Cost is a perennial challenge across the financial services sector. For retail banks, low interest rates have squeezed margins while market, operating, technology and regulatory pressures have driven up cost-income ratios. In insurance, market pressure on premiums, operating constraints and drivers of loss (even before the COVID-19 crisis) have increased focus on the combined ratio. For example, it’s been estimated that insurance underwriting cost ratios have risen from 40% at the start of the decade to nearly 50% by 2019.
Even so, our latest report on the continuous and innovative cost-out paradigm shows that financial services firms lag other industries when it comes to gaining competitive advantage through cost optimisation. As an industry, it’s behind in both relative cost performance measures and enterprise maturity in cost management. In a ranking of ten key sectors against the six dimensions of cost maturity we feel are most critical, financial services is 8th out of the ten.
Progress may have been made to tackle some key cost lines, with a sample of UK banks reporting an average of two per cent reduction in cost income ratios in latest reports. But financial businesses have a way to go to re-think how they create more radical and long-term shifts in cost performance. No longer merely an internal objective, a robust approach to cost optimisation can enhance speed to market with new products and create more reliable on-going delivery, improving customer experience.
For mainstream financial services businesses, we believe there are three areas where radical approaches will be needed to create a sustainable reduction in cost that will drive improved customer and operational performance.
Simpler businesses tend to have a much lower cost to serve. But financial institutions tend to have siloed and inflexible legacy technologies that create complex, costly and often fragile architectures. So, these complex and costly institutions need to simplify.
The first step is a ruthless cull of apparent complexity – simplifying products and removing excessive, duplicative operations and management structures. We know this works across both national and multi-national retail banking operations. By rigorously assessing product overlap and removing the excess product lines, a UK retail bank we worked with reduced excess products by 80 per cent in 6 months, leading to a reduction in product management costs by 40 per cent. We’ve also seen the risk function of a global bank reduce risk change costs by a quarter by adopting simplification approaches that allowed it to deliver coordinated simpler management of change rather than tackling each change event as a separate item.
However, cutting out the complexity is only part of the solution. Real, long-term benefits come from aligning the business to more straightforward operations. We believe that aligning around customer value streams is the best way to achieve this. This is because it breaks traditional functional silos and the separation between ‘run’ and ‘change’ to bring technology and the business closer together. We are currently working with two banks who are doing just this. By bringing together cross-discipline teams to manage the delivery of customer outcomes, they are finding ways to deploy simpler processes, reduce handoffs, reduce unnecessary checks, lowering costs for the business and improving speed for customers.
Until now, legacy technology has been the knot many financial services businesses have been unable to untie. However, the latest technologies and digital capabilities mean it’s now possible to create a simple, flexible IT infrastructure.
Cloud-based digital applications and platforms can help create simpler, joined-up and more flexible architectures. This reduces the total cost of both ownership and the use of end-to-end automation. Artificial intelligence can lower operating costs, bolster operational resilience and improve regulatory compliance. We’ve seen businesses save up to 20 per cent of their core IT costs, and 30-40 per cent in end-to-end processing costs, by automating and streamlining customer fulfilment and operational delivery with new digital capabilities.
There are now over 20,000 fintech firms out there, offering innovative solutions that allow firms to simplify and automate whole sections of their operation, dramatically lowering costs. We’re increasingly seeing firms building their vendor ecosystems and collaborating to streamline value chains and bring customers excellent, streamlined experiences too.
Across the sector, we've seen the pandemic spur innovation and digitisation with newly automated onboarding processes, claims management processes, reporting processes and customer service management as well as more sophisticated use of machine learning and AI. Lloyds have implemented new digital mortgage application and insurance claim processes within weeks, as have many of their competitors - a speed of delivery unheard of before the pandemic.
Changing customer behaviour, new competition and innovative technologies are continually disrupting financial services markets. We’ve seen an increased take up of digital technologies, with a 15-25% increase in Italy and China as they emerge from lockdown.
Creating an operation that’s fit for today but unable to adapt will quickly erode operating efficiency. Lasting efficiency comes from building organisational agility. In fact, our research shows the most successful companies across industries are more agile than their competitors
An alignment to customer value and a drive for simplification overlap completely with best practice cost-out thinking. We know that the most agile businesses use funding, governance and agile delivery techniques to collapse delivery times and speed up time to value, as well as building more flexible operating models and technology architectures that are designed to evolve easily.
Finally, agile businesses recognise that all organisations are only as capable as their people, so have invested in developing their people and giving them greater autonomy to deliver. The result in financial services and more broadly across may sectors is clear, the top 10% of firms in terms of financial performance are 30% more likely to display these agile characteristics.
Use cost optimisation to gain an advantage, through crisis and beyond
Traditional cost management can help drive some efficiency improvement, but the impact tends to be limited in scope and longevity. Inefficiency creeps back in quickly. Instead, approaching cost optimisation with a mindset of radical simplicity, technology innovation and agility can create competitive advantage.
The pandemic has only increased the importance of cost management for financial firms. The increase in digital engagement and recent technological innovation not only gives firms the means to radically improve cost performance, but also to drive the ultimate competitive advantage - a better experience for their customers.