Innovation and the Future Proof Bank

A Practical Guide to Doing Different Business-as-Usual

James A Gardner

• Publisher: Wiley
• Year: 2011
• ISBN:
  9780470685211
• Edition: 1
• Topic: Economics
• Subtopic: Banks & Banking
• Index: Economics

Innovation, the conversion of the new to business as usual, is a very special business process. It is the business process able to reprogram all others. Creating the practices that make this process work is a key challenge for all in financial services that are worried about responding to the future. When an institution can identify things that are outside its present practices and convert them, production line style, into products, processes, cultural changes, or new markets, it will never be outpaced by internal or external change again. The institution becomes "FutureProof".

This is a book about those practices in banks. It explains, using examples from institutions around the world, what it takes to create an innovation culture that consistently introduces new things into undifferentiated markets and internal cultures. It shows how banks can leverage the power of the new to establish unexpected revenue lines, or make old ones grow. And it provides advice on the social and political factors that either help or hinder the germination of the new in banks. Moreover, though, this is a book about the science of innovation in a banking context. Drawing from practices already highly developed in financial services—managing portfolios of assets to mitigate risk—it explains how practitioners can run their innovations groups like any other business line in the bank one that delivers a return on investment predictably and at high multiples of internal cost of capital.

For leaders, Innovation and the Future Proof Bank provides the diagnostic tools to guide benchmarking and investment decisions for the innovation function. And for innovation practitioners, the book lays out everything needed to make sure that converting the new to business as usual is predictable, measurable, and profitable.

1

Introduction

What you will find in this chapter

• A useful definition of innovation that can be applied to an institution.

• Five key mistakes people make when they think about innovation in banks.

• A brief history of innovation in banks.

• An overview of the futureproofing process.

• An explanation of how it is that not all innovation is good.

There is no such thing as a bank that is innovative. At least, that is what I would believe if all I read was the popular press or the blogs of customers. Try this experiment: say the words ‘bank’ and ‘innovation’ in the same sentence to anyone in the street, and see if you get much more than a blank look in return.

Most people think of innovation in terms of breakthroughs of the sort one regularly sees coming from high technology companies. They rarely consider that, in their day, ATMs were breakthroughs. They don’t think of the revolution of Internet and browser technologies combining to bring banking into the home. Nor do they realise or care that many incremental changes banks implement every day – a change to the call centre interactive voice response, or the update to queue management in the branch – are in fact innovations that other industries have, from time to time, copied.

Perhaps because their customers don’t perceive the innovation all around them, bankers have started to believe they aren’t very innovative as well. They accept that change will be slow. That they will react when the market demands they do so. And, in fact, that this represents the prudent course which will safeguard their institution and its customers.

But there is a problem with this, and that is the pace of change in financial services has accelerated markedly. When it was just regulators, competitors, and markets that were the issue, the glacial engine of prudence was entirely satisfactory. But the democratisation of the tools of financial services has changed that. Now anyone can do things banks used to think were safely behind the competitive barriers of their very special role in the economy. A savvy consumer is fully capable of using online tools to run a small loan book via emerging person-to-person lending sites. They can pick and choose from dozens of customer service experiences courtesy of the next generation of personal finance software. And they can make international or domestic payments, even to the unbanked, and do so instantly, pretty much without fees.

Many of the commercial, technical, and regulatory barriers which protected banks in the past are about to, or have already, fallen. Their fall brings a groundswell of new change which will utterly defeat prudence as a strategy. Prudence is simply too slow to react.

What is needed, then, is a business process which can predictably and reliably respond to all this change, and which doesn’t abandon the fundamental tenet of prudence upon which banks must rely. Futureproofing, the subject of this book, is one way of doing that.

Futureproofing is the process of planning what the future might bring and doing something about it. Having read that sentence, you’d be excused for imagining these pages – as so many others at present – might concern themselves with examining doomsday scenarios in which banking no longer exists as an industry. Or if you are more positive, the happy alternative where all present threats to the special economic role of institutions have been dealt with and we continue onward indefinitely. But actually, this is a book which makes only one prediction about the future, and it is one firmly based in historical fact: change is a constant, and there is nothing that can be done to stop it happening.

Once one accepts that change is inevitable, it is only a small step further to the realisation that a business process which can systematically deal with change provides assurances against many of the challenges that might arise in the future.

This book is about building such business processes. It was born from understanding that whilst innovation might be the engine that drives progress and competitive advantage, ad-hoc innovation is, well, random. That randomness, far from providing assurances for the future, is gambling without knowing the odds in advance. Since it is possible to stack the cards in one’s favour, it makes excellent business sense to do so.

So, what are the characteristics of an institution that is futureproof?

Firstly, it will have systematised a focus on tomorrow. Many organisations spend the greatest part of their operational attention seeking to optimise the business of today. A futureproof institution recognises that putting structure around future consideration is the best way to avoid surprises. This book explains how such structure can be optimised into a futurecast, a substantive vision of alternative futures that can be used to rehearse key strategic decisions in advance.

