While eating my heart-healthy lunch at Cornerstone’s World Headquarters in Scottsdale, Arizona, I browsed through the May 2003 edition of the Harvard Business Review. An article titled, “IT Doesn’t Matter” by Nicholas Carr grabbed my attention.
Mr. Carr believes that information technology (IT), like electricity and trains, has peaked and its strategic importance diminished. He suggests that the appropriate response to this lessened strategic focus is to ensure spending is on “essential” items while avoiding “discretionary, unnecessary or counterproductive” investments. Unfortunately, he did not offer any advice on how to determine if an IT project is “essential” – guidance that would be well received by all of our customers.
We at Cornerstone Advisors have observed over time the commoditization of core products and services. Where core systems drove bank strategy 10 years ago, they are merely “posting engines” in today’s environment. Nowadays, banks strategically differentiate through a variety of ancillary products and services. For instance, all core deposit systems allow for a robust set of deposit products, but it no longer matters which core product actually services the deposit account. Differentiation is made by combining the deposit product with other banking products and services.
Because core system products have become commodities, they should be acquired at the lowest possible cost, but the last decade has convinced me that it has become too expensive to outsource core processing services. Why? Because although core processing vendors have grown and achieved large scale standing, they don’t pass the leverage on to their bank customers.
This is proven time and again in the many engagements Cornerstone completes each year. In-house, outsourced, resource managed, facilities managed – you name it, I’ve seen every possible delivery. And for big banks, community banks and de novos, national and regional vendors, the story is always the same – the unit cost of serving an account increases over time.
When Cornerstone is engaged by a bank to assist in selecting a core system, one of the products we deliver is a five-year cost model. We use the model to predict total costs and for “shocking” volumes to see what happens. “The CEO decided to buy Anybody’s State Bank and our volumes have doubled. What happens to our cost?” One piece of information calculated by the model is the unit cost per account. We define “account” as all open deposit and loan accounts. Unfortunately, although I learned in my college economics class that unit costs go down as volumes go up, this doesn’t happen with the deals we see.
Discussions with outsourcing providers have not satisfactorily explained to us why this is so. We’re told staff costs are on the rise, new technology is more expensive, and R&D consumes dollars, but the cost model the industry has been using just does not work for growing banks. I know staff is more expensive, but I also know disk storage, processors, and all technology continues to drop in price. So why aren’t these efficiencies being passed along? Why should a bank be forced to “pay up” as it grows?
The situation brings to mind the state of our airline industry today. Major airlines continue to bleed money trying to make their ailing hub and spoke models work, while Southwest, Jet Blue and others are making money with point-to-point, low cost systems. Like the key air carriers, leading core processing vendors that continue to play with the same pricing model will simply drive banks to acquire less expensive solutions, which often are in-house solutions. In taking advantage of the low cost of technology, many banks are inadvertently taking Mr. Carr’s advice to spend less on the essentials.
When will the community of outsourcing providers get the message? I say it’s time for one of the “big guys” to offer a high volume, low cost “posting engine” service with, say, a unit cost of 25 cents in volumes of 750,000 decreasing to 10 cents when the volumes reach 2 million or more.
Hey, it could happen. Couldn’t it?