in turn, helps produce bottom-line numbers, such as costs and revenues — both per-customer, and per-product.

This scientific approach brings numerous benefits to the bank. By understanding better which products and services help generate revenues, it can make smarter decisions about which ones should be enhanced, and which are best shelved. In recent months, for instance, Bank of America has halted investments in both wireless banking and person-to-person e-payments. And because the process is based on solid data, the politics are less sticky.

"If we can say, 'These are the metrics and criteria we're using,' and it's open to discussion, then it's much more difficult for someone to complain that it was an arbitrary decision," says Stephanie Smith, a San Francisco-based senior vice president and e-commerce strategy development executive.

This, in turn, strengthens the e-commerce division's hand when it seeks funding for additional initiatives. "It would be very difficult for us to argue that online banking customers are more valuable if we didn't have a baseline group with which to compare them," Smith says.

The final crucial step in any prioritization process is assessing whether initiatives achieve their goals. The Wells Fargo system attempts to maintain accountability at all levels, including the review process. This is important, because future funding for a business group depends, in large part, on the success of an existing initiative in achieving the promised cost savings or returns. "When you sign on for a project, it had better return what you said it will return, or you won't get funded next time," Dabney says.

These prioritization programs remain works-in-progress and it will be some years down the road before outsiders can judge which banks have broken ahead of the pack in this area. But the effort will surely not be wasted. While prioritizing technology projects can never be reduced entirely to a numbers game, the quantitative exercise does give managers a stronger foundation upon which to base long-term investment decisions.

Mr. Engen is a freelance writer based in Minneapolis.

Copyright © 2003 by Banking Strategies, published by BAI.

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