Building Competitive Advantage Through Strategic Cost Reduction

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Deloitte Research A financial services industry study by Deloitte Research FUTURE Building competitive advantage through strategic cost reduction Fit for the

Transcript of Building Competitive Advantage Through Strategic Cost Reduction

Page 1: Building Competitive Advantage Through Strategic Cost Reduction

Deloitte Research

A financial services industry study by Deloitte Research

FUTUREBuilding competitive advantagethrough strategic cost reduction

Fit for the

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For too many firms, cutting costs is a management priority when

business conditions are weak, only to be forgotten when economic

growth resumes. But continually increasing operating efficiency is

fundamental to success in both good times and bad. In this report,

Deloitte Research presents the latest approaches to building

competitive advantage by reducing costs throughout every aspect of

the enterprise.

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CONTENTS

Executive Summary .............................................................. 2

Introduction ........................................................................ 5

A Strategic Approach Required .............................................. 7

Crafting a Cost Reduction Program ........................................ 8

Building Blocks for a Cost Reduction Program ....................... 14

Tomorrow’s Agenda ............................................................ 24

About Deloitte Research ...................................................... 27

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Executive Summary

Financial services institutions need to adopt a strategic approach

to cost reduction that generates near-term cost savings while at

the same time builds a more efficient operating model over the

long term. Firms that use cost reduction to create a leaner, more

efficient organization will not only survive the current difficult

economic conditions, but will also prosper throughout all phases

of the business cycle.

The economic downturn that hit the United States and other

countries in 2001 has made cost reduction the management topic

of the day. Financial services firms have moved aggressively to

cut expenses, including widespread layoffs. But while reduced

business volumes require fewer employees, too often firms fail to

take steps to permanently increase their operating efficiency.

Yet in both good economic times and bad, firms that

successfully increase their operating efficiency are rewarded by

investors. For example, during the period of strong economic

growth from 1997 to 2000, the large banks with the best efficiency

ratios saw their share prices rise by an average annual rate of

13.6 percent, compared to an average annual share price increase

of 9.6 percent for the 100 largest banks. However, the large banks

that showed the greatest improvement in efficiency fared even

better, with an average annual share price increase of 19.2 percent

over the period. Firms that continue to improve their efficiency

are rewarded by investors with higher share prices.

A Strategic Approach Required. To reap these benefits,

financial services firms need to take a strategic approach to cost

reduction with the following five characteristics:

1. Linked to Strategic Goals. The first step is to reexamine a firm’s

business strategy to ensure that it remains relevant to changing

market conditions. A strategic approach then carefully aligns

cost reduction initiatives with the reconfirmed strategy, rather

than relying on across-the-board reductions that could

undermine business objectives.

2. Comprehensive. Instead of focusing only on staff reductions,

strategic cost reduction analyzes the entire organization for

cost-cutting opportunities.

3. Sustainable Cost Savings. A strategic approach increases

efficiency by rethinking both what the firm does and how it

does it.

4. Phased Implementation. Initiatives include both quick wins

and longer-term measures that are more difficult to implement

but offer greater cost savings.

5. Senior Management Commitment. An essential ingredient is

the full commitment of senior management, which can best

be demonstrated by appointing a prominent senior executive

to lead the effort.

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Crafting a Cost Reduction Program. A five-step

methodology can help firms design a strategic cost reduction

program that will create long-term gains in efficiency:

1. Reexamine Strategy. A firm first needs to review its business

strategy to ensure it remains relevant and then clarify its

strategic goals before designing a cost reduction program to

complement them.

2. Establish the Cost Base. A cost reduction program is only as

good as the data on which it is based. Firms need to gather

and analyze detailed data on their current costs, as well as

understand the history of management decisions that led to

the current cost structure.

3. Set Cost Reduction Targets. Firms can establish the goals for

a cost reduction initiative by analyzing the enterprise from

three perspectives: industry best practice, an internal

assessment of cost reduction opportunities, and the level of

cost reduction that is assumed in the current share price.

4. Identify Potential Initiatives. A variety of techniques can be

used to develop a list of potential cost reduction initiatives,

including tapping management knowledge, identifying large

areas of cost and their cost drivers, comparing the level of costs

across the organization, and examining best practices.

5. Prioritize Initiatives. Finally, a portfolio of short-term and

long-term initiatives must be created and prioritized using

criteria such as the investment required, potential benefit,

speed of implementation, and risks involved.

Strategic cost reduction is complex and requires a significant

commitment to be successful. Before undertaking a strategic cost

reduction program, a firm must ask itself some pointed questions:

1. The Devil is in the Details: Does the organization have—or is

it prepared to develop—accurate, detailed cost data on which

to design and defend a strategic cost reduction program?

2. Best Practice: How efficient are individual business units when

compared both internally and to leading competitors?

3. Investor Criteria: What are investor expectations regarding the

size and speed of cost reductions?

4. Gauging Appetites: How urgent is the need to reduce costs?

Does the organization have the appetite for the fundamental

changes required to increase efficiency?

5. Total Commitment: Is senior management fully committed to

the effort and ready to stay actively involved? What methods

and measures are in place to monitor progress? Are these

criteria embedded in the organization and linked to employee

evaluation and compensation systems?

Firms that are prepared to make the commitment to a strategic

cost reduction program can not only generate short-term cost

savings, they also build long-term competitive advantage by

creating leaner, more efficient operations. Financial services firms

that integrate an ongoing search for increased efficiency into their

business cultures will be those that emerge as leaders in the years

ahead.

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CATEGORY SAMPLE INITIATIVESPOTENTIAL COST

REDUCTION* COMMENTS

Human Resources

CATEGORY

■ Pay severance benefits from qualified pensionplan

■ Consolidate pension and benefit programs

■ Link compensation more closely toperformance

■ Renegotiate leases

■ Contest tax assessments

■ Seek government incentives

■ Revise policies and procedures

■ Improve monitoring and enforcement of compliance

■ Revise policies and procedures

■ Improve monitoring of return on spend

■ Tax-efficient structuring of financing, leasing,research and development, and corporaterestructuring

■ Outsourcing aspects of major businessprocesses

■ Strategic partnerships with vendors

■ Create global procurement

■ Create uniform standards

■ Reduce number of suppliers

■ Improve monitoring of contract compliance

■ Shared-service centers to achieveeconomies of scale

■ Straight through processing

■ Billing and collection

■ Procurement

■ T&E administration

5–10%

*Sustainable cost reduction that can be achieved by typical firms consistent with long-term growth. Depending on their specific circumstances, individual firms may achieve either higher or lower cost savings than these estimates. Note: These cost reduction estimates are not cumulative.

BUILDING BLOCKS FOR COST REDUCTION

SAMPLE INITIATIVESPOTENTIAL COST

REDUCTION* COMMENTS

Occupancy Costs

Travel andEntertainment

Advertisingand Marketing

Tax

Outsourcing

Strategic Sourcing

Automation

Reengineering

5–20%

5–10%

5–10%

NA

Up to 10%

15–25%

10–20%

15–20%

25–30%

SOURCE: DELOITTE RESEARCH

■ Single largest expense category, often 50 percentof total expenses

■ Reductions of 25 percent in HR administrativeexpenses are possible

■ Improved HR practices can also drive desiredbusiness outcomes

■ Difficult to achieve short-term savings due to leasecontracts

■ Savings of up to 20 percent are possible, but only ifaggressively pursued; three to five yearsrequired for full implementation

■ Additional short-term savings can be achievedquickly (30 percent or more), but are notsustainable

■ Although larger cost reductions are possible, theseare not sustainable without long-term damage

■ Firms that maintain their level of marketing activitycan gain market share

■ Cost reductions can be substantial, although sizeof savings varies widely depending on thecharacteristics of individual firms and countrytax regimes

■ Shift to lower-cost provider, who performs functionas core competency

■ Replace fixed costs with variable costs

■ Management time and resources freed to focus oncore business activities

■ Opportunity to generate additional revenue fromstrategic partnerships with vendors

