Article

Juggling Priorities

By Terence Roche and Bob Roth

9 minutes

Funding innovation requires making good tech investments and efficiently managing current vendors.

It is not news to any credit union manager that we are in a period of dynamic change in technology. Technology is re-shaping member delivery, member experience, sales, growth, money movement, and efficiency in fundamental ways and at a rapid pace.

This change has a big impact on the bottom line. Technology is one of the three biggest non-interest expenses at credit unions today, along with people and facilities. And the payoff from new technology, in growth and efficiency, is both real and crucial to achieve.

To manage technology vendors and spending in the next few years, credit union executives will need to manage competing and equally important priorities and realities.

On the one hand, to remain competitive in an increasingly competitive market, it will be essential to invest new dollars in innovation and the new technology that powers it. This innovation will manifest itself in delivery, sales and analytical systems/solutions.

On the other hand, credit unions are faced with the mandate to become more efficient and reduce delivery costs. IT groups will need to reduce overall non-interest expense, and they cannot plan on having a much bigger piece of that budget than they have today.

How will credit unions and CIOs manage the dichotomy?

Some Key Definitions

First, let’s divide technology into two major categories:

1. Technology and channel delivery—expenses involved with the delivery of systems, both member-touching and back office/support, that allow members to access banking services. Core systems, Internet banking, mobile, information management, sales and risk systems are all examples of this.

2. Payments—systems and solutions that allow members to move money. Debit and bill payment are two examples.

Although they serve different purposes, both categories of technology must be managed in similar ways.

Next, let’s divide the lifecycle of a technology solution into three major phases: innovative, mainstream and commoditized.

In the innovative phase:

  • Base system features and functions are still being developed, and differences in system capabilities can vary widely.
  • There can be many different vendors in the marketplace, and the strength (financial, clients) can also vary widely.
  • Costs are varied, often the result of irrational pricing and poor market information.
  • Business payoff from investments is not always clear, even if the investments are required for competitive purposes.
  • Vendor performance focuses on making sure promised development is completed and vendor financial performance is satisfactory.

Mobile-to-mobile payments are examples of innovative technology today.

In the mainstream phase:

  • Base system features and functions are fairly mature, and different systems are more similar and competitive.
  • Vendors have begun to consolidate, and the large core system vendors have more presence.
  • Consolidation and competition result in reduced pricing.
  • Payoff becomes a requirement.
  • Vendor performance begins to focus more on cost in addition to development.

Online loan and deposit opening and fraud solutions are examples of mainstream technology today.

In the commoditized phase:

  • Systems are mature and very competitive.
  • There are fewer vendors, caused by competition and consolidation (often, the major core vendors are the consolidators).
  • Remaining vendors are strong financially, and competition is keen.
  • Prices are very competitive and very rational. Market pricing information is very good.
  • Business payoff from these investments is being realized—or should be.
  • Vendor performance focuses on getting market-level features/performance at market price.

Core systems and item processing are examples of commoditized technology today.

CU Tech Spending Trends

Now, let’s examine how much credit unions spend on technology. In the latest Cornerstone Report: Benchmarks and Best Practices for Credit Unions, Sixth Edition, we saw a wide variance in total technology spending at credit unions:

  Technology Spend as a % of Assets Annual Spend at a $300M CU Annual Spend at a $1B CU
Median .354% $1.06 Million $3.54 Million
25th Percentile .238% $714,000 $2.38 Million
75th Percentile .516% $1.55 Million $5.16 Million

Source: The Cornerstone Report: Benchmarks and Best Practices for Credit Unions

In addition, credit unions have made large investments in payments solutions (notably debit transaction processing and bill payment). Those costs have grown considerably in recent years:

  Bill Payment Costs as a % of Assets Debit Transaction Costs as a % of Assets Annual Spend (Combined) at a $300M CU Annual Spend (Combined) at a $1B CU
Median .026% .091% $250K $1.16 Million
25th Percentile .015% .047% $186K $620K
75th Percentile .040% .221% $783K $2.61 Million

Source: The Cornerstone Report: Benchmarks and Best Practices for Credit Unions

The difference in spending is quite pronounced, but not altogether surprising. Each credit union has a unique strategy and delivery system, and this will result in different investments and different degrees of investment. A credit union with a big mortgage banking business and a big investment/wealth management business will have different technology costs than one that does not. A credit union with a big off-site ATM network will have investments that other credit unions do not. These investments are justified by business payoff (fee income, margin) that make perfect sense.

In the payments area, the differences can be much bigger and entirely valid simply based on the amount of debit transactions performed by members (in this case, higher spending is good, because it translates to more debit income).

