This final Newsletter for 2004 continues our focus on issues and areas that we believe will be of critical importance in the next year. The three themes reviewed in past newsletters highlighted:

 

• An emphasis on cross-sell and wallet-share growth

 

• The redrawing of internal organizational boundaries to better align channels with customers

 

• The return of reengineering as a method of change

 

Hovering over all these issues, and more, is our final theme: the financial services industry (in particular, banking) will continue to undergo significant consolidation in 2005. No U.S. bank, with the possible exception of one or two behemoths, is too large to be acquired by someone else. Given the state of the dollar, U.S. acquisitions are particularly attractive to foreign buyers. As Gene Ludwig wrote in a recent American Banker column, U.S. banks are at selling at “half-price” from the perspective of some potential foreign buyers.

 

Our experience in working with a broad cross-section of various sizes and types of banks suggests that senior management is reacting to the acquisition “threat” with one of three approaches: feeling the fire, hoping against hope, or active acceptance. We will review each category.

 

Feeling the fire. During the past year, it has become clear to us that an organization’s size bears no relationship to its flexibility or openness to change. We see some of the largest banks acting to stoke their growth engines and change their organizations to enhance responsiveness to customers. Conversely, we see smaller institutions operating in parochial ways, allowing “tradition” to snuff out new ways of thinking about how to define the customer and fulfill their requirements.

 

Typically, larger banks are leveraging managements’ understanding of the acquisition “threat” to instill a sense of urgency throughout the organization. These banks, relatively few in number, are conducting objective diagnoses of their revenue and cost bases and rethinking who they serve and how. Their ultimate objective is to ensure that they create a sustainable growth engine; however, at the same time, they are also reevaluating how they spend their operating and capital dollars.

 

These banks are feeling the fire generated by M&A activity and are doing all they can to increase their performance, enhance their stock price, and keep their fate in their own hands. The good news for shareholders is that, even if these banks cannot avoid acquisition, their selling stock price will be highly attractive.

 

Hoping against hope. The banks portrayed above are operating with a cohesive plan, one that has clear goals and a defined roadmap toward those goals. Unfortunately, most banks appear to lack the discipline and/or management strength required to examine themselves honestly and make some fundamental changes. Instead, they are like the headless chicken, running chaotically in various directions, not realizing that it is dead.

 

In too many cases, senior management is either unaware of the inertia within the institution, actually feeds that inertia, or is in denial about the changes needed to turn the bank into a growing sales company. In recent years, these banks may have generated some fine results based in large part on mortgage revenues, the carry trade, and investment sales. However, they are stuck in the past, deluding themselves into thinking that the good times will continue. These banks lack the ability to generate organic growth.

 

Clearly, shareholders and shareholder/workers in the bank need to be concerned. The banks “feeling the fire” will either thrive as independents or, to a substantial degree, call their own shots in the event of an acquirer coming to call. The banks that are “hoping against hope” may find themselves struggling to match the Street’s expectations and, therefore, facing eroding value.

 

To avoid this situation, top management needs to demand honesty in evaluating itself and celebrate those who suggest new or untried approaches from the past. However, the likelihood of most banks transforming themselves into customer-oriented selling machines is low.

 

Active acceptance. A third group of banks understands that for them the game is, in effect, over. They believe that acquisition brings them substantial benefits related to product depth, delivery capabilities, or other areas. These banks may have performed well in recent years; however, in the words of a manager from one recently acquired bank, “we ran out of gas.” Managements of these banks are dressing them up and coming close to putting the “For Sale” sign on the front door. Frankly, these managers are smart; they have read the tealeaves and are responding to their view of the future. Shareholders of this type of bank will be better served than those of the self-delusionally hopeful.

 

Final thought

When I began my consulting career at McKinsey in the 1980s, many consultants viewed banking projects as boring and tried to avoid them. The financial services world has not been boring for many years. 2005 looks to be a year of unprecedented challenges for senior managers. Bank management is not for the meek.