■ Outsourcing not a cure for inefficient operations

■ Global purchasing power leveraged

■ Increased price transparency

■ Improved oversight to ensure that appropriategoods and services are purchased and atcompetitive cost

■ Multiple operations centers resulting fromacquisitions have often not been integrated

■ Redundant IT systems can be eliminated andheadcount reduced

■ Service centers can be located where real estateand labor are less expensive

■ Eliminating manual processes can reduceheadcount

■ Reduced interest expense on outstandingreceivables

■ Automated processes are less expensive toadminister and produce fewer processing errors

■ Zero-based evaluation of business processes canresult in significant reductions in headcount

■ Streamlined processes must not weaken riskmanagement controls

■ Elimination of bottlenecks, redundancies,and unnecessary handoffs

FunctionalConsolidation

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Introduction

Increasing efficiency should be a cornerstone of corporate strategy

whether the economy is expanding or contracting, yet most

financial services firms have only focused on cost reduction in

response to the economic slowdown that began in many countries

in 2001. Firms in sectors with declining business activity and

revenues, such as investment banking, have announced deep cuts

in personnel and other expense items to reflect reduced business

volumes. While needed, these volume-related reductions don’t build

sustainable competitive advantage by increasing productivity.

Often, they can instead be handicaps. When business picks up,

headcount and expenses rise once again, and firms must bear the

cost of rehiring and retraining staff.

This phenomenon is most pronounced in the securities

industry, which is dependent on volatile revenues from capital

markets. Longer-term cost reduction programs are more common

among commercial banks and insurance companies, which attempt

to improve their returns through cost-cutting to compensate for

their more stable, but slower-growing, revenues. There are instances

of drastic cost reduction programs even in these parts of the

industry, however, such as the estimated 10 percent reduction in

workforce at Germany’s big banks in late 2001.

Today, all financial services firms are finding that several long-

term trends will continue to place pressure on profits even when

the economy is growing well:

■ Commoditization of Products. For many financial products,

there is little difference in the offerings from different

providers. As financial products become perceived as

commodities, firms are forced to compete more on price.

■ e-Commerce. The Internet has driven down margins by

giving consumers the ability to easily compare offerings

from multiple providers. The motto of LendingTree, which

allows consumers to instantly solicit quotes from its 3,600

participating U.S. financial institutions, sums up the impact

of e-commerce: When banks compete, you win.

■ Increased Competition. Today, banks, securities firms, and

insurance companies have entered each other’s markets as

traditional industry lines have faded. Meanwhile, financial

services firms are now competing as well with

nontraditional competitors, such as retail, industrial, and

software firms.

These long-term trends have all tended to reduce profit margins

for financial services firms, making operating efficiency an

essential ingredient to generating superior shareholder returns.

Efficiency Creates Shareholder Value

We analyzed the performance from 1997 to 2000 of the 100

largest banks in the world as measured by assets. During this

period, the average compounded annual growth rate for their

share prices was 9.6 percent, while their average efficiency ratio

was just under 70 percent. (See Exhibit 1.)

SOURCE: DELOITTE RESEARCH

E X H I B I T 1 . E F F I C I E N C Y C R E AT E S S H A R E H O L D E R VA LU EAV E R AG E A N N UA L P E R C E N T C H A N G E I N S H A R E P R I C E, 1 9 9 7 – 2 0 0 0

100 largestbanks

10 mostefficient banks

10 banks with greatestimprovement in

efficiency

9.6

13.6

19.2

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More efficient banks fared better. The 10 banks in the group

with the best efficiency ratios (defined as the ratio of non-interest

expense to operating income) had an average efficiency ratio of

only 40.4 percent, and their share prices outpaced the group as a

whole, growing at an annual rate of 13.6 percent.

But the greatest increases in share prices occurred in the stocks

of the banks that showed the greatest improvement in their

efficiency ratios, rather than those that were most efficient in an

absolute sense. The 10 banks with the greatest improvement in

their efficiency ratios had an average ratio of just 60.8 percent—

better than the average ratio for the group as a whole, but far

behind the average ratio for the 10 most efficient banks. Yet the

average annual change in their stock prices over the period was

19.2 percent—significantly higher than the 13.6 percent gain for

the 10 most efficient banks.

More efficient firms are rewarded by the market, but the key

to maximizing shareholder value is increasing the efficiency of

operations. Rather than a goal that is ultimately achieved,

continually improving operating efficiency has to become a way

of doing business.

Layoffs: Proceed with Caution

The first way that most financial services firms look to cut costs is

by reducing the number of employees. More than twice as many

layoffs have been announced by companies in the United States

through the first 10 months of 2001—almost 1.4 million—as were

announced in all of 1999 and 2000 combined. Financial services

firms are prominent among the companies reducing the number

of staff. Investment banks cut more than 25,000 jobs through the

first three quarters of 2001. Some financial services firms have

announced that they intend to lay off as much as 20 percent of

their employees in certain divisions.

Even in continental Europe, where labor laws and unions tend

to make layoffs more difficult, firms are also reducing headcount.

One of Germany’s leading banks announced the first staff cuts

since the firm was formed in 1870, saying that staff reductions of

up to 10 percent were possible.

It is not surprising that financial services firms look first to

reducing headcount. Personnel costs are easily the largest expense

item, exceeding 60 percent of total non-interest expenses for some

institutions. Firms added employees rapidly during the 1990s to

serve booming markets in such areas as online securities trading,

M&A, underwriting, and IPOs. Employment in investment banks

around the world swelled by four-fifths over the past decade.

When revenues dropped in most lines of business, firms were

left with excessive payrolls. For example, cost-income ratios for

major securities firms deteriorated between 2000 and 2001.

(See Exhibit 2.)

Financial services firms must be especially careful to ensure

that staff reductions don’t damage customer service or threaten

hard-won customer relationships. One approach is to use

technology more creatively, but this becomes more difficult as IT

employees and budgets are also being slashed.

SOURCE: DELOITTE RESEARCH

E X H I B I T 2 . CO S T - I N CO M E R AT I O S A R E R I S I N G

COST

-INCO

ME

RATI

O, %

100%

Q4

Bank ABank BBank C

90%

60%

TIME

70%

Q3Q22001Q1Q4Q3Q22000Q1

80%

Note: Cost-income ratios for three leading banks

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Firms also face the danger that they will lose valuable

knowledge and skills that can only be replaced with significant

hiring and training costs when business picks up. Some securities

firms laid off employees in the financial crisis of 1998–99 only to

find that they had to rehire them a few months later. Firms need a

clear understanding of what skills they need to retain and what

knowledge each employee possesses.

In fact, a Watson Wyatt Worldwide study found that fewer than

half the companies surveyed after the 1990–91 recession met their

profit goals after downsizing. "The evidence that downsizing

boosts productivity is very weak," Alan Blinder, former vice

chairman of the Federal Reserve Board, told The Wall Street Journal

Europe.1

Even when planned with care, layoffs are at best only one

element of a strategic cost reduction program. Although they

reduce compensation expense, layoffs alone don’t increase

productivity. Firms require a strategic approach to cost reduction

that will generate the short-term cost savings that investors

demand, while creating a more efficient operating model over

the long term.

A Strategic Approach Required

Five characteristics of a strategic cost reduction program provide

advantages over piecemeal approaches:

1. Linked to Strategic Goals. A strategic cost reduction program

doesn’t rely on across-the-board staff or budget reductions.

Instead, it is targeted carefully to ensure that it complements,

rather than unintentionally undermines, a firm’s business

strategy.

2. Comprehensive. Rather than focus narrowly on staff

reductions, strategic cost reduction scours every aspect of the

enterprise to identify opportunities to reduce costs in such

areas as outsourcing, real estate, travel and entertainment,

employee benefits, and procurement.

3. Focus on Sustainable Cost Savings. A strategic approach to

cost reduction goes beyond volume-related savings to create

a more efficient operating model by rethinking both what the

firm does and how it does it.

