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Innovation: The Growth Accelerator
BY ZUBIN TARAPOREVALA AND MARLA M. CAPOZZI
To jumpstart innovation, banks should seek models outside their own industry.
|SYNOPSIS | With organic growth and customer satisfaction stagnating, banks need innovation to perform better in the market, according to consultants at McKinsey & Co. The authors say more can be done by using customer insights and external idea networks; dedicated innovation funding; and facilitating a culture for innovation. They recommend learning lessons from global innovation champions about breaking industry- and company-specific orthodoxies, utilizing senior leadership to move the process forward and building new ideas on a foundation of consumer insights.
Retail banking is an industry ripe for innovation. While this statement may come across as counter-intuitive in today's difficult credit environment, consider the long-term view: customer satisfaction and efficiency gains are both stagnating; growth has primarily been driven through mergers and acquisitions (M&A); and the vast majority of industry breakthroughs have come from attackers, not incumbents. Historically, banks have seen all of these issues reflected in their stock prices which, on average, are valued almost exclusively on current earnings rather than future growth expectations.
Over 300 financial services executives in a 2007 McKinsey global survey identified three main innovation challenges facing their companies. They were: limited use of customer insights and external idea networks; lack of organizational mechanisms, such as dedicated innovation funding; and poor capabilities in specific areas critical to innovation, such as facilitating a culture for innovation and governing innovation from the c-suite.
These challenges can be overcome by applying proven lessons from global innovation champions who have six distinctive and sustaining characteristics. These include the ability to identify and break orthodoxies that discourage creativity; world-class senior leadership that drives innovation; processes that provide discipline to innovation; a willingness to look outside the organization for ideas and commercialization opportunities; a culture that encourages new ideas; and distinctive approaches for gathering the insights that drive superior idea generation.
Banks must begin to break through conventional thinking by taking a new lens to innovation and the customer experience. Innovation is just as important today— in a slower growth, margin-challenged environment as in better times to fuel the valuations of retail banks beyond M&A.
Growth Divergence
The need for some new thinking in retail banking is obvious. A McKinsey Cross-Industry Customer Experience Survey in 2007 found that retail banking customer satisfaction stagnated from 2006 to 2007 in comparison to other industries, such as department and grocery stores. Even airlines, not usually considered an example of good customer service, experienced a small year-over-year increase.
In addition, retail banks have historically grown mostly through M&A, leaving them with limited organic growth capabilities and competencies. According to a McKinsey analysis of the leading U.S. banks from 1999 to 2006, M&A contributed 62% of overall growth, underlying market momentum drove 54% while the organic share growth actually contracted by 16%. The story for European retail banks is similar. By contrast, top global innovators have made organic growth a major component of their overall growth. For example, organic growth contributed 25% of total growth for leading consumer companies and 13% for the fastest-growing global organizations.
Investors have learned to take this divergence into account. Our analysis of the 2007 share price of the leading U.S. retail banks revealed that, on average, 91% of their value is based on current earnings while only 9% is based on the expected value of future growth. By comparison, approximately 74% of Genentech Inc.’s share price represents the value of future growth, while the figure is 69% for Apple Inc. and 49% for P&G.
What accounts for this divergence? Our global survey of executives in the financial services industry highlighted several fundamental areas in which banks’ operations and organization create barriers to innovation. While a little over half the executives surveyed believe that they have pockets of successful innovation within their organizations, they still face scaling challenges and don’t believe they are capturing maximum value from innovation.
The problem appears clustered in three areas. First, customer insights and external networks play relatively limited roles in idea generation. Nearly two-thirds of the financial executives surveyed identified employees or competitive and market dynamics as the most frequent sources of new ideas in their company. Only around one-third cited data about customer insights, behavior and trends, or external sources, such as partnerships and joint ventures. Less than 1% cited senior management and the CEO as a source for ideas, which suggests the absence of active leadership attention to innovation.
Our research also highlighted a second problem area: few organizational mechanisms are in place for innovation. Forty percent of financial services executives indicated that their company lacks any organizational mechanism dedicated to facilitating innovation. Even more striking, just one-fourth of survey respondents said their company has set aside dedicated funding for innovation initiatives. Additionally, innovation funding is not always aligned with the most important innovation area to drive future growth (see chart, “Innovation Funding Mis-Directed”).
