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Pruning 'Bad' Complexity
BY JOE REIFEL, CHRISTIAN HAGEN and ERIC STETTLER
Customized products can help or hinder financial institutions depending on how they manage the attendant complexity.
SYNOPSIS | In recent years, financial services companies have customized products and services to accommodate customers. The attendant complexity, however, has saddled banks with excessive operating costs, according to consultants at A.T. Kearney. To reduce this complexity while still retaining some customization capability, the authors recommend a five-step process that includes reviewing company-wide complexity, simplifying offers, streamlining bank-office operations, pricing for complexity and building the case for change by ensuring commitment from the top of the organization.
Banking has a complexity problem, although not by design. Most institutions merely wander into it.
Complexity is the inadvertent effect of a well-meaning effort to please the customer through custom-designed products and services no matter what the cost. In the aftermath of such altruism, most of these providers are trapped in a maze of increased operating costs, reduced margins, slower time-to-market and a clumsy multi-channel delivery process that is severely damaging the customer experience and operating efficiency. The situation worsened as companies focused more on raising revenues than profits, failed to understand the true costs associated with the customization and watched the lines of accountability blur following the latest merger or acquisition (see chart, "Root Causes of Complexity").
Today, industry executives are proclaiming an awakening and promise to streamline their products and services, as well as simplify some overly complex business processes. So far, the results have been mixed. The job is neither as straightforward nor as easy as one might think. There is good and bad complexity just as there is good and bad cholesterol, which means banks can't simply take a slash-and-burn approach.
Good complexity is necessary. It adds value for the company and the customer and, by doing so, is at once desirable and sustainable. Bad complexity is inefficiency that drains value from the company and therefore must be identified, targeted and eliminated. Good complexity drives the company to customize its products and services in a way that will help increase revenues, profits and customer loyalty. Bad complexity pushes the customer away and sends the company into chaos and confusion.
Companies must understand that complexity, both good and bad, is a strategic issue that requires a business solution. Rather than taking the straight-line approach of eliminating a few slow-moving products or services, the best companies think about how to achieve and maintain profitable growth by adding complexity only where it increases profits. These leaders keep their focus on providing customers with an appropriate variety of products, while ruthlessly and constantly driving unnecessary complexity out of the business.
Customization Tradeoff
The financial services industry is prone to bad complexity, particularly in banks. It is a service business where products can be changed with a keystroke and variability can be hidden in underlying processes. While financial services companies are customer-focused, they are not terribly good at managing the tradeoffs between customization and complexity. Before offering a customized product or service, executives must weigh the added costs against the price they can charge and the value the company will derive (see chart, “Customization/Complexity Trade-off”). In the end, complexity is not the problem. The real problem is in how effectively companies manage it.
Take, for example, the treasury services arm of a major U.S. bank and one of A.T. Kearney's clients. The bank was custom designing almost all of its products only to discover that it had created a patchwork quilt of too many costly and unprofitable products and services. Although customers appreciated the variety, the bank reaped few benefits. It did not charge for the customization, so it received no incremental revenue while it continued to incur the additional costs for each product.
Now consider how the complexity associated with selling these custom products filters down the value chain. The sales force had the additional work of creating a complex client proposal to sell each non-standard product. And when a sale was made, all functions after the sale—implementation, technology changes, operations and customer service—had to accommodate each product. Instead of the frontline sales people looking forward to the new features they could sell, they had trouble staying up-to-date and answering the ever-expanding list of questions posed by customers. Product managers were not spared as they struggled with a muddle of products and saw profits erode amid rising costs.
Internal processes suffered as well. How many costly manual hand-offs did each custom product require? How many more people would it take to answer customer questions? The division could hire more people to deal with a barrage of customer complaints but this only solved problems in the short term. What about the technology needed to develop and support the different products? How much did it cost for the Information Technology (IT) group to expend time and talent to develop “one-off” or “bolt-on” solutions for every customer?
So while a financial institution might be reluctant to curtail product offers and service levels for fear of losing customers, it must, at the very least, understand the full impact such customization has on the entire value chain and on profitability.
Managing Complexity
Fortunately, unnecessary complexity can be fought while still preserving and managing the necessary complexity. We know, for example, that managing complexity requires first understanding its root causes and the implications on profitability, understanding how complexity relates to perceived customer value and, finally, armed with this knowledge, reshaping the product portfolio and demand to optimize the business (see chart, “Roadmap for Eliminating Complexity”). There are five key steps in this process:
1. Locate complexity throughout the organization
A first step in battling unnecessary complexity is to locate it. Much like a disease, it is often hidden and difficult to recognize. Complexity is not likely to show up on a standard accounting system. Indeed, it might first show up in customer defections or increased operating costs.
Finding complexity requires an end-to-end analysis across the organization to identify root causes that lead to unhealthy variations in products, services and processes. But getting an unobstructed view is difficult for companies that operate in functional silos. When sales, marketing, product development, customer service, IT, finance and human resources units operate independently, communication is limited. What's worse is that the people making decisions about custom products are usually not the same people who understand the cost and profitability implications of those decisions.
Walk into almost any major bank in any country and you will find the same situation: managers of each business unit are making market-facing and operational decisions while sales managers are committing to delivering new product features - all without considering the revenue implications. Managers need to ask if a new feature could be sold to other customers or even delivered cost-effectively. One manager's customer-focused modification is another manager's downstream costs and complexity.
A company-wide complexity review will begin to solve these problems. This review should take place early in the product-planning stages and involve key managers in all businesses or processes that will touch the final product or service channels.
