Product Profitability Anyone? The JFB Pro-Growth Matrix

A bank attorney spoke at a recent Financial Managers' Society (FMS) meeting that I attended. His topic: Leadership. His thesis: Analytics should be the basis for strategic decision making. He offered an interesting fact: 40% of critical decisions in U.S. companies are made from the gut. This style of decision making was romanticized by Jack Welch in his popular 2001 book: Jack Straight from the Gut.

But in reading Welch's tome regarding his successful years at the helm of GE, it is clear that he was far more analytical than the book's title indicates.

Community FI's are similar to other companies in their strategic decision making. Often, critical decisions are made from the gut or based on past experience that becomes more irrelevant as industries, such as ours, rapidly transform. Such disruption gave rise to strategic advisory firms that break down strategic decisions to the facts important to increasing the likelihood of positive outcomes.

One such firm is the Boston Consulting Group (BCG), creator of the Growth-Share Matrix that depicts the potential for a company's products based on growth prospects and market share. Intrigued by BCG's concept and the ability to illustrate facts to improve decision making in FI's, I created the jeff for banks (jfb) pro-growth matrix.

Instead of using market share, as in the BCG model, I utilized net revenue per product. For loans, this was calculated as a percent of the product portfolio as follows: coterminous spread - provision + fee income. For deposit products the formula was: coterminous spread + fee income. This data was pulled from my firm's profitability database for all FI's that subscribe(d) to our profitability outsourcing service.

I chose to use net revenue instead of product profits because of the step-variable nature of an FI's cost structure. Most costs are fixed until a certain level where employees struggle to get the work done and the FI must invest in people and/or technology to increase capacity. If revenues decline, it is not typical for expenses to decline, as banks don't often let people go or scale down operations like a mortgage origination shop or a brokerage firm. Therefore, focusing on the products that drive the greatest revenue through a relatively fixed expense base would be closer to a realistic alternative for FIs.

I measured for both the fourth quarter of 2000 and 2010 to look at how our industry has changed. Change it has! Gone are the days that core deposit products generate net revenue between 4%-9%, as depicted by the "Stars" from 2000. That is because the re-investment rate, or credit for funds, for deposit products has dropped dramatically as a result of the interest rate environment today, particularly at the low end of the yield curve. Many readers may have experienced their treasurer lamenting they don't want any more deposits because they have no place to put them. That phenomenon is represented in the pullback of deposit products from 2000 to today.

But even in our historically low rate environment, core deposit products linger near the "Stars" box. Because revenues are low, some have drifted into the question marks. Interest rates are beyond our control, but if the net revenues per product decline, and much of the decline is outside of our control, then to move "Question Marks" to "Stars" may require an analysis of our expense base and the processes in place to support those products. Are we using technology to its fullest capacity? Do we still engage in outdated processes to protect from a risk that is negligible today?

Another interesting point from the jfb pro-growth matrix was that commercial real estate (CRE), much maligned since the recent crisis, remained in the Question Marks camp, albeit knocked down a notch because of the decline in the 3-year compound annual growth rate (CAGR) used to calculate the Market Growth portion of the chart. With today's elevated loan loss provisioning, CRE continues to contribute to an FIs profitability with above average net revenue generation.

Time deposits have declined on a CAGR basis since 2007, as noted in its position on the chart. In 2000, time deposits had a CAGR of 4.65% and net revenue of 0.53%. Today, CDs CAGR is -8.69% as FIs backed away from this expensive funding source because there is no loan demand. Why book a CD when its current coterminous spread is negative, which is where it stands today? But even when CDs had a positive spread, this product remained unprofitable.

Lastly, the sheer gaggle of products in the "Question Marks" quadrant indicates an opportunity for FIs. Using analytics, product managers have the opportunity to migrate marginally profitable products into either "Stars" or "Cash Cows". Knowing where you do and don't make money is a critical starting point, and positive action based on analytics can improve your FIs financial performance.

How do you use analytics for critical decision making?

~ Jeff

Book Report: The Lords of Strategy by Walter Kiechel III

B+ This book, written by a journalist and former editor of Fortune magazine and editorial director of Harvard Business Publishing, tracks the growth and philosophical evolution of strategy. It focuses on three strategy firms in particular: Boston Consulting Group ("BCG"), Bain & Company, and McKinsey & Company. In its entirety, I would suggest that it would be a very beneficial read for banking industry consultants, and a beneficial read for executives at community FIs.

How business is done is often, if not mostly, evolutionary. Understanding how  we moved from the days when small businesses in small towns dominated the landscape, to how merchants operated in our large pre-industrial revolution cities, the emergence of large industrial firms, the birth of the corporate man, to where we are today is important to understanding today's business climate.

Management "fads" came and went. These fads were often touted by strategy firms and their army of elite business school educated consultants. This book tracks the evolution of strategy from its early days in the 1960's at BCG to where we are today. Strategy's emergence, and its evolution, being driven by what the author terms the "fiercing of capitalism", i.e. the escalation of competition beyond a few firms and the shortening of competitive advantage driven by technology.

This created fertile ground for strategy's ascendancy and the firms that touted its virtues. Understanding the genesis of strategy and its evolution is an important step in its development and implementation at community FIs and is the basis for my recommendation for the book.

From my perspective, it was interesting to note how strategy became in vogue and how our pre-eminent strategy firms differed in their approach. Creating teams to ponder in a conference room, ruminating how strategy should be formulated and executed is foreign to relatively small consulting firms like mine. We don't develop techniques in our firm's interior. Instead, we develop it across the table from clients, while on the phone with colleagues, or at conferences listening to experts and gauging bankers' opinions.

My world is foreign to BCG's, but it was instructive for me to learn of their methods. Knowing how they do it can only help me do it better. I think it can help you too.

Here is what I liked about the book:

1. Gave detailed descriptions of how strategy came about at BCG, and how it grew and flourished not only at that august firm but also Bain and McKinsey;

2. Introduced the key players in strategy's development, not only at the above firms but also at Harvard Business School;

3. Described strategy through each stage of its evolution, and used interviews with key players in the evolution.

Here is what I didn't like:

1. Focused only on three strategy firms and Harvard Business School. Did other B-schools or consulting firms participate in a material way?

2. The author gave me several vocabulary lessons, such as when he said an author "continued to sound the tocsin" (sound the alarm). Fortunately, I read it on a Kindle and could highlight and get definitions for the difficult words. This is probably a pet peeve of mine, and I should be more thankful that I can now use "tocsin" in a sentence.

But the book is very well put together and thorough in its review of how strategy came to be. I found it a very worthwhile read and recommend it to you.

~ Jeff

Book Report note: I will occasionally read books that I believe are relevant to the banking industry. To help you determine if the book is a worthwhile read for your purposes, I will review them here. My mother said if I did not have something nice to say about someone, then don’t say it. In that vein, I will only review books that I perceive to be a “B” grade or better. Disclosure: I will typically have the reviewed book on my Amazon.com bookshelf on the right margin of this blog. If you click on any book on the shelf and buy it, I receive a small commission; typically not enough to buy a Starbucks skinny decaf latte with a sugar-free caramel shot, but perhaps enough to buy a small coffee at Wawa.