Embed Size (px)
Citation preview
Credit Union Financial Sustainability:
A Colloquium at Harvard University
ideas grow here
PO Box 2998
Madison, WI 53701-2998
Phone (608) 231-8550
PUBLICATION #232 (3/11)
www.filene.org ISBN 978-1-936468-11-9
Credit Union Financial Sustainability:
A Colloquium at Harvard University
Copyright © 2011 by Filene Research Institute. All rights reserved.ISBN 978-1-936468-11-9Printed in U.S.A.
Deeply embedded in the credit union tradition is an ongoing
search for better ways to understand and serve credit union
members. Open inquiry, the free flow of ideas, and debate are
essential parts of the true democratic process.
The Filene Research Institute is a 501(c)(3) not-for-profit
research organization dedicated to scientific and thoughtful
analysis about issues affecting the future of consumer finance.
Through independent research and innovation programs the
Institute examines issues vital to the future of credit unions.
Ideas grow through thoughtful and scientific analysis of top-
priority consumer, public policy, and credit union competitive
issues. Researchers are given considerable latitude in their
exploration and studies of these high-priority issues.
The Institute is governed by an Administrative Board made
up of the credit union industry’s top leaders. Research topics
and priorities are set by the Research Council, a select group
of credit union CEOs, and the Filene Research Fellows, a blue
ribbon panel of academic experts. Innovation programs are
developed in part by Filene i3, an assembly of credit union
executives screened for entrepreneurial competencies.
The name of the Institute honors Edward A. Filene, the “father
of the U.S. credit union movement.” Filene was an innova-
tive leader who relied on insightful research and analysis when
encouraging credit union development.
Since its founding in 1989, the Institute has worked with over
one hundred academic institutions and published hundreds of
research studies. The entire research library is available online
at www.filene.org.
Progress is the constant replacing of the best there
is with something still better!
— Edward A. Filene
iii
Filene Research Institute
iv
For their help with, and participation in, this important research
colloquium, the Filene Research Institute would like to thank the
presenters:
• Frances Frei, UPS Foundation Professor of Service Management
at Harvard Business School.
• John Lass, senior vice president at CUNA Mutual Group.
• Dorian Stone, partner at McKinsey & Company and Filene
Research Fellow.
• Peter Tufano, Sylvan C. Coleman Professor of Financial Manage-
ment at Harvard Business School and Filene Research Fellow.
• We would like to thank Theran Colwell of CUNA Mutual for his
fantastic and ongoing efforts in gathering and synthesizing this
essential sustainability analysis for credit unions.
In addition, the colloquium came together due to the work of won-
derful partners. We would like to thank:
• Dan Egan, CEO, and the staff of the Massachusetts, New Hamp-
shire, and Rhode Island Credit Union Leagues.
• Gene Foley, CEO of Harvard University Employees Credit
Union.
Acknowledgments
v
List of Figures vi
Executive Summary and Commentary vii
About the Colloquium Leaders x
Introduction xi
Chapter 1 Lumber and Credit Unions 2
Chapter 2 Sustainability of the Credit Union
Business Model 5
Chapter 3 Operational Excellence Drives Sustainability 14
Chapter 4 The Basis and Need for Operational
Innovation 25
Chapter 5 Conclusion and Synthesis 33
Endnotes 44
Table of Contents
vi
1. Quarterly Personal Savings Rates as a Percentage of Disposable
Income
2. Ratio of Household Debt to Disposable Income
3. Gross Spreads Move Lower
4. Increasing Reliance on Fees and Other Income
5. Credit Union System Sustainable Growth History
6. Credit Union System Sustainable Growth Trend
(ROE, 1985–2007)
7. Sustainability Factors: Will the Trend Reverse or Continue?
8. ROA and ROE Defined
9. Credit Union Sustainable Growth Analysis
10. Credit Union Summary—June 2010
11. Case Studies Summary (As of June 30, 2010)
12. Labor Reality
13. Commerce Bank Attribute Map
14. Employee Management System
15. Job Design Dilemma
16. Focus on Rate of Improvement
17. Consumers Are Deleveraging, Especially in Credit Cards
18. Consumers Increasingly Rely on Online Channels
19. High Penetration or High Balances, but Not Both
20. Account Opening and First Month Accounts for 72% of
Lifetime Cross-Sells
List of Figures
vii
by Ben Rogers,
Research DirectorJohn Walton, billionaire son of Walmart founder Sam Walton, died
in 2005 in a tragic airplane crash. A skilled pilot, Walton crashed
while flying an experimental aircraft he had built himself. An inves-
tigation found that the aircraft had crashed when a malfunction cut
off control of the airplane’s pitch—the up or down angle of the nose
of the plane. Controlling pitch, along with roll and yaw, is essential
to flying an airplane. Careful command of all three factors is vital
whether you’re flying one mile or one thousand, and even a slight
malfunction in the control of any of them turns a routine flight into
a deadly one.
The stakes are lower but the dynamics are the same in sustainable
credit union growth. A colloquium called “Credit Union Sustainabil-
ity: Evidence and Actions,” held in Fall 2010 at Harvard University,
addressed the variables that—like pitch, roll, and yaw—must be
monitored and maintained in order for credit unions to both stay
aloft and gain altitude. Flight dynamics are a useful metaphor for
balance sheet dynamics, because small changes corrected in the mid-
dle of a long flight are not likely to have large effects. But when those
changes come during takeoff or landing (a financial crisis) or when
they continue uncorrected (years of declining growth), the results
are as sad as they are predictable. Instead of pitch, roll, and yaw, this
colloquium considered factors like net interest margins, operating
expenses, asset turnover, and leverage. In both cases, the factors must
be finely calibrated to assure a successful flight. In both cases, failure
to do so will result, eventually, in a crash.
What Is the Research About?This report documents the presentations and discussions of the col-
loquium, which combined insights from academia and business to
make a stark assessment of how sustainable the credit union business
model appears—how well the system and individual credit unions
are managing their pitch and roll. With the exception of some indi-
vidual credit unions, the trends are sobering. But the problems are
understandable and, therefore, manageable.
Colloquiums are designed for interaction, not just presentation,
and this one didn’t disappoint. Perhaps the most intriguing part of
the whole event was the panel discussion at the end, where the day’s
presenters took on trenchant questions, like: “What kinds of collabo-
ration should credit unions invest in?,” “How do you change strategy
with an unreceptive board of directors?,” and “Should credit unions
minimize operating expenses in exactly the same way as other firms?”
Executive Summary and Commentary
viii
What Are the Credit Union Implications?Peter Tufano, a Harvard Business School professor and Filene
Research Fellow, introduced a classic Harvard business case to show
that growing profits and growing sales do not always a viable busi-
ness make. The case study’s Butler Lumber Co. has to determine—
just like credit unions—the right mix of profit margin (lowering
costs, raising revenues, or both), asset turnover, leverage (using as
much capital as possible), and payout (distributing funds to share-
holders). If Butler gets it wrong, they will grow their way right into
default. The credit union corollary: Credit unions with excess capital
can manage with low profits for a long time, but without access to
outside capital, the only way to grow sustainably in the long run is to
pull one of those four levers.
Building on Tufano’s sustainable growth theme, John Lass, senior
vice president at CUNA Mutual Group, led a lengthy discussion of
exactly what those levers look like at credit unions. John noted he
had first learned the sustainable growth model while studying the
Butler case during the first year of his MBA program 30 years earlier.
He also noted he had applied it in numerous industries as a strategy
consultant and has recently found the model works particularly well
for the credit union system given the lack of access to secondary capi-
tal and the tax exemption.
Harvard Business School Professor Frances Frei taught that you can
fail even though nobody dislikes you. Credit unions have to be par-
ticularly careful about trying to be all things to all members, because
a drive for across-the-board excellence is likely to lead to mediocre
performance in all areas. It takes strategic courage to instead decide
what your credit union will not do well . . . and make sure you don’t
do it. If you try to be good at everything, you will run out of money
long before you’ve succeeded. Not a recipe for success.
Outsized op erating expense ratios are the bane of the majority of
US credit unions, argues McKinsey & Company partner and Filene
Research Fellow Dorian Stone. A straightforward comparison of
operating expenses at the smallest US banks and credit unions shows
credit unions lagging banks by 20% or more. Moreover, competitors
aren’t likely to get less efficient, so it’s time for credit unions to do
better. Key elements for credit unions to assess include whether they
are utilizing scaled operational models, prioritizing the right perfor-
mance improvements in order to deliver value to the member, and
putting the right accountability in place at each level to ensure high
levels of performance.
ix
The good news, and the key difference between Walton’s crash and
credit unions’ plight, is that most credit unions are not yet at the
mercy of emergency fixes. Most have time to fix their pitch, moder-
ate their yaw, and steady their roll.
x
Frances FreiFrances Frei is UPS Foundation Professor of Service Management
at Harvard Business School. Her research, course development, and
teaching examine how organizations can more effectively design ser-
vice excellence. Her academic research has been published in top-tier
journals such as Management Science and Harvard Business Review. In
addition, she has published dozens of case studies across a variety of
industries, including financial services, government, retail, software,
telecommunications, and hospitality.
George HofheimerGeorge Hofheimer is the chief research officer at the Filene Research
Institute, where he oversees a large pipeline of economic, behavioral,
and policy research related to the consumer finance industry. He also
leads a new Filene initiative focused on applied research and innova-
tion. George has authored numerous papers on consumer finance
topics and is a frequent presenter at national and international trade
events on topics such as executive development, technology, gover-
nance, and strategic planning.
John LassJohn Lass, senior vice president at CUNA Mutual Group, directs
corporate strategic planning and CUNA Mutual’s business develop-
ment unit with a focus on identifying and pursuing strategic diver-
sification opportunities. John has worked extensively in the credit
union system and worldwide as a speaker and strategic advisor.
Dorian StoneDorian Stone is a partner at McKinsey & Company’s San Fran-
cisco office. His consulting work focuses on customer experience
and growth opportunities in service industries, including financial
services.
