Strategic Sourcing in Banking - A Framework Markus Lammers, E-Finance Lab University of Frankfurt...

Strategic Sourcing in Banking- A Framework

Markus Lammers, E-Finance Lab

University of Frankfurt

October 08, 2004

Agenda

Problem, Research Questions, Definitions

A Qualitative Framework for Sourcing Decisions

The Banking Value Chain as Sourcing Subject

A Formalized Sourcing Decision Model

Conclusion and Further Research

http://www.efinancelab.de/

Problem

German Banking Industry*

German Banking Industry*

26 mortgage banks

Special banks: 68

Institutions

28 building and loan

associations

14 banks with specific

functions

Universal banks: 2288

Institutions

271 credit banks (incl.

foreign banks)

524 savings and state

banks

1491 coop. banking

associations

The German banking market has a polyplolistic market structure consisting of 2354 institutions.

96,7 % of the German banks are universal banks. Universal banks are highly vertically integrated

High Redundancy of Products, Processes, IT Infrastructure and Application Systems

*source: monthly report as of May 2003 of the Deutsche Bundesbank


ProcurementHuman Resources

Technology DevelopmentInfrastructure

Products

CreditsSecurities

Fin. ProductsCorp. Invest.Other assets

InvestmentDeposits

SecuritizationCredits

FundingAcct. Mgmt.

Services

Asset Mgmt.Issuance/IPO

M & AAdvis. Serv.Other Serv.

PaymentTrading

Clearing & Settlement

Custody

Transactions

AcquisitionOffering

Multichannel Management

Sales

AdvertisingBranding

Sales Support

Marketing

Firm InfrastructureHuman Resources

Technology DevelopmentRisk Management

Products

CreditsSecurities


InvestmentDeposits


FundingAcct. Mgmt.

Services



PaymentTrading


Custody

Transactions

AcquisitionOffering


Sales

AdvertisingBranding

Sales Support

Marketing

Synergy potential

Bank 2

Bank 2288

e.g.2288 times redundant credit processes

High vertical integration and polypolistic market structure indicates high synergy potentials

Firm InfrastreuctureHuman Resources

Technology DevelopmentRisk Management

Products

CreditsSecurities


InvestmentDeposits


FundingAcct. Mgmt.

Services



PaymentTrading


Custody

Transactions

AcquisitionOffering


Sales

AdvertisingBranding

Sales Support

Marketing

Bank 1


Hamoir et al. expects that 4 banking models may emerge

(1) Purely regional distribution(2) Global wholesale,

investment

(3) Asset management

(3)Credits

(3)Other1

(3)Other1

(3)Other1(3) Insurance (3) M & A

(4) Exchanges

(4) Clearing, Settlement

(4) Payments (national, international)

Infra- structure

Products

Distribution

Pos

itio

n al

ong

the

valu

e ch

ain

Mass Affluent Private Small Midsize Multinational Corporations

Retail SME2

Type of banking customer

Potential banking models

Regional retail distributors (1)

Global wholesale and investment bank (2)

Pan-European product specialists (3)

Pan-European service providers (4)

1Such as commercial insucrane and institutional asset management2Small and midsize enterprises

Source: Hamoir et al. (2001), p. 123


Research Questions

What activities should be made internally?

What activities should be made or produced by a (specialized) supplier?

What are drivers for in- or outsourcing an activity?

What is the optimal degree of vertical integration for a bank?


Definitions

Sourcing Analysis: Analysis of the combination of internal and external resources to improve the production mix of a bank by decreasing costs or increasing value generation.

Outsourcing: Usage of (superior) resources outside the company.

Outsourcer: A company that gives an activity to an external company, which was formerly produced in-house.

Insourcer: A company that takes over the activity from the outsourcer.

Agenda

Problem, Research Questions, Defintions






Theoretic Foundation: An Introduction to Transaction Cost Economics (1/2)

Transaction Costs Economics analyzes the efficiency of different governance forms using transactions as basic analysis unit. (Williamson 1981, p. 548)

Transactions are defined as the transfer of goods or services between technologially separable interface (Williamson, 1981, p. 522)

Governance forms are: Hierarchy: governance is based on property rights of management, processes and administrative control mechanisms, i.e. companies.

Markets: Are steered by price mechanisms and hierarchical control is replaced by contractual agreements.

Hybrids: include governance elements from both markets and hierarchy, e.g. joint ventures, alliances, shared service organizations.


Theoretic Foundation: An Introduction to Transaction Cost Economics (2/2)

Increasing transaction costs are determined by:

Frequency of Transactions: Transaction that are frequently processed will more likely produced internally.

Uncertainty: Increasing uncertainty imply higher transaction costs, e.g. in long-lasting outsourcing deals.

Asset Specificity: Insourcer would have to make specific production investments when taking over highly specific assets.


