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									Strategic Sourcing in Banking
       - A Framework



 Markus Lammers, E-Finance Lab


     University of Frankfurt



         October 08, 2004
                                             Agenda


 Problem, Research Questions, Definitions


 A Qualitative Framework for Sourcing Decisions


 The Banking Value Chain as Sourcing Subject


 A Formalized Sourcing Decision Model


 Conclusion and Further Research
                                                                                                           Problem

                                                                     German
                                                                     Banking
                                                                    Industry*

                            Universal banks:                                            Special banks:
                            2288 Institutions                                           68 Institutions


        1491 coop.             524 savings              271 credit        26 mortgage    28 building      14 banks with
          banking               and state              banks (incl.          banks         and loan          specific
        associations             banks               foreign banks)                      associations       functions




     The German banking market has a polyplolistic market structure
      consisting of 2354 institutions.
      96,7 % of the German banks are universal banks. Universal banks
      are highly vertically integrated

                 High Redundancy of Products, Processes, IT
                 Infrastructure and Application Systems
*source: monthly report as of May 2003 of the Deutsche Bundesbank
http://www.efinancelab.de/
                                                                                                                                        Synergy potential

                                                      Marketing                 Sales                                  Products                         Transactions

                                                      Advertising          Acquisition
                                                                                                    Funding
                                                                                                    Deposits
                                                                                                                     Investment
                                                                                                                       Credits
                                                                                                                                                 Bank 2288
                                                                                                                                           Services
                                                                                                                                         Acct. Mgmt.  Payment
                                                       Branding             Offering              Securitization      Securities         Asset Mgmt.     Trading
                                                         Sales             Multichannel              Credits        Fin. Products       Issuance/IPO    Clearing &
                                                       Support             Management                               Corp. Invest.          M&A          Settlement
                                                                                                                    Other assets         Advis. Serv.    Custody
                                                                                                                                         Other Serv.
                                                                                                      Risk Management
                                                                                                   Technology Development
                                                                                                      Human Resources
                                                                                                     Firm Infrastructure



                                                             e.g.2288 times redundant
                                                                  credit processes
                   Marketing              Sales                                    Products                              Transactions

                   Advertising          Acquisition
                                                                 Funding
                                                                Deposits
                                                                                 Investment
                                                                                   Credits
                                                                                                       Services
                                                                                                     Acct. Mgmt.
                                                                                                                    Bank 2
                                                                                                                      Payment
                    Branding             Offering            Securitization       Securities         Asset Mgmt.            Trading
             Marketing Sales        Sales
                                       Multichannel              Credits ProductsProducts
                                                                               Fin.                 Issuance/IPO   Transactions
                                                                                                                          Clearing &
                      Support
             Advertising
                                       Management
                                 Acquisition
                                                         Funding
                                                         Deposits
                                                                               Corp.
                                                                          Investment Invest. Services & A
                                                                                Other
                                                                            Credits assets
                                                                                                       M
                                                                                                     Advis.
                                                                                                             Bank 1
                                                                                              Acct. Mgmt. Serv.     Payment
                                                                                                                           Settlement
                                                                                                                            Custody
              Branding            Offering             Securitization      Securities                Other
                                                                                              Asset Mgmt. Serv.      Trading
                Sales            Multichannel             Credits Infrastructure
                                                                        Fin. Products        Issuance/IPO          Clearing &
              Support            Management                              Corp. Invest.
                                                               Technology Development           M&A                 Settlement
                                                                   HumanOther assets
                                                                          Resources           Advis. Serv.           Custody
                                                                     Procurement              Other Serv.
                                                           Risk Management
                                                        Technology Development
                                                           Human Resources
                                                          Firm Infrastreucture


             High vertical integration and polypolistic market
             structure indicates high synergy potentials
http://www.efinancelab.de/
                                                                                      Hamoir et al. expects that 4 banking
                                                                                                      models may emerge

                                                                                                                                Potential banking models
                                                    (4) Payments (national, international)
                                                                                                                                Regional retail distributors (1)
                                     Infra-         (4) Clearing, Settlement
                                     structure
   Position along the value chain