Peter TufanoPeter Tufano is the Sylvan C. Coleman Professor of Financial Man-
agement at Harvard Business School and the incoming dean of the
Saïd Business School at the University of Oxford. He previously
served as Harvard Business School’s senior associate dean for plan-
ning and university affairs, as its director of faculty development, and
as head of the finance unit. His research and course development
focus on mutual funds, corporate financial engineering, and con-
sumer finance.
About the Colloquium Leaders
xi
The “Credit Union Sustainability: Evidence and Actions” collo-
quium was intended to serve as a funnel, to take broad principles of
finance and strategy and then boil them down into credit union–
specific contexts. So, Professor Peter Tufano taught an introductory
Harvard Business School case on ROE, while Professor Frances Frei
talked about design principles for effective service organizations.
Beyond that, John Lass broke down ROE in the credit union context
to examine the financial growth levers available to credit union lead-
ers, and Dorian Stone unpacked the state of the financial services
industry to identify challenges and opportunities available to credit
unions. The final session of the day, a panel among the lecturers,
synthesized the discussion and took aim at some of the credit union
system’s warts.
Consider the credit union system in the context of the following
quote from Analysis for Financial Management: “When a company
is unable to generate sufficient growth from within, it has three
options, ignore the problem, return money to shareholders, or buy
growth.”1 For a mature industry or a mature institution, those are the
options.
Many are choosing the first option and ignoring the problem, hop-
ing that some gradual return to normal earnings is in the future. For
credit unions with a strong capital position, ignoring the problem is
a straightforward proposition. And it’s possible to ignore the problem
all the way into the night, because their capital position will shield
many credit unions into irrelevance.
Very few credit unions call it quits and return money to their
shareholders. Instead, buying growth (or seeking growth) through a
merger is a common route. But these are the stark options available
to credit unions that cannot grow organically. So, the Harvard collo-
quium and this report prize sustainability and seek out ways to keep
organic growth alive at credit unions.
Introduction
Professor Peter Tufano of Harvard Business School teaches the classic case study on sustain-able growth. But what do credit unions have in common with a small lumber company? No matter what the industry, financial perfor-mance and business model sustainability turn on just a few key hinges.
CHAPTER 1Lumber and Credit Unions
3
“Butler Lumber Company” is a classic Harvard Business School
case. For more than 50 years, it has served as an introductory look
at enterprise- level financial analysis. And while the specifics of Mark
Butler’s business selling finished lumber to contractors are quite
different from those of issuing loans to credit union members, the
financial principles of ROE and sustainable growth are the same.
The case method encourages readers to take the story and decide
how to act on the information. This is the classic case study for
understanding the financial management of companies. Here’s a
short summary of the situation from the four-page case: Despite
good profits, the Butler Lumber Company has experienced a short-
age of cash and now needs to increase its borrowing, but it is near the
limit on its current line of credit. Butler’s net worth is increasing, as
are his sales, but his cash is dwindling. Readers are given the compa-
ny’s operating statements and balance sheet and asked whether they
would extend a larger loan to Butler.2
Growth Is Good but Not Always SustainableWhy all these details about a little lumber company? It builds a con-
ceptual point. Normally growth is good, and readers of the case see
that Butler’s sales growth is 26% per year, that net income is growing
19% per year, and that his capital is 35% of assets. But uncontrolled
growth is not a good thing, and his growth trajectory demands more
and more cash. Just putting up big growth numbers is not a reason
for celebration; in this case, the more Butler grows, the deeper the
hole he digs for himself.
Butler’s equity is growing, but his debt is growing at a faster rate.
That trend is manageable in the short term if Butler takes on addi-
tional debt, but in the long term it’s unsustainable. He has to find
a way to keep his overall growth in line with his return on equity
(ROE = net income / equity). If he wants to keep constant leverage
(net worth ratio) and grow his business, the only rate that works
4
without outside capital is his return on equity (ROE) times 1 minus
the payout rate (dividends).
Sustainable growth rate (G ) = (R × earnings) / equity
R is the firm’s retention rate, or 1 minus the dividend payout ratio.
G can also be written in other, more familiar iterations:
G = R × ROE
G = P × R × A × T
In this last equation, P is a firm’s profit margin, A is its asset turn-
over, and T is its assets-to-equity ratio, or leverage. All of these will
be examined in greater depth in Chapter 2, but the long and short
of it is that any company, including a credit union, can only grow in
a way that keeps its margins, its dividends, its asset turnover, and its
leverage in good correspondence.
If your actual growth rate is greater than your sustainable growth
rate, then the leverage ratio goes up and you need more cash. If your
actual growth rate is slower than your sustainable growth rate, you
are becoming less leveraged. In one sense, that’s a good problem to
have, because it’s easy to solve: Pay out more to members.
Basic Financial Levers for Improving ROEROE is the upper limit of sustainable growth, so an efficient busi-
ness’s goal should be to improve ROE. Because ROE is composed of
two financial measures (leverage and dividends) and two operational
measures (profit margin and asset turnover), those are the four areas
to target.
For credit unions, dividends are tied to interest rates on loans and
deposits and thus are distributed to member shareholders in the
normal course of business. Leverage, on the other hand, is variable
and—within regulatory boundaries—under management’s control. A
lower capital ratio means more leverage, and more leverage translates
into higher ROE.
On the operational side, asset turnover means selling your products
faster. Credit unions can increase asset turnover by selling loans more
often, either by bringing loan duration down or by selling newly
issued loans in order to re-lend more money.
And finally, profit margin is one of the most straightforward ways to
improve ROE. You can do it by either raising prices or bringing cash
expenses down. Credit unions are inefficient compared to similarly
sized banks, so reducing expenses is one of the credit union’s best
shots at improving ROE dramatically.
With the general principles of financial sustain-ability in hand, John Lass, senior vice president of CUNA Mutual Group, defines sustainability for credit unions, identifies unsustainable credit union trends, and homes in on the factors credit union leaders can control today.
CHAPTER 2Sustainability of the Credit Union
Business Model
6
Sustainability in FocusThe word sustainability holds a myriad of meanings in modern busi-
ness. But for the purposes of this examination, its meaning is quite
simple, as expressed in these two definitions shared by John Lass:
Sustainability is the ability to continue a defined behavior
indefinitely.
A sustainability system or process must be based on resources that will
not be exhausted over a reasonable period, sometimes expressed as the
long term.
In credit unions, the resource that should not be exhausted is capital,
so sustainable growth is business growth that maintains a steady level
of capital in reserve. That challenge is pressing, not just among credit
unions, but among larger sophisticated enterprises, too. According to
researchers at Bain & Company, “The odds of achieving sustained,
profitable growth remain challenging: Only about one in 10 com-
panies worldwide managed to grow profits and revenues more than
5.5% over the 10 years ending in 2008, and earn back their cost of
capital.”3
So credit unions are in the same milieu with other firms; both are
challenged to maintain steady sustainable growth. Healthy growth is
imperative, because it generates returns that serve members’ eco-
nomic interests, it creates space for retaining and promoting talent,
and the resources it generates can be further invested to keep up with
changing markets and shifting consumer demands.
If only 10% of companies have been able to post consistent growth
in the 10 years through 2008, consider the macroeconomic head-
winds credit unions face today. And consider whether they are
sustainable.
Figure 1 shows the personal savings rates of American consumers,
expressed as a percentage of disposable personal income. From 1950
up until about 1980, consumers tended to save anywhere from 8%
to 12% of their disposable personal income. But in 1980, it was as if
7
somebody had flipped a switch:
The savings rate started on a
nearly straight- line decline.
What’s going on here?
Some argue that the definition
of savings changed with the
growing use of 401(k)s, IRAs,
and mutual funds. That may
be true, but regardless of that
trend, the percentage of funds
that people put into a safe
investment with a limited risk
of loss of capital did take a deep
nosedive.
The decline in savings shows
an interesting correlation to a
post-1980 rise in the ratio of debt to disposable household income.
“Back in 1952, the ratio of household debt to disposable income was
less than 40% in the US. At its peak in 2007, it reached 133%, up
from 90% a decade before.”4
Could that trend have continued? Would it have been theoreti-
cally or practically possible for consumers to keep piling on debt? Is
there any structural or mechanical reason why that would have to
blow up? The answer is: It’s
unsustainable.
Sinking interest rates are one
cause of the slack savings and
booming loans, but 10-year
Treasury rates are close to 0%
now, down from 16% in the
early 80s, and there’s nowhere
lower to go. Add to that unsus-
tainable trend another in the
form of a rising debt-to-GDP
ratio and increasingly stressed
state-level debt loads. The
current macro environment is
bleak.
Unsustainable Credit Union TrendsCredit unions confront their own set of challenges in addition to
those facing all firms.
1980 1985 1990 1995 2000 2005 2010
0%
2%
4%
6%
8%
10%
12%
14%
Figure 1: Quarterly Personal Savings Rates as a Percentage of Disposable Income
Sources: CUNA Mutual Group; Bureau of Economic Analysis.
1980 1985 1990 1995 2000 2005 2010
0%
20%
40%
60%
80%
100%
120%
140%
Figure 2: Ratio of Household Debt to Disposable Income
Sources: CUNA Mutual Group; Board of Governors of the Federal Reserve System; Bureau of Economic Analysis.
8
The compression in the gross spread has been similar among banks
and credit unions. Although the spread widened a bit through the
middle of 2010, it’s
unclear how much
more it will move
and how much of
the improvement
is permanent. But
regardless of causes
and permanence,
the constricted
spread makes it
much more difficult
to earn high ROA.
Historically, ROA
and gross spread
have moved
together. They still
do, but the increas-
ing reliance on fee
income has had the benefit of weaning credit unions off pure interest
rate earnings, with the downside that fee income is subject to regula-
tion. Overdraft and interchange income represent 70% of credit
union fee income.
The recession also took a bite out of credit unions’ historically high
capital ratios, which moved from more than 11% at the start of the
300
Bas
is p
oin
ts
320
340
360
380
400
1992 1994 1996 1998 2000 2002 2004 2006 2008 Q2
2010
420
Figure 3: Gross Spreads Move Lower
Sources: CUNA Economics and Statistics; CUNA Mutual Economics.
