Battling the Beast: Complexity vs. Customization
For years, the financial services industry has designed custom products and services to satisfy a client's every whim. And their clients know it. But in an era of rising interest rates and a flattening or inverted yield curve, banks have to reduce operating costs and improve margins. Customized products and services are a legitimate target.
If someone were to write the history of complexity in the financial services industry, it would read like the rules of a Rube Goldberg contest-an annual competition in which aspiring engineers take a simple task and make it exceedingly complex. This year's winning team concocted 215 steps to shred five sheets of paper. Banks and other financial institutions have also become exceedingly complex but, unlike the Goldberg contestants, it was not by design. Most merely wandered into it.
Complexity is the inadvertent effect of a well-meaning effort to please the customer through custom-designed products and services no matter what the cost. In the aftermath of such altruism, most of these companies are trapped in a maze of increased operating costs, reduced margins, slower time to market, and a clumsy multichannel delivery process that is severely damaging the customer experience and operating efficiency. The situation deteriorated as companies focused more on raising revenues than profits, failed to understand the true costs associated with the customization, and watched the lines of accountability blur following the latest merger or acquisition. Other causes of complexity are shown in figure 1.
Today, industry executives are proclaiming an awakening and promise to streamline their product and services, as well as simplify some overly complex business processes. So far the results have been mixed. The job is neither as straightforward nor as easy as one might think. There is good and bad complexity just as there is good and bad cholesterol, which means they can't simply take a slash-and-burn approach. Good complexity is necessary. It adds value for the company and the customer and, by doing so, is at once desirable and sustainable. Bad complexity is inefficiency that drains value from the company, and therefore must be identified, targeted and eliminated. Good complexity drives the company to customize its products and services in a way that will help increase revenues, profits and customer loyalty. Bad complexity pushes the customer away and sends the company into chaos and confusion.
Capital One offers a prime example of good complexity. About 10 years ago, it was the first credit card company to offer variable interest rates to customers based on their credit scores. Before that, there was one product for all cardholders. Although the move increased complexity in Capital One's operations, it paid off. Business surged at a compound annual growth rate of 40 percent and the company lured away the most profitable and low-risk customers from competitors. 1 Within five years, competitors began offering variable rates as well.
Managing Complexity
The financial services industry is prone to bad complexity, primarily because it is a service business where products can be changed with a keystroke and variability can be hidden in underlying processes. While financial services companies are customer-focused, they are not terribly good at managing the trade-offs between customization and complexity. Before offering a customized product or service, executives must weigh the added costs against the price they can charge and the value the company will derive. Figure 2 shows a matrix that highlights some of the trade-offs and strategies to consider. In the end, complexity is not the problem: The real problem is in how effectively companies manage it.
Take, for example, the treasury services arm of a major U.S. bank and one of A.T. Kearney's clients. The bank was custom designing almost all of its products only to discover that it had created a patchwork quilt of too many costly and unprofitable products and services. Although customers appreciated the variety, the bank reaped few benefits. It did not charge for the customization, so it received no incremental revenue while it continued to incur the additional costs for each product.
Now consider how the complexity associated with selling these custom products filters down the value chain. The sales force had the additional work of creating a complex client proposal to sell each non-standard product, and when a sale was made, all functions after the sale—implementation, technology changes, operations and customer service—had to accommodate each product. Instead of the frontline salespeople looking forward to the new features they could sell, they had trouble staying current and answering the everexpanding list of questions that customers posed. Product managers were not spared as they struggled with a muddle of products and saw profits erode. Internal processes suffered as well. How many costly manual hand-offs did each custom product require? How many more people would it take to answer customers' questions? The division could hire more people to deal with a barrage of customer complaints, but this would only solve problems in the short term. What about the technology needed to develop and support the different products? How much did it cost for the IT group to expend time and talent to develop "one-off " or "bolt-on" solutions for every customer?
So while a financial institution might be reluctant to curtail product offers and services for fear of losing customers, it must, at the very least, understand the full impact such customization has on the entire value chain and on profitability.
Insights on Complexity
In our work in the financial services industry, we have helped our clients battle their unnecessary complexity while preserving and managing their necessary complexity. In the process, we have developed some key insights on the issue (see figure 3). We know, for example, that managing complexity requires first understanding its root causes and the implications on profitability, understanding how complexity relates to perceived customer value and, finally, armed with this knowledge, managing complexity requires reshaping the product portfolio and demand. The following outlines five key steps in managing complexity:
1. Locate complexity throughout the organization. A first step in battling unnecessary complexity is to locate it. Much like a disease, it is often hidden and difficult to recognize. Complexity is not likely to show up on a standard accounting system. Indeed, the first time you see it, it might be in customer defections or increased operating costs.
