DISCLAIMER: There is no absolute amount that a financial institution should be spending on technology! Technology spending must be considered in the context of the value received from it.
I had occasion this week to recall bank merger deals in the go-go days (back when they were unassisted by the government), where a major part of the justification consisted of scale economies. While espoused by many investment bankers, the only thing that seemed to scale well consistently were investment banking fees, as projected cost savings were rarely realized.
The technology spending numbers in the forthcoming Cornerstone Technology Report are consistent with other research on the topic: scale economies exist, but only in smaller banks. We found that once banks reach a certain size, technology spending actually begins to increase as a percentage of assets. What’s the cause? Strategic system spending.
Note: Cornerstone considers the following areas in technology spending (not all of which may be charged to I.T. cost centers): core systems, data communications, electronic delivery, infrastructure, and strategic systems.
As expected, the smaller banks in our study also spend the most as a percentage of assets. They need most of the systems that larger institutions have but don’t have the asset base to spread those costs across. As community banks grow beyond $1 billion in assets, spending on an asset basis starts a gradual decline.
The (inexact) dotted line in the chart above illustrates the inflection point somewhere around $7-$9 billion where spending on an asset basis starts to increase. Median spending in $5-$10 billion banks is still lower than smaller banks, but in this range there are very different kinds of institutions from a spending perspective. Banks spending below the median tend to be riding their core system and core vendor-provided ancillary solutions (i.e. strategic systems), allowing them to spend less than similar-sized peers. On the other end of the spectrum, towards the 75th percentile, banks are using mainframe-based core solutions, supporting one or more major strategic systems that their peers are not and possibly engaging in large-scale custom system development.
Once banks hit $10 billion, complexity seen in the bigger spenders in the $5-$10 billion segment becomes the norm, manifesting itself not only in the form of significantly higher strategic spending, but also higher infrastructure and core system spending.
What happened to strategic spending in the largest banks in our study (mostly in the $10-$20 billion asset range)? Part of the answer lies in utilization of non-traditional strategic systems such as trust and insurance. Larger institutions are more likely to be diversified into non-traditional businesses on a larger scale than their smaller peers. That explains about one-fifth of the increase from the $5-$10 billion segment to the over $10 billion segment.
Again, the bigger institutions get, the more likely they are to go best-of-breed for a given strategic system. Branch automation, loan automation, data warehouse, profitability, and various flavors of CRM solutions are all more likely to be found in these large institutions. Software, hardware, and outsourced services associated with these systems are more expensive than their core vendor-provided ilk and are responsible for much of the variance, but don’t forget the significant number of resources that have to implement, upgrade, and support these systems—it’s not just a one-time implementation event. In addition, large and mid-size institutions customize often, as opposed to smaller institutions, which rarely do. This adds to the complexity of an organization’s I.T. environment.
What kinds of resources are required to address this extra level of complexity? How about:
Yes, in some caffeine-addled state I was able to cleverly arrange these resource categories into an acronym: Crab Dip. Go ahead, groan, but you will remember my point, now won’t you?
Larger banks have to keep larger I.T. staffs to deal with the complexity of their best-of-breed environments. Staffing in “Crab Dip” categories described above makes up over 40% of I.T. staffing in $10 billion and over banks. I.T. staffing ratios, when measured as a percentage of total bank staffing, are less efficient in banks where the strategic systems environment is more complex because of the additional staffing. This staffing has a substantial strategic spending impact in the largest institutions.
Banks that are already in the high-strategic-spend boat have a hard time bringing strategic system spending down in the near term if the benefits don’t justify the expense. In general, these kinds of systems can’t simply be turned off. Limiting customization in the near term may be all these banks can do until depreciation runs out or contracts expire, at which point other solutions can be considered or the lower ongoing costs become tenable.
For growing institutions pondering strategic system acquisitions, here are some rules to live by when considering strategic system investments that will keep you out of the strategic system spending stratosphere:
Now don’t misread this as a treatise on why there’s never a good reason to invest in a strategic system. There are plenty of success stories about high-dollar system deployments that were successfully implemented, achieving the desired payback. While spending will be higher as a result of implementing best-of-breed strategic systems, revenue or efficiency gains can more than offset the additional expense. Remember, technology spending must be considered in the context of the value received from it.
If their business mix remains constant over time, banks can ride many of the integrated solutions from core providers a long way. By growing and not switching core systems, assets grow faster than maintenance costs, depreciation is reduced as installation costs are fully amortized, and better pricing tiers are achieved in outsourcing arrangements. Keeping tightly integrated ancillary solutions provides additional benefit as $1-$5B institutions avoid the temptation to install best-of-breed solutions or to develop/support large custom solutions.
See also: Change is in the Air
NOTE: Cornerstone would like to see your bank participate in our next Benchmarking Report, so if you haven’t participated before, drop us a line and we’ll contact you before surveys go out. Also, let us know if you would like to be notified when the Cornerstone Technology Report is available.