“The profit was five, split evenly between the two of us, which meant that my fair share was three (2.5 rounded off).” -Jarod Kintz,
A Zebra is the Piano of the Animal Kingdom
Gonzo denizens, all of us like nothing better than a little test to start the day. As always, we are here to help. Here’s today’s question: Which of the following is the correct definition of a profitability system at a bank?
- A program that resides somewhere in the financial group from which we have to look at reports every six months or so that allows the CFO to make any line of business or office profitable or unprofitable based on how he/she does transfer pricing.
- The system we put in where we all went to endless meetings and argued about activity-based cost allocations and why we were being charged too much, which led to us saying things about each other’s moms at the water cooler, after which we just gave up and went along with whatever got decided.
- A tool that will be a factual basis for some hard conversations we all need to have in the next few years.
GonzoBankers are the perfect mix of cynic and pragmatist, so the most common answer would probably be “all of the above.” And you know what? There is some truth to that answer. A great deal of time and money has gone into the development of profitability reports at banks. There have been a fair amount of arguments about the answers and the factors that went into them. And, we have heard two common criticisms of the output and the effort. First, we got to learn things we already pretty much knew (big branches are more profitable than small ones. Dude! ). Second, nobody trusted the data enough to take hard action like eliminating a business or closing an office.
Maybe so. But let’s put those criticisms to the side and talk about some of the issues banks must face in the next few years that require the discipline and information these systems provide.
First, banks are going to have fewer physical locations. No amount of omnichannel deployment, improved sales capabilities or marketing campaigns is going to change this fact. We all know it. And, those that remain are going to have to be of a size and design that makes money in new ways. That means we have to make hard, objective decisions about which ones get closed, sold or downsized. The only real basis for deciding this is the profitability numbers.
Second, successful banks will need to focus on profitable businesses and get out of ones that are marginal. We see too many banks with anemic investment sales, or credit card sales, or insurance referrals. These are examples of businesses where focused banks need to get big or get out. Banking is too tough a business to tolerate half-baked success in any area. Where do we go to agree on what is big enough and what we get out of? Profitability systems.
Third, there are two mongo areas where we will need to understand profitability – both the revenue drivers and the expense drivers – way better. One is channels. We need to get clear about how we decide how profitable a channel like online is. No small question. That channel might be really profitable because it produces business at a lower cost. At the same time, it might be making the branch channel less profitable because it took business from a channel that is mostly fixed cost (see note on fewer locations above). This is not an academic exercise. Important technology and marketing dollars will be invested based on these answers.
The other area is payments. Debit, credit, non-sufficient funds and other payments sources are throwing off huge revenue, but too few of our clients have a good grasp on how profitable they are, how much they contribute to product profitability, and what the impact would be if this payments revenue declines. (Note to self: It’s very likely to be challenged in the next few years.)
The thing about understanding and discussing channel and payments profitability is that these are not topics that tie to traditional cost centers or product lines. They are very “horizontal” in that the revenue they produce and costs they incur cross cost centers, regions, products and customers/members. Yet, even if they are not discreet products or cost centers, analyzing how to maximize their contribution to the bottom lines requires the same discipline of measuring key revenue drivers, expense drivers and bottom-line profit. At this point, I bet we all can guess the best tool to do this. Come on. You know.
It’s time for both the data and the discipline profitability systems provide to get front and center into planning and answering hard questions. That said, so that we avoid future fisticuffs and name calling, some Gonzo rules of engagement:
- No digging for facts then deciding and debating what to do with them. Know the questions you are trying to answer and the decisions you need to make – then aim the effort at them.
- No killing ourselves overbaking the analysis to get from 90% right to 100% right. At 90% right, you know what you need to know.
- Line of business/product line managers: You get to argue about how to make the numbers right. For a while. Then you work with them. No saying they’re wrong for eternity.
- Finance: Those managers have some good points. Listen and adjust. Then, when rules of transfer pricing, intercorporate allocations and activity based costing are set, don’t meddle with them.
- Use profitability information to empower businesses, not drive them.
“If your conduct is determined solely by considerations of profit you will arouse great resentment.” -Confucius
It’s important to get this discipline right. Big questions need answering.
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Ready to Tackle the Hard Conversations?
Cornerstone Advisors can show your bank how to get the most out of your profitability system and build a lasting discipline into your strategic plan.
Contact us today to learn more.