–150
Bas
is p
oin
ts
–100
–50
0
50
100
150
1992 19941990 1996
*Q2 2010 annualized
1998 2000 2002 2004
ROA less fees and other income*
Return on average assets (ROA)*
2006 2008 Q2
2010
Figure 4: Increasing Reliance on Fees and Other Income
Sources: CUNA Economics and Statistics; NCUA; CUNA Mutual Economics.
9
crisis to 9.8% in the middle of 2010. And while that ratio certainly
seems strong, it is only the average, with sand-state credit unions and
others showing much weaker capital positions.
One trend that is not at crisis, yet, is the membership growth rate.
At 0.9% in the middle of 2010, it’s still positive, but it’s down from
about 3% at the end of the 1990s. Further, it is not a net growth
rate. To be truly healthy, the membership growth rate should hover
above the US population growth rate, which in 2010 was estimated
at 0.97%.5 A lower number means a gradual loss of market share.
Similar macroeconomic forces are driving banks and credit unions to
consolidate at nearly identical rates. The total number of institutions
in both systems is nearly identical, but the difference is stark in terms
of size. Out of 8,000 banks, only 228 have less than $20 million (M)
in assets. But out of 7,700 credit unions, 4,161 have less than $20M
in assets. The trend reverses on the other side, with just 3 credit
unions but 110 banks that have more than $10 billion (B) in assets.
That size makes a lot of difference in analyzing sustainable growth
rates.
In 1987, the credit union system as a whole had, on average, 6%
capital. This was before HR 1151, when prompt corrective action
didn’t exist. Credit unions could actually operate with a very
0.00
RO
A (
%)
0.20
0.40
0.60
0.80
1.00
1.20
1.40
12.00 11.60
Capital/Leverage (%)
11.20 10.80 10.40
8.5× 10× 14×
2009 system
10.00 9.60 9.20 8.80 8.008.40 7.60 7.20 6.80
1.60
1.80
2.00
5% 10%Sustainable growth rate: 15%
Q2 2010 system
2006 system
1992 system
2002 system
1997 system
1987 system
2008 system
2007 system
Figure 5: Credit Union System Sustainable Growth History
Sources: NCUA 5300 Reports; CUNA Economics and Statistics; CUNA Mutual Analysis.
10
significant amount of leverage, and that leverage fueled the growth of
the system.
ROAs were also strong, averaging about 100 basis points. From 1987
to 1992, and on to 1997 and 2002, the strength of ROA built the
capital of the system. Earnings carried capital from 6% all the way
up to 11%. From 2002 on, ROAs started to weaken. So from 2002
through the first half of 2010, ROA has weakened, and capital has
been pulled back by lower earnings and the financial crisis.
Your ability to grow is equal to ROA times leverage. So the top line
in Figure 5 means that the credit union system as a whole could grow
at a rate of 15% per year. The middle line represents a 10% growth
rate, and the bottom line is 5%.
Despite some small recent improvements, the challenge at the col-
lective and individual levels is to figure out what growth level credit
unions need to sustain. The long and short of it is that today, in most
cases, it has to come more from
ROA, because many credit
unions have pulled their net
worth down to the point where
it would be somewhat risky to
use that as the principal driver
of growth.
The sustainable growth trend
shown in Figure 6 is clearly
problematic. The deterioration
in the first half of the trend is
mainly due to the system build-
ing capital, which is not bad.
However, the second half of the
trend line results from declin-
ing ROA, pushed lower by nar-
rower interest rate spreads, loan
securitization, increased com-
petition, higher compliance
costs, cyclical headwinds, and
increased operating expenses.
That’s the bad news. The good news is that although the system as
a whole may be engaged in an unsustainable trend, individual credit
unions don’t have to participate. Figure 7 shows the seven factors
that weigh on credit union sustainability and the requisites for each
that contribute to, or detract from, ongoing sustainability.
1985 1990 1995 2000 2005 2010
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
Figure 6: Credit Union System Sustainable Growth Trend (ROE, 1985–2007)
Sources: NCUA 5300 Reports; CUNA Economics and Statistics; CUNA Mutual Analysis.
11
Credit Union Levers for Controlling Financial SustainabilityJohn Lass recalls, “Six years ago, when I was first coming into the credit
union system, one of the first things Jeff Post [CUNA Mutual CEO]
asked me to do was go around the country interviewing CEOs of large
credit unions. I asked the CEO of a very large credit union if it was
important for that credit union to be able to grow. The CEO’s answer
was, ‘If we stop growing, we cannot remain relevant to our members’
needs.’” Not every credit union needs to have the same answer, but it
is a prospect that each needs to consider and debate.
The DuPont model offers a simple way to unpack the different fac-
tors that roll up into ROE and therefore determine financial sustain-
ability (see Figure 8).
The first ratio is profit margin.
Profit margin is equal to net
income divided by net revenue.
For most credit unions, net
revenue has three primary com-
ponents: net interest income
(spread income); fee income,
which is your noninterest
income; and nonoperating
income.
Now, nonoperating income is
usually a very small number. In
2009, some credit unions had
Figure 7: Sustainability Factors: Will the Trend Reverse or Continue?
Trend reverses Factor Trend continues
Spread widening continues Spread Compression reverts to trend
System costs rationalized Operating costs Costs increase (regulatory
burden, channel proliferation)
Release improves ROA Loan loss provision/allowance
for loan loss
Macroeconomic challenges
continue
New sources identified Fee income Caps imposed
Risk-based capital (RBC)
reduces overall burden
Regulatory capital
requirement
More capital required
Credit unions sell more loans
to secondary market
Asset turnover Continue to balance sheet
loans (except real estate)
No further assessments Special assessments Additional assessments
Source: CUNA Mutual Group.
Sustainable growthThe fastest a credit union can grow assets without affecting its capital ratio
× ×
ROA
Net income
Profit margin
Revenue
Asset turnover
Revenue
Assets
Leverage
Assets
Capital
ROE
Figure 8: ROA and ROE Defined
Source: CUNA Mutual Group.
12
big numbers because they pushed the NCUA insurance fund assess-
ment back to 2008. And when the Temporary Corporate Credit
Union Stabilization Fund came out, many credit unions spread their
payments over seven years. As a result, many booked a large gain
that showed up in nonoperating income. For some credit unions, as
much as 15% of revenue in 2009 was in the nonoperating income
box. But typically, that portion of net revenue is small.
Six primary factors that credit unions can control feed into the over-
all ROE equation:
• Interest rate spread.
• Fee income.
• Loan loss provision.
• Operating expense.
• Asset turnover.
• Leverage factor.
Pushing on any of them is akin to controlling an airplane. Instead of
having the rudder, flaps, and thrust, credit unions have the six levers
to pull. By manipulating those levers properly, individual credit
unions stay on a sustainable course. Moving one lever in a positive
direction can cause another one to move in the opposite direction.
For example, increasing spread income by getting into member busi-
ness lending is a perfectly reasonable strategy. But what does that do
to the loan loss provision? That will have to rise as well. The trick in
flying the credit union airplane is understanding and controlling the
intricate interrelationships among all six levers.
Of the six controllable factors in ROE, operating expense is the one
most under management control, and there are some very clear ben-
efits of scale when it comes to operating expense (see Figure 10).
The smallest credit unions run operating expenses of 85.6% of
revenue. Credit unions between $250M and $1B in assets run 75%,
$1B–$10B credit unions average 65%, and the operating expenses
for the largest three credit unions are 55% of revenue. The differ-
ential between the smaller institutions and the larger institutions is
consistent and it’s huge: 30 percentage points of operating expense
13
relative to revenue. These are impressive numbers in terms of ongo-
ing sustainable growth.
The differential raises several questions: What are the redundant
costs in the system? What is the sustainability threshold?
Influencers
Net margin to average
earning assets
Yield on average loan
Yield on average
investment
Cost of funds to average
interest-bearing liabilities
Average earning assets to
average interest-bearing
liabilities
Estimated breakdown
Interchange and fees
NSF and Courtesy Pay
Other fees and operating
income
Breakdown
Gain on investments
Gain on assets
Other
Influencers
Delinquency
Net charge-offs/
Average loans
Allowance for loan
losses/Total loans
Loan loss provision/
Average loans
Influencers
Operating expense/
Average assets
Operating expense/
Net revenue
Members/Branch
Net
interest
income
Net revenue Total expenses
Fee and other
operating
income
Nonoperating
incomePlus Plus
Minus
Divided by
PlusLoan loss
provision
Operating
expense
Net income/
Net revenue
Net revenue/
Average assets
Average assets
to average equityROA
ROE
Times
Times
Profit
margin
Asset
turnover
Leverage
factor
First mortgages sold YTD/Total first
mortgage real estate sold but serviced
to Total real estate loan to share
Net income Net revenue
Figure 9: Credit Union Sustainable Growth Analysis
Source: CUNA Mutual Group.
Figure 10: Credit Union Summary—June 2010
Credit union
asset size
Number of
credit unions ROE
Operating expense
(% of net revenue)
<$250M 6,905 0.70% 85.6%
$250M–$1B 528 3.88% 75.3%
$1B–$10B 164 5.65% 65.4%
>$10B 3 11.36% 55.4%
All credit unions 7,600 4.10% 72.9%
Sources: NCUA 5300 Reports; CUNA Mutual Analysis.
Looking outside the financial services sector, Professor Frances Frei of Harvard Business School uses short case studies to show how ser-vice excellence demands having the stomach to be bad at some things, avoiding gratuitous ser-vice, designing better systems for employees, and teaching customers to behave differently.
CHAPTER 3Operational Excellence
Drives Sustainability
15
There are four traits that sustainably excellent service organizations
have in common—four design principles. They can also be seen
as four obstacles that get in the way of well- intentioned manage-
ment. What follows is a description of each, along with illustrative
examples. Each principle is incredibly important, and together they
are essential.