                                                                                                                                Global wholesale and
                                                    (4) Exchanges                                                               investment bank (2)
                                                                                                               (3)
                                                   (3) Insurance                    (3) M & A                                   Pan-European product
                                                                                                              Other1
                                     Products                                                                                   specialists (3)
                                                   (3) Asset                (3)             (3)       (3)
                                                   management             Credits          Other1    Other1                     Pan-European service
                                                                                                                                providers (4)
                                                                                                      (2) Global wholesale,
                                    Distribution          (1) Purely regional distribution
                                                                                                           investment

                                                   Mass     Affluent     Private           Small    Midsize     Multinational
                                                                                                                Corporations

                                                                Retail                         SME2

                                                                       Type of banking customer
                   1     Such as commercial insucrane and institutional asset management
                   2     Small and midsize enterprises

                   Source: Hamoir et al. (2001), p. 123

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                                       Research Questions


      What is the optimal degree of vertical integration for
      a bank?

       What activities should be made internally?
       What activities should be made or produced by a
        (specialized) supplier?
       What are drivers for in- or outsourcing an
        activity?




http://www.efinancelab.de/
                                              Definitions

      Sourcing Analysis: Analysis of the combination of
      internal and external resources to improve the
      production mix of a bank by decreasing costs or
      increasing value generation.
      Outsourcing: Usage of (superior) resources outside
      the company.
      Outsourcer: A company that gives an activity to an
      external company, which was formerly produced in-
      house.
      Insourcer: A company that takes over the activity
      from the outsourcer.


http://www.efinancelab.de/
                                            Agenda


 Problem, Research Questions, Defintions


 A Qualitative Framework for Sourcing Decisions


 The Banking Value Chain as Sourcing Subject


 A Formalized Sourcing Decision Model


 Conclusion and Further Research
                             Theoretic Foundation: An Introduction to
                                   Transaction Cost Economics (1/2)

      Transaction Costs Economics analyzes the efficiency
      of different governance forms using transactions
      as basic analysis unit. (Williamson 1981, p. 548)
      Transactions are defined as the transfer of goods
      or services between technologially separable
      interface (Williamson, 1981, p. 522)
      Governance forms are:
       Hierarchy: governance is based on property rights of
      management, processes and administrative control mechanisms, i.e.
      companies.
       Markets: Are steered by price mechanisms and hierarchical control
      is replaced by contractual agreements.
       Hybrids: include governance elements from both markets and
      hierarchy, e.g. joint ventures, alliances, shared service organizations.
http://www.efinancelab.de/
                             Theoretic Foundation: An Introduction to
                                   Transaction Cost Economics (2/2)

      Increasing transaction costs are determined by:
      Frequency of Transactions: Transaction that are
      frequently processed will more likely produced
      internally.
      Uncertainty: Increasing uncertainty imply higher
      transaction costs, e.g. in long-lasting outsourcing
      deals.
      Asset Specificity: Insourcer would have to make
      specific production investments when taking over
      highly specific assets.



http://www.efinancelab.de/
                             Theroretic Foundation: An Introduction to
                                       the Resource Based-View (1/2)

      The Resource Based-View (RBV) explains how companies
      can gain and sustain a competitive advantage having
      superior resources.

      Barney (1991) derives that a sustainable competitive
      advantage results from resources that are:

        Valuable: Resources increase revenues or decrease costs
        Rare: Resources are not freely availabe
        Imperfectly imitable: it is not clear for a competitor how
         to build identical resources
        Non-substitutable: no alternative resources providing
         identical value

http://www.efinancelab.de/
                                           Theroretic Foundation: An Introduction to
                                                     the Resource Based-View (2/2)



                                          sustainable                            competitive
                                                                                 advantage




                     rare                    Imperfectly            Non-                            valuable
                                             imitable               substitutable

               1. The resource or the     1. The resource bundle 1. The resources or           1. Analyze cost,
                  resource bundle is         is heterogene from     resource bundle can           revenue or value
                  not freely available.      other resource         not be substituted by         contriubtion
                                             bundles                other resources            2. Benchmark against
               2. Competitors can not
                  buy the resources   2. Heterogenity cannot                                      competitors, e.g.
                  immediately            be rebuild in the                                        using DEA
                                         short to medium time                                  3. Determine
               3. Direct competitors
                                         frame                                                    competitve
                  do not deploy
                  identical                                                                       advantage
                  resources/resource
                  bundle




http://www.efinancelab.de/
                                              Qualtitative Sourcing Framework
                      Institutional design
                      of sourcing               Making                       Sharing                         Buying
                      alternatives
                                                                          hybrid forms:
                                                             Joint Ventures / Shared Services / Alliances