4. Phased Implementation. A well-planned portfolio of cost

reduction initiatives includes both quick wins that provide

short-term savings and more radical measures that require

more time to implement and more investment but deliver

greater benefits.

5. Senior Management Commitment. A successful strategic cost

reduction program has the full commitment of senior

management, which can best be communicated by appointing

a prominent senior executive to lead the effort. A high-quality

project team is needed to manage the program with three

senior executives in very different roles: a diplomat to mediate

differences, a fixer to manage the operational details of the

program, and an enforcer to ensure that everyone implements

the program developed.

A strategic cost reduction program will produce greater short-

term savings as well as longer-term gains in efficiency. A five-step

methodology provides a framework for designing an effective

program to reduce costs across a firm.

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Crafting a Cost Reduction Program

A methodology with five steps is helpful in designing a

comprehensive cost reduction program:

Reexamine Strategy

Establish the Cost Base

Set Cost Reduction Targets

Identify Potential Initiatives

Prioritize Initiatives

1. Reexamine Strategy

Before designing a cost reduction program, firms need to

reexamine their strategy to ensure that it remains relevant,

particularly within a highly uncertain environment. Once a firm

has reconfirmed and clarified its strategy, it can proceed to design

a cost reduction program that complements it.

A number of prominent financial services firms have been

revising their strategies. AXA and ING both sold their investment

banking subsidiaries to concentrate on other businesses. Zurich

Financial Services ended its foray into asset management by selling

Scudder to Deutsche Bank, and has announced that it will float

Zurich Re in an IPO. Merrill Lynch sold its Canadian brokerage

business to Canadian Imperial Bank of Commerce, while Charles

Schwab announced that it would close its online trading joint

venture in Japan.

Yet the rapid changes in the business environment today

make developing a sound strategy more challenging than ever.

The Wall Street Journal reported that Richard Kovacevich, CEO of

Wells Fargo & Co., told his board that “whatever budget we come

up with is almost meaningless.”2

Traditionally, a firm based its strategy on its best prediction of

what will occur that will affect the firm’s business and when it will

occur. With today’s increasingly uncertain future—whether about

economic growth, consumer preferences, or the impact of

terrorism—firms need an approach to strategy that doesn’t require

them to pretend to have a clear picture of the future.

Deloitte Research calls this new approach “Strategic Flexibility”

— first defining a range of scenarios of what the future may hold

and then developing the optimum strategy to respond to each

scenario.3 (See The Deloitte Research Strategic Flexibility Initiative on

page 26.) Strategic initiatives that are common to all the scenarios

constitute the firm’s core strategy, that is, initiatives that should be

undertaken no matter what the future may hold. Investments to

improve customer service may be part of the core strategy for many

firms. On the other hand, the firm’s contingent strategies only make

sense for certain scenarios. For example, expansion into China may

only make sense if China continues to open its market to foreign

investment as part of its agreed entry into the World Trade

Organization, the political situation remains stable, and Chinese

consumers become more financially sophisticated.

Core initiatives will go forward no matter what scenario comes

to pass. For contingent initiatives, which are only appropriate to

some scenarios, firms must be prepared to implement them if their

scenarios become reality. For example, a firm may forge a strategic

alliance with a Chinese firm to give it the option to expand its

presence in the Chinese market if conditions warrant.

Once the core and contingent strategies have been

formulated, a firm’s cost reduction program will have to

demonstrate the same flexibility. The cost reduction program will

need to ensure that it preserves the capabilities required to execute

the core strategy, while providing the ability to change course as

required to implement contingent initiatives. Commenting on the

uncertain economic environment in which firms operate today,

Don Layton, head of J.P. Morgan Chase’s investment bank, told The

Economist that you “don’t want to bet your life on a forecast. This

makes you more interested in a flexible cost structure, and more

radical in cutting.”4

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COMMERCIAL BANKS* SECURITIES FIRMS **

2. Establish the Cost Base

The next step is to determine the current cost baseline—the costs

that will be incurred if no new cost reduction initiatives are

undertaken. Determining the cost baseline allows a firm to

measure the impact of its cost reduction program by comparing

actual costs to the expense levels that would have occurred

without it. The contribution of major expense categories to overall

spending in major banks and securities firms is provided in Exhibit

3. (Quantifying spending on these categories by insurance

companies and real estate entities is difficult due to reporting

differences.)

A cost reduction program is only as good as the data on which

it is based. Detailed cost data are essential to identify which factors

are driving business costs and provide senior management with

the justification for undertaking cost reductions. An accurate

analysis of transfer pricing is an essential part of this effort. Yet

many financial services firms suffer from poor management of cost

information. A major reason is the complexity of the task, with

around 200 separate expense categories in a typical financial

services organization. Firms can start by analyzing the current

year's budget, along with any necessary revisions to reflect

planned initiatives that are not included in the budget, such as

anticipated staff reductions, increased disaster-protection and

business-continuity measures, or the introduction of new products.

This is also an opportunity to revisit planned initiatives and cancel

any that no longer support the firm’s strategy or fail to meet

investment thresholds.

This top-line analysis then needs to be drilled down, analyzing

each element of the firm’s costs and headcount by business line,

support function, and location. The analysis should include a clear

statement of any rules for allocating central and support services,

such as systems development and marketing, to individual lines

of business.

Beyond simply quantifying the cost base, firms should also

dig into the past to unearth the history of how the organization

came to have its current cost structure. Each organization’s cost

base is inevitably a product of many regimes of corporate

leadership and often numerous acquisitions. Understanding this

history often helps a firm identify promising areas for cost

reduction. For example, a large U.S. commercial bank was able to

reduce mortgage processing costs by 30 percent once it changed

a handful of archaic rules that were no longer relevant.

EXHIBIT 3. EXPENSE ITEMS: COMMERCIAL BANKS VS. SECURITIES FIRMSP E R C E N T, 2 0 0 0

SOURCE: DELOITTE RESEARCH

Compensation 38–50 52– 60(salaries, incentive compensation, and benefits)

Communications and IT 7–20 3–10(including outsourcing)

Occupancy 5–8 4–7

Advertising and Marketing 2–5 4–10

Other 18–25 12–14

Income Tax 17–19 8–15

COMMERCIAL BANKS* SECURITIES FIRMS **

*Analysis of spending of four major U.S. banks as provided in financial statements.**Analysis of spending of three major U.S. securities firms as provided in financial statements.Note: Insurance companies and real estate entities have similar expense categories, but analysis of spending is difficult given reporting differences.

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3. Set Cost Reduction Targets

In setting the goals for a cost reduction program, firms need to

consider what is possible to achieve and also what investors

expect. There is no single method to establish these targets;

instead, they should be analyzed from several perspectives.

■ Competitive View. One approach is to quantify the level of

cost savings that would be required to raise the firm’s

efficiency to the median efficiency of the leading firms in its

industry. Examining what the leading competitors have

achieved provides one perspective on the size of cost

reductions that are possible.

■ Operational View. An internal assessment of possible cost

savings can be developed by analyzing each line of business

and function to identify potential expense reductions and

then aggregating these potential savings across the firm.

■ Investor View. An analysis from an investor’s perspective

determines the level of cost reduction that will be required

to support a firm’s current share price, assuming no growth

in revenues. In this worst-case scenario, the expected

increase in net income reflected in the share price will need

to come from cost reductions alone. Most firms find that this

analysis yields a required expense reduction of 10 to

15 percent.

Each view provides one perspective on the appropriate cost

reduction targets. By examining cost reduction from all three

perspectives, firms can triangulate among them to set a cost

reduction target that is both achievable and acceptable to

investors. (See Exhibit 4.)

4. Identify Potential Initiatives

Once the strategy is set, the next step is to identify potential cost

reduction initiatives. Four distinct methods are available. By using

them all and aggregating the results, a firm can generate a

comprehensive list of potential initiatives—a more

comprehensive list than would be generated by a single approach.