Four Traits for Sustainably Excellent OrganizationsHave the Stomach to Be BadBy far, the number- one obstacle to service excellence across indus-
tries, and this includes credit unions, is that firms don’t have the
stomach to be bad at anything. The number- one obstacle to service
excellence is actually an emotional obstacle. A culture that can’t bear
being bad at something can’t have sustained excellence.
The best illustrative example for this is Commerce Bank. Com-
merce Bank became the fastest growing bank in the United States on
deposits by bucking conventional wisdom about how to grow a retail
bank. Historically, the rules of the road were straightforward: Offer
the most attractive rates and you’ll attract customers. And if that’s
too onerous, just buy another bank, and you’ll look bigger.
But Commerce didn’t make acquisitions, nor did they offer attractive
rates. In fact, they offered the worst rates in every local market. It was
a promise that they made to their customers: “No one will pay you
less for your money than we will.” Yet, they became the fastest grow-
ing bank in terms of deposits.
They did it by differentiating on two very specific attributes of ser-
vice. First, Commerce had the best hours in every local market. They
kept their branches open late at night—sometimes until 11 p.m.—
and all day Saturday and Sunday. Customers loved this. The custom-
ers of the competition loved it, too. They asked their banks to do the
same thing, and these competitors very reasonably said they couldn’t
afford it. Right? It would cost too much money. So the question is,
16
if the competition couldn’t afford it, why could Commerce afford
it? And the answer is, because they paid the worst rates in every
local market. Commerce Bank is best in class at one thing precisely
because it is worst in class at another.
If you learn nothing else from this discussion, you should at least
understand that you cannot be great at everything. You should also
realize that if you have an inability to make tradeoffs, you’re taking
it out on your employees. At some point, it becomes unfair to ask
employees to support that. It’s a classic price/quality tradeoff.
Second, Commerce had the best customer interactions by far. Some-
times their competition would indicate that Commerce was 20 points
better on a 100-point scale. These were really distinguished interac-
tions. Commerce had better customer interactions because they hired
a different type of employee than the competition did. They selected
on attitude.
They didn’t select on attitude because they were more enlightened.
They selected on attitude because they could. That is, they didn’t
need much aptitude. And that is the dirty little secret of service
organizations.
Any organization can deliver great service with
employees who have great attitude and great apti-
tude. Here’s the problem: Everybody wants those
employees, and as a result, they end up costing about
twice as much as anyone on the diagonal (see Fig-
ure 12). Commerce Bank, given the market it was
serving, could simply not afford the upper right-hand
quadrant.
Instead, they ended up with very simple, happy
employees with very little aptitude. But they had the
simplest product set in all of banking, so no aptitude
was required. The competition had 40 different check-
ing accounts. Commerce had 4. The competition had
all kinds of loans and fancy products. At Commerce,
they said they offered loans, but quite honestly, as a
customer, you could never get a loan.
All of Commerce’s customers got essentially the
same product. That meant that these low- aptitude
employees could thrive. Commerce could deliver excellence with
these employees, and good luck trying to beat them on attitude. If
Citibank took Commerce’s employees, they would have pleasant
incompetence. So this only works if you have a simple system. Com-
merce was best in class at customer interactions precisely because
they were worst in class at cross-sell.
Low
Ap
titu
de
High
Low High
Attitude
$
$
$ $
Figure 12: Labor Reality
Source: Frances Frei.
AN ALTERNATE VIEW OF COMMERCE BANK’S SUCCESS
There’s more to the Commerce story than
meets the eye, says McKinsey partner and
Filene Research Fellow Dorian Stone. One
of the things Commerce did exceptionally
well was high- service, convenient delivery.
One of the things they didn’t do so well
was manage noninterest expense (NIE).
And with success, the bank’s NIE started to
skyrocket. So their growth came, and they
kept doing the things they were good at, in
the spirit of driving growth. But they were
not always good at managing the ROI of
the incremental decisions they were mak-
ing in the spirit of the “Commerce Way.”
The bank’s NIE took off and growth was
tremendous, easily outpacing revenue.
But that didn’t show up in the headlines,
because everybody loved Commerce. And
the bank didn’t have to face the conse-
quences, because for quite a while their
stock continued to go up—until things fell
apart.
They’re best in class at the two dimensions
of convenience and customer interactions
(Figure 13). The engine for that is that
they’re worst in class in the two dimen-
sions of product range and price. You want
to be best in class in things that are most
important to customers and worst in class
at things that are least important. It’s that
diagonal that’s important.
Do you want to be great? Super. Just make
sure you have the stomach to be bad, and be
really smart about which things to be bad
at. Sometimes saying you have a culture of
excellence really means that you can’t make
tradeoffs. No problem. But just understand
that in the real world you’re competing against companies that are
making those tradeoffs.
Don’t do the corporate version of Whac-A-Mole. Don’t run after one
thing you’re bad at, and another thing, and another, with everything
snapping back to mediocre along the way. That’s a good way to end
up with exhausted employees and still not be good at everything.
Consider the MacBook Air. Apple scanned the horizon and decided
they wanted the MacBook Air to be best in class at laptop lightness.
That meant it had to be worst in class at memory. At a moment in
time, these two things traded off against each other. Apple had a
Price
Product range
. . .
Convenience
Customer
interactions
Most important
to target market
Least important
to target market
1 5432
Relative performance of firm
Figure 13: Commerce Bank Attribute Map
Source: Frances Frei.
17
18
choice: Being best in class at weight meant being worst in class at
memory. If you don’t want to make tradeoffs, you can be average at
everything. Just put a Dell sticker on it.
Importantly, the engineers at Apple were not tormented by the
MacBook Air having the worst memory. The reason they weren’t
tormented is that physics applies to physical products. The message
for credit unions is that physics applies to financial services as well.
Yet, we seduce ourselves into thinking that’s not true. In the presence
of charisma, it often looks like we can overcome physics.
The challenge is that customers do not simply state their prefer-
ences. Given a list of variables and asked to rank them in importance
on a scale of one to five, most customers will give everything a five.
Instead, consumers reveal preferences. Conjoint analysis is the way
to get there. Ask members a series of questions: Do you prefer this to
this? Consumers have to be coaxed into revealing their preferences.
The good news? You can influence what your customers care about.
Consider tap water. Everyone was perfectly fine with tap water
until bottled water came along. Bottled water companies were able
to convince us to care about water, so there’s hope for credit union
marketers.
Avoid Gratuitous ServiceThe second principle is avoiding gratuitous service. The longer you
have customers, the more steady the drumbeat to give them stuff for
free. That’s called gratuitous service. Unfortunately, you can’t sustain
service excellence if you have too much gratuitous service, so you
need to design reliable funding mechanisms into the service offering.
There are three ways to do that. If you have at least one designed in,
you have a chance at sustained excellence. If you don’t, you’ll likely
get episodic excellence, because you won’t be able to pay for the
additional service.
The first method is clear from the example of Commerce Bank. The
Commerce customer paid more for convenience every day, whether
they used it or not. By receiving half a percentage point less on
deposits, they paid for the extended hours.
If you’re going to ask the customer to pay more, however, make it
as palatable as possible. Charging for a teller is not palatable. Half
a percentage point less on deposits is more palatable. Even if the
member is economically better off being charged for the teller, it just
doesn’t feel right.
The second method is best illustrated with an example: Progressive
Insurance. The auto insurance industry is interesting for a number of
reasons, primarily because it loses on insurance by design. It pays out
19
more than its customers pay in. The reason the industry stays afloat
is that its customers pay in advance. It’s also the most price- sensitive
industry in the United States. If Progressive charges $100 and State
Farm charges $95, customers flock to State Farm. This is a true com-
moditized service industry.
Against that backdrop is Progressive, which spends more on ser-
vice than anyone else by far. The customer won’t pay extra for that
service, and yet the service directly contributes to why the company
is more profitable. If you’re a Progressive customer and you get into
an accident, you call the police and you call Progressive. Progres-
sive shows up at the scene of the accident long before the police do.
They come in a sporty, white van. They’re really kind. They dust you
off. They ask if you’re OK. They assess the damage right on the site.
They even write a check right there and give it to you. Customers
love this service. But those vans are very expensive. The wireless tech-
nology to support remote claim settlement is very expensive. Claims
adjusters, unfortunately, can no longer work just 9 to 5, because
customers get into accidents at all times of day and night. Managing
three shifts of workers is very expensive.
How does Progressive make it work? By showing up at the scene of
the accident, they reduce a really big cost: fraud. In this industry, $15
out of every $100 of premiums goes to fraud and legal fees. Progres-
sive didn’t come up with this idea to enhance customer service: This
is fraud reduction in a pretty dress.
That’s the second method. Start with operational savings and cre-
atively figure out how to dress it up. There is not an organization
that has attempted to do that and been unsuccessful. Sequencing
matters. If you start with a service and try to reverse- engineer how to
pay for it, it’s a needle in a haystack. Instead, start with your biggest,
most persistent bucket of cost, preferably one that has plagued the
industry. Put a cross- functional team on it. It’s not even going to take
them more than three hours. Fraud- busters framed as the immediate
response van. That’s the second funding mechanism.
The third funding mechanism is becoming increasingly popular:
Shift employee labor to customer labor. But be cautious. This is a
way to fund service, not necessarily a way to fund excellence.
The requisite quality standard for turning customer labor into an
excellent experience is not easy, but it is straightforward: Design a
self- service that is so good that customers prefer it to a readily avail-
able full- service alternative.
Think airline kiosk check-in, not supermarket checkout. That seat
map in the airline kiosk that lets you pick your seat is lovely. It allows
you to work out all your own private idiosyncrasies and then just
20
point and click; it’s a beautiful thing. No full- service person can help
as much as that seat map can help. The supermarket checkout is
completely the opposite. Designing a system that pushes customers
toward self- service because full- service is grim can’t lead to excellence.
At the supermarket self- checkout, you do exactly what an employee
would do. Asking the customer to do the exact same task as an
employee cannot lead to excellence. You have to fundamentally rede-
sign the task so that unskilled, heterogeneous customers can do it.