Finding complexity requires an end-to-end analysis across the organization to identify root causes that lead to unhealthy variations in products, services and processes. But getting an unobstructed view is difficult, especially for companies that operate in functional silos. When sales, marketing, product development, customer service, IT, finance and HR units operate independently, communication is limited. What's worse is that the people making decisions about custom products are usually not the same people who understand the cost and profitability implications of those decisions. Walk into almost any major bank in any country and you will find the same situation: Managers of each business unit are making market-facing and operational decisions, while sales managers are committing to delivering new product features without considering the revenue implications. Managers need to ask if a new feature could be sold to other customers, or even delivered cost-effectively. One manager's customer-focused modification is another manager's downstream costs and complexity.
A company-wide complexity review will begin to solve these problems. This review should take place early in the product-planning stages and involve key managers in all businesses or processes that will touch the final product or service channels.
2. Simplify offerings, shape consumer demand. In many ways, financial institutions are where automakers were in the 1970s, when every feature of every car model could be customized. But allowing total freedom proved too costly. As cars became more sophisticated, manufacturers had to respond by paring down the choices and offering standard-feature bundles—and then altering the manufacturing platform and process to deliver those bundles. The trick was finding the most successful bundles. Financial institutions now face a similar challenge.
There is good and bad complexity just as there is good and bad cholesterol, which means banks can't simply take a slash-and-burn approach.
At its most basic, product simplification requires three steps (see figure 4). The first is to identify and eliminate product varieties that destroy value. Most products have a clearly recognizable point at which customization does not add to the bottom line. The second step is to determine the base components of the product or service and decide how future enhancements will fit into these components. This begins the process of building flexibility into the product, which is vital to maintain competitive advantage. Finally, companies should go back and adjust the complexity in the component-based product and service mix. This calibration will enhance products and increase profits.
The key is to view products as a series of modular pieces that can be combined or integrated into a variety of other products or even separate "product lines." Managers define the customer-facing base product (or service) and determine which components to offer as variations to the base product. Rather than managing unrelated pieces, product managers oversee one product with some customized variations. This is the essence of mass customization.
There are several benefits to this approach. For one, it becomes obvious where costs should be incurred and which costs should be passed on to the customer-information that can help identify the elusive tradeoff point between customization and complexity. In addition, the company improves its customer feedback loop and therefore its product offerings, and managers gain a better understanding of what customers value and use the information as an additional source of creativity and innovation. Over time, the variations can be incorporated into the base product.
In addition to reducing complexity, modularity can help a company increase revenues. For example, most insurance companies, including Allstate and The Hartford Group, sell auto insurance to customers who select their policies from a discrete set of insurance packages. The companies bundle their insurance policies based on customer needs. By focusing on what the customer values and simplifying the options, agents find it easier to do business with the company and the insurer gains market share and customer loyalty.
Modularity can also improve the underlying architecture of a product or service. For example, the treasury services division in our earlier example is using modules to offer variations of its core treasury products. A wire transfer product is designed to handle all basic information such as bank name and routing number in a similar manner. Then the IT team established specific integration points where variations to the base product (such as bill payment or invoice information) can be added. This way, the bank's software developers reduce the time spent on developing one-off solutions and product and sales managers can easily deliver products with more features.
Modularity is not only for developing products and services but also for managing the complexity surrounding business processes and functions. When we applied this approach at a benefits provider, our initial goal was to reduce complexity in the provider's employee retirement service offering—if the company could standardize processes and systems, it could improve efficiency. The results are impressive. The retirement process is 25 percent faster, and it now takes 33 days rather than 45 to 48 days to process an employee's retirement. The error rate dropped by 10 percent, and there are fewer questions and complaints from customers. Overall, we expect the savings to reach 20 to 25 percent of the company's current cost base.
3. Improve back-office alignment and operations. The overhead structures and information flows related to excessive products, channels, target markets and customer segments carry over to back-office operations. In the 1990s, when banks had fewer products and distribution channels, the technology and processes ran what amounted to an assembly line. Now, with more offerings, banks have been doing their best to stretch the old technology, while standardizing and automating their business processes.
Also, as companies have grown through mergers and acquisitions, they are struggling to cobble together disparate IT systems. The complexity of current systems will likely keep IT on the CEO agenda for years to come. We often recommend using open standards through platforms such as web services to alleviate unnecessary complexity caused by too many proprietary technologies, platforms and languages.