The four methods are the following:

■ Management Knowledge. Where do management and

employees believe opportunities exist? Interviews, focus

groups, and workshops can be held with employees at all

levels to collate their knowledge of operations and steps that

could be taken to lower costs. Although the suggestions

generated by these sessions are often directionally correct,

they should be treated as hypotheses that need to be tested

against facts.

SOURCE: DELOITTE RESEARCH

E X H I B I T 4 . S E T T I N G CO S T R E D U C T I O N TA R G E TSILLUSTRATION FROM MAJOR COMMERCIAL BANK

DESCRIPTIONPOTENTIAL SAVINGSOF TOTAL COST BASE

Savings OpportunityAssessment

Operational View

Competitive View

Investor View

■ Benchmark comparison ofkey performance metrics

11–15%

■ Assessment of cost reductionopportunity by organizationand function

10–15%

■ Shareholder expectationimperative based onaverage return

7–11%

10–13%Potential Savings

10–13%Potential Savings

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■ Cost Structure Analysis. Where are the large areas of cost

and what are the primary cost drivers? A firm can also

analyze each expense line item across all functions, lines of

business, and processes to identify which have the highest

costs for particular expenses and which are most appropriate

to reduce.

A firm should also identify high-cost processes that cut across

line items and lines of business, such as billing, payment, and

transaction processing. This analysis can discover areas

where similar or duplicate activities are being performed by

different functions that could be streamlined.

■ Internal Comparative Analysis. How do costs compare

across the organization? By comparing cost centers in the

firm, a firm can identify where costs are high relative to

revenues. A comparative analysis should be conducted of

costs for business units, product groups, delivery channels,

geographic locations, and customer segments. This analysis

can discover discrepancies in staffing or expense levels,

although it must always take into account the specific

requirements of the products or services involved. It can also

highlight areas that have significant levels of manual

processes that could potentially be automated. A

comparative analysis can identify the best practices that the

firm should consider replicating.

■ External Comparative Analysis. How does the firm

compare to best practices? For each area, a firm needs to

assess how its performance compares to the companies

exhibiting best practices. The firm should then determine

what level of improvement would be required to place it at

or near best practice on the relevant metrics.

This phase results in a list of potential cost reduction initiatives,

which can then be prioritized to create a cost reduction program.

5. Prioritize Initiatives

The final step is to prioritize the list of potential initiatives. While

each firm needs to develop evaluation criteria suited to its

situation, the following considerations are likely to form the core

of any evaluation:

■ Required Investment. What is the required investment,

both financially and in staff time?

■ Size of Benefit. What is the potential benefit if

implemented?

■ Speed. How quickly will the expected benefits be realized?

■ Ease of Implementation. How easily can the initiative be

implemented? Are there technical or cultural obstacles?

■ Risk. How significant are any risks in implementation?

■ Contribution to Strategy. How will the initiative affect the

organization’s strategic goals?

■ Impact on Business Continuity. How will the initiative

affect the firm’s ability to withstand a disruptive event and

maintain continuous operations?

Using the criteria developed, the firm can design a program with

a mix of short-term and longer-term initiatives in which each

phase generates a positive return on investment and is aligned

to overall business goals. A detailed business case must then be

developed for each high-priority initiative, detailing the required

investment, the timetable to implement and to realize savings,

and the benefits promised. (See Exhibits 5 and 6.)

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SOURCE: DELOITTE RESEARCH

E X H I B I T 5 . D E S I G N I N G A P O RT F O L I O O F CO S T R E D U C T I O N I N I T I AT I V E S

INCR

EASI

NG B

ENEF

ITS

AND

SUST

AINA

BILI

TY

High

Medium

Low

Creating a low-costoperating model

INCREASING IMPLEMENTATION TIME AND COSTS

Streamliningthe cost base

Quick wins

Short LongMedium

■ Reengineering■ Automation

■ Outsourcing

■ Functional consolidation

■ Strategic sourcing

■ Human resources

■ Tax

■ Travel and entertainment

■ Real Estate

■ Advertising and marketing

SOURCE: DELOITTE RESEARCH

E X H I B I T 6 . P R I O R I T I Z I N G P OT E N T I A L CO S T R E D U C T I O N I N I T I AT I V E S

Contributionto strategy

Sharedservicecenter

Migration oftransactionprocessing

ITdevelopment

rationalizationTrading deskconsolidation

Riskmanagement

efficiency

Potential sizeof benefitEase ofimplementation

Efficiency gap

Speed ofrealization

Organizational impact

Priority 1 2 1 2 2

OPPORTUNITY (EXAMPLES)

CRITERIA

= Low = Medium = High

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■ Across-the-Board Cuts. Indiscriminate reductions that cut

muscle as well as fat.

■ Strategy Undermined. Cost reductions that threaten the core

capabilities required to achieve the firm’s strategic objectives.

■ No Buy-in. Insufficient input and involvement by employees who

are best placed to identify savings and will have to achieve them.

■ Analysis Paralysis. Prolonged analysis of the business and

potential opportunities.

■ Too Many Initiatives. No single message about what is most

important.

■ Wrong Mix of Initiatives. For example, a few large, complex

projects, instead of a mix of easy and hard, short- and long-term

projects.

■ Inadequate Leadership. Lack of active and visible involvement

by senior management.

Mistakes to Avoid: Features of Unsuccessful Cost Reduction Programs

Mistakes to Avoid: Features of Unsuccessful Cost Reduction Programs

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Building Blocks for aCost Reduction Program

The cost reduction methodology outlined above will yield a

coordinated set of initiatives specifically tailored to a firm’s needs.

But while each firm is unique, cost reduction initiatives can be

organized into broad categories that are relevant to most

organizations, which range from those offering quick wins to

others providing substantial savings but requiring a longer

commitment of time and resources. This section describes some

of the areas, including a sampling of innovative practices, where

many firms find opportunities to reduce costs and increase

operating efficiency.

Human Resources Initiatives Beyond Layoffs

Personnel costs are by far the largest expense item for financial

institutions, and firms have made reducing these costs a top

priority. Automation and reengineering are two strategies that can

reduce the number of employees required for a given volume of

business by increasing a firm's operational efficiency. (See the

sections on Automation, page 21, and Reengineering, page 22.)

Beyond reducing headcount, however, additional strategies are

available to reduce personnel expenses. Here we focus mainly on

examples from the United States to illustrate practical examples

of short-term cost reduction initiatives.

Severance Payments. Layoffs reduce compensation expense,

but they also require firms to pay significant severance benefits.

In the United States, firms can often reduce these expenses

through innovative strategies that pay severance benefits from

the firm’s qualified pension plan. If its pension plan is over-funded,

a firm can pay severance benefits from pension assets rather than

from operating revenues. In addition, the firm saves FICA taxes,

which range from 2.9 percent to 15.3 percent. (The individuals

receiving the benefits save FICA taxes, as well.)

Even if no headcount reductions are expected, an opportunity

exists to turn surplus pension assets into working capital by

transferring non-qualified executive pension benefits to a

company's qualified plan. One large U.S. bank used this approach

to realize a one-time cash-flow savings of US$6 million.

When a pension plan is not over-funded, a firm can still often

achieve a valuable cash-flow savings by paying benefits from the

plan and then repaying over a 30-year period. In addition, the first

payment may not be due for more than a year, depending on the

specific date of the transaction. For a firm with a US$1 million

severance payment, the annual amortized repayment over 30

years at 8 percent would be US$108,500. The reduced cash flow is

especially valuable in the current economic climate.

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Employee Benefits. Typically, 18 to 20 percent of

compensation expense goes to employee benefits. With

compensation often accounting for up to 60 percent of a financial

services firm’s total expenses, benefits alone can account for

12 percent of total expenses. Yet, the cost of employee benefit

programs has not usually been managed as aggressively as other

elements of the business.

Some financial services firms have four or five separate

pension and benefit programs, often due to acquisitions, resulting

in higher administrative costs. The level of benefits may also vary

significantly across plans, increasing costs and threatening to

undermine morale. By consolidating pension and benefit plans,

firms can reduce both fees to vendors and internal administrative

costs. Where plans differ in the level of benefits provided, firms

can consider moving over time to a uniform level of benefits at a

lower cost. An analysis conducted for a major U.S. insurance

company found that rationalizing employee benefits could

potentially realize more than US$40 million in annual savings.