However, some of this difference in spending is for another reason, and that is the mix. In Cornerstone’s estimation, at least half of this spending is on technology and payments systems that are commoditized, and more than 75 percent is in either the commoditized or mainstream phases. So, part of the variation in spending is a result of the different degrees of success credit unions have had in obtaining commodity pricing for commoditized solutions.

Take the example of the $300 million credit union shown in the first table. A 75th percentile credit union is spending $920,000 more than the median. What if 75 percent of this is legitimate based on strategy and delivery, but the remaining 25 percent is due to the fact that better pricing on more mature technologies has not been realized? That amount, at $230,000, could be the funding for required future investments in innovation.

This becomes even more important because it is not clear how credit unions can plan for technology budgets to grow significantly, at least as a percentage of assets. Many are now planning for the likelihood that non-interest expense will need to reduce relative to assets over the next three to five years. So, even if investments in innovation need to occur, they may need to occur without a significant overall increase in technology budgets.

Four Possible Strategies

This places even more emphasis and importance on the credit union’s vendor management approach. We see four major strategies credit unions will need to follow.

1. Understand the different priorities in vendor management based on the technology lifecycle. This environment brings a new perspective to vendor management. Going forward, credit unions will need to oversee vendor management in different ways.

Technologies and vendors in the innovative stage need to be managed with heightened focus on performance, both development and financial. There are many key performance indicators of whether a smaller company in the innovative phase will handle unavoidable growing pains, including:

  • financial performance and progress toward sustainable market share and profitability,
  • meeting commitments on new functionality,
  • quality of releases,
  • problem resolution, and
  • the degree to which releases reflect what was committed.

These are all indicators of whether small, innovative companies are managing growth and maturing.

As technologies mature into the mainstream and commodity phases, vendor management increasingly focuses on additional items related to cost and product bundling. Issues include:

  • managing relationships between best-of-breed vendors and larger core vendors that now almost certainly have a competitive product. This becomes less an issue of middleware and application programming interfaces and more one of managing the business relationship and integration commitments on both sides.
  • determining when functionality and other factors still warrant best-of-breed solutions and when, as certain technologies become more commoditized and less strategic, it makes sense to bundle with one vendor.
  • making sure contracts are structured to allow the credit union to take advantage of lower market pricing.

The fact that the timeframe from “innovative” to “mainstream” is much shorter than it was even five to 10 years ago makes this issue even more important. Such mature technologies as core systems or automated teller machines took 20 years or more to become commoditized. Newer technologies, such as mobile banking, are seeing member adoption rates and development cycles that will reduce that timeframe to five years or less.

2. Have a roadmap for technology spending/investments that supports the overall roadmap. The migration in vendor management discussed here requires that credit unions have an approach and roadmap that paint the picture of system migration and the investment it will require. Most credit unions have a roadmap for technology investments that looks at which systems will need to be replaced/upgraded and when. It is important to do the same with spending. Any roadmap and plan should be able to answer three questions on spending:

  • What re-pricing opportunities do we have on mature solutions that can be used to fund new ones?
  • When can we realize them based on current agreements?
  • What is the most effective way to re-invest those dollars as they become available?

3. Manage the “reduce and redirect” that will need to occur with technology spending. With the information in hand, credit unions need to take an approach to this spending redirect that places accountability very high in the organization and is very transparent with information. The roadmap must be understood and debated by the senior management team. Contracts cannot be managed and negotiated one by one by individual business groups. They must be managed at the “C” level and in tandem. Think about how the credit union approaches its asset/liability and loan committees. They are both good models for the IT committee.

4. Understand that investments in innovation have different ground rules. Credit unions have developed a strong ROI approach to all investments, not just technology and delivery. That can lead to discomfort with the “R&D” nature of some investments that will need to be made. They are, by definition, investments with no realistic expectation of payoff and may even be written off as bad ideas. Instead, these investments are made for the purpose of learning and experimentation. Credit union management and boards need to allocate some part of future investments into this category and understand two things:

  • There may be no explicit payoff.
  • There should almost be an expectation that the investment is likely to have a short useful life and might need replacement and reinvestment in the future.

Some part of any technology/delivery budget should be in this category, even if it is small.

There has never been a time where technology, delivery and payments systems have provided such an equalizing effect between credit unions and larger banks. In many cases, a small to mid-size credit union can take advantage of the same technology capabilities as larger financial institutions as quickly, or nearly as quickly.

The challenge will be to grow and adapt technology plans, technology spending and vendor management strategies to make sure that important technology dollars are spent on the right investments at the right time. Fast-evolving member needs and solutions will demand it.

Terence Roche is a principal and Bob Roth is a managing director with Cornerstone Advisors, a CUES Supplier member and strategic provider based in Scottsdale, Ariz.

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