Many of the industry powerhouses, including Bank of America, Deutsche Bank, Merrill Lynch and Citibank, are improving their operations using the principles of Six Sigma. For example, a global credit card company launched a Six Sigma initiative to improve its customer-retention abilities. When it analyzed its current processes, its rolled throughput yield (RTY) came in at a surprisingly low 10 percent. 2 It then identified the operational problems-everything from too many handoffs and a dysfunctional channel-management process to a complicated web of IT systems-that were causing the low score. The company has since launched a series of initiatives to raise its RTY.
Similarly, when Capital One upped its credit card offerings, it did what all companies should do—invested in the technology necessary to deal with the additional complexity. By the third ring of a customer phone call, the computer recognizes the customer's telephone number, identifies the most likely reason for the call, routes the call to the appropriate person, and then populates the customer representative's computer screen with products and services the customer may be interested in purchasing. 3
Finally, there should be a strategy to deal with the hidden costs caused by these one-off solutions. Once a customer is promised a custom product, both the IT group and customer service have to move quickly to deliver it-usually at a high cost and at the expense of other needed activities. To avoid these extra costs, companies should work with the IT group to define the needed services and determine service requirements. This cross-business planning ensures more informed decision-making and reduces longer-term delivery and maintenance surprises. In fact, some firms publish an IT services catalog that clearly defines the IT services, estimates the cost to the business, and outlines how to prioritize and deliver the service.
4. Price for complexity. Putting a price on a product or service brings its own challenges. First, executives must acknowledge the close relationship between price and complexity, and then manage the relationship to maximize gross margins, regardless of the customization level. Price should be ascertained by calculating the economics of a product from the customer's perspective. When a company knows the features a customer values and which components support those features, it can then focus on those areas while reducing costs and complexity in others. It also makes sense to keep features that customers value, raise the product's price and then become more aggressive in communicating its superiority. This is the essence of a differentiation strategy. The matrix in figure 2 illustrates what product assessments and preliminary strategies might look like.
Financial services firms use such pricing approaches in some parts of their businesses but not in others. Full-service banks use aggressive pricing techniques in their more differentiated businesses such as investment banking or fixed-income banking. They develop highly customized products that offer individual risk profiles and deliver substantial margins. For example, Bank of America Investment Services lets its personal checking account customers perform self-directed equity transactions online for $7 to $10 per trade. Bank of America Premier Banking, the arm that provides wealth-management services for high-net-worth clients, charges just $5 per trade.4
Banks use less-aggressive pricing strategies in the more commoditized parts of their business, such as in retail banking, credit cards and cash-management functions. This is where one-off solutions lead to problems, as products in these businesses often sell below cost. Banks that price appropriately in these areas will see significant results. For example, after performing a value-based pricing analysis on one client's credit card offers, we suggested eliminating features that added to product complexity and delivery costs but did not return a monetary advantage. We then pointed out how the bank could capitalize on the emotional value that its more affluent customers attached to concierge services and experiential rewards.
5. Build the case for change. The most successful complexity reductions require an organizational culture change. People should reject the status quo and become accustomed to measuring complexity routinely and taking a continuous-improvement approach to reducing it. They must also challenge beliefs regarding what customers' value-and then streamline processes to meet customers' "true" needs. The first step is to structure processes, reporting and IT to see the complexity and determine how much it is costing the company. But visibility will only get a company so far. Eventually, establishing a long-term strategy for managing complexity requires a dedicated focus on cross-business coordination, performance management and incentive programs, an active governance structure, and decision-making processes. Success requires a commitment that begins at the top levels of the organization.
It's a Business Issue
Companies must remember that complexity—both good and bad—is a strategic issue that requires a business solution. Rather than taking the straight-line approach of eliminating a few slow-moving products or services, the best companies think about how to achieve and maintain profitable growth by adding complexity only where it increases profits. The leaders focus on providing customers with an appropriate variety of products, while ruthlessly and constantly driving unnecessary complexity out of the business.
Consulting Authors
Joseph Reifel is a vice president based in the Chicago office. He can be reached at
This e-mail address is being protected from spambots. You need JavaScript enabled to view it
.
Christian Hagen is a principal based in the Chicago office. He can be reached at
This e-mail address is being protected from spambots. You need JavaScript enabled to view it
.
Eric Stettler is a principal based in the Dallas office. He can be reached at
This e-mail address is being protected from spambots. You need JavaScript enabled to view it
.
The authors wish to acknowledge the contributions of their colleagues, Andrew Green, Joachim Ebert, Ashutosh Saxena, Rebecca Sweda and Omer Sevil in writing this article.
|
RSS FEEDS