This week’s post is inspired by a couple of recent events. A discussion last week with a group of banks about operational improvements and the challenge that Operations has of getting funds to invest in change that will reduce costs, as well as reports in today’s Times, of London, not New York that is, about the trouble the UK government are having with the Civil Service. The challenge; getting anything at all done.
Operations are in charge of day-to-day production. On any given day they must play the hand they are dealt; dealing with the internal processes such as they are and with the external ones too such as they are. Operations managers do though tend to have a fairly good eye for how things might be improved, either in terms of costs, controls or both. Their ability to drive change though is more often than not rather limited. Internally they are a cost centre, allocating all their costs out to business units based on some allocation key. This is a pretty inexact science and one I have opined on at some length in prior posts (see various posts titled “Allocations” from June and July 2012 ).
When the Ops folk do have an idea, they need a sponsor. Sometimes, the idea is about internal change, in the which case it is a matter of the sponsor, of resources and priorities. The latter of late is something driven almost entirely by matters regulatory, which are all must do tasks. If the idea requires external change, there is an additional degree of complexity from the need to get all the banks to do the same thing at once. This is quite often like trying to align the moon and the stars.
Internal Change
From my experience, the 80:20 rule applies to change in banks. IT is at the centre of things at least 80% of the time, with any change that would improve things needing IT change of one sort or another. Quite often that change might involve some external spend. Most often, IT look to the “business” to decide priorities and not Ops. So, Ops are left to try to work out a business case, of tangible and intangible benefits and lobby the business to change priorities.
Now, as 2013 kicks off, the business side of banks is having trouble making money, so the focus is on cost and rightly so. However, it is Operations who have perhaps the best view of where those costs are.
When looking at projects from a purely academic or theoretical perspective in Cost & Management Accounting, I was taught to look at ROI, IRR and NPV perspective. You ought to invest in projects with a positive ROI and NPV and would pick those amongst them with the highest IRR. Imagine you could invest $500k once, to get an an annual return of $1.5 million, gross or $1.4 million after extra operating costs. No internal IT change is needed. Rare, if not unheard of, but nonetheless true. Add to this a few intangibles for good measure. Break even in 4 months, NPV of about $9 million, even at a cost of capital of 15%.
Should you go ahead?
As my 14 year old would say: “Hell yeah”. At 15% you could borrow the money on your credit card, even get an overdraft. You could even ask the Greek Finance Minister for a loan. Outside of the banking world, CFO’s are looking at major investments that have payback periods north of 10 years. They would bite your hand off for projects that payback in four months.
The example above is a real one, from Banking, which is of course a different world. The proposal came out of Operations and was rejected by the divisional CFO on the business side who would have had to “write the cheque”. Why? Cui Bono, or who benefits, was the stumbling block. The suggested change was going to reduce the fees charged by the Nostro banks to the firm by internalising some 40% of the payments sent to the Nostros. Implementing the change would reduce the fees charged out via the expense management process. This was supervised by Operations, but the expense was passed directly through to the business. That allocation process meant that costs were passed on as soon as charged, even in very small amounts, and on the basis of tickets booked, not payments made. Under that scenario, many people would benefit and most likely the business making the investment would not get 100% of the benefit. The shareholders would though, as would the Investment Banking business as a whole. Perhaps if we could have re-engineered every bit of several bad bits of process, this might have happened. Even if we could have, some of those benefits would already have been lost.
External Change
My recent discussion with a group of senior Operations managers was around a research proposal. With a major business services vendor, we had identified a process improvement that we think will have a hugely beneficial impact on liquidity. Some work is needed to check the assumptions in the model in terms of potential benefits and figure out what we think it would cost to build the systems to realise those benefits, as well as preparing a road map. Every one of the small group is pretty convinced we have an idea with pretty large benefits, but again came the question of cui bono. Each bank representative acknowledged there were charges for liquidity, but for the most part the charges were dealt with by Treasury, or some arm thereof. Operations themselves, whilst tasked with improving things, nobody had any budget approval authority, nor any discretionary spending power. To make progress, all the banks need to move in tandem. With six different banks having to go through six different approval processes, this is a big challenge. At best, progress will be slow. At worst, it will not happen.
Forces of Bureaucracy
The Times article from Jan 14th cited a one-liner from the wonderful series of books by Anthony Jay and Jonathan Lynn: Yes Minister and Yes Prime Minister. The Civil Service are viewed there as “the Opposition in residence”, firmly opposed to any change.
Civil Servants might be motivated to prevent change simply to perpetuate the status quo where privileges are clear, the future is quite certain and failure is unlikely. In big places, like a bank, there will be the same factors at play and on top of that the worry that if proposals are made, it might become apparent that the previous state of affairs was poorly managed or that certain people had made a mistake. In an earlier post (see: Cost savings: the perils and pitfalls of trying to get things done. The Emperor’s Got No Clothes On, from 30 Apr 2012) I offered a view on the peril that a cost saving might reveal prior incompetence. More recently, Jamie Dimon experienced some similar frustration as he sought to clear up the very large mess created by the “London Whale”, when his Chief Risk Officer area got way out of control Comments at a JPM event, he said: Some people “felt they could take advantage of it personally, they were willing to hurt the company by maneuvering.” (Read more)
Lessons Learned: Operations are under empowered, especially in the current environment. The immediate upside is in the process, with less opportunity on the revenue side. The winning formula needs process and people; they need to be empowered to do the projects they think are right. There is an expression often applied to lotteries and the football pools: if you are not in it, you can’t win it.
Operations need investment to improve the bottom line and the leaders in that area need some discretion. More, I would suggest, than the current processes allow.
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