                                                                                                     Degree of market
                                             Degree of                                                   coordination
                                             hierarchical coordination

                      TCE based
                                                  high           Asset specificity of activity                    low
                      recommendation
                      for sourcing
                                                  high           Frequency of activity                             low
                      decisions
                                                  high           Uncertainty                                       low

                       RBV based             Resources and           Resources and                          Resources
                       recommendation        capabilities pro-       capabilities are a                     and
                       for sourcing          vide a                  source of competitive                  capabilities
                       decisions
                                             sustainable             advantage, but may                     provide a
                                             competitive             be easily to imitate                   competitive
                                             advantage               or substitute                          disadvantage

                       Company
                       Objective
                                             increase own            realize efficiency                     realize
                                             market share            improvements /                         efficiency
                                                                     scale economies by                     improve-
                                                                     bundling activities                    ments from
                                                                                                            specialists
http://www.efinancelab.de/
                                            Agenda


 Problem, Research Questions, Defintions


 A Qualitative Framework for Sourcing Decisions


 The Banking Value Chain as Sourcing Subject


 A Formalized Sourcing Decision Model


 Conclusion and Further Research
                                                   Detailed Generic Value Chain of the
                                                                     Banking Industry

      Marketing                Sales                            Products                       Trans-
                                                 Funding        Investment       Services      actions
       Advertising           Acquisition         Deposits         Credits       Acct. Mgmt.    Payments

         Branding              Offering        Securitization    Securities     Asset Mgmt.     Trading

          Sales                                   Credits       Fin. Products   Issuance/IPO   Clearing &
                             Multichannel
         Support             Management                         Corp. Invest.                  Settlement
                                                                                   M&A

                                                                Other assets    Advis. Serv.    Custody

                                                                                 Other Serv.

                                               Risk Management
                                            Technology Development
                                               Human Resources
                                              Firm Infrastructure


    In opposite to the industrial value chain from Porter (1985, p. 86), the developed
    banking value chain starts from the customer side.
     Fist the product will be offered to the market, sold, provided to the
      customer and finally corresponding transactions will be executed.
     Additionally, Risk Management is introduced as supporting activity.
http://www.efinancelab.de/
                                                 A generic value chain for consumer credits


            Marketing                            Sales                       Product                   Transaction

                                           Multi      Acquisition                                                    Clearing
        Branding of        Sales
                                          Channel        and              Credit         Funding       Payments        and
         a Product        Support
                                           Mgmt.       Offering                                                     Settlement

       •Introducing    •e.g. general   •Management•Determine         •Collateral      •Credit data   •Payment of •Booking of
       a brand e.g.    offers to       of Sales via financial        evaluation       to Treasury    Interest     Payments
       „easycredit“    customers       Internet,    requirement      •Rating of       •Refinancing   •Payment of •Governance
                                                                                                                                   Consumer Credit
       in the credit
       market
                       via letters     branches and •Identificatio
                                       sales banks n of potential
                                                                     borrower
                                                                     •Final pricing
                                                                                      of Credit      amortisement of in-time
                                                                                                                  payments
                                                                                                                                   Process derived
       •Advertising                                 collaterals      •Credit                                      •Bad Loan        from the generic
                                                    •Pricing         Approval                                     Mgmt./
                                                                     •Credit                                      Realisation      value chain
                                                                     Account                                      of collaterals
                                                                     opening
                                                                     •Payout of
                                                                     credit



             Risk Management: Management of Credit Portfolio and Credit Risk


               Identify the resources allocated to the consumer credit process                                                     Evaluation of in-
                                                                                                                                   house efficiency
                           Calculate costs and revenues for each process step                                                      of value activities
          Evaluate cost efficiency respectively value added for each process step




http://www.efinancelab.de/
                                       Mini Case Study: Norisbank

      Marketing:
      Branding of product “easycredit®”
      Independently from corporate identity of Norisbank
      Registered trademark: valuable and rare

      Sales:
      Effectively leveraging product via different sales channels
      Norisbank is able to invest 87% of all funds easycredit