Design Systems So Typical Employee Can Be ExcellentThe third principle—and this is one that bedevils credit unions—
is that great organizations design their systems so that a typical
employee can reliably produce excellence. Most organizations design
their systems so that their best employees can achieve excellence, but
what you need to do is design your systems for employees that you are
likely to attract and retain—not for the employees you wish you had,
but for the employees you actually do have. Well- intentioned manag-
ers try to set their best employees up for success. But sustained excel-
lence comes from aiming at the middle of the pack, not at the top.
You shouldn’t optimize for your best employees because you can
never have enough of them. Instead, optimize for typical employees.
If your employees can’t achieve excellence, you haven’t designed the
job correctly. In other words, if your service is not dependent on the
person delivering it, you’ve designed a system that reliably produces
excellence. That system decomposes into four parts: (1) who you
hire, which has to be aligned with (2) the training you provide,
(3) the job that you ask employees to do, and (4) the performance
Permits Creates
Limited
product set
Hire for attitude
Train for service
Design a system where typical employees have a reasonable chance of success
Better customer
interactions
Figure 14: Employee Management System
Source: Frances Frei.
21
management system you put in place. Employees are reasonably able
to excel when your job design matches these four characteristics.
Incentives rarely solve problems, but they can certainly create dys-
function. Job design solves lots of problems. For instance, Commerce
Bank knew within 15 seconds if they were hiring the right person
for a frontline job. How? They looked to see whether the applicant
smiled in a resting state. Most people smile when provoked, but
Commerce tested for more than that. They hired people for whom
smiling was not a conscious decision. They aligned their job design,
their selection, and their training. And they were very thoughtful
about how they did it.
Another example, because Commerce is almost artificially simple,
comes from a large international bank trying desperately to improve
their branch experiences. They put in incentives. They put in train-
ing programs. They tried everything, and they couldn’t get there.
So a senior executive went to work on the front line. Here’s what
she reported after her first day: “From the time the doors opened,
customers were yelling at me. Now, we knew it was bad, so this was
unfortunate, but confirming.” But then she sheepishly admitted, “By
the end of the day, I was yelling back.”
This executive was working with a system reliably designed to pro-
duce customer antagonism. Behind the scenes was a common cul-
prit: Marketing was making promises that operations couldn’t deliver
on. And the disconnect was experienced at the front line.
In just the past few years in financial services, operational complexity
has increased. It’s had to. But has the level of employee sophistica-
tion changed over the same period of time? Probably not. You can’t
get excellence with that gap (see Figure 15). That
gap reliably produces unpleasant experiences on
the front line.
You can dramatically enhance employee sophis-
tication. But it’s easy to underestimate how big a
deal that is. You can’t solve this with a weekend
retreat.
The other choice is to reduce operational com-
plexity to match employee sophistication. The
challenge is to do it in a way that doesn’t simul-
taneously reduce revenue. It is the obligation of
executives, not frontline staff, to close the gap.
Teach Customers to Behave DifferentlyIn order to deliver excellence, sometimes you
have to get customers to behave differently than
Leve
l
Time
Employee
sophistication
Gap
experienced by
front line
Operational
complexity
Figure 15: Job Design Dilemma
Source: Frances Frei.
22
they want to. When your customers are blocking your path to excel-
lence, you have to get them to behave differently in order to be able
to thrive.
Here’s the problem. It’s pretty easy to get customers to behave differ-
ently and have them dislike you for it. But great organizations can
get customers to behave differently while simultaneously boosting
satisfaction. That’s the trick.
The classic example here is Starbucks. Starbucks was experiencing
severe product proliferation. It got so severe that it threatened the
graciousness with which their baristas could deliver their service. So
they came up with a really good idea. They decided to offload the
ordering process to the customers, so the baristas wouldn’t have to
remember all of those drinks. But if customers used any language
they wanted, in any sequence they wanted, it would introduce
chaos into Starbucks’ operating environment. So they came up with
a mechanism that got customers to use their language and their
sequence and, just as importantly, to like them for it.
They did two important things to accomplish this. First, they
published a 22-page book. Part of it reads, “If you’re nervous about
ordering, don’t be. There’s no right way to order at Starbucks. Just
tell us what you want, and we’ll get it to you. But if we call your
drink back in a way that’s different from what you told us, we’re not
correcting you, we’re just translating your order into barista speak.”
They’re telling you how the cool kids would have ordered it, is what
they’re doing, but they’re doing it in a really important way. They yell
it back so everyone else in line can hear. Doing that has a normative
effect, and customers aspire to get it right. If they order it wrong,
they apologize.
In quick review, remember the four principles:
• In order to be great, you’ve got to be bad.
• You’ve got to pay for the service you give.
• Set your average employee up for success.
• Don’t be afraid of confronting ingrained customer behavior.
Excellent Organizations Ruthlessly Expose ProblemsBeyond the four principles that characterize excellent service organi-
zations, here is a final illustration about strategy.
Steinway & Sons, in its heyday, essentially owned the entire piano
market. They owned the top of the market. They owned the bottom
of the market. This wasn’t surprising, because every single Steinway
piano was a work of art. It was handcrafted, lovingly assembled with
23
aged wood. To Steinway’s craftsmen, each assembly of a piano was
really just a magical experience.
And then along came Yamaha, which had just finished conquering
the not-so-related field of lawnmowers. They looked around the
world and saw an uncontested market. The problem was, nobody
at Yamaha had any idea how to make a piano. But they had excess
capacity, and they had a really good idea. They bought a Steinway
piano, and they very carefully disassembled it. They kept track of all
their disassembled pieces, and with their automated processes they
built something like it. Because at Yamaha, there are no craftsmen;
they just manage automated processes.
They replicated every one of the disassembled Steinway pieces,
and then they reassembled their replica pieces into something that
seemed exactly like a piano—until you played it. By every objective
measure, this piano sounded like crap. But in the piano market, the
quality of the piano only has to be slightly greater than the skill of
the person playing it.
Yamaha was able to get away with lower quality, which was less
expensive, and they got the entire bottom of the market. The next
year, Yamaha got a little bit better at their automated processes. They
still made lousy pianos, but they were good enough to get the next
layer of the market.
The next year, they got a little bit better again, and at this point,
Steinway got scared. They did what a lot of companies do when
they get scared: They hired a consultant. Their consultant came in
and did a beautiful analysis. The conclusion: Yamaha’s incursion was
good news for Steinway. Why? Because pianos are a segmented mar-
ket. And Yamaha’s low quality emphasized Steinway’s high quality.
What a relief.
But Yamaha kept getting better year after year, and when Steinway
finally decided to take them seriously, it was, quite tragically, too late.
Steinway filed for Chapter 11 the day after the first Yamaha piano
was played in Carnegie Hall. And since then, they have been rescued
on the verge of bankruptcy repeatedly. The brand is now a shadow of
its former self.
In Figure 16, it’s unimportant which specific organizations you give
as examples. The generalizable lesson comes down to: Which would
you rather be, Company A or Company B? Steinway or Yamaha
pianos? GM or Toyota cars? Triumph or Honda motorcycles? If
someone else is improving at a faster rate than you, they will become
better than you. It is simply a question of when.
Company A often waits too long to take action. Company A loves
to benchmark how much better they are than everyone else. If
24
Company A would just focus on rates
of improvement instead of the absolute
difference, they would get terrified
sooner and have a chance to act.
So how do you improve at a faster rate?
Surprisingly, there is in fact something
demonstrably different about compa-
nies that improve faster than everybody
else. They relentlessly seek to expose
problems. A typical organization does
not strive to surface problems. For
example, utter the phrase, “Don’t bring
me a problem unless you bring me a
solution.” That’s a magnificent way to
make sure that you only surface a sub-
set of all the improvement opportunities. It’s a magnificent way to
make sure that someone else has a rate of improvement that’s better
than yours.
In excellent organizations, problem surfacing can be a solo sport.
Solving problems, that’s a team effort. People in lagging organiza-
tions don’t make waves, because nobody wants to be a squeaky
wheel.
In conclusion, you have to get the service design principles right and
change your attitude toward problems. Relentlessly seeking out prob-
lems coincides with extraordinary rates of improvement.
Qu
alit
y
Time
Company B
At any point in time,
benchmarks of absolute
difference can be very
misleading for Company A
Company A
Figure 16: Focus on Rate of Improvement
Source: Frances Frei.
Dorian Stone, partner at McKinsey & Com-pany, examines credit unions against competi-tors, finding strengths in loyalty and trust but weakness in operational expenses. Collabora-tion will be helpful, eventually, but better effi-ciencies need to start today.
CHAPTER 4The Basis and Need for Operational Innovation
26
Improving operational efficiencies and changing the focus of your
credit union is like remodeling an airliner in midflight. You can’t take
it out of commission or you’ll lose your business, but you have to
make overhauls and adjust your course or the plane will eventually
drop out of the sky.
The efficiency ratios of the credit union system are unsustainable,
and there are a lot of moving pieces to manipulate in order to fix that
problem. But fixing the problem is not optional; either you do it or
you will eventually be out of business.
Credit unions enjoyed a single- pronged challenge over the last few
years as the banking industry was getting rocked. Deposits were
flowing in, and even though loan growth was stagnant, there was a
feeling of success, of gains in market share.
But now a two- pronged challenge is emerging. In addition, a more
efficient and competitive banking industry is emerging. They are
already stripped through and reinvesting in performance culture.
And they are upping the ante on some functional elements as well.
In response, your credit unions are now the plane in the sky that
needs to be rebuilt but, at the same time, needs to keep moving. As
leaders of your institutions, you have to look for win–win ways to
reduce costs while winning over customers in such a way that they
actually increase their value to you as an institution.
Consumer Sentiment and Credit UnionsConsumers are starting to feel a little bit like they did before the
recession. For example, think about the revolving debt segment (see
Figure 17). Intention to use loans sank across the board through
early 2010, but it sank most dramatically for credit cards.
You don’t need any more warnings about the importance of the
Internet. The way consumers get information about financial prod-
ucts has already shifted. And the way consumers open accounts is
27
shifting quickly. Anywhere from a fifth to a third of financial prod-
ucts are being acquired online. Even more interesting is that the
majority of credit card solicitations arrive in the mail, but they are
drawing their largest set of responses online.