Compensation Structure. Compensation systems are

coming under scrutiny to ensure that they support a firm’s strategy.

A common approach is to link incentive compensation more

closely with performance. Today, many firms are paying too much

for poor performers and not enough for high performers. As part

of this review, firms are also considering shifting short-term cash

compensation to longer-term programs that serve to retain strong

performers. Innovative non-qualified deferred compensation and

performance-driven equity plans are two approaches that some

firms are adopting. Critical to the development of these plans is

their link to individual performance. Finally, firms are using strategic

performance management systems that identify the critical

competencies that are required to achieve the firm’s business goals

and then linking these competencies to merit increases and

promotions. Employing a range of these techniques has the

potential to reduce a firm’s cost of sales by 3 to 6 percent.

Administrative Efficiency. Firms have the opportunity to

significantly reduce their costs of HR administration, often by as

much as 25 percent. As the result of mergers, acquisitions, and

ERP implementations, many large financial services firms are faced

with a complex web of HR technologies and systems. Some

services may be outsourced to vendors, while others are managed

internally on multiple legacy systems. Coordinating and

rationalizing these systems and delivery models can reduce

administrative costs by increasing automation and boosting the

productivity of the HR function. Service levels can improve as well,

with managers and employees gaining remote access to timely

HR information.

Additional techniques can also generate administrative

savings. Employees in other departments performing HR functions

can often be consolidated or eliminated. In some cases, headcount

can be reduced by consolidating technology staff in HR with those

supporting payroll, T&E, tuition reimbursement, and benefits

collections. Consolidation of search firms at a time when little

hiring is being done can provide significant negotiating leverage

that will yield sustainable savings in recruitment fees when the

pace of hiring picks up. Finally, some firms are reducing costs by

outsourcing HR administration to an outside vendor. (See Page

18.)

Training. Consolidation of training programs and use of the

Internet to facilitate training (e-learning) can provide both direct

and indirect savings by reducing the costs of program

development and delivery and by increasing employee

productivity by eliminating travel. Although these initiatives are

far from simple, requiring changes in both infrastructure and

business culture, they can generate significant cost reductions that

can be measured in the hundreds of millions of dollars for large,

global enterprises.

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Reducing Occupancy Costs

Real estate is a large item on a financial services firm’s income

statement, yet it does not always receive adequate attention in

cost reduction programs. Interest expenses are a key factor in

overall real estate costs, and firms need to monitor carefully

refinancing opportunities as interest rates change. Firms can also

reduce occupancy costs and generate needed cash flow through

other innovative approaches to their real estate.

Renegotiating Leases. In the wake of September 11th,

financial services firms are more interested in dispersing their

operations— particularly from Manhattan—and other central

business districts to minimize the impact in case of another attack.

The lower occupancy costs in suburban locations are another

attraction. These trends have given tenants, especially well-known

firms, an increased ability to renegotiate their leases. The potential

savings from renegotiation vary greatly depending on the

dynamics of each real estate market and the negotiating power

of the firm, but some firms can hope to achieve rent reductions of

up to 10 percent.

Contesting Real Estate Assessments. Firms that own

property may have an opportunity to reduce their property tax

liability by contesting their assessments. Property values are now

declining, yet most assessed values were established when

property values were higher.

Seeking Business Incentives. Firms should examine the

opportunity to secure business incentives from state and local

governments, such as reductions or deferrals of property and sales

taxes. While the potential may be highest in New York City in light

of September 11th, governments around the United States are

likely to be more receptive to requests for business incentives as

they work to retain jobs and business activity in the midst of the

economic slowdown.

Containing Travel and Entertainment Expenses

Travel and entertainment (T&E) expenses are an attractive target

for expense reduction. In most cases no investment is required,

only changes to policies and procedures that can usually be

implemented quickly.

For example, some firms are requiring special permission

before employees can travel first-class, while others are banning

first-class travel completely. Firms are also canceling many trips

entirely in favor of videoconferencing and webcasts.

Having systems in place to ensure that T&E policies are

followed is just as important as having the right policies. Firms

can arrange with their travel management firm to receive a pre-

trip report showing who is going where, at what price, and why, so

that they can confirm that the travel arrangements conform with

policy.

Fraud is also a problem that firms need to address with closer

monitoring. A 2001 Gallup survey of 10 million U.S. employees

suggests that at least 25 percent use creative accounting when it

comes to their expense reports, such as inflating claimed taxi fares

or requesting reimbursement for personal expenses.

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Advertising and Marketing Expenses

Advertising and marketing expenses are a significant expense

item, often accounting for 2 to 4 percent of total expenses. Firms

can trim marketing expenses by working smarter—negotiating

harder, consolidating vendors, and assessing more carefully the

return on their marketing investment. Beyond such efforts to

achieve the same results at lower cost, the discretionary nature of

these expenditures leads some firms to target advertising and

marketing budgets for more drastic reductions. Firms have the

option of cutting back on advertising, reducing direct mail, and

canceling promotional events. Even better, these savings can be

achieved quickly, often within 60 to 90 days. The shrinking size of

many business publications due to fewer pages of advertising is

testament to the appeal of cutting marketing budgets.

But drastic reductions in advertising and marketing may be

penny-wise and pound-foolish. A marketing campaign requires a

year or more before it creates awareness in the marketplace and

generates results. Firms that slash marketing will only have to

increase expenses eventually, often at greater cost, to avoid losing

business.

So far, many financial services firms appear to have realized

the importance of maintaining a strong marketing presence.

Advertising by U.S. banks increased 12.4 percent in the first nine

months of 2001 compared to the comparable period a year before.

An informal survey by U.S. Banker found that many banks

continued to increase their advertising in the fourth quarter as

well .

Firms that can maintain spending, or cut only modestly, can

build market share. "When other companies are pulling back on

advertising, you have an opportunity to be heard and to have a

greater impact," Karen Mulvahill, senior vice president at Comerica

Inc., told U.S. Banker. "The strong companies really should stay in

there .”5

Minimizing Tax Liability

Financial services firms can often reduce expenses through

innovative strategies to minimize their tax liability in the

jurisdictions around the world where they do business. In many

cases, cash flow can also be increased by deferring required tax

payments to a subsequent year. Other cost reduction initiatives,

such as disposition of subsidiaries or strategic procurement,

should be structured carefully to take advantage of tax provisions

that can minimize tax liability.

Tax-reduction opportunities vary by country. By way of

illustration, the following are some of the opportunities for firms

operating in the United States to reduce tax liability.

Tax Implications of Other Strategic Cost Management

Initiatives. Many, if not most, cost reduction initiatives have

significant tax aspects. For example, termination-type payments

when reducing headcount can often be made in a tax-efficient

manner. Closing or consolidating offices will have international

tax and/or state and local tax consequences that must be

managed carefully.

Corporate Restructuring. When restructuring, a firm can

often significantly reduce its effective tax rate and avoid Subpart

F and foreign tax credit limitations with respect to its business

outside the United States, as well as enable the U.S. operations to

access low-taxed earnings and profits accumulated by its non-

U.S. affiliates. Restructuring should also be considered in state and

local tax planning, as well.

Research and Development. Firms can often obtain research

and development credits of approximately 1 percent of their

annual information technology expenditures using such

provisions as the Research Credit Fixed-Base Percentage

Reduction, Enhanced Research Credit for Flow-Through Entities,

and Increasing Qualified Research Wages.

Financing Strategies. In some circumstances, a firm may be

able to take interest deductions in both the United States and a

foreign jurisdiction. Other strategies reduce tax liability when a

U.S. firm finances non-U.S. acquisitions or refinances existing

obligations of their foreign subsidiaries.

