While it may not be obvious right now, at some point in the future, the global banking environment is going to stabilise and institutions will begin the long and arduous journey to rebuild their businesses. And when the rebuilding begins, one question uppermost in everyone's minds will be: "What was the true impact on IT budgets and spending?"
The consensus thus far is that IT expenditure will be dramatically reduced. But the real issue will not be trying to predict how much banks will spend, but rather figuring out what types of projects have the best chance of being funded. To do so, a longer-term view is needed so that we can better understand how the rebuilding process could potentially shape up.
In September 2008, Boston Consulting Group published the most insightful analysis of the situation available today. In its paper Banks and Capital Markets Report 2nd Quarter 2008, BCG makes a strong case that banks will go through three distinct phases in this rebuilding process over the next couple of years. The following is a roundup of these findings and some further analysis of how this will impact the vendor community during these unsettled times.
First, banks are going to attempt to stabilise by repairing their balance sheets through recapitalisation and liquidity management. Secondly, they will try to realign their business by focusing on their franchise synergy, business mix and productivity. And finally, they will begin to focus on growth again.
Currently, we are in the first stage. While it's anyone's guess as to how long this stabilisation period will last, it's safe to say that that for everyone in this business, the next few months are going to be very challenging indeed. Banks will be focusing most of their time and energy on tactics for survival. Funding may continue for some existing projects, but it's pretty clear that the appetite for new projects is not favourable, particularly for those that require major resource allocations.
It's in the second realignment phase where things should get really interesting. The realignment process will require a concerted effort by banks to drastically improve their return on assets. They will attempt to do this by pursuing a strategy that focuses on growing their existing high return on assets businesses, squeezing short-term revenue increases across their entire business mix, and most importantly, initiating significant cost containment and reduction strategies throughout the organisation. In terms of cost savings, BCG estimates that banks will need to achieve $100 million in cost reductions for every $100 billion in balance sheet assets - and they need to do it fast. Although the common assumption in the marketplace is that banks will implement across-the-board cuts in IT spending to help accomplish these cost saving goals, we may see something slightly different.
While the level of IT spending will certainly decline, targeted IT investments that can generate significant near-term savings should be high on the priority list. When these banks look at their options, they are going to give high priority to projects that require low investment and low lead-time - projects that are relatively low risk and offer very visible savings. Vendors need to understand this as they market their services to banks over the next year or two. IT projects with long lead-times that are accompanied by long-term projections of increased revenue will simply not get the necessary funding in this stage. Similarly, projects that might have previously been funded based on projected cost savings criteria but without the benefit of having very low lead-times or transparent savings will also have a much tougher time being approved.
It could take 12 to 24 months before we make it into the third stage where banks will once again focus their attention on growing revenues across their entire business mix. It is only when we reach this stage that we may see a rebound in the overall level of IT spending.
So what does this mean for the vendors?
Primarily, they must focus on keeping things simple; projects and initiatives where cost savings drive the solution. Vendors who are able to successfully identify pain points on the cost side of the business and package a solution that solves these problems will have a clear advantage. However, it's not enough to just re-package an existing solution and then change a few bullet points on the PowerPoint pitch. It requires having detailed conversations with the marketplace - everyone from industry analysts, to the end user community, the sales force and those implementing projects in the field. Spend time with these people; be relentless with your questions; and don't be afraid to get them further involved in the process.
Secondly, vendors need to reduce the perceived risk of installing their solutions. The risk-reward criteria banks use to evaluate projects have changed dramatically. The returns gained from an IT gamble during the boom years often outweighed the risk of making the investment. Reducing the actual risk as well as the notional feeling of riskiness (from the bank's perspective) associated with IT projects should be high on vendors' list of priorities - it will play a major part in whether any project gets a positive response from decision makers at board level. The meaning of this is twofold. Vendors need to work to reduce the various risks associated with the overall solution - everything from implementation, lead-times and costs, to the actual pricing structure itself. Short of eliminating these potential pitfalls, vendors will see increased pressure to assume more and more of these risks themselves. Where exposure used to be split between the vendor and the client, bank's renewed aversion to risk will demand that vendors be more creative in their approach. The bottom line is that banks don't want to invest in anything but a sure thing - either eliminate the project risk, or be prepared to take it on board.
Finally, vendors need to be able to execute better. Execution has always been important, but over the next year or two, banks will have significantly less patience for vendors who can't deliver on their promises. The leash that banks use to pull projects that aren't meeting agreed-upon milestones will be unusually short. Project delays and unsuccessful implementations will simply not be tolerated; they will cause real pain for those who aren't skilled in execution. And for those who are skilled, this will turn out to be a significant strategic advantage.
The next two years will be extremely challenging for banks and their software partners alike. While it may be impossible to predict how things will turn out, one thing we do know is that the rules have changed. Vendors need to understand this and adjust accordingly.
Contact: Patrick Lefler, The Spruance Group