Deleveraging activities will continue across most loan products, but the focus will continue to be on credit cards
What are you likely to do with your loans over the next six months?
Percent of respondents*
*Balance indicated no change intended.
Product Q1 2009 Q2 2009 Q3 2009 Q1 2010
Mortgage
Home equity loan
Auto loan
Personal loan
Credit card balance
8
20
3
7+12 +4
3
6+3
4
8+4
Open/Increase DeltaClose/Decrease
11
14
3
5+3 +2
4
5+1
5
7+2
6
20
4
7+14 +3
5
6+1
6
8+2
10
9
3
6–1 +3
3
7+4
4
7+3
6
36
4
27+30 +23
6
26+20
6
26+20
Figure 17: Consumers Are Deleveraging, Especially in Credit Cards
Source: McKinsey Consumer Financial Health Survey, January 2010 (survey of 3,000 consumers across 13 segments).
Information gathering Account servicing Product purchasing
Preferred source of financial information Use of online banking Acquired last financial product online
Checking 21%
Non-Checking 27%
2000
Q2 2010
8%
48%
TV and radio
Internet66%
25%
9%
Figure 18: Consumers Increasingly Rely on Online Channels
Source: McKinsey 2010.
28
Do consumers think of credit unions as an industry easy to do busi-
ness with online? Do they see remote channels and multichannel
functions? Combine that challenge with the uptick in smartphone
usage and it becomes even more pronounced. Smartphones are
expected to constitute 58% of US handset shipments in 2013. They
offer an opportunity to resolve traditional consumer pain points,
but only for financial institutions with the scale or the willingness to
keep up.
When it comes to customer satisfaction, every year the largest banks
underperform the regional banks. The regional banks underperform
the small banks.
The small banks underperform credit unions, right? You don’t even
have to look at the scores, because that’s always the basic trend: credit
unions at the top. The problem is that despite the fact that people
may not have a lot of goodwill toward their financial institutions,
they’re not likely to leave them. So you may be gaining deposits, but
it’s a lot harder to become the primary financial institution. People
still love the devil they know. People say, “Even though I don’t trust
the system, I trust my bank.”
When comparing the different reasons that people are loyal to an
institution, trust and service are always important, and credit unions
consistently score well there. But consumers actually tend to rank
credit unions as underperforming on overall value. And in the down-
turn, across industries people are making decisions based on the
value portion.
Consumers are looking for an institution that is proactive and value-
oriented and that understands the balance between functional and
feel- good. When I walk into a credit union, I think about people
who are really friendly. If I need something, they’ll react. That’s good.
And I trust them to do the right thing. But frankly, the front line
may not always be the sharpest. They’re not always the most aggres-
sive. I don’t get the sense that they’re always really banging away. And
that may be fine, but in this economic cycle, that starts to raise some
questions as to what type of growth you can win.
Challenge: Cost- Efficient and AttractiveEven the smallest banks outperform similarly sized credit unions
in operational efficiency. A steady gap persists, with banks between
$500M and $17B running noninterest expenses on average around
50% of net interest and noninterest income. Credit unions of the
same size run noninterest expenses 10–20 percentage points higher.
29
In a competitive market, that’s a fatal difference. What can credit
unions do about it?
First, there’s a structural issue: You’re only as big as you are for opera-
tional efficiency. But there’s a DNA issue as well, which is also very
real when you consider credit unions’ performance culture. Most
credit unions have historically pounded on service, and in many
cases that has been a crutch to justify higher expenses.
Efficiency ratios for larger credit unions should be below 55%, or
even below 50%. Union Bank operates at about 42%. The more
efficient elements of Washington Mutual, before it went under, were
operating at about 38%. As a thought exercise, try to rebuild a credit
union and hit 42%. It’s a fascinating exercise.
We did this in 2007. We rebuilt banks, universal banks, with differ-
ent mixes of business. The early hypothesis was that not every bank
can get below 50%, because some are deeper in mortgages, and some
are doing more on the retail side; some have credit cards and some
don’t. That hypothesis was wrong. Everyone could get below 50%.
That’s a strategic consideration for every credit union: Banks out
there are going to keep pushing to get below 50%.
The winning formula is below 50%. There you can actually hold
your own and take market share from the weaker banks in the
mid-50s. North of the 60s is dangerous territory.
Better Execution, Not New StrategyUp until about 24 months ago, the largest banks were telling us, “We
don’t want to tinker with strategy anymore. That’s just not where
the juice is.” Instead they wanted to know how to get a distributed
group of networks—branches, service teams, etc.—to perform better.
In breaking the issue apart, you find that the execution quality of
the branch network is at least half of the value at stake for any given
bank regardless of whether the bank’s historical performance is good
or bad. This is very encouraging, particularly for the credit union
system.
In the near term, maintaining the growth that credit unions have
seen will come by increasing the total customer value per customer.
You, like any financial institution, probably have a large percent-
age of customers who are unprofitable. So turn inside the network
instead of trying to solve the harder strategic issues. That might be
the best place to focus.
But there’s always a choice. Most banks focus on one strategy or
another (see Figure 19). It’s either lots of products or high balances
30
on fewer products. There
doesn’t seem to be anyone that
can sustain a high total number
of products and high balances
in those products.
The Wells Fargos of the world
(the lower left quadrant in Fig-
ure 19) have a product- oriented
culture. The target is eight or
more products per household
and the focus is on execution
within product silos. They don’t
have to coordinate. Every sepa-
rate business unit is accountable
for cross- selling their product
line, and it’s ruthless.
The banks in the upper left
are different. These are like
Citibank, where they shield the
customer from frenetic cross-
selling because they want higher- value, more sophisticated custom-
ers. They reinforce deeper, higher- balance relationships, and they’re
not afraid to introduce new products more slowly, more deliberately.
And when they get those cus-
tomers, they get two, three, or
four times the balance of what
the retail side of Wells Fargo
would be getting.
Regardless of how many prod-
ucts are opened, however, the
initial account opening and
the first month are critical for
overall cross-sells (see Fig-
ure 20). In contrast, consumers
on average add virtually no
accounts between 60 and 180
days from initial account open-
ing. And beyond the first year,
there’s only a gradual addition
of accounts.
Branch execution means
several things. First, it’s every-
thing from scheduling the
right people for the volume
100
175
Cu
stom
er r
elat
ion
ship
val
ue
(CR
V)
per
pro
du
ct (
dol
lars
)*
250
3.0 6.04.5
Customer relationship index (CRI; number)**
*Average annual revenue generated per product across all products per demand-deposit-account household.
**Average number of total products per demand-deposit-account household.
No bank is in sweet spot of
high penetration and high
revenue generated per product
High product penetration
but low balances per product
Few products per household
but high balances per product
Figure 19: High Penetration or High Balances, but Not Both
Source: McKinsey Branch Benchmark.
Products per new personal demand-deposit-account
household by time since first account opened*
Percent of lifetime value—average across all participant banks and branches
*Includes all new personal demand-deposit-account households originated within the branch network; for purposes of this
metric, direct deposit, online banking, bill pay, and overdraft were not counted as product accounts; includes savings, money
market, CD, mortgage, home equity loans, home equity lines, investments, and credit cards.
**Average product accounts per personal demand-deposit-account household as of December 2008 for all banks that reported.
Range across banks
100
757372
30 days
61%–87% 61%–88% 62%–88%
60 days 180 days Lifetime**
Figure 20: Account Opening and First Month Accounts for 72% of Lifetime Cross-Sells
Source: McKinsey Branch Benchmark.
KEY BRANCH SUCCESS QUESTIONS
How do you simplify member- facing
materials?
How do you design the member’s process
at key moments like account opening or
cross-sell?
How do you minimize the time members
have to interact with tellers without sacrific-
ing satisfaction?
of customers—predictive staffing. It’s frontline training. It’s making
sure that administrative tasks get done during service troughs instead
of trying to stay open extra hours. It’s putting saved money back into
sales incentive and staffing in the branch. It’s getting the right forms
into customers’ hands before they get to the teller.
Another great example is the now-defunct Washington Mutual. They
were trying to cross-sell personal financial services, their equivalent
account opening for a brokerage account. The problem was that the
original forms were made for a financial advisor, but they couldn’t
pay top salaries for frontline employees who could make sense of
such complex material. They realized that it didn’t work to have
lower capacity individuals trying to explain these complex forms that
were designed for mass affluent customers.
So they dumbed down their forms. They literally put pictures on
them. The question “How much do you want to save?” was accom-
panied by a picture of a dollar sign and a blank space for the number.
They piloted this approach in a number of areas very successfully.
It was like a cartoon, and they did that so their lower- cost frontline
employees could actually understand it.
A secondary positive result was that the customer was put at ease,
because everything was simple. They marketed it as bringing sim-
plicity to customers’ lives. They said, “Trust us. We’ll take care of all
the complexity. And people that are trying to make it hard for you,
they’re taking advantage of you.” They certainly didn’t talk about it as
a crutch for frontline employees. They weren’t seen as the unsophisti-
cated bank. Instead they were bringing value to the customer.
Effective branch management is not always fun, though. In credit
unions, like everywhere else, there are different people staffed into
different roles. What’s different about credit unions is that you try to
move them into other roles to keep them. Maybe they’ve been with
31
MORNING HUDDLES TO DRIVE BRANCH EXCELLENCE
Morning huddles are best when they actu-
ally review daily performance instead of
simply waving pom-poms. They recognize
good performers and seek input from
them. They indirectly target low performers
by spotlighting success stories.
you for a long time. Maybe they’re very friendly. Credit unions are
like the Southwest hug culture, not the Virgin America clubbing cul-
ture. This friendliness pervades credit unions’ management decisions.
There’s nothing wrong with being nice . . . until there is. And strong
branch execution relies on having a performance culture at the front
line. Performance culture at the front line relies on knowing what
good looks like and holding people to it. And you can’t do that cred-
ibly if you allow employees to miss the bar and still stay. It’s nice,
but it means your good employees will start to look around and get
frustrated by the culture.