Theroretic Foundation: An Introduction to the Resource Based-View (1/2)

Valuable: Resources increase revenues or decrease costs

Rare: Resources are not freely availabe

Imperfectly imitable: it is not clear for a competitor how to build identical resources

Non-substitutable: no alternative resources providing identical value

The Resource Based-View (RBV) explains how companies can gain and sustain a competitive advantage having superior resources.

Barney (1991) derives that a sustainable competitive advantage results from resources that are:


Theroretic Foundation: An Introduction to the Resource Based-View (2/2)

sustainable competitive advantage

valuable

1. Analyze cost, revenue or value contriubtion

2. Benchmark against competitors, e.g. using DEA

3. Determine competitve advantage

Non-substitutable

Imperfectly imitable

rare

1. The resources or resource bundle can not be substituted by other resources

1. The resource bundle is heterogene from other resource bundles

2. Heterogenity cannot be rebuild in the short to medium time frame

1. The resource or the resource bundle is not freely available.

2. Competitors can not buy the resources immediately

3. Direct competitors do not deploy identical resources/resource bundle


Qualtitative Sourcing Framework

Degree of market coordination

Making Sharing Buying

hybrid forms:Joint Ventures / Shared Services / Alliances

Degree of hierarchical coordination

high Asset specificity of activity low

high Frequency of activity low

high Uncertainty low

Resources and capabilities pro-vide a sustainable competitive advantage

Resources and capabilities are a source of competitive advantage, but may be easily to imitateor substitute

Resources and capabilities provide a competitive disadvantage

realize efficiency improve-ments from specialists

realize efficiency improvements /scale economies by bundling activities

increase own market share

Institutional design of sourcing alternatives

TCE based recommendation for sourcing decisions

RBV based recommendation for sourcing decisions

Company Objective

Agenda







Detailed Generic Value Chain of the Banking Industry

Fist the product will be offered to the market, sold, provided to the customer and finally corresponding transactions will be executed.

Additionally, Risk Management is introduced as supporting activity.

Firm Infrastructure

Human Resources

Technology Development

Risk Management

Products

Credits

Securities

Fin. Products

Corp. Invest.

Other assets

Investment

Deposits

Securitization

Credits

Funding

Acct. Mgmt.

Services

Asset Mgmt.

Issuance/IPO

M & A

Advis. Serv.

Other Serv.

Payments

Trading


Custody

Trans-actions

Acquisition

Offering


Sales

Advertising

Branding

Sales Support

Marketing

In opposite to the industrial value chain from Porter (1985, p. 86), the developed banking value chain starts from the customer side.


A generic value chain for consumer credits

Consumer Credit Process derived from the generic value chain

Evaluation of in-house efficiency of value activities

Transaction

•Booking of Payments•Governance of in-time payments•Bad Loan Mgmt./ Realisation of collaterals

•Payment of Interest•Payment of amortisement

•Credit data to Treasury•Refinancing of Credit

•Collateral evaluation•Rating of borrower•Final pricing•Credit Approval•Credit Account opening•Payout of credit

•Determine financial requirement•Identification of potential collaterals•Pricing

•Management of Sales via Internet, branches and sales banks

•e.g. general offers to customers via letters

•Introducing a brand e.g. „easycredit“ in the credit market •Advertising

ProductSalesMarketing

Clearing and

Settlement

Payments Funding Credit

Acquisition and

Offering

Multi Channel Mgmt.

Sales Support

Branding of a Product

Risk Management: Management of Credit Portfolio and Credit Risk

Identify the resources allocated to the consumer credit process

Calculate costs and revenues for each process step

Evaluate cost efficiency respectively value added for each process step


Mini Case Study: Norisbank

Marketing:

Branding of product “easycredit®”Independently from corporate identity of NorisbankRegistered trademark: valuable and rare

Sales: Effectively leveraging product via different sales channels Norisbank is able to invest 87% of all funds easycredit

Products/Transactions: Fully automated processing of consumer creditAverage processing-time reduced from 128 to 35 minutes

Agenda







Production Cost Economics

„Squeeze Out Potential “ – Reality Check Financial Services


Production Cost Economics

Scale and Skill economies of Insourcer

C/y

y

C/y Insourcer

C/y Outsourcer

CO

CI‘

Insourcer „Skill Potential“

CI‘‘

Insourcer „Scale Potential“


Economies of Scope:Def.: Economies where it is less costly to combine two or more product lines in one firm than to produce them separately.

n

1iNi w),C(yw),C(y

= Set of products under study

= Quantities of products

= Multiproduct Cost Function

= Vector of factor prices

w

w),C(y

y,...,yy

n1,2,....,N

n

21

[Source: Panzar and Willig, 1981]

Economies of Scope vs. Economies of Scale

vs.

Economies of Scale: Def.: Economies realized by output expansion, i.e. decreasing marginal costs when expanding the output.