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Outsourcing

Outsourcing has been a popular cost reduction strategy for years,

but now firms are applying the concept more broadly and

employing new outsourcing arrangements. Firms turn to

outsourcing to benefit from the economies of scale that a service

provider with larger volumes enjoys, while avoiding large IT

investments. In addition, outsourcing allows firms to focus

resources and senior management time on core business

activities.

But outsourcing is not a cure for an inefficient operation—in

many ways it is as closely linked with financial management as it

is with cost reduction. To reap the maximum benefits, workflow

should be streamlined before it is outsourced, and then the firm

needs to work with its vendor to continually improve operations.

For this reason, many firms are looking for shorter contract periods,

for instance, five years rather than 10 years, so that they can change

the specifications of the contract as their business evolves.

Financial services firms are taking a fresh look at their

operations to see if there are additional opportunities for

outsourcing. Processes or functions that are not central to a firm’s

strategy make good candidates.

Business Process Outsourcing. In the past, firms have

outsourced specific processing services, such as consumer

payments, claims, payroll, or orders, as well as specific aspects of

their information systems, such as data center operations, desktop

management, and e-commerce services. Now firms are moving

to outsource aspects of major business processes, such as finance,

human resources, marketing, and sales. Business process

outsourcing across all industries is growing at 29 percent annually,

much faster than other types of outsourcing.

The following are just a few of the firms that have

substantially reduced operating costs through outsourcing

business processes:

■ One of the top five bank holding companies in the United

States outsourced its process for issuing credit cards, which

involved several groups in the firm. Although moving from

an in-house to a third-party provider was complex, the

change resulted in a US$6 million reduction in its total

annual cost of US$30 million.

■ By outsourcing its IT operations, a major U.S. insurance

company reduced its IT expenditures by 20 percent, while

still handling increased volumes.

■ A European insurance company’s U.K. operations saved

£15 million annually by outsourcing its IT operations.

New Outsourcing Models. Not only are firms outsourcing new

functions, they are also employing new business models. Some

firms are entering into relationships with their vendors that are

more like strategic alliances than traditional vendor relationships.

For example, Bank of America signed a 10-year contract for

US$1.1 billion with Exult, which will assume responsibility for

much of the bank’s human resources and administrative services,

including payroll, accounts payable, and travel-related expenses.

In addition to receiving a guaranteed savings of 10 percent per

year, Bank of America will have access to sell financial services to

the roughly half million employees of other Exult clients, like BP

Amoco and Unisys Corporation.

Financial services firms are also collaborating with their

competitors to achieve higher volumes and economies of scale.

In the United Kingdom, Barclays and Lloyds TSB (the third and

fourth largest banks in the country) combined their check

processing into a new company controlled by Unisys. Each bank

has a 24.5 percent interest in the new company, which will not

only handle their own check processing, but will also compete

for business from other banks.

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Strategic Sourcing

Many financial institutions pay little attention to their external

spending and consequently miss out on the huge potential for

cost savings provided by strategic sourcing. Savings can be

achieved on a broad range of purchasing categories, including

employee benefits, telecommunications, advertising and

marketing materials, travel, facilities, and maintenance. (See

Exhibit 7.) Procurement should always be aligned with a firm’s

strategic goals and take into consideration such factors as service

quality, corporate relationships, and competitive dynamics. While

cost is never the sole consideration, firms can achieve important

cost reductions by reviewing their procurement processes.

Most firms purchase supplies and services from a wide variety

of vendors. Price varies between vendors, and each may have

different terms and conditions of sale, making analysis and

comparison difficult. The purchasing process often varies, with

individual departments or branches deciding which products and

services to purchase, and negotiating contracts separately. The lack

SOURCE: DELOITTE RESEARCH

E X H I B I T 7 . P OT E N T I A L S AV I N G S F R O M S T R AT E G I C S O U R C I N G

Vendorconsideration

Tough vendornegotiations

Savings LOSTdue to vendor

non-compliance

Typical purchasingresult

Create pricetransparency by

unbundling

Leverage vendoreconomics

Define andmonitor product

standards

Monitor andenforce vendor

compliance

Strategicsourcing

result

3%

22%4%

5%

3%

4%

6%

-4%7%

Users should be orderingonly what they need.Exceptions should bemonitored andappropriately controlled

Straightforward pricing metrics allowbid comparison and facilitate vendorcompetition

Effective monitoring prevents and/orrecaptures savings lost due to vendorcheating

Making a customer cheaperto service enables a vendorto offer a lower price

Lacking a comprehensive pricetracking system, most vendorswill find ways to charge morethan negotiated rates

Sourcing 101

TRADITIONAL WINSTYPICAL CLIENT SITUATION

VALUE ADD

Traditional sources of savingsAdditional sources of savings

of standards makes it difficult or impossible to ensure that

appropriate amounts of goods and services are purchased at a

competitive cost and that contracts are enforced. By making

numerous individual purchases, firms forego economies of scale.

Firms usually attempt to improve sourcing by increasing

competition—soliciting additional bids and negotiating harder.

While these are helpful, other strategies that can unlock additional

savings are often overlooked. Innovative strategies include the

following:

■ Increasing price transparency by disaggregating bids.

■ Reducing complexity by establishing uniform standards.

■ Reducing the number of suppliers within a given category.

■ Improving monitoring and enforcement of contract

compliance.

■ Creating a global procurement structure to leverage the

organization’s global purchasing power.

■ Working in partnership with key suppliers to jointly lower

costs.

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The following firms illustrate the substantial savings that can

be achieved by strategic sourcing:

■ One of the largest commercial banks in the United States

was concerned to reduce its US$500 million annual

procurement expense, especially since a merger had left it

with duplicate vendor contracts in such areas as computer

maintenance, direct marketing, and office equipment. By

renegotiating duplicate vendor contracts, the firm reduced

procurement expense by more than US$50 million within

the first 12 months, and expects the program to yield

US$80 million in annual cost savings when fully

implemented.

■ A major U.S. commercial bank undertook an aggressive

program to reduce its annual telecommunications expense,

including contracts for voice, data, and wireless service. The

firm analyzed best practices in the industry and reorganized

its telecommunications sourcing through such initiatives as

renegotiated contract rates, competitive bidding, a central

contract database, and enterprise-wide sourcing. The

strategic sourcing program reduced the bank’s total voice

and data bill by 15 percent within 24 months.

■ A global diversified financial services company

headquartered in Europe established global procurement

and uniform procurement processes for IT, renegotiated its

fragmented IT contracts using competitive bidding, and

installed a new procurement technology infrastructure. The

result was a savings of approximately US$200 million in the

firm’s annual IT procurement expense of US$1.2 billion.

Strategic sourcing is a critical tool for financial institutions that

want to achieve sustainable cost savings. A holistic approach to

sourcing can not only reduce overall spending, but can also yield

additional benefits including better service levels and improved

access to the latest technologies. Strategic sourcing is more than

a tactical cost reduction effort. Instead, it is integral to developing

sustainable long-term competitive advantage.

Functional Consolidation

Creating shared-service centers to centralize functions such as

accounts payable, customer order processing, credit card

processing, and other back-office functions can achieve significant

savings—although moves to concentrate operations need to be

balanced with concern over risks from disasters. Today, most firms

maintain multiple centers for these activities, often located in each

of the countries or regions where they operate. Financial services

firms that have grown through mergers have often not integrated

the operations and information systems of each of their

acquisitions.

Moving to centralize these activities drives down costs in

several ways. Redundant IT systems are eliminated, leading to

fewer hardware and software purchases and a lower headcount.

Shared-service centers can be located wherever real estate and

labor are cheapest, provided the labor force is adequate and well-

trained. Firms have put these centers in such locations as India to

benefit from lower operating costs.

Firms can hire the best expertise centrally and make it

available to its divisions and subsidiaries. Given their lower

volumes, local divisions often can’t justify the expense of hiring

top-quality IT professionals.

A major European insurance company with global operations

was formed from a merger, resulting in more than 1,000 IT

employees and an annual IT budget of more than US$100 million.