32
The final panel discussion asked the speakers to consider the structure and mission of credit unions in relation to operating expenses and profitability. Also explored: the role of boards, marketplace opportunities, and what member value should look like.
CHAPTER 5Conclusion and Synthesis
34
The Sustainability Colloquium drew 75 CEOs and senior credit
union leaders, all of whom participated throughout the day. But at
the end, a panel discussion exploring the suitability of the DuPont
model and its place for credit unions brought the lessons of the day
into focus.
What follows is a summary of the in-depth conversation.
The credit union structure is a cooperative structure with members as
shareholders and shareholders as customers that derive benefits from
a firm’s expenditures. What does that mean about operating expenses?
Given that structure, should credit unions simply minimize them as
any other firm would?
John Lass: You have to have a cost structure in your organization
that’s going to be consistent with your value proposition. I think that
came through loud and clear in several of the presentations, particu-
larly in Frances’s presentation. Whether you’re a cooperative entity
purely, or a mutual entity, or a for- profit entity, you still have to
make the numbers work.
I remember when I first got involved in the credit union system six
years ago, I interviewed a CEO. This person said their credit union’s
ROA had gone over 100 basis points, but not to worry, they would
figure out how to get it back down again. This person saw me twitch
a little bit and said, “In theory, if your capital’s adequate, your ROA
should be zero, because if it’s not zero, you’re not giving enough
value back to the members.” Now I understand that kind of philoso-
phy, but in the current environment, I don’t think that that works
anymore.
You have to have a reasonable ROA, because many of our institutions
have pulled the capital down to the point where, in order to support
growth, you’ve got to have earnings. And so I think it’s just a ques-
tion of coming up with an operating cost structure that works within
the value proposition. But I think you have to be prepared to try and
drive some profit in the organization.
35
George Hofheimer: We do have one foot in the for- profit world and
one foot in the not-for- profit world. But considering the economic
environment that we’re in, I think the discussion has changed so
much that we have to consider operating expenses as: If we’re not
efficient, we’re taking money out of our members’ pockets.
So I think kind of flipping the discussion around such that everyone
asks, “What is our main purpose?” It’s to provide the best possible
service to members. And part of that equation, I think, has to be
centered around the cost structure of the credit union.
Peter Tufano: I will just ask, “What is the means, and what is an
end?” Cost reduction and operating efficiencies are a means to an
end. The end is member satisfaction, member service, and all the
kinds of things that the cooperative movement is designed to deliver.
I think it’s a pretty important means to that end but not the only
means to the end.
Similarly, we talked about sustainable growth, which isn’t about the
sustainable part but the growth part. And you could ask the same
question: Why should credit unions want to grow, and how does that
relate to their mission or just to the pure economics of it?
So I think as long as you maintain this organizational structure and
the tax implications of this organizational structure, you’re going to
have to face this at two levels: one, at your organization’s level; and
two, in Washington, where other questions are brought to bear.
There’s so much opportunity to the meltdown that’s happened in
financial services for credit unions to move into spaces that competi-
tors had been operating in. And yet, coming off of the assessment,
there’s also a sense of: Hunker down; now’s not the time to stretch.
Could you talk about the opportunity for us to grow market share?
George Hofheimer: We still have 7,600 credit unions in the United
States. We know that the consolidation and concentration process is
going to continue. I personally believe that there’s opportunity for a
fair amount of efficiency gain to be had as that consolidation process
takes place, which could be a means of achieving growth through the
merger process but also creating a platform for the expanded entity
to drive better organic growth.
My guess is that within three to five years, you will see significant
consolidation taking place. There’s organic growth, which is really
what we focused on, but there’s also acquisitive growth, and I think
that has to really be on the radar screen right now.
John Lass: It’s all about smart growth, too. Right? The point of this
morning wasn’t to beat you into submission and tell you, “You can’t
36
grow. Just hunker down.” Not even close. But if you want to do that,
you’ve got to do it really, really smart.
So you have to worry about operational efficiencies. You have to
worry about whether there is a new business model. You have to
worry about where the money’s going to come from as opposed
to doing it on a hope and a dream. So I don’t see what we said this
morning as trying to throw cold water on innovation or on growth
or anything. It simply says there’s a discipline that goes with it,
and that can’t be avoided either by you or by Citibank and Bank of
America.
This new market is a combination of market forces and regulatory
forces. We haven’t seen yet unleashed the full complement of regu-
lation that’s going to happen when the new Bureau of Consumer
Financial Protection comes into place. We better be really smart
about that stuff. Historically, credit unions have taken the high road.
I think there’s opportunities there, but, again, you can’t lose money
when you do it.
Dorian Stone: Three years ago, the banks were gearing up, as every-
body remembers. Branches were growing at 9% a year, but popula-
tion growth’s only 2% a year. So what’s going on?
It was riding on the back of our real estate boom that was reaching
the apex of the bubble by 2008. These last three years actually have
been quite an inflection point. And I think you’re at a crossroads. I
unfortunately think that the credit union movement as a whole has
not done what it should have done.
I am not as close to it as you all are, but if I look at the numbers
in terms of the efficiency ratios, if I look at the celebration of the
growth in deposits as if it were something that anyone could take
credit for. My bigger concern is that the job of aggressively growing
in 2011 is going to be tougher than it has been in the last few years. I
think you absolutely should do it, but I think you’re going to have to
do it in a way that also drives your efficiency ratios down.
If you’re a credit union that hopes to be of scale or thinks you are of
scale right now, if you are not trying to find ways to get your effi-
ciency ratio down to the low 50s, if you’re not fighting toward that
number while at the same time making these other improvements,
you’re not working hard enough. And that’s me, and you can throw a
brick, but I would put hard numbers there.
We’re going to see huge shifts in where our money’s going. We’re
going to see spreads fluctuating. And I think that’s going to continue
to hide the true efficiency of what you need to be driving down. But
part of what we’ve also seen is that when spreads and everything else
37
are moving, it actually hides the true cost of running your credit
union.
I’ve heard very little talk about driving down unit costs, let alone
considering that in parallel with the percentage of operating costs.
That would be a really healthy conversation that would allow you to
grow in that smart way.
At a credit union, the governing structure is not just economic return
to our members, and changing strategy with a credit union board of
directors is very different from changing strategy with a shareholder-
owned company. So what should the conversation be like when we go
back to the boards with this kind of information and say, “We need
to make our legacy members angry; we need to drive down costs and
give less service”? How does that fly among directors who are often
focused on different issues and not pure economic issues?
George Hofheimer: You probably want to use different language. I
think you flip it on its head, and you talk about operational effi-
ciency not as a way to better serve our members, but that every dollar
that we do not spend efficiently is a dollar that we take out of the
members’ pockets. That’s how you frame the discussion.
Dorian Stone: Have you truly coalesced around a vision of what the
credit union’s going to look like in three and five years and how that’s
going to translate into specific metrics? Forget segments; forget any
of that.
I want to be bigger, smaller, I want to do it by how much, and I want
to move at this pace to get there, and I want to keep my customers
happy at some level of happiness. Can each of your board of direc-
tors say, “We have built a set of what good looks like that I know
when I get there”?
If you don’t, then I think these conversations become very problem-
atic, and they become regular. We could invest all that money to go
penetrate the left- handed, disabled, under-five-foot-two category. We
could do that. And for the credit union movement and for whatever,
we’re going to feel great. We’re going to talk about what we’re doing
to get into the community . . . but if we assign operating budget ver-
sus PR dollars to justify that, we’d better be damn sure that that gets
us to our vision of what this means to be a scaled business.
Without that sort of very clear definition of success, you start to
do the things that are actually in all the right spirit and all the right
mission, but without any common foundation for discussion, it has
a hard edge.
If you’re not getting that discussion from your board of directors,
then I would put that on the table to the board of directors. And if
38
they’re still not, and they seem just comfortable with what’s going on,
and you’re not comfortable with what you see, then I think you need
to have a hard talk about if you’ve got the right board of directors.
Can a nonprofit navigate the same environment as well as a for-
profit organization?
Peter Tufano: I run a small nonprofit. It’s not a credit union, but it’s
a small nonprofit here in Boston. And we are actually going through
this exact process with our board. We don’t see any reason why we
can’t be just as nimble as any for-profit.
If you think that part of the solution is creativity—thinking new
things, doing new things—there’s no reason, especially if you can
align your staff around mission, you can’t make a hard right when
the situation demands.
I see your ability to do this in a small organization that’s mission-
driven as probably a lot easier than in a larger organization that’s not
mission- driven, where you’ve got a lot of employees that you have
to drag along. You know, that’s idealistic. All I’m telling you is, I’ve
seen it in nonprofits. Nonprofits can be just as bad if not worse than
for-profits.
When I first started this, I thought that nonprofits were this idyllic
world, and for- profits were tough, even though I teach at the Har-
vard Business School. I found that the variation in both of them is
extraordinarily large. You can be nimble in either organization. You
can shoot me if you’d like, but you can’t hide behind your nonprofit
status. There are times when it might sound like you can. You say,
“Oh, we don’t have the capital. Oh, we can’t hire the same people,
because they’re going for these outsized salaries.” I just don’t buy that.
Dorian Stone: I spent the last two days in a transformation work-
shop where I and my client go for two days, and we talk about
performance culture. And in that room were a couple of the top
executives of a top- three bank, a chancellor of a major public educa-
tion system, two top executives of a major environmental company,
and I could go down the list. Every one personified the Dilbert car-
toon pertaining to them—every single one. We’re all human beings;
we all have the same problems.
And if it’s not because we’re nonprofit, it’s because of something else,
or it’s that we’re bigger, or we’re bureaucratic. So I totally agree with
Peter. I don’t think it’s a question of being nonprofit, for- profit, or
credit union versus bank, or highly incented or not. I think it’s much
more of, Are we going to do it or not? Do we have the wherewithal
to make the tough decisions?
39
The groups that actually perform in the market, the top three things
they say they focus on are accountability, consequences . . . and only
later things like managerial leadership. The low- performing ones that
say they are really strong at managerial leadership, it’s like, “Thou
dost protest too much.” Stop talking about it and do it.