Secondly, it will embed a business process that actively seeks out solutions for the problems of tomorrow. A futureproof institution knows that ad-hoc, random innovation is just as likely to generate bad ideas as good ones, so it puts sophisticated tools in place to eliminate the guesswork. It recognises also that this is a process that can pay its own way, and demands that each step towards tomorrow makes good business sense.

Finally, a futureproof institution explores multiple things at once. It knows that individual innovations may be successful or may not, but taken as a portfolio, the returns can be predicted with great accuracy.

But futureproofing requires a great deal of hard work. And inevitably, there are plenty of individuals in institutions who argue that the effort, capital, and organisational bandwidth involved is better spent on core businesses. They make the point that banking has been going well since its incarnation in modern form in the late 16th century, pointing to these hundreds of years of development as proof that financial services are able to respond to change without a formal process for doing so.

They would be correct in pointing this out. But now there is an emerging body of evidence suggesting that institutions which proactively and deliberately design their future are significantly superior performers in the long term. And the interesting thing is that such superior performance is almost never about the amount of money spent. Booz Allen Hamilton, who review the top 1000 corporate spenders on R&D every year [1], found there is almost no relationship at all between spending on innovation and superior financial returns. What they did discover, though, was that those companies with a deliberate innovation process – one with links to corporate strategy and customer needs – achieved up to 40% higher growth in their operating income as a result.

With arguments such as these, it is interesting that so few financial services organisations are listed as innovative. In fact, according to Boston Consulting Group and Business Week [2], there are only five institutions who make the top 50 innovators globally. That any institution is listed alongside such famous innovators as Apple, Google, and General Electric is surprising, given the widely held view that banks aren’t innovative at all.

What are those institutions doing to draw the attention of Business Week? What they all have in common is that they’ve developed robust processes to help them design their own futures, and they use them to get reliable and predictable returns from their innovation investments. They are institutions whose futures are secure.

Most banks spend years building their innovation capabilities before achieving this level of mastery. Having said that, however, the basic principles that underlie success are easily understood, and the chief concern is usually operationalising them in such a way that they become a core part of doing business. It is my hope that this book will help you do that in your own institutions.

1.1 WHAT IS INNOVATION ANYWAY?

In many financial services firms, it isn’t hard to find groups that are responsible for something that is, conceptually at least, innovation. It is typical that the focus of such groups be laser-sharp on the core business operations of the organisational lines that host them. In fact, in most banks, there are many innovation teams scattered across various silos, though they might not always think of themselves as being part of the innovation function.

It is hardly unusual, for example, for a group calling itself ‘Business Development’ to engage in new product innovation, whilst sitting across the hall a technology team looks for innovative gadgets they can shoehorn into a banking context. Meanwhile the strategy function is undoubtedly looking at new business models and new markets, and inevitably, the CEO herself is pushing along some pet projects that have an innovative aspect to them.

Unsurprisingly, such diversity of focus leads directly to organisational confusion with respect to the corporate innovation agenda, if an institution is lucky enough to have one at all. And almost certainly, getting to an adequate definition of innovation that works for everyone is pretty much a hopeless task with so many conflicting priorities.

It is useful, then, to look first at common definitions of innovation. This will give us common language we’ll be able to use throughout the remainder of this book.

With that in mind, it is possible to classify innovations in two dimensions. The first is the degree of newness incarnated in whatever-it-is. The second relates to the relationship of innovation to the competitive position of the firm. The latter of these two I’ll get to in a moment, but first let us look at innovations based on the amount of uniqueness inherent in them.

Breakthrough, revolutionary, and incremental innovation

Innovations which are completely unprecedented are variously called breakthrough, radical, or discontinuous innovations depending on which book you read (I’ll call them breakthroughs from now on). Breakthroughs have several attributes: they have few analogues to anything that has gone before, they change the rules of the game substantially in some way, they involve high levels of risk and reward, and they are inherently unpredictable.

History gives us a rich tapestry of breakthroughs to examine: the Wright Brothers with their first aircraft, the creation of the transistor, the discovery of penicillin. What do all these have in common? They were the result of years of thankless work with no guarantee of reward. But more importantly, they all changed the world. It is hard to imagine the inventors knew, when they started their work, how very important their efforts would be to those coming later.

A very common preconception is that innovation teams spend their days doing this kind of work: creation that is so substantially different from what has gone before that the rules of the game are completely rewritten. In fact, only unsuccessful innovation organisations spend all their time seeking breakthroughs, as will become evident later.

Nonetheless, there is a deceptive attraction to being first with something that completely changes the nature of a market or product. The rewards may be exceptionally large, and quite often result in a long-term sustainable competitive advantage as well. The downside, though, is that breakthrough innovations, no matter how clever they are, are extremely unpredictable. One cannot easily control when, or even if, one will make a return on what is almost certainly going to be a very large investment up front.

Breakthroughs have occurred from time to time in banking. When they have, they have substantially changed the playing field for everyone. One of the most famous was the introduction of computing to financial services by Bank of America.

