"People have three ways to act wisely: first, think through, that is the noblest; second, imitate, that is the easiest; and third, by experience, is the most bitter" - Confucius
The aim of this article is to help organisations avoid the 'bitter' lessons of experience by designing a dexterous organisation that enables them to respond to changing market conditions.
Setting the Scene
In the last 15 years, through periods of economic uncertainty, heightened regulation, increased competition and a prolonged low interest rate environment we have seen financial services firms look to reduce their Cost: Income ratios often through driving economies of scale through their IT and operating models. Observers of both banking and insurance markets have seen almost all the main players take steps to increase efficiency and in doing so they have often had to embrace organisational complexity. Steps taken to increase efficiency include:
- Growing their geographical footprint by offshoring functions to lower cost locations
- Outsourcing their day to day operations to a number of different suppliers
- Hard-wiring their IT to service multiple, and often significantly different, business units
- Acquisitions to drive scale
There are a number of examples emerging where it has proved necessary to decouple business units, whether for regulatory or commercial reasons. The increased complexity that often goes hand in hand with efficient organisations can be difficult and complex to unwind and in attempting to do so can prove costly and potentially value destroying. This difficulty and cost was highly evident in the time and resources employed by RBS and LBG to make significant disposals of branches and customer holdings to meet conditions imposed by the European Commission following their respective bail-outs by the Government in 2008. Project Verde, according to LBG’s financial accounts in 2013, cost the bank a total of c. £1.5BN. As regards Project Rainbow, the Telegraph in 2016 reported that RBS had borne £1.4BN of cumulative costs and in their 2017 Annual report RBS advised that they had made further provisions of £0.75BN for their remaining State Aid obligations and £0.7BN for further restructuring costs relating to the business to have been disposed of through Project Rainbow. There has also been the high profile case of IT outages and customer failures encountered by TSB during their migration from the LBG platform onto the IT platform of their parent company, Banco Sabadell.
Partly as a response to regulatory and economic pressures we have seen an increase in forms of decoupling, separation or divestment. Actions in recent times have taken a number of different guises, including:
- Disposal of non-core parts of the business
- ICB and ring-fencing driving revised legal entities, further structural changes and cost optimisation, along with customer protection
- Private Equity investors seeking to release a return to their investors without necessarily selling the business – a lack of good new investment opportunities might mean that Private Equity houses will consider selling part of a business to pay a return and also reinvest for further growth and start the clock ticking on a new investment period.
So shouldn’t financial services firms be much more agile in order to take advantage of positive market dynamics and demand? Surely the answer to that has to be yes given that strategic dexterity should ensure a firm has a number of premeditated options to respond to market conditions. This may also be seen as advantageous by potential buyers.
Designing for Dexterity
Entrepreneurs have always valued the ability to buy low and sell high to take advantage of favourable markets. They also understand the need to be able to act fast to seize opportunities when they arise!
The last 20 years has seen many banks and insurers pursue inorganic growth strategies and integration programmes to drive economies of scale. The last crisis shone a light on organisations that were considered too big to govern and once again value is seen in being able to quickly uncouple businesses in order to dispose of them for value.
So if a business is fully integrated now and they want to be able to create a stand-alone entity is there an interim stage that makes the business strategically dexterous? In many respects this is what Barclays and HSBC have done in creating their ring-fenced entities which in turn have a Servicing Company (ServCo) providing contractual operational and IT services to the ring-fenced entity.
However, designing a stand-alone Target Operating Model is the easy part. Determining and envisioning an organisation’s transitional states (between the ‘integrated’ present and the ‘target state’) is much more difficult. Of particular difficulty is determining the core capabilities and competencies to manage each part of an organisation right up to the point each part can ‘stand on its own two feet’. Yet this part is vital in order to fulfil a firm’s obligations to customers, regulators and investors and prove they can effectively operate, and manage risk associated with, their operations.
In designing for a stand-alone or a hybrid business model, or even planning for independence from an existing service provider, IT services and systems should be front of mind – flexibility and use of the latest technology could perhaps be a better option than using older more scalable technology. It is also worth considering whether re-platforming or outsourcing is actually required as the use of a market leading IT system / package / support provider can in itself add to digital distribution capability, deal value and, therefore, ‘attractiveness’.
Also a high priority is to determine which functions sit outside the specific business unit. Often functions like HR, Risk, Finance and Legal need not be specifically wired to the business, especially if they are not unique, specific to the business model or differentiators that drive competitive advantage.
Armed with a clear understanding of the desired business model and having considered technology and business function alignment, focus can now shift to implementation. There are a number of crucial elements here in this next stage of delivering dexterity including:
- A well-articulated TOM reflecting clear dividing lines between businesses, and the respective remit for each. This is particularly important for businesses where division is not clear cut and sit in, so-called, ‘grey areas’
- Defined Service Level Agreements (SLAs) articulating performance levels and associated key performance indicators (KPIs) for each service provider
- A service credit mechanism ensuring outsourced or insourced providers are incentivised to consistently achieve the levels set out in the SLAs
- A clear understanding of how services will be managed, particularly those intended to be outsourced /hosted elsewhere, with contractual obligations set out in a Master Service Agreement (MSA) [and Transitional Services Agreement (TSA)]
- Thorough consideration of pension and property implications for the organisation
- A high level financial model demonstrating how costs are split between businesses
- Contractually binding documentation formally negotiated and agreed between the two corporate entities
- Governance considerations and where new board members may be required in order to maintain independence
- Careful consideration of people’s roles and where they sit both now and in the future, facilitating any potential TUPE agreement(s)
- A detailed internal user-guide outlining roles, committees and processes by which employees of the two corporate entities exchange information during the term of the SLA
Strategic Dexterity Super Six
The opportunity to gain value from businesses decoupling is likely to remain whilst the complexity, inherent in so many organisations, will continue to make this decoupling process difficult. This is particularly relevant in financial services as organisations continue to face economic pressures and an ever evolving regulatory environment.
Those organisations looking to become more agile and strategically dexterous should at the very least:
- Seek experienced advice – if you haven’t done this before the pitfalls may take you unawares if not designed out or mitigated up front
- Manage external stakeholders (investors and regulators in particular) and operate on a ‘no unpleasant surprises’ basis
- Think through the practical implications of your MSA and TSA and don’t over rely on the legal wording (if things ‘go legal’ it is difficult to ever resume constructive relationships)
- Select IT systems and platforms that are flexible and can be easily integrated and updated
- Take your people with you and ensure they understand the logic and rationale of what you are doing
- Identify causes of organisational complexity, any particular pain points and ways to break this down, or simplify the area of concern
If you would like to discuss this article in more detail, please feel free to contact me at: email@example.com.