John Lass: I want to link the last two questions. When I work with
credit unions, I try to lump everything into three buckets: gover-
nance, cost structure, and value proposition. I can pretty much get
to everything from those three, but it all starts with governance. If
you can’t get that piece right, it’s very difficult to get the rest of it to
work.
What I have loved about the credit union system over the last six
years is I have met many tremendous people that are highly dedi-
cated to what they’re doing. They’re mission- driven, passionate;
there’s a fervor and a commitment that you don’t find outside the
system.
However, I also see governance structures that are weak, that are
outmoded—where individual agendas and egos drive the day as
opposed to a focus on member value. And so I don’t think there’s a
disadvantage to being a nonprofit. I think the key thing to remember
is that it’s got to be about the member value.
Dorian, a year ago you said operating efficiencies or lack thereof will
be the doomsday of credit unions. It’s even worse now. We now have
more knowledge about assessments; we now have interchange. What
are the things that we’re doing that are just stupid?
Dorian Stone: I don’t know the specifics well enough, but I think I
know the themes. So let me try the thematic level. The first challenge
is coming to a recognition that what you do in terms of the products
you offer is actually commoditized, a recognition of how the world is
actually working around you.
The second is the overemphasis on the mission and underemphasis
on the tangible success or the performance culture that we need and
the tough people decisions that sit behind that. I don’t think there’s
any lack of intelligence at credit unions; there’s no lack of capability.
I just don’t see any of that. The one thing I do see, though, that is
fundamentally different than in other financial institutions and other
companies is the unwillingness and the wherewithal to make tough
decisions managerially and call the spade a spade.
The third theme is too much historical focus on regulatory issues.
I’m so glad that I have not heard much about the credit union
charter today. That’s a legacy issue that, in the current times and with
everything that’s moving, is irrelevant. I’m hearing, “Let’s run the
40
business, we’ve got a real opportunity, let’s make stuff happen.” And
that’s great.
So what is the single biggest of those three that stands in the way of
success? It’s the performance culture issue. I’ll ask again: How many
of you right now know someone in your credit union that is lower-
performing or that you would not hire again? Was that person there
six months ago? Did you know that then? Why are they still there
now? I mean, it’s just a very simple question. You should ask the
same question about your board.
An exercise that each person could go through is to ask, “What are
the key initiatives that I think we need to be successful?” Then write
down who are the 5, 6, or 10 people that I’m going to count on in
my credit union to get that done. Then ask three more questions:
Do they know what they have to do? Are they capable, personally
capable, of being able to manage to that end? Do they have the
resources to do it?
Take a look at that, and then put an “X” next to which ones are
performing and which ones aren’t. Then start to ask whether they
are not performing because there’s something external to them that’s
not working, or is it because I’ve actually got the wrong person? Has
he got the wrong talent? If you start to go through that exercise, to
see how people are stacking up, you’ll actually find some stuff that’ll
force you to really think.
George Hofheimer: These are thematic issues. The notion that credit
unions overinvest in service, I think the research project that we did
with McKinsey last year bears that out with some really impressive
data.
I see a real lack of differentiation and a willingness to try and differ-
entiate in the marketplace and use different language. It’s like what
Frances Frei talked about: that love/hate paradox and being willing
to have an offering or a value proposition that a certain portion of
the population is going to love and certain portion of the population
is going to hate.
And as a result a lot of credit unions—and I say this because they’ve
told us this—they kind of meet in the middle. And we like to call it
white bread. It’s a homogenized experience that is not differentiated
in the marketplace. And as a result, it doesn’t capture the imagination
of the end consumers.
John Lass: Several months ago, I facilitated a planning session and at
the end of it, we had a long debate, kind of similar to this one, and at
the end of it, a board member stood up, and he said, “Listen, I want
to ask you a question. If we had to do it all over again—if we could
start from scratch—would we build the US credit union system the
41
way it is today? “For example, would we create 7,600 credit unions?
Would we operate off 12 different core operating systems? Would we
use 35 different loan origination platforms? If the answer is no, what
can we feasibly do to narrow the gap?”
What should shareholder value look like at credit unions? In for-
profit companies, it’s very clear. It needs to be economic, it needs to
be tangible and liquid, you should be able to sell it, and you should
be able to buy it. But at a credit union, it’s not tangible. Do you have
opinions about what shareholder value needs to look like at credit
unions?
Peter Tufano: I’ll start by not answering the question, because I
don’t think that shareholder value is nearly as well- defined in the real
world as you’re pretending it is. For example, I spent some time in
Europe, and there are for- profit firms there, and what exactly does
shareholder value mean there? It’s a completely different equation.
These days, even in large for- profit firms the notion [of share price]
as a single- minded, unidimensional metric that you can use for
everything is largely gone.
It’s not gone completely, because it’s still an important constraint,
but it’s not nearly as stark as you might think. Everyone seems to
understand, even in business schools, that there’s value delivered to a
customer. If not, there’s no long- term franchise value for a firm.
And so maybe it’s back to your 0–100 scale [0 as totally not-for-
profit and 100 as totally for- profit]. The folks that you think are
at 100 are actually backing in a lot. They worry about operational
constraints, and metrics, and the value of the membership to the
consumer. They’re worried about the long- term value of a customer
to them, which is not that far off. They’re worried about cross-sell,
because they want a deeper relationship. You’re worried about deeper
relationships, too. So I’m not so sure that it’s actually that much
different.
But is that a difference between the managers and the capital holders?
It seems like the capital holders still see it a little more starkly than
the management would.
Peter Tufano: Yes, but the capital holders don’t make decisions on a
day-to-day basis to set strategy or implement it. So, the other kinds
of concerns we who are academics and directors worry about are that
there are shareholders for sure, there are customers or members for
sure, and then there are managers. And sometimes managers’ inter-
ests are aligned with neither of the other two.
I sit as a director of a couple of public companies. We worry
about that a lot, because we have fiduciary duties to our ultimate
42
customers; to make sure that the managers are aligned with the cus-
tomers is a big deal.
John Lass: In many ways, for a credit union, it should be a simpler
equation, because the member is the customer is the owner. It’s much
more complicated when you get out in the rest of the world.
Dorian Stone: I think you should just go out and make as much
money as you can. I’m being totally serious. You should do that over
time, so you’re not doing things that are unhealthy in the long term
for gains today and vice versa. And that’s the advantage you have, is
you have less pressure to make those types of decisions. You should
use that very much strategically to your advantage over time.
But I think your mindset should be: I want to make as much money
as I can, and then I’m going to give that money back to my mem-
bers. There’s this slippery slope that I just detest, which is, I’m not
going to [become more operationally efficient] because we’re going
to give a little bit back to the members.
We don’t even know if the members are willing to pay for that or
not. Make as much money as you can, then give the money back
to the members. You get that tension built back in, and I think you
have a much healthier system. And I think it feeds into some of the
other stuff we’ve been talking about.
So I don’t make this distinction of credit union or not. The ways you
can redistribute that wealth, there are laws and rules around it, but I
can think of at least some creative ways to do that in a way that also
holds tough on trying to reward profitable customers.
I was just curious if the panel had some opinions on specifically what
types of collaboration or shared services the industry should focus on
and who should really be driving that bus.
George Hofheimer: I can answer that with some data that we came
up with a few years ago. The top three ideas were around compli-
ance, HR, and training. Those were the three areas that had the high-
est probability according to actual research done with industry folks
and how it should be conducted. It should be conducted through de
novo organizations like CUSOs. That’s what the research says.
Dorian Stone: I’d come at it the other way. I don’t care what you’re
most likely to do. I think we should talk about what you should do.
And if you don’t like it, well, I don’t like going to the gym, but I have
to do it, right? So I agree, [willingness to collaborate] is one axis of
the equation. I think the other axis of the equation is, where’s the real
dollar value?
43
If I had to think about where the dollar and impact value is, I’d say
training is probably not the right one. But I would think that your
IT would start to come up, your bookkeeping would start to come
up, your internal help desk to the extent that any of you have scaled
institutions. I would think those would just carve out.
And in terms of a CUSO, I think that’s a great idea, if you believe as
an institution that you can actually do that better than the competi-
tion, the competition being other outsourcing firms that have been
doing this for decades. But if you think you can do it, great. If not,
then maybe it’s a purchasing cooperative with Wipro or somebody
like that. But I would start with the blank sheet of paper and say,
what do we think the right answer looks like?
Now who’s the most competitive to do that? Do we believe that we
can actually do it, or do we just want to do it? And there are ways
of reinforcing the credit union movement and working together to
collaborate around the purchasing cooperative notion rather than the
building infrastructure notion. It should be an option on the table.
John Lass: Right now, I think there are about 700 CUSOs. Of the
700, I believe that two have revenue north of $100M, and about 12
have revenue north of $10M, so I just want to second what Dorian
said. I like the CUSO structure, but only when it makes sense
economically. My advice is: Don’t get hung up on trying to keep it
inside the system if that means that you’re going to create a subscale
operation.
44
1. Robert Higgins, Analysis for Financial Management, ninth ed.
(Boston: McGraw-Hill Irwin, 2009), 138.
2. Thomas R. Piper, “Butler Lumber Company,” Harvard Business
School Case 9-292-013 (Boston: Harvard Business Publishing,
1991).
3. Chris Zook and James Allen, Profit from the Core: Growth Strat-
egy in an Era of Turbulence (Boston: Bain & Company, 2010).
4. Niall Ferguson, “Wall Street Lays Another Egg,” Janu-
ary 15, 2009, www.niallferguson.com/site/FERG/Templates/
ArticleItem.aspx?pageid=202.
5. Central Intelligence Agency, “The World Factbook—United
States,” www.cia.gov/library/publications/the-world-factbook/
geos/us.html.
Endnotes
Credit Union Financial Sustainability:
A Colloquium at Harvard University
ideas grow here
PO Box 2998
Madison, WI 53701-2998
Phone (608) 231-8550
PUBLICATION #232 (3/11)
www.filene.org ISBN 978-1-936468-11-9
