Measuring Success when Improving Your Efficiency Ratio and Profitability

Bill Waid, FICO's chief product and technology officer, recently shared his insights into how banks can measure their success with their efficiency ratio and profitability. I'm sharing his insights below - let me  know what you think!

When you’re investing significant amounts of time and money into the biggest digital transformation programme the organisation has ever seen, you want to know it’s performing as expected. You need to know the investment was worthwhile and your profits will increase as a result – in the near future, if not immediately.

I don’t know of any bank or other financial institution (FI) that is not in the midst of such a project, in fact many of them have several initiatives running concurrently on different areas, for a holistic overhaul. The problem is not all these programmes are set to meet their ultimate aim of improving profitability. Industry experts at McKinsey, Boston Consulting Group, Ernst & Young, KPMG and Bain & Company collectively found that the success rate sits in the disappointing 20-30% range.

Measuring success must form a vital part of the transformation project, and it should begin with setting a target for improved efficiency ratios.

An important measure of financial stability, the efficiency ratio scores an institution’s profitability. Efficiency ratios are calculated by dividing expenses by net revenues, and a ratio of under 50 is optimal, indicating that every US$1 of expenses results in US$2 of revenue. The lower the score, the less the organisation is spending to generate every dollar of income.

As an example:

• Net revenue = US$100m
• Expenses = US$65m
• US$65m/US$100m = 0.65 = 65% efficiency ratio

65% isn’t bad, but it could – and should – be better. I would encourage an FI with a score like that to utilise in-house data to focus on more efficient customer service and retention strategies to stop defections before trying to acquire new customers. Offering new financial products, cross-selling and up-selling efforts focused on existing customers incur dramatically lower cost than new customer acquisition programmes. In fact, acquisition programmes can cost five times more than retention programmes.

Nine Success Factors that Help Drive Efficiency Ratios Lower

Having an end-goal like improving your efficiency ratio is important, but to meet that goal you do need understand exactly how a digital transformation programme can help get you there. How can you set up more specific objectives to guide your work and measure your progress? In FICO’s experience working with banks and other FIs around the world, we have found nine success factors for digital transformation projects that address business goals.

1                 Driving additional lending and improved risk management through enhanced decisioning that uses previously siloed customer and product data from across multiple divisions. The emphasis here is on revenue generation through improved customer retention, profit per customer and lending per customer.

2                 Driving down long-term structural IT costs using cloud innovation and more flexible technology solutions. This time the emphasis is on cost control, improving income ratios and cutting costs per account and per application.

3                 Quickly assessing and seizing strategic and tactical opportunities, pivoting initiatives where necessary in an increasingly volatile economic climate. The emphasis is firmly on revenue generation and cost control, with the speed of change increasing and the cost decreasing.

4                 Reducing losses through next-generation collections and recovery capabilities. The emphasis will be on cost control, with improved customer outcomes, increased capacity and take-up rates alongside decreased charge-offs and shorter agent call times.

5                 Improving the customer experience by delivering targeted omnichannel communications and AI-informed customer relationship management/next best action. Emphasis is again on revenue generation and cost control, but with increased customer engagement scores, reduced costs to service accounts and reduced attrition.

6                 Rapidly deploying analytic advancements using new data sources. This time the emphasis on revenue generation and cost control again, but also on compliance, with new models and strategies deployed and effective marketing utilised.

7                 Moving important decisions to real time, including the continuous evaluation of customer exposure. With an emphasis on revenue generation and cost control, this should see increased profitability per customer and reduced cost to serve.

8                 Maintaining regulatory compliance through a customer-level view of decisions, preferences and responses. The emphasis is focused on compliance, reducing the cost of governance and reputational risk, and reducing regulatory penalties.

9                 Adopting enterprise fraud management, minimising the cost and negative customer experience of multichannel fraud patterns like account takeover. The emphasis is once again on revenue generation, cost control and compliance, concentrating on reducing credit and operational losses.

Digital transformation should directly impact – and improve – everyday customer interactions, so that every decision you take drives your strategic outcomes.

To do this means moving beyond today’s legacy systems, which perpetuate a fragmented, poorly managed customer experience, and generate slow and sub-optimal decisions with increased requirements to maintain data across multiple platforms. Financial institutions need a single decision management platform, which enables real-time data streaming and connected, centralised decisioning.

It is simple and inexpensive to upgrade data within a cloud-based platform, and new data sources can be easily absorbed into the decisioning framework. Such a platform also moves control of change from IT to the business, enabling cheaper, faster response to changing market conditions. Another benefit is that the shift to a digital-first model through which consumers can interact with the FI at any time of day or night becomes far easier. As a result, the organisation can meet customers’ changing expectations and requirements more quickly and at lower cost.

- Bill Waid, Chief Product and Technology Officer for FICO