Banking: How the pursuit of efficiency kills innovation

Published February 16, 2016   |   

While banks are on a quest to improve efficiency ratios, I’ve noticed a recent increase in the use of the word “innovation” in more and more bank job descriptions and even in bank job titles. I view this as both good news and bad news.

Good news because at least it seems that banks may be recognizing the need to create new products and services, and new ways of doing things. Bad news because in too many cases I fear it represents a narrow solution to a much broader issue.

The good news

I’m a believer in innovation teams, and I applaud any efforts to empower and support a team of divergent thinkers and risk takers. I also like that many banks are looking outside the industry, seeking people who haven’t spent their careers marinating in a culture steeped in risk avoidance.

Capital One made headlines for bringing in Dan Makoski from Google to be their first Vice President of Design, and I would argue that most of the most successful financial innovations of the last decade have come from outside of banks. A fresh perspective is welcome and much needed.

In essence, many banks are effectively setting up “skunkworks projects”, special teams charged with generating new ideas. This approach has certainly produced its share of successes, from the idea’s original namesake at Lockheed, to IBM’s famous break from mainframes into the PC world, to Google X, Google’s research lab and self-described “factory for moonshots”. Google’s Richard DeVaul was quoted in Businessweek as saying “Google X is very consciously looking at things that Google in its right mind wouldn’t do. They built the rocket pad far away from the widget factory so if the rocket blows up, it’s hopefully not disrupting the core business.”

This approach is appealing, and appropriate, for banks. Banks seek efficiency, predictability, and consistency, not to mention that predilection for measuring, quantifying and managing risk. In this post-crisis recovery cycle, banks are now especially turning their focus to improving efficiency ratios, and those charged with breaking new ground need some amount of insulation from that stultifying environment.

The bad news

Taken alone, the skunkworks projects are likely to be slow to generate real results, and consequently, many will be shut down within a few years.

A group of smart people in a creative environment sheltered from the daily pressures of business will probably generate a lot of good ideas. But good ideas that get executed poorly, or worse– don’t get executed at all, are worthless. Not only do the designated innovators oftentimes lack the real-life context of whether their ideas solve problems that customers (and executives) care about, there is also quite often a lack of connection to others in the broader organization who could make the difference between a neat idea and business success.

A team of researchers at MIT published a study in 2011 called Creating Employee Networks that Deliver Open Innovation, and in it they describe how two kinds of employees are needed for a successful innovation initiative. The first is “Idea Scouts”. These are the kinds of people who tend to be selected to populate innovation teams, but they also exist naturally. These are the people who are always reading, attending conferences and workshops and trying new things on their own.

But to really make Idea Scouts effective, they must be complemented by “Idea Connectors”. Idea Connectors possess the organizational context to align ideas with priorities, resources, and budgets. The problem is that Idea Scouts and Idea Connectors don’t show up on organization charts, so it takes some work and some tools like organizational network analysis (ONA) to find the right people and create the right linkages.

In his book Built to Thrive: Using Innovation to Make Your Mark in a Connected World, my colleague Dr. Jay van Zyl describes how he helped FNB, South Africa’s oldest bank, take a more integrated and holistic approach to innovation. FNB’s approach harnessed ideas from all over the bank’s footprint, not just from an isolated innovation team. The result was thousands of ideas generated and hundreds actually implemented, and the bank won the 2012 BAI-Finacle Most Innovative Bank of the Year Award. More importantly, the bank attributed $200 million in value directly generated from the program.

Innovation versus Efficiency

I recently joked in a talk I gave at Next Bank Asia in Singapore that it is apparently a new regulation that anyone talking about innovation in banking has to regularly cite Clayton Christensen’s 1997 book The Innovator’s Dilemma– and that I could attest to being in full compliance. The dilemma is whether you should take resources away from the things that have made you successful to invest in new, unproven ideas.

One of the underpinnings of Christensen’s work comes from one of his predecessors at Harvard, William Abernathy. Abernathy introduced the idea of the “productivity dilemma”, the notion that a company gains efficiency by improving the things that made them successful in the past; and that a company’s focus on productivity gains inhibits its ability to learn new information and to innovate. He used it to describe the challenges in the U.S. auto industry in the 1970s, and how their focus on short-term profits undermined their long-term competitiveness.

Banks currently seeking to improve efficiency ratios need to heed these lessons. The blind pursuit of immediate and tangible productivity gains will lead to banks learning how to do all of the wrong activities very efficiently, while more nimble competitors continue to take market share with more relevant offerings. Efficiency is very important, but it should be pursued over the long-run, not the short-run.

Toyota’s contradictions exemplify the balanced approach that is needed. Recognized as both a relentless innovator and as a relentless pursuer of quality and efficiency, Toyota is uniquely characterized as “ambidextrous”. Innovating new ways to increase revenues and reduce expenses will require some amount of short-term investment one way or the other, the challenge is investing in the things that will drive long-term value.

As Jim Collins, author of Great by Choice would put it; to thrive in this era, banks need a blend of discipline and creativity “So the discipline amplifies it instead of destroys it.”

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