Headwinds or a Brick Wall

While current headlines of economic progress are modestly positive, this is looking in the rearview mirror. Looking forward, we see potential economic and regulatory consequences caused by the deferral of tough budgetary decisions starting in 2013.

Consider each of the following:

• Automatic spending cuts (failure of the ‘Super Committee”) 
• End of payroll tax cut 
• No extension of unemployment benefits 
• End of “Bush” tax cuts 
• No added stimuli for state and local governments 
• Alternative minimum tax 

Why is this important? The above items represent the unwinding of actions originally intended to stimulate the economy. They all had a positive effect on disposable personal income (income after taxes). This is what consumers use for consumption (to spend and service debt), and consumption is 65-70% of the U.S. economy.

When stimulus is removed, it initially has the opposite effect resulting in less take home pay and potentially an increase in unemployment. Even moving to a neutral position (pre-stimulus) will be a drag on overall economic growth and risks destabilizing our fragile recovery.

As you think about your long-term strategy it’s important to consider the impacts of evolving fiscal policy.

Channel Shifts

The question of how to most effectively distribute products and services is always a fundamental component of marketing strategy. The digital age has dramatically increased the number and efficiency of channels many industries utilize in distribution. In virtually every industry, where the product or service content can be digitized, channel strategies have evolved rapidly and emerged as key competitive differentiators.

Consider how digital delivery has changed the competitive landscape in the music, photography, movie rental, and book industries. Apple has sold over 300 million iPods alone as music has moved into the digital platform. In the digital age of photography and movies, Kodak and Blockbuster could not shift their strategy/distribution channels fast enough, causing both to go bankrupt. Amazon now sells more e-books than paper books only three years after launching the Kindle!

The following graph from Bank Technology News illustrates how rapidly channel shifts are occurring within the financial services industry. 

http://digital.banktechnews.com/banktechnews/201001?pg=16#pg16

It is no surprise to see branch utilization declining while online and mobile banking are increasing. What is surprising, however, is the speed at which mobile banking is being adopted. Mobile banking is currently growing at three times the rate at which online banking grew at a similar stage of its evolution. Mobile is now forecast to surpass online as a banking channel by 2014.

As you review this graph think about your institution and the following:

• Which of your current channels are table stakes versus differentiators? How do you expect this to change over the next three years? 
• How are you investing across your current and future distribution channels? 
• Can you measure profitability across channels? 
• Are there any channels that are no longer needed? 

The rapidity of channel preference shifts clearly poses challenges for managers of financial services institutions. It is not a trivial process to determine which channels deserve the greatest investment and when to make bets on emerging channels. At the same time, these trends also create a real opportunity for leading financial institutions to transform their distribution by giving customers the added convenience and richer experience they seek while simultaneously lowering their overall operating costs.

A Formula For Sustainability

The SGS blog has grown out of research our Strategy team at CUNA Mutual Group has conducted over the past three years examining what credit unions and other financial services firms must do to develop and maintain truly sustainable financial models.  Our work was initially inspired by seminal financial analysis conducted at DuPont Corporation in 1919 by F. Donaldson Brown, who was then the DuPont CFO.

Brown developed the so-called “DuPont Formula” (also known as the “DuPont Analysis” or “Sustainable Growth Model”).  Brown discovered that a firm’s maximum sustainable growth rate is equal to its Return on Equity (ROE).  For a credit union, growth is measured in terms of asset growth and ROE is equal to a credit union’s ROA multiplied by its leverage factor (which is the inverse of the capital ratio).  The model is a practical tool that links growth, earnings and capital.  If you are interested in learning more about the model, please click this link.

Over the past two years we have presented the Sustainable Growth Model to credit union leaders across the U.S. and Europe.  We have spoken at numerous League and trade association events and have participated in three academic colloquia on this topic – at Harvard in October 2010; at UC Berkeley in March 2011; and at University College Dublin in Ireland in June 2011.

We are encouraged by the positive response to this new application of a very old financial tool and are excited to see many credit unions incorporating the sustainable growth model in their strategic and financial planning.

However, as we applied this model to literally hundreds of credit unions, we realized that true sustainability in cooperative financial institutions requires more than just a solid financial strategy.  We have come to see two other factors as being absolutely critical components of sustainability:  strong governance and a vibrant value proposition.  We call the conjunction of these three factors the “Sustainability Formula”.

This blog will focus on the continual need to strive towards optimizing the balance between these three variables:  financial strategy, governance and value proposition.  We will use the issues of the day as a platform to discuss how boards and management teams might approach critical issues using this new triple strategic lens.  We look forward to engaging with you in a robust dialog.