By reducing the number of mainframe operations centers from

five to two and streamlining the IT function, the firm was able to

reduce its annual IT expenses by 20 percent over three years.

A major investment bank made significant savings from the

centralizing of a number of disparate activities into a new unit

created to administer all business services. The centralization

involved the merging together of real estate, human resource,

procurement and financial operations into a central unit. The

complex operation took 18 months and involved 4,000 staff, but

the bottom-line benefits were significant with a fifth of total costs

being removed.

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Centralization also improves service. With all the data for a

particular aspect of the organization in one location, gaining

access to data for any location or business unit becomes easier.

As a result, management reports analyzing data across the

enterprise can be produced more quickly and cheaply.

Automation

Financial services firms have opportunities to reduce headcount

and administrative expenses by using technology to automate

manual processes. While these projects can be complex, the cost

savings are significant. Beyond increased efficiency, firms also

benefit from reduced processing errors.

The following are a few of the areas where financial services

firms have achieved substantial cost reductions through

automation.

Straight Through Processing. Broker-dealers are

automating trade processing to reduce settlement times to T+1,

that is, settlement within one day after a trade occurs. Asset

management firms are investing in order management systems

that route orders to multiple brokers, and provide portfolio

modeling and compliance verification. Traditional exchanges and

alternative trading systems are also investing to prepare for ever-

expanding trade volumes.

For example, one diversified financial services firm now

processes almost 100 percent of its investment accounting and

asset management transactions automatically. The firm’s

automation project achieved its return on investment in 15

months and reduced total expenses by 40 percent.

Another example is a global investment bank that cut the

costs of processing money market transactions in half over a two-

year period by eliminating most manual processes. The project

has been so successful that it has created a joint venture to offer

similar back-office processing services to other banks.

The ultimate vision for securities firms is straight through

processing (STP)—the processing of trade information from front

office to confirmation, payment, and delivery automatically,

without the need for manual processes such as the re-entering of

information. Our analysis found that achieving STP would result

in an estimated 15–20 percent reduction in annual operating

expenses after the initial investment for a hypothetical broker-

dealer, due to the improved labor and systems efficiencies.

With STP requiring a substantial investment at a time of

declining revenues, each firm will need to assess carefully its

current processing environment and where it should invest limited

resources. Some firms with older technology will find that they

need to replace significant portions of their legacy systems to

achieve STP. But other firms will be able to avoid the expense and

complexity of replacing legacy systems, at least in the near term.

Instead, they will upgrade existing systems and rely on the latest

technologies to knit them together. These firms are turning to Web-

enabled tools, data warehouses, and middleware to allow multiple

legacy systems to seamlessly interact and function as if they were

one.

e-Procurement. Many firms are going beyond simply

purchasing online to automating the entire purchasing process,

with data entered manually only once and then routed

automatically, so that most paper is eliminated. E-procurement

systems not only order goods electronically, they can automatically

match the goods received with the purchase order and invoice.

Some systems automatically notify the supplier that payment has

been authorized so that the invoice can be eliminated and the

reconciliation process simplified. Financial data are updated in real

time throughout the process and can link with the firm’s financial

systems.

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Reducing the Billing and Collection Cycle. Firms can

generate significant savings by reducing the time required to set

up accounts, generate invoices, and collect outstanding balances.

The strategies that have proven successful include clearly defining

performance goals across functions within the firm, standardizing

contracts, streamlining account setup and maintenance, and

automating the production and distribution of invoices. These

initiatives not only reduce operating expenses, they also improve

cash flow that results in increased interest revenue of

approximately US$11,000 per day for each US$100 million in

revenue.

Travel and Entertainment Administration. Automation can

reduce the 10 percent of total T&E expenses that is spent on

administration. One innovation is automated reporting. An

analysis by Visa International found that automated reporting

systems can achieve supplier discounts of 18 percent and

administrative savings of 80 percent. For example, while the cost

of processing a manual expense report is about US$25, the cost

drops to just a few dollars in an automated system.

Reengineering Business Processes

Some of the greatest long-term gains in operational efficiency are

achieved when firms reengineer business processes to

fundamentally change how work is done. Benefits from

reengineering can be maximized by integrating it with other cost

reduction initiatives such as strategic sourcing and automation.

The approach is to take a zero-based evaluation of each business

process and ask: How would the firm design this process today if

it were starting from scratch?

The first step is to define the core functions of the organization

and the individual business units. Secondly, the uses, value, and

output of each activity need to be assessed in light of the firm’s

goals to identify steps that don’t add value. A useful technique is

to map each process to identify any bottlenecks, redundancies, or

unnecessary handoffs.

Once a new process has been designed, most firms use piloting

and simulation to test and optimize the design. An important

consideration is that the streamlined process not weaken risk

management controls or expose the firm to other liabilities. Firms

then need to develop the business procedures and rules to govern

the process and build the necessary infrastructure to support it.

They also need to consider the impact of the redesigned process

on the organization, for example, whether the need for physical

facilities or for employee training will change.

Redesigning a business process to eliminate unnecessary steps

usually allows a firm to reduce headcount significantly. (See Exhibit

8.) In addition, streamlining processes saves additional expenses

by reducing cycle time and error rates.

The redesign of the telephone mortgage lending process by

a major U.S. commercial bank provides a good example of what

can be achieved. The bank set a goal of increasing the efficiency of

its mortgage process to match best practices in the industry. In

addition, it wanted the redesigned process to deepen the customer

relationship and improve the bank’s value proposition.

The bank increased efficiency and reduced errors in the

telephone mortgage lending process by reducing the number of

handoffs between departments from five to two. The loan center

associate who makes the loan decision now notifies the customer

directly, rather than passing the decision back to the sales associate.

The ultimate goal is to reduce handoffs to just one—the loan center

associate will receive the application, make the decisions on

lending and collateral, prepare the closing documents, and only

hand off the loan to a personal banker to conduct the closing.

The results have already been dramatic. The time required to

make a decision on a loan application dropped an astounding

87 percent in a year and a half—from 2.4 days to just 0.3 days. The

total cycle time from loan application to closing has dropped from

36 days to 19 days. With quicker service, revenues and customer

satisfaction are both up.

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SOURCE: DELOITTE RESEARCH

E X H I B I T 8 . S A M P L E R E E N G I N E E R I N G P R O J E C T

Relationshipmanagers

30%

STAFFING IMPACT ANALYSISPOTENTIAL IMPACT OF REENGINEERING ON STAFFING LEVELS

CORPORATE LENDING GROUP AT A MAJOR BANK

BEFORE AFTER

Lendingmanagers

27%

Analysts

22%

Creditstaff

11%

Othersupport

10%

Totalimpacted

staff

100%

Seniorbankers

15%

Relationshipbankers

33%

Creditand

support

38%

Total staffto be

redeployed

14%

PROCESS MAPS

BEST PRACTICE LOAN APPLICATION PROCESS

Prepare streamlinedonline application

Review andapprove application

Transmit authorizedapplication

Loan operations startsprocessing loan

Annual savings US$2.7M

BACKOFFICE

MIDDLEOFFICE

FRONTOFFICE

CURRENT LOAN APPLICATION PROCESS

Begintwo-page

transactionmemo

BACKOFFICE

MIDDLEOFFICE

FRONTOFFICE

Prepareapplication,including all

write-upsand analysis

Departmentmanager

chopscompletedapplication

Receivetransaction

memo

RM requestsglobal

exposurereport as

appropriate

CDAcompletes

preliminaryrisk

assessment

CDA sendsapplication

to CCO

COrequests

additionalinformation

from RM

COcompletes

risk analysis

RM providesadditional info to CO

as requested

CO forwardsapplication

to grouphead fordecision

CO informsRM verballyand sends

memo

RM receivesapproved

application

RMcompiles

packet for LCD

RMcompiles

packet for LCD

CCO chopsapplication

LCD reviewsapplication

Legal chopsapplication

Loan opsstarts

processing

RM submitsclosingmemo

SUPPORT

Annual savings US$2.7M

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Tomorrow’s Agenda

Optimizing operating efficiency should be a linchpin of corporate

strategy in both good economic times and bad. Too often,

however, financial services firms only focus on controlling costs

when they are forced to respond to a slowing economy. Many

firms then rush to reduce staffing levels and other expenses to

reflect reduced business volumes. Yet volume-related reductions

alone leave firms no more efficient than they were before. And

unless targeted carefully, cost reductions can threaten to

undermine a firm’s business goals and value proposition.