2. Simplify offerings, shape consumer demand
In many ways, financial institutions are where automakers were in the 1970s, when every feature of every car model could be customized. But allowing total freedom proved too costly. As cars became more sophisticated, manufacturers had to respond by paring down the choices and offering standard-feature bundles and then altering the manufacturing platform and process to deliver those bundles. The trick was finding the most successful bundles. Financial institutions now face a similar challenge.
At its most basic, product simplification requires three steps (see chart, “Simplifying Component-Based Products”). The first is to identify and eliminate product varieties that destroy value. Most products have a clearly recognizable point at which customization does not add to the bottom line. The second step is to determine the base components of the product or service and decide how future enhancements will fit into these components. This begins the process of building flexibility into the product, which is vital to maintain competitive advantage. Finally, companies should go back and adjust the complexity in the current product and service mix. This calibration will enhance products and increase profits.
The key is to view products as a series of modular pieces that can combine or integrate into a variety of other products or even separate “product lines.” Managers define the customer-facing base product (or service) and determine which components to offer as “variations” to the base product. Rather than managing unrelated pieces, product managers oversee one product with some customized variations. This is the essence of mass customization.
There are several benefits to this approach. For one, it becomes obvious where costs should be incurred by the institution and which costs should be passed to the customer. This information can help identify the elusive trade-off point between customization and complexity. In addition, the company improves its customer feedback loop and therefore its product offerings, giving managers a better understanding of what customers value. They can use that information as an additional source of creativity and innovation. Over time, the variations can be incorporated into the base product.
Modularity can also improve the underlying architecture of a product or service. For example, the treasury services division in our earlier example is beginning to use modularity to design variations in its core treasury products. The bank is structuring shared components in products such as wire transfers to handle basic information—bank name, routing and account numbers—in a similar manner.
By establishing this standard, the bank can also define variations that could be added. For example, the bank's customer may want to add bill payment or invoice information to the file transfer layout. To do this, the IT team is establishing specific integration points where it can incorporate the variations. In that manner, the bank's software developers will reduce the time spent on developing one-off solutions and product and sales managers can easily deliver products with more features.
Modularity is not only for developing products and services but also for managing the complexity surrounding business processes and functions. When we applied this approach at a benefits provider, our initial goal was to reduce complexity in the provider's employee retirement service offering; if the company could standardize processes and systems, it could improve efficiency. The results are impressive. The retirement process for employees is 25% faster and it now takes 33 days rather than 45 to 48 days. The error rate dropped by 10% and there are fewer questions and complaints from customers. Overall, savings are expected to reach 20% to 25% of the company's current cost base.
3. Improve back-office alignment and operations
The overhead structures and information flows related to excessive products, channels, target markets and customer segments carry over to the back-office operation to exacerbate an organization's overall complexity. In the 1990s, when banks had fewer products and distribution channels, the technology and process capabilities ran what amounted to an assembly line. Now, with more offerings, banks have been doing their best to stretch the old technology, while standardizing and automating their business processes.
Aging core operating systems are proving to be the Achilles heel of many banks and insurers, driving up costs and severely affecting their agility and flexibility. Also, as companies have grown through mergers and acquisitions, they are struggling to cobble together disparate IT systems. The complexity of current systems will likely keep IT on the CEO agenda for years to come. We often recommend using open standards through platforms such as Web services to alleviate unnecessary complexity caused by too many proprietary technologies, platforms and languages.
Finally, there should be a strategy to deal with hidden technology and service costs caused by those one-off solutions. Once a customer is promised a custom product, both the IT and customer service groups have to move quickly to deliver it—usually at a high cost and at the expense of other needed activities. To avoid these extra costs, companies should work with the IT group to define the needed services, as well as the broader delivery organizations to determine service requirements. This cross-business planning ensures more informed decision-making and reduces longer-term delivery and maintenance surprises.
4. Price for complexity
Putting a price on a product or service brings its own challenges. First, executives must acknowledge the close relationship between price and complexity and then manage the relationship to maximize gross margins, regardless of the customization level. Price should be ascertained by calculating the economics of a product from the customer's perspective. When a company knows the features a customer values and which components support those features, it can then focus on those areas while reducing costs and complexity in others. It also makes sense to keep features that customers value but raise the product's price and then become more aggressive in communicating its superiority. This is the essence of a differentiation strategy.
Financial services firms use such pricing approaches in some parts of their businesses but not in others. Full-service banks use aggressive pricing techniques in their more differentiated businesses such as investment banking or fixed-income banking. They develop highly customized products that offer individual risk profiles and deliver substantial margins.
Banks use less-aggressive pricing strategies in the more commoditized parts of their business, such as in retail banking, credit cards and their cash-management functions. This is where one-off solutions lead to problems, as products in these businesses often sell below cost. Banks that price appropriately in these areas will see significant results. For example, after performing a value-based pricing analysis on one client's credit card offers, we suggested eliminating features that added to product complexity and delivery costs but did not return a financial advantage. We then pointed out how the bank could capitalize on the emotional value that its more affluent customers attached to concierge services and experiential rewards.
5. Build the case for change
The most successful complexity reductions require an organizational culture change. Managers should reject the status quo and become accustomed to measuring complexity routinely and taking a continuous-improvement approach to reducing it. They must also challenge beliefs regarding what customers' value and then streamline processes to meet customers' “true” needs.
The first step is to structure processes, reporting and IT to see the complexity and determine how much it is costing the company. But visibility will only get a company so far. Eventually, establishing a long-term strategy for managing complexity requires a dedicated focus on cross-business coordination, performance management, incentive programs, an active governance structure and solid decision-making processes.
Mr. Reifel is a vice president based in the Chicago office of A.T. Kearney, the global management consulting firm; Mr. Hagen is a principal based in Chicago and Mr. Stettler is a principal based in Dallas.
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