The third problem area that surfaced is in regard to leadership and culture, with just over 30% of financial executives stating that their companies have an innovation council or committee that reviews initiatives and progress. And, approximately 70% rated their performance as poor or merely adequate across leadership capabilities such as establishing clear incentives to innovate and setting clear targets and metrics for innovation initiatives.
Proven Approaches
Retail banks can learn from the proven approaches of global innovation leaders. We have identified six characteristics and capabilities of high-performing innovators that can form the foundation for redefining how banks approach innovation:
- Orthodoxies must be challenged and broken
- Senior leadership separates innovation winners from the pack
- Consumer insights are the foundation for new ideas
- Process and structure matters
- Innovation networks have a lot to offer
- Culture and talent ensure a lasting advantage
Leading innovators identify and break orthodoxies—i.e., industry—and company specific beliefs/behaviors that discourage creativity. An example was the belief held by many analysts that Apple could not be successful in retailing. They believed consumers would not purchase computer products in stores given the dominance of the industry’s direct-selling business model. But Apple bet on a unique retail customer experience and unparalleled service levels. The company now has approximately 200 outlets and a five-year sales compound annual growth rate of 40% from 2003 to 2007. Retail store sales represent 17% of total revenues.
A few of the common retail banking orthodoxies include: the ability to differentiate is limited since product imitation is easy; relationship banking can only be offered to high-value customers; and the branch is the driver of new deposit accounts. Given new technologies and consumer behaviors, are these beliefs still true across all customer segments?
To date, many of the sector’s disruptive innovations have come from attackers, who have challenged these beliefs, rather than incumbents. Consider several attacker positions: PayPal, which led the development of online payments; Intuit Inc.’s QuickBooks, the leader in personal finance software for small businesses; and ING Direct, which targeted Internet-savvy consumers with a high-rate savings offer and a simple, efficient, primarily online customer experience. Incumbent retail banks had the assets to pursue these opportunities but didn’t, in part due to their beliefs about the industry or consumers or both.
Committed senior leadership distinguishes the winners. Leading innovators integrate innovation into the team agenda and make it a systematic part of strategic planning and budgeting discussions. General Electric Co. CEO Jeffrey Immelt established Imagination Breakthroughs, which are projects that were either very difficult or very important and could potentially generate $100-million in new sales in three years. These projects are protected from budget cutting, since Immelt has personally blessed each one and several report their progress directly to him. This activity signals to the organization the importance of innovation to the CEO.
Innovation leaders go beyond focus groups and quantitative analytics to understand consumer needs and emotions. They use a range of consumer insight techniques, such as in-home visits and field trips, to directly observe consumers interacting with products and services. Intuit, for example, set out to develop small business accounting software that would build upon the QuickBooks brand. Ethnographers researched accounting behaviors of small business owners and discovered that over half used simple spreadsheets. Most rejected a stripped down version of QuickBooks because it caused confusion with their bank accounts. Intuit then created QuickBooks: Simple Start Edition after six iterations of ethnographic research with prototypes. In its first year of release (2004), the program outsold all other accounting software in the U.S. except for QuickBooks itself.
Innovation leaders also invest in process and structure to drive change rather than hoping innovations emerge from creative chaos. What our research demonstrates is that leaders implement a set of adaptable processes such as “stage gates” to release funding and approve projects in a venture capital-like model and formal structures in the form of innovation centers or dedicated teams (see chart, “Stage Gates for Innovation,” above).
For example, IBM, which has a large internal research and development (R&D) group, organized an Emerging Business Opportunities (EBO) group to systematically develop new businesses within the organization. Funding for the EBO is protected centrally and based on milestone progress as opposed to short-term business results. The program, developed in 2000, sets out to explore and test emerging business opportunities. A Research EBO group was subsequently added in order to accelerate the transfer of technology in the marketplace. This team thinks about four types of growth: new businesses, new practices, new products and accelerating product extensions.
External idea networks that capitalize on communities of consumers or suppliers are creating real value. Cisco Systems Inc. moved to an open architecture model to get in front of new technologies and not rely solely on internal R&D, which could not keep pace with the market. Cisco signaled to the market that it was open to ideas from technology entrepreneurs resulting in many products and solutions being developed in the hopes of being bought out by Cisco.