As accessibility to retail banking services grew in the 1950s, especially with the rise of the credit card, banks began to struggle with the volume of paper processing required. It was becoming increasingly obvious to everyone that paper was going to put an upper limit on just how large an institution could reasonably grow. Computers seemed one answer, but the application of real computing to banking was substantially delayed by the fact that, at the time, the technology was primarily a scientific and military endeavour. Electronic machines had extremely limited input and output capabilities, which seemed to mitigate against their use in volume transaction processing environments.

Nonetheless, in 1950, Bank of America approached Stanford University regarding the possibility of an electronic machine for data processing [3]. At the time, an experienced book keeper could post 245 accounts per hour, or about 2000 per 8-hour work day. But growing volume was forcing the bank to shut its doors at 2 p.m. each day to deal with the paper backlog and checking accounts were growing at a rate of 23,000 a month. There were few alternatives but automation if the business was to continue its growth trajectory.

An early feasibility study was completed by Stanford University in 1951, leading to a first practical demonstration of a machine in 1955. This machine (called ERMA for Electronic Recording Method of Accounting) introduced several new innovations specific to banking. The first of these, Magnetic Ink Character Reading (MICR), addressed the input problem for volume cheque processing. Another parallel development was the creation of machines that could move paper at speed to the MICR reader. The use of transistors instead of valves made the machine practicable from a heat and power perspective. And magnetic memories were introduced to store instructions and intermediate data.

In 1956 the machine was tested for three months in a branch environment with loads that would be required of a central accounting facility. The tests were successful, leading to the acquisition of 32 ERMA machines by 1959.

The mechanisation of business – in which Bank of America was the pioneering innovator of the day – led to the rise of central accounting as the default mode of operation for banks globally. The breakthrough was so fundamental it was replicated by practically everyone else in short order. By 1965, almost all banks in the UK and the USA were running automated machines similar to ERMA [4].

Following breakthrough innovation (classified, as before, by the amount of uniqueness involved) is revolutionary innovation. Revolutionary innovations are sufficiently superior to what they replace that they become the default choice for a significant percentage of the market. They offer substantial advantages over what has gone before, but do not, themselves, redefine existing categories or create new ones. The Apple iPhone is a revolutionary innovation. It does not create a new product category (high end mobile phones), but it enhances the concept of an integrated phone, player, and organiser device in such a way that it has become the default choice for many people. It is revolutionary because it is winning share away from incumbent products, rather than changing the way things work fundamentally.

Revolutionary innovations tend to be less risky than breakthroughs, but as might be expected, usually have less upside. The reason? Revolutionary innovations, arising from well understood areas, are far less likely to have the kinds of entry barriers that breakthroughs have. As a result, they are copied more easily. Less than a year after the first release of Apple’s iPhone, companies such as HTC of Taiwan were already releasing phones that duplicated some of its best features, for example.

Revolutionary innovations in banking are not that common, but have occurred from time to time. The launch of ING Direct, a Canadian innovation that opened its doors in 1997, is one example. At the time, Canadians had little choice but to choose a low-interest, fee-charging savings account from one of the incumbent big five banks. ING Direct’s flagship product, a chargeless, high-interest savings account, was something quite new: it offered bare bones service to low margin customers, but did so at volume. It was immediately a runaway success. Apparently customers were over-served by the features of accounts they could get at their traditional banks.

In 1999, ING Direct opened in Australia, disrupting the industry there as they had done in Canada. Once again, the successful formula was repeated: provide a bare bones service and pass on those savings to customers. I recall being in a meeting with a senior banker in Australia at this time, during which he expressed his irritation that ING was ‘borrowing’ the use of his institution’s channels without paying for them. His complaint stemmed from the fact that ING Direct offered a branchless service, and therefore customers were forced to use the facilities of his bank in order to get funds in and out of their ING accounts. Bankers’ complaints aside, ING Direct in Australia went from standing start to the sixth largest retail bank in a few short years.

The next year, 2000, ING Direct opened in the USA, again repeating its successful branchless model, and except for some trademark ‘ING Direct’ cafes in key markets, remains relatively bricks-and-mortar free. It has now grown to become the largest direct bank in that country.

ING Direct is now operating in the UK, Spain, Germany, Italy, France, and Japan. Its revolutionary model that cut service back as much as reasonably possible and returned customers the savings is one that is, apparently, easy to transplant across cultures and geographic boundaries.

Finally, we come to the least new of all types of innovation: incremental, also known as continuous in...

Table of contents

• Title Page
• Copyright Page
• List of Tables
• Table of Figures
• Preface
• Chapter 1 - Introduction
• Chapter 2 - Innovation Theories and Models
• Chapter 3 - Innovating in Banks
• Chapter 4 - Futurecasting
• Chapter 5 - Managing Ideation
• Chapter 6 - The Innovation Phase
• Chapter 7 - Execution
• Chapter 8 - Leading Innovation Teams
• Chapter 9 - The Innovation Team
• Chapter 10 - Processes and Controls
• Chapter 11 - Making Futureproofing Work in Your Institution
• Some Final Words
• References
• Index