Investing in the Franchise
BAI RETAIL DELIVERY CONFERENCE & EXPO SPECIAL REPORT | PART I
BY KENNETH CLINE
For PNC Chairman and CEO James Rohr, retail success requires continual investment in the business. Future acquisition activity would be aided by capital provided by BlackRock.
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SYNOPSIS | In an interview, PNC Chairman and CEO James Rohr says success in retail banking requires continual investment in the business and monitoring changing trends in technology and customer behavior. While satisfied with PNC?s current balance of interest- and fee-income businesses, he says expansion of PNC?s retail franchise is likely, including acquisitions in adjacent markets, using capital obtained from the recent sale of part of its BlackRock subsidiary. Rohr cites changes in technology that have enabled PNC to gain more control over its credit card and mortgage businesses. Challenges include improving PNC?s brand as one means of enhancing its appeal to prospective customers.
James E. Rohr, chairman and CEO of Pittsburgh-based PNC Financial Services Group, Inc., has learned the value of strategic clarity.
He took command of the company in 2000 at a time when the economy and financial markets were taking a beating and PNC itself was perceived as a middling performer among superregional banks. It didn’t help that PNC encountered some regulatory problems related to accounting issues in 2001 and Bank Secrecy Act violations at Riggs National Corp. in Washington, D.C., which PNC acquired in 2005.
Rohr used strategic clarity and management inno-vation, topics that will be prominently discussed at the upcoming BAI Retail Delivery Conference & Expo to turn that situation around. The strategic clarity included a cost-cutting program known as ?One PNC,? which improved operating leverage, and freeing up capital by selling part of PNC?s asset management subsidiary, BlackRock Inc. Longer term, Rohr has spent several years strengthening PNC?s retail franchise by making essential investments in technology, branches and employees.
?If you don?t commit to it and don?t invest in it, if you don?t manage the change that?s taking place in that space, then you won?t be successful,? says Rohr, who will speak about his approach to retail banking at the BAI Retail Delivery Conference & Expo.
Management innovation at PNC meant eliminating the various management silos that sprouted up during the previous decade and focusing the company?s banking businesses on two units: retail banking and corporate and institutional banking. Reorganizing in this way, Rohr says, improved efficiency and provided a more integrated, unified view of the customer.
These initiatives have paid off as $95 billion-asset PNC continues to report strong earnings in a difficult interest rate environment ($381 million in the second quarter, up 35% from the year earlier quarter). Reflecting the company?s improving performance, PNC moved up this year in Fortune magazine?s ranking of America?s largest 500 companies, to #290 from #323 in 2005, and #5 among superregional banks as a ?most admired company.?
As for customer service, PNC has always focused on retaining clients, Rohr says. Now, he adds, the company needs to do a better job of attracting new customers. Toward that end, PNC?s brand image is due for an overhaul. ?We have to make ourselves more visible to prospects,? Rohr says.
Q: The notion of “strategic clarity” is emerging as a management imperative for retail banks. How does this concept relate to what you’re doing at PNC?
ROHR: First of all, we really like retail banking as a business. It has been criticized for being slow-growth. But run properly, it has very high returns and good growth. It should grow 5% to 12% over a long period of time because you’ve got population growth, money supply growth and all of those kinds of things. So, there is the opportunity to grow your business very nicely.
But it’s like any other business: If you don’t commit to it and don’t invest in it, if you don’t manage the change that’s taking place in that space, then you won’t be successful. Because it’s very competitive. Everybody’s in the business and the pace of change today is greater than it’s ever been.
So, you either invest and involve yourself in the change, and work with the customer around those trends, or you ought to get out. No decision is a decision. If you don’t invest, you are effectively getting out. But, if you’re really focused on that customer strategically, I think you can be very successful in this business for a long period of time.
Q: PNC has a strong component of fee income businesses that complement the traditional retail bank. At midyear, fee income provides 69% of your revenues versus 31% interest income. What sort of strategic clarity are you seeking in terms of how you balance those two?
ROHR: We actually like our current position. We have a great asset manager in BlackRock Inc.; with the completion of the Merrill Lynch transaction, BlackRock will be about a $1 trillion global asset manager. We’ll also get about $1.6 billion in incremental capital, which we will be able to leverage. So, BlackRock has been a great success.
Secondly, we own this company called PFPC, which we invented back in the early 1980s. It is the nation’s largest sub-account provider and second largest full-service mutual fund transfer agent. That’s also been very successful. As a matter of fact, PFPC’s profits were up 50% last year.
Then, we have the banking business, which includes our Corporate & Institutional Banking unit and the retail bank. I think of PNC as four businesses, with retail being the largest. We’re in eight of the top 15 wealthiest counties in the U.S. Since BlackRock and PFPC are also leaders within their respective industries, it makes for an effective mix of interest income and fee-driven businesses.
Regional banking is a local business to a great extent. You’ve got to have a strong market share, which allows you to build a very competitive delivery system. Whether it’s ATMs, in-store branches, call center or online, you’ve got to have a competitive delivery mechanism in the market.