      Products/Transactions:
      Fully automated processing of consumer credit
      Average processing-time reduced from 128 to 35 minutes




http://www.efinancelab.de/
                                            Agenda


 Problem, Research Questions, Defintions


 A Qualitative Framework for Sourcing Decisions


 The Banking Value Chain as Sourcing Subject


 A Formalized Sourcing Decision Model


 Conclusion and Further Research
                                   Production Cost Economics

        „Squeeze Out Potential “ – Reality Check Financial Services




http://www.efinancelab.de/
                                             Production Cost Economics

       Scale and Skill economies of Insourcer


        C/y




        CO

                                       Insourcer „Skill Potential“

        CI„
                                                                     C/y Outsourcer
         CI„„
                                                            C/y Insourcer
                             Insourcer „Scale Potential“


                                                                                      y

http://www.efinancelab.de/
                                        Economies of Scope vs. Economies of Scale


   Economies of Scope:                                    Economies of Scale:
   Def.: Economies where it is less                       Def.: Economies realized by output
   costly to combine two or more                          expansion, i.e. decreasing marginal
   product lines in one firm than to                      costs when expanding the output.
   produce them separately.
    n

    C(y , w)  C(y
               i                N   , w)                  ΔC/C
                                                               1
    i1
                                                    vs.   ΔX/X
   N  1,2,....,n = Set of products under study
   y  y1 ,...,y2  = Quantities of products
                                                          C          = Kosten
   C(yn , w)         = Multiproduct Cost Function         X          = Outputmenge
   w                 = Vector of factor prices
  [Source: Panzar and Willig, 1981]                       [Source: e.g. Murray/White 1983, Mester 1987]




   Economies of scope can only be                         Scale economies may be realized
   realized by Universal banks, and                       by Specialized Banks as well as by
   may be a driver not to disaggregate                    Universal Banks.
   the value chain.

http://www.efinancelab.de/
                               Internal Production vs. Joint Venture vs.
                                                              Specialist



   Universal                     Joint Venture:        Specialized
   banks:                                              Service Provider
                                 Banks jointly
   Highly diversified            produce specific       Specialists is
   banks, which                  bank products or       concentrating on
   have separate                 processes to           one specific
   business units            vs. generate scale     vs. business segment
   may generate                  economies.             thus being able to
   economies of                                         generate
   scope.                                               economies of scale
                                                        and skill.

   Example:                      Example:              Examples: IBM,
   Deutsche Bank                 Eurohypo              Aareal Hypotheken
                                                       Management

http://www.efinancelab.de/
                                                                          Make vs. Buy Decision


                        C( y , w )  C( y          , w )  C( y i , w )  C( y N , w )   G m (f , u, s)/(1 rm ) t 
                         T
     Make                           i             M
                        t 1

                               Cost Function      -      Scope economies             +       Transaction costs
     vs.
                                         T
                                                                                   
     Buy                 S(s, f , u )   P * y i  G b (f , u, s) / (1 rb ) t   0     i  N
                                        t 1                                      

                     One-time costs for
                     outsourcing
                                           +    Price   +   Transaction costs



  C(y,w)      = Cost function output and factor prices          G(f,u,s) =            Governance cost function
  N={1,2,...,n}= Set of activities under study                  M          =          N without i
  P           = Price per output unit of the potential supplier r          =          Risk-adjusted discount rate in percent
  S(s,f,u)    = One-time sourcing cost function                 T          =          Years of contract
  w           = Vector of factor prices
  Yi          = Yearly output from diversified company of activity i
  YN          = Yearly output from diversified company of activities 1 to n
  YM          = Yearly output from diversified company of all activities M


http://www.efinancelab.de/
                                                                                  Make vs. Share Decision

    
            
    K T C ( y , w)  C ( y , w)  C ( y , w)  C ( y , w)   G ( f , u , s ) 
                    j
                    k             N       k      M         k       i k      mkk k  k
                                                                                      
                                                                                             
                                                                                      
     k 1 t 1
                                      (1  rm / 100)t
                                                 k                                   
                                                                                     
    S ( s, f , u )  T C ( y , w)  G ( f , u, s )/ (1  r / 100)t   0
   
   
                      
                      t 1
                              j        h                     h
                                                                      
                                                                      
   s.t.

   
                i
                              
    T C ( y , w)  C ( y , w)  C ( y , w)  C ( y , w)  G ( f , u , s ) 
                k               N    k         M       k         i
                                                                 k
                                                                           mkk  k  k
                                                                                       