To gain long-term competitive advantage and increase

shareholder value, firms need to make ongoing improvements

to operating efficiency a permanent way of doing business

throughout the business cycle. A strategic approach ensures that

a cost reduction program generates permanent improvements

in operating efficiency, while being aligned with a firm’s business

strategy.

Strategic cost reduction is not for the faint of heart—there is

little gain without pain. Before embarking on a cost reduction

program, firms need to ask themselves some fundamental

questions:

1. The Devil is in the Details: Does the organization have—or is

it prepared to develop—accurate, detailed cost data on which

to design and defend a strategic cost reduction program?

2. Best Practice: How efficient are individual business units when

compared both internally and to leading competitors?

3. Investor Criteria: What are investor expectations regarding the

size and speed of cost reductions?

4. Gauging Appetites: How urgent is the need to reduce costs?

Does the organization have the appetite for the fundamental

changes required to increase efficiency?

5. Total Commitment: Is senior management fully committed to

the effort and ready to stay actively involved? What methods

and measures are in place to monitor progress? Are these

criteria embedded in the organization and linked to employee

evaluation and compensation systems?

These questions are not easy to answer. But as the experiences of

the financial services institutions presented in this report

demonstrate, firms that make the organizational commitment to

design, implement, and monitor a strategic cost reduction

program can achieve dramatic increases in efficiency. Financial

services firms that adopt a strategic approach to cost reduction

that goes far beyond layoffs will not only survive the current

economic slowdown, but emerge as leaders in the years ahead.

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End Notes1 "Layoffs Can Hurt Firms More Than They Help; Beware of

Damage to Staff and Customer Trust," The Wall StreetJournal Europe, February 22, 2001.

2 “Uncertainty Inc.,” The Wall Street Journal, October 16, 2001.

3 Strategic Flexibility in the Financial Services Industry: CreatingCompetitive Advantage out of Competitive Turbulence,Deloitte Research, 2001.

4 “So long, banker,” The Economist, October 27, 2001.

5 "Advertising Budgets Escape the Knife," U.S. Banker,February 1, 2002.

Page 28: Building Competitive Advantage Through Strategic Cost Reduction

26

Deloitte Research Studies

Strategic Flexibility in the Financial Services Industry: Creating

competitive advantage out of competitive turbulence

Strategic Flexibility in the Communications Industry: Coping

with uncertainty in a world of billion-dollar bets

Strategic Flexibility in the Energy Sector: Competing in a decade

of uncertainty, 2000-2010

Strategic Flexibility in Life Sciences: From discovering the

unknown to exploiting the uncertain (forthcoming)

Strategic Flexibility in the Media Industry: Real options in the

pursuit of digital convergence (forthcoming)

Deloitte Research has been developing the concept of strategic flexibility for over two years. Through a series of

industry-specific research reports and other publications, Deloitte Research professionals have created a body of

work that articulates the four-phase strategic flexibility framework and demonstrates its usefulness in a wide range

of applications.

Many of the items below are available from Deloitte Research at www.dc.com/research or upon request at

[email protected].

Other Publications

“Real Options in Real Organizations: Creating and exercising real

options through corporate diversification.“ Chapter 2 in

Innovation and Strategy, Operating Flexibility, and Foreign

Investment: New Developments and Applications in Real Options.

L. Trigeorgis (ed.) Oxford University Press, 2002

“Real Options and Restructuring the Communications

Industry,” Telecom Investor, December 2001

“Lead from the Center: How to manage divisions dynamically.”

Harvard Business Review, May 2001

“Tracking Stocks and the Acquisition of Real Options,” Journal

of Applied Corporate Finance, Summer 2000

“Hidden in Plain Sight: Hybrid diversification, economic

performance, and real options in corporate strategy,” in Winning

Strategies in a Deconstructing World, J. Wiley & Sons, 2000

The Deloitte Research Strategic Flexibility InitiativeThe Deloitte Research Strategic Flexibility Initiative

26

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©2002 Deloitte Consulting and Deloitte & Touche LLP. All rights reserved.ISBN 1-892384-09-8

Recent Financial Services Industry Thought Leadership

About Deloitte ResearchDeloitte Research, a permanent thought leadership organization established by Deloitte & Touche and Deloitte Consulting, is dedicated

to providing ongoing research and insight into the critical global and industry-specific issues facing business today. Comprised of both

practitioners and dedicated research professionals from around the world, Deloitte Research combines industry experience with academic

rigor. Our research identifies and analyzes market forces and major strategic, organizational, and technical issues that are changing the

dynamics of business. It focuses on leading-edge industry-specific issues and global trends, providing insight into new evolving challenges.

For more information about Deloitte Research, please contact:

ANN BAXTERGlobal DirectorTel: 415.783.4952 E-mail: [email protected]

■ Top 10 Global Banking & Securities Trends 2002

■ Top 10 Global Insurance Trends 2002

■ Reinventing Financial Services: Succeeding with Corporate Transformation

■ Strategic Flexibility in the Financial Services Industry: Creating Competitive Advantage out of Competitive Turbulence

■ Leaders and Laggards: How Pensions Reform Will Drive Change in the European Long-Term Savings Industry

■ Shaken or Stirred: Understanding the Coming Revolution in German Retail Financial Services

■ Myth vs. Reality in Financial Services: What Your Customers Really Want

■ Competing for Your Customer: The Future of Retail Financial Services

■ The Road Ahead: An ECN Industry Outlook

■ Solving the Merger Mystery: Maximizing the Payoff of Mergers & Acquisitions

■ Risk Management in an Age of Change

■ Will the Securities Industry Meet Its ACID Test? Automation–Consolidation–Internationalization–Diversification

■ Top 10 Real Estate Capital Markets Trends 2002

■ Top 10 Private Equity Trends 2002

■ Online Securities Trading Survey 2001

ARTHUR A. GRUBBDirector of FSI ResearchTel: 212.492.4942E-mail: [email protected]

CHRIS GENTLEDirector, EuropeTel: 44.20.7303.0201E-mail: [email protected]

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AMERICAS ASIA PACIFIC EUROPEGLOBAL

For Further Information, Please Contact:KEY CONTRIBUTORS

BILL FREDA

Tel: 212.436.6762

E-mail: [email protected]

JACK RIBEIRO

Tel: 81.3.3451.0403

E-mail: [email protected]

HOWARD LOVELL

Tel: 44.20.7303.7951

E-mail: [email protected]

PIERRE BUHLER

Tel: 646.348.4222

E-mail: [email protected]

MIKE HARTLEY

Tel: 44.207.303.3000

E-mail: [email protected]

DENNIS YESKEY

Tel: 212.436.6497

E-mail: [email protected]

MIKE IPPOLITO

Tel: 646.348.4824

E-mail: [email protected]

RANDI BROSTERMAN

Tel: 212.436.2959

E-mail: [email protected]

PAT JACKSON

Tel: 973.683.6403

E-mail: [email protected]

JEFF CALLENDER

Tel: 212.436.3465

E-mail: [email protected]

KATHRYN HAYLEY

Tel: 212.618.4344

E-mail: [email protected]

PHIL STRAUSE

Tel: 852.2852.6391

E-mail: [email protected]

COLIN WILKS

Tel: 48.22.511.0804

E-mail: [email protected]

FRANK KOLHATKAR

Tel: 416.601.6181

E-mail: [email protected]

JACK WITLIN

Tel: 312.374.3228

E-mail: [email protected]

BILL FREDA

Tel: 212.436.6762

E-mail: [email protected]

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