We have the market share in those businesses and we have invested in the technology. Our online banking penetration is among the very best in the industry. And we are upgrading our Web site, pnc.com to better represent our unified organizational structure and make it easier for visitors to navigate. Information Week named us the number one bank in technology in the entire industry a couple of years ago. We’ve also been named, again, one of the top 100 companies by CIO magazine, so technology is very important to us.
I think you’ll see us investing more in our retail markets down the road. Leveraging the retail platform is really a strategy that you’ll see us pursue.
Q: How do you plan to do that?
ROHR: Over the next two-and-a-half years, we plan to build 125 branches and we’re spending about $100 million a year in refurbishing existing branches. By the end of that period, we’ll have redone all the branches in the system. These enhancements will also help unify our brand and signage across our retail footprint, providing an upgraded, consistent look and feel throughout the franchise.
Q: The biggest strategic question hanging over PNC is clearly what to do with the $1.6 billion in capital you received earlier this year when you reduced your holdings in BlackRock from 70% to 35% in a joint venture with Merrill Lynch & Co. Can you provide any guidance on that?
ROHR: That’s the question most often asked by investors: what will you do with the money?
We’ve already raised the dividend and we’ve already started buying back shares. But we can also use the funds for judicious acquisitions, most likely in the retail space.
To the extent we can add acquisitions at a shareholder-friendly price, our strategy is to buy into markets that are adjacent or near-adjacent to our existing ones. United National Bancorp, for example, was a perfect fit for our New Jersey franchise. And Riggs was a unique opportunity in Washington, D.C., a market we like a lot.
Q: Some analysts feel that the banking industry, overall, is over-burdened with infrastructure, that too many institutions are out there spending a lot of money chasing the same customers. (See “Is a Profitability Squeeze in the Works?”) Do you agree this is a long-term issue the industry must address?
ROHR: It is a huge industry. Until the early 1980s, you didn’t have a natural evolution of the industry because regulation prevented interstate acquisitions. Then they changed the rules on expansion. We did the largest banking transaction in the history of the United States in 1983 by acquiring Provident National Bank in Philadelphia, which created a $10 billion bank. A deal that size probably wouldn’t even make The Wall Street Journal today.
Today, you have interstate banks, and technology is making a difference. You’ve got dramatic technological advances and changing consumer behavior patterns, which I think facilitate a changing banking industry. That’s why you have to understand the customer, think about the customer trends and invest in them.
I think you’ll see more consolidation of the banking industry because not everyone can afford to keep up with the pace of change in technology. Neither can everyone afford the sophisticated risk management and the compliance costs. So I think we’ll continue to see more consolidation.
Q: How committed are you to PNC being a survivor?
ROHR: We are very committed. We have the technology and the market position, the business mix and, clearly, the capital.
Q: What part has management innovation—another recent theme—played in the recent reorganization of PNC into the four main business units: BlackRock, PFPC, Corporate & Institutional Banking and Retail Banking?
ROHR: The 1990s was an interesting period of time, in which the markets were driving value in a very unique way. And we had a unique group of products and businesses, including PFPC and BlackRock, which really did play into the marketplace very strongly at that time. We used a silo form of organization to really build those businesses. And PNC traded at a premium at that time.
Obviously, the market has changed a great deal. As a matter of fact, the last months that my predecessor was CEO, the Dow and the NASDAQ peaked. They began falling when I began my new job.
By the early 2000s, we had a different environment, where margins were under pressure. At that time, we consolidated some of our businesses and adopted an interdependence model that moved us away from silos to a unified business structure within our banking businesses headed by our most senior executives, Bill Demchak (vice chairman, head of corporate and institutional banking) and Joe Guyaux (president, head of retail banking). And now we’ve moved completely to a corporate and retail structure.
Q: So your model is to basically leverage your earnings off a shallower expense base, as opposed to having a lot of redundant management structure?
ROHR: Yes. But from the customer point of view, quite bluntly, we ran into some issues. For example, the siloed structure was very effective for business customers who kept their business money and personal money separate. It wasn’t as effective for those individuals who actually think about PNC as a comprehensive financial services provider.
Q: So now you have a consolidated view of the customer?
ROHR: Yes, absolutely. And that’s been showing up in the improved customer satisfaction scores we are tracking.
Q: How does the “One PNC” expense reduction program that you launched in 2004 play into the customer experience you deliver? Although you did reduce cost, the program also resulted in the elimination of 3,000 positions. Did customer service suffer?
ROHR: I truly believe we did it the right way with One PNC. The program enabled us to use our own people to come up with cost-saving ideas rather than insisting on an across-the-board percentage budget reduction. We did not want to cut resources in places where we are trying to grow.
So we actually gave the program to the employees, 400 of whom were actively involved. We received 6,000 ideas on cost-cutting from thousands of employees. As a general principle, we said you can’t injure the customer. Customer service has always been the focus of the company. It shows up in our high retention of demand deposit accounts.