                                                                                             
                                                                                       
     t 1
                                      (1  rm / 100)     t
                                                  k                                   
                                                                                      
                                                                                   
      S ( s, f , u )   C ( yi , w)  Gh ( f , u , s )/ (1  rh / 100)t  yi / yi   0
                        T

   
                     t 1
                                                                           
                                                                            k
                                                                                     
                                    K
   i  N , k  K with  yi  yi              k
                                   k 1




   C(y,w)               =   Cost function of dependent output and factor prices   G(f,u,s)        =   Governance cost function
   N={1,2,...,n}        =   Set of activities under study                         K={1,2,...,k}   =   Firms participating in joint venture
   M                    =   N without I                                           P               =   Price per output unit of the potential supplier
   r                    =   Risk-adjusted discount rate in percent                S(s,f,u)        =   One-time sourcing cost function
   T                    =   Years of contract                                     w               =   Vector of factor prices
   Yi                   =   Yearly output om diversified company of activity I    YN              =   Yearly output of activities 1 to n
   YM                   =   Yearly output of all activities M



http://www.efinancelab.de/
                                            Agenda


 Problem, Research Questions, Defintions


 A Qualitative Framework for Sourcing Decisions


 The Banking Value Chain as Sourcing Subject


 A Formalized Sourcing Decision Model


 Conclusion and Further Research
                             Conclusion and Further Research

      Conclusion:
      a qualitative framework using RBV and TCE was introduced to identify:
           Superior Skill Sets
           Superior Governance Structures
        consequently supporting a make, buy or share decision.
      A top-down approach for identifying and analyzing activities in banking
      was introduced using the generic banking value chain
      Co-opetition/Share is a possible sourcing solution for activities and a
      way to increase production efficiency
      Influencing variables of a sourcing decision were formalized to show
      interrelation and impact on a sourcing decision

      Further Research:
      Extending the Model by Uncertainty and Risk
      Sensitivity Testing of the Model Variables

http://www.efinancelab.de/
Backup
                                                                   Literature

      Barney, J.B. (1991): Firm resources and sustained competitive
        advantage, in: Journal of Management, 17, 99-120.
      Barron, T. (1992) “Some new results in testing for Economies of
        Scale in Computing” Decision Support Systems, 4/8, 405-429
      Lacity, M; Willcocks, L. (1996): Editorial; Information Systems
        Outsourcing in Theory and Practice, in: Journal of Information
        Technology, 10, 203-207
      Lacity, M; Willcocks, L. (1996): The Value of Selective IT
        Outsourcing, Sloan Manangement Review, 13-25
      Porter, Michael, E. (1985): Competitive Advantage: Creating and
        Sustaining Superior Performance, Free Press, New York.
      Williamson, O. E. (1981): The Economics of Orgnaization: The
        Transaction Cost Approach, in: American Journal of Sociology,
        87, p.548-577.



http://www.efinancelab.de/
                                                   Model of three banks


                             Model of three banks
          Salesbank               Portfolio bank         Production bank
           Marketing              Risk Management       IT- and Transaction
            management              and term transfor-     Management
           Multichannel            mation                „manufacturer“ for
            mangement              Issuance and           clearing, settlement,
           Distribution of         advisory business      payments and other
            products to private    Building and           transaction related
            and corporate           allocation of          business
            customers               special financial
                                    know-how

        DG Bank as well as the Norisbank divides the banking business
         into sales-, portfolio and production activities. They expect using
         these function banking holding companies and specialized banks
         will evolve (source: Salmony 2002, Norisbank 2002).
http://www.efinancelab.de/
                                         Steffens (2002) expects special
                             distribution, transaction and product banks


             Distribution             Products                Transaction

       Distribution              Product specialists     Transaction banks
          specialists concen-      like Credit Card,        provide clearing and
          trating on sales         Credit and Asset         settlement, payment,
          channels like            Management               trading and custody
          Charels Schwab,          companies provide        facilities
          MLP or American          their products to
          Express.                 universal banks
                                   resp. global players



        Steffens (2002) expects a specialization of banks towards
         distribution, product and transaction banks. Anyway, the author
         expects still global players and universal banks which use
         specialized banks as supply or sales channel.


http://www.efinancelab.de/

								
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