P&G has created Connect & Develop, an open source network that is credited with producing more than 35% of P&G’s innovations and billions in revenues. The program brings together technology entrepreneurs and suppliers in communities to generate and share ideas while connecting them to P&G. Large banking companies work with dozens of technology suppliers so this same approach could be utilized.
Finally, innovation champions actively engage employees in a culture that encourages new ideas, where people feel that their opinions are valued. Methods of engaging employees include business plan competitions and call-for-ideas programs. A critical element is how leaders, and especially middle managers, react to new ideas. At BMW AG, design teams in Munich and Los Angeles often compete head-on to develop the best concepts. The company’s culture expects participation from everyone, including those on the shop floor.
Starting Point
The innovation journey depends on your company’s starting point. Some companies have pockets of successful innovation but the organization is not designed to scale and sustain innovation. This requires a top-down focus on driving and managing innovation. Specifically, these companies need to:
- Integrate innovation into the top team agenda and make it a regular monthly topic for discussion and debate;
- Set up an innovation council of top business and functional leaders to drive innovation and manage the portfolio of initiatives;
- Set aside and protect funding for innovation initiatives;
- Set direction through innovation themes that will drive growth and set key targets to be met.
One of the most obvious innovation themes for banks involves the retirement market. Banks have opportunities to serve this market both online and through more personal channels. Our research highlights that 77% of baby boomers are online and 66% research products and services electronically. Nearly half of affluent pre-retirees don’t use a financial advisor while those who have an advisor say they are not necessarily getting what they want. Banks should consider innovative products, channels and advice models that would set them apart within this market (see, “Accentuate the Positive: Building Banks’ Retirement Brand”).
Other relevant consumer trends that offer additional growth potential include the development of online communities and the new ways in which consumers are interacting with each other and segment-specific needs from women or Hispanics.
Innovation is a journey that requires managing an ongoing pipeline of ideas across both short-term and long-term horizons as well as across innovation types—product, distribution, service, process and business models. A balanced portfolio ensures that value is being captured from innovation now and in the future while balancing risk across the options (see chart, “Innovation Pipeline,” above).
During the initial phases of insight generation and concept development, the most important resource is top talent, which is often more scarce than funding for many organizations. Having a few small teams work on the trends and themes identified above for longer-term ideas will go a long way toward focusing leadership on a few areas to place bets. As breakthrough innovation projects develop, they should be funded and tracked differently, avoiding sizing and net present value metrics too soon in the process, both of which frequently result in big ideas turning into smaller ideas in order to fit the required criteria.
For companies that say they don’t have enough big ideas, the focus should be on better capturing and leveraging consumer insights and opening the organization to external idea networks. First, institute regular brainstorming sessions to generate new ideas. Second, get out and personally observe consumers using your products. Many innovation leaders such as Google have regular (weekly or monthly) idea sessions where new ideas are presented, debated and selected for further exploration. Lastly, task a small team to explore a trend or a white space opportunity and require that 50% of their ideas come from outside the organization.
There are companies that say they have good ideas but lack the skill to commercialize new concepts. This requires a focus on two capabilities. The first is to improve and formalize prototyping and testing; consumer insights alone are not a panacea. More effective proof of concept and testing with consumers also speeds the commercialization process. The second is to fundamentally transform the product launch process with tighter linkages and accountability among product development, marketing, lines of business and Information Technology. The classic “hands-off” trap paralyzes organizations from getting many good ideas out the door. “The lines of business won’t execute upon our good ideas” is the typical complaint in these situations.
Most senior financial services leaders see substantial opportunity for their company to improve performance and believe their own role is critical. When asked which practices, if implemented effectively, would promote successful innovation, executives cited how leaders behave—their willingness to consider and implement new ideas—and making innovation part of the top team agenda.
Clearly, innovation is not easy to pull off in retail banking. Banks that invest in developing an aggressive innovation agenda will, however, be better positioned to drive growth and long-term profitability. Is your institution ready to take that step? Ask yourself the following questions about the role of innovation in your company’s future growth plans:
- Does your bank have a clear sense for what products, distribution channels and business models will drive organic growth above the market average in the next three to five years?
- Does your bank have a clear view on what it will be known for beyond convenience, relationship banking and well-priced products?
- Do you know what fundamental operating model changes will deliver the next 10 points of efficiency ratio improvement?
If you answered no to any of these questions, you might consider making innovation a priority.
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