With One PNC we said, “Tell us things that will enhance revenue, take costs out, eliminate redundancies and not harm the customer.” Our employees analyzed the 6,000 ideas, risk-rated them and qualified them with regard to the ability to execute. A committee that I chaired reviewed all of the recommendations and came back with 2,400 ideas, which we are in the process of implementing. Ninety percent of them are completed or underway. It’s $300 million worth of cost savings and at least $100 million worth of revenue.
The beauty of it is, the ideas came from the employees. They knew how they would implement them. It’s not like a consultant or an executive uninvolved in that business is saying, “Here’s an idea, now do it.” As a result, customer satisfaction numbers continued to move north right through the One PNC initiative.
Q: Is One PNC complete now, or is it an ongoing process?
ROHR: We’re taking a much smaller subset of the original group of 400 employees to develop what we call a “continuous improvement process.” We’re seeking to foster a culture that allows people to bring in ideas continually.
Q: You’ve had a lot of cultural change in your company. How have you been able to manage that?
ROHR: We have great people. We’ve always had good benefit plans. We probably have the top decile 401(k) plan, with a dollar per dollar match for up to 6% of compensation. I think retirement money is very important, so we have lower turnover as a result. So that’s always been a philosophy here: Take care of the employees and the employees take care of the customer.
In the early 1990s, we implemented a franchise-wide initiative to enhance and monitor customer service and satisfaction. Then in the late 1990s, we placed increased emphasis on sales and cross-sell with a more disciplined approach within each of our businesses and introduced Chairman’s Challenge. Here, we were able to get non-sales employees referring business to PNC’s retail bank. Today, the Chairman’s Challenge has resulted in incremental business equivalent to the size of four of our mid-size branch offices. These initiatives have really helped provide a cultural framework for the company.
The next issue for us is to be more aspirational in our brand, to be more visible with non-customers. Our retention of existing customers has been strong, but we have to make ourselves more visible to prospects.
Q: So your strategic challenge on the retail side is to acquire new customers?
ROHR: That’s right. We want to ensure our brand is supporting our acquisition goals. That will be a continuous, long-term program. In 2007, we’ll introduce an “external brand” campaign, designed to appeal more to non-customers. That campaign will be one of the largest marketing campaigns we’ve ever undertaken.
Right now, our focus is on motivating and training our retail bank employees to live up to our brand promise of “ease and confidence”. This project, headed by Joe Guyaux, is wrapped up with our branch upgrading program and is focused on existing customers. We want to make sure that when you come into the bank, the experience is the same across the company. The customer experience makes a difference. Call it the moment of truth every time you are confronted with a customer issue, whether it’s online or in the branch.
Institutionalizing the customer experience in this way will set the stage for our external branding next year. Long-term sustainability and differentiation is tied to whether customers and prospects understand what PNC is really all about.
Q: Looking ahead, how do you see the industry changing? What challenges do you face in the future?
ROHR: First, this is really a competitive business. More people are getting in it so competition is increasing. Secondly, technology is changing the nature of the business.
One example of that is in the payments business. We changed our relationship with the merchant processing business. We used to have a minority stake in a joint venture with First Data Corp. Now, we have a majority stake, which provides us with more control over the sales force and access to a comprehensive array of merchant products. And we will probably see some similar changes on the credit card side, with us taking more control over the sales process. It is kind of interesting. We sold our credit card business a number of years ago because we needed massive scale to be in that business. Now you can be in the business using a provider, where the provider provides the scale, and you provide the customer base, so that business has changed some as well.
We’ve made some investments and some changes in some of the products, whether it’s a mortgage in a joint venture with Wells Fargo & Co., where we now control the product, or whether it’s bringing the credit card back as ours and not a product that we’re distributing for someone else. Now we own the majority of our relationship with retail customers, so we can control that interface as we feel necessary. And technology allows that to happen, where five years ago it didn’t.
Q: A lot of banks have probably regretted selling off their card portfolios ...
ROHR: We never did. We thought it was a good sale. We didn’t think we had the scale to run it at the time. But today, now you can actually build a card portfolio on your own balance sheet, using other peoples’ technology. Ten years ago you couldn’t do it.
Q: Given these challenges, do you envision PNC being a very different company, say, five or 10 years from now, with perhaps a different strategy and business mix?
ROHR: Well, it’s hard to look that far ahead. I do think it will be a larger company. But I would guess the mix of businesses will be very similar.
Q: You seem to have had a strong personal impact on where PNC is going. How do you do that in a large organization and sustain it over time?
ROHR: I don’t know if that’s true. I would say that our team has had the impact.
People ask me how I got to be chairman. I say I was lucky, which is true. It’s also always important is to be a hard worker and show you’re passionate about what you’re doing.
But there’s a time, at least in my experience, where you can no longer move the numbers yourself. At some point, you get promoted to a place where it doesn’t matter as much what you do personally. The numbers are of a size where you are irrelevant. Your effort, no matter what you do, doesn’t create success.
Many people get promoted and don’t realize that they are totally dependent upon the success of their people. I think that’s a watershed event for managers, in any company. I guess I learned a long time ago, probably the hard way, that I’m totally dependent on the work, results and success of our 25,000 employees.
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