C = Kosten

X = Outputmenge

[Source: e.g. Murray/White 1983, Mester 1987]

1ΔX/XΔC/C

Economies of scope can only be realized by Universal banks, and may be a driver not to disaggregate the value chain.

Scale economies may be realized by Specialized Banks as well as by Universal Banks.


Internal Production vs. Joint Venture vs. Specialist

Universal banks:

Highly diversified banks, which have separate business units may generate economies of scope.

Example: Deutsche Bank

Specialized Service Provider

Specialists is concentrating on one specific business segment thus being able to generate economies of scale and skill.

Examples: IBM, Aareal Hypotheken Management

vs.

Joint Venture:

Banks jointly produce specific bank products or processes to generate scale economies.

Example: Eurohypo

vs.


Make vs. Buy Decision

tm

T

tmN,iMi )r/()s,u,f(G)w,y(C)wy(C)w,y(C)w,y(C 1

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C(y,w) = Cost function output and factor prices G(f,u,s) = Governance cost functionN={1,2,...,n}= Set of activities under study M = N without iP = Price per output unit of the potential supplier r = Risk-adjusted discount rate in percentS(s,f,u) = One-time sourcing cost function T = Years of contractw = Vector of factor pricesYi = Yearly output from diversified company of activity iYN = Yearly output from diversified company of activities 1 to nYM = Yearly output from diversified company of all activities M

Ni)r(/)s,u,f(Gy*P)u,f,s(S tb

T

tbi

011

One-time costs for outsourcing

Price Transaction costs

Make

vs.

Buy

Cost Function Scope economies Transaction costs+

+

-

+


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C(y,w) = Cost function of dependent output and factor prices G(f,u,s) = Governance cost functionN={1,2,...,n} = Set of activities under study K={1,2,...,k} = Firms participating in joint ventureM = N without I P = Price per output unit of the potential supplierr = Risk-adjusted discount rate in percent S(s,f,u) = One-time sourcing cost functionT = Years of contract w = Vector of factor pricesYi = Yearly output om diversified company of activity I YN = Yearly output of activities 1 to nYM = Yearly output of all activities M

Make vs. Share Decision

Agenda








Conclusion:

a qualitative framework using RBV and TCE was introduced to identify:

Superior Skill SetsSuperior Governance Structures

consequently supporting a make, buy or share decision. A top-down approach for identifying and analyzing activities in banking was introduced using the generic banking value chainCo-opetition/Share is a possible sourcing solution for activities and a way to increase production efficiencyInfluencing variables of a sourcing decision were formalized to show interrelation and impact on a sourcing decision

Further Research: Extending the Model by Uncertainty and Risk Sensitivity Testing of the Model Variables

Backup


Literature

Barney, J.B. (1991): Firm resources and sustained competitive advantage, in: Journal of Management, 17, 99-120.

Barron, T. (1992) “Some new results in testing for Economies of Scale in Computing” Decision Support Systems, 4/8, 405-429

Lacity, M; Willcocks, L. (1996): Editorial; Information Systems Outsourcing in Theory and Practice, in: Journal of Information Technology, 10, 203-207

Lacity, M; Willcocks, L. (1996): The Value of Selective IT Outsourcing, Sloan Manangement Review, 13-25

Porter, Michael, E. (1985): Competitive Advantage: Creating and Sustaining Superior Performance, Free Press, New York.

Williamson, O. E. (1981): The Economics of Orgnaization: The Transaction Cost Approach, in: American Journal of Sociology, 87, p.548-577.


Model of three banks

Production bank

IT- and Transaction Management

„manufacturer“ for clearing, settlement, payments and other transaction related business

Model of three banksModel of three banksModel of three banksModel of three banks

Salesbank Marketing

management Multichannel

mangement Distribution of

products to private and corporate customers

Portfolio bank Risk

Management and term transfor-mation

Issuance and advisory business

Building and allocation of special financial know-how DG Bank as well as the Norisbank divides the banking business into sales-,

portfolio and production activities. They expect using these function banking holding companies and specialized banks will evolve (source: Salmony 2002, Norisbank 2002).


Steffens (2002) expects special distribution, transaction and product banks

Distribution

Distribution specialists concen-trating on sales channels like Charels Schwab, MLP or American Express.

Distribution

Distribution specialists concen-trating on sales channels like Charels Schwab, MLP or American Express.

Transaction

Transaction banks provide clearing and settlement, payment, trading and custody facilities

Transaction

Transaction banks provide clearing and settlement, payment, trading and custody facilities

Products

Product specialists like Credit Card, Credit and Asset Management companies provide their products to universal banks resp. global players

Products

Product specialists like Credit Card, Credit and Asset Management companies provide their products to universal banks resp. global players

Steffens (2002) expects a specialization of banks towards distribution, product and transaction banks. Anyway, the author expects still global players and universal banks which use specialized banks as supply or sales channel.

Strategic Sourcing in Banking - A Framework Markus Lammers, E-Finance Lab University of Frankfurt...

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