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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

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strategic sourcing in banking a framework markus lammers e finance lab university of frankfurt

Strategic Sourcing in Banking- A FrameworkMarkus Lammers, E-Finance Lab University of Frankfurt

October 08, 2004

slide2

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
Problem

German Banking Industry*

Special banks: 68 Institutions

Universal banks: 2288 Institutions

28 building and loan associations

14 banks with specific functions

1491 coop. banking associations

524 savings and state banks

271 credit banks (incl. foreign banks)

26 mortgage banks

  • 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

Products

Products

Products

Investment

Investment

Investment

Services

Services

Services

Funding

Funding

Funding

Deposits

Deposits

Deposits

Credits

Credits

Credits

Acct. Mgmt.

Acct. Mgmt.

Acct. Mgmt.

Securitization

Securitization

Securitization

Securities

Securities

Securities

Asset Mgmt.

Asset Mgmt.

Asset Mgmt.

Credits

Credits

Credits

Fin. Products

Fin. Products

Fin. Products

Transactions

Transactions

Transactions

Issuance/IPO

Issuance/IPO

Issuance/IPO

Marketing

Marketing

Marketing

Sales

Sales

Sales

Corp. Invest.

Corp. Invest.

Corp. Invest.

M & A

M & A

M & A

Payment

Payment

Payment

Advertising

Advertising

Advertising

Acquisition

Acquisition

Acquisition

Trading

Trading

Trading

Branding

Branding

Branding

Offering

Offering

Offering

Other assets

Other assets

Other assets

Advis. Serv.

Advis. Serv.

Advis. Serv.

Clearing &

Settlement

Clearing &

Settlement

Clearing &

Settlement

Sales

Support

Sales

Support

Sales

Support

Multichannel Management

Multichannel Management

Multichannel Management

Other Serv.

Other Serv.

Other Serv.

Custody

Custody

Custody

Infrastructure

Risk Management

Risk Management

Technology Development

Technology Development

Technology Development

Human Resources

Human Resources

Human Resources

Firm Infrastreucture

Procurement

Firm Infrastructure

Synergy potential

Bank 2288

e.g.2288 times redundant credit processes

Bank 2

Bank 1

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

(4) Payments (national, international)

(4) Clearing, Settlement

(4) Exchanges

(3) M & A

(3)

Other1

(3) Insurance

(3) Asset

management

(3)

Credits

(3)

Other1

(3)

Other1

(1) Purely regional distribution

(2) Global wholesale,

investment

Hamoir et al. expects that 4 banking models may emerge

Potential banking models

Regional retail distributors (1)

Global wholesale and investment bank (2)

Pan-European product specialists (3)

Pan-European service providers (4)

Infra- structure

Position along the value chain

Products

Distribution

Mass Affluent Private

Small Midsize

Multinational Corporations

Retail

SME2

Type of banking customer

1Such as commercial insucrane and institutional asset management

2Small and midsize enterprises

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

http://www.efinancelab.de/

research questions
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
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/

slide8

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
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
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
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

competitive advantage

sustainable

Non-substitutable

Imperfectly imitable

rare

valuable

  • Analyze cost, revenue or value contriubtion
  • Benchmark against competitors, e.g. using DEA
  • Determine competitve advantage
  • The resource or the resource bundle is not freely available.
  • Competitors can not buy the resources immediately
  • Direct competitors do not deploy identical resources/resource bundle
  • The resource bundle is heterogene from other resource bundles
  • Heterogenity cannot be rebuild in the short to medium time frame
  • The resources or resource bundle can not be substituted by other resources
Theroretic Foundation: An Introduction to the Resource Based-View (2/2)

http://www.efinancelab.de/

qualtitative sourcing framework

Institutional design

of sourcing alternatives

Making

Sharing

Buying

hybrid forms:

Joint Ventures / Shared Services / Alliances

Degree of market

coordination

Degree of

hierarchical coordination

TCE based recommendation

for sourcing

decisions

high Asset specificity of activity low

high Frequency of activity low

high Uncertainty low

Resources and capabilities pro-vide a sustainable competitive advantage

RBV based recommendation

for sourcing

decisions

Resources and capabilities are a

source of competitive advantage, but may

be easily to imitate

or substitute

Resources and capabilities provide a competitive disadvantage

Company

Objective

realize efficiency improvements /

scale economies by bundling activities

increase own

market share

realize efficiency improve-

ments from specialists

Qualtitative Sourcing Framework

http://www.efinancelab.de/

slide14

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

Products

Marketing

Trans-actions

Sales

Investment

Services

Funding

Deposits

Payments

Advertising

Credits

Acquisition

Acct. Mgmt.

Securitization

Securities

Asset Mgmt.

Trading

Branding

Offering

Credits

Fin. Products

Issuance/IPO

Clearing &

Settlement

Sales

Support

Multichannel Management

Corp. Invest.

M & A

Custody

Other assets

Advis. Serv.

Other Serv.

Risk Management

Technology Development

Human Resources

Firm Infrastructure

Detailed Generic Value Chain of the Banking Industry

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

Transaction

Marketing

Sales

Product

Branding of

a Product

Sales

Support

Multi Channel Mgmt.

Acquisition and

Offering

Credit

Funding

Payments

Clearing

and Settlement

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

Risk Management: Management of Credit Portfolio and Credit Risk

Identify the resources allocated to the consumer credit process

Calculate costs and revenues for each process step

Evaluate cost efficiency respectively value added for each process step

A generic value chain for consumer credits

Consumer Credit Process derived from the generic value chain

Evaluation of in-house efficiency of value activities

http://www.efinancelab.de/

mini case study norisbank
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/

slide18

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
Production Cost Economics
  • „Squeeze Out Potential “ – Reality Check Financial Services

http://www.efinancelab.de/

production cost economics20
Scale and Skill economies of InsourcerProduction Cost Economics

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 vs. Economies of Scale

Economies of Scope:

Def.: Economies where it is less costly to combine two or more product lines in one firm than to produce them separately.

  • Economies of Scale: Def.: Economies realized by output expansion, i.e. decreasing marginal costs when expanding the output.
  • C = Kosten
  • X = Outputmenge
  • [Source: e.g. Murray/White 1983, Mester 1987]
  • vs.

= Set of products under study

= Quantities of products

= Multiproduct Cost Function

= Vector of factor prices

[Source: Panzar and Willig, 1981]

Economies of scope can only be realized by Universal banks, and may be a driver not to disaggregate the value chain.

Scale economies may be realized by Specialized Banks as well as by Universal Banks.

http://www.efinancelab.de/

internal production vs joint venture vs specialist
Internal Production vs. Joint Venture vs. Specialist
  • vs.

Universal banks:

Highly diversified banks, which have separate business units may generate economies of scope.

  • Example: Deutsche Bank

Joint Venture:

Banks jointly produce specific bank products or processes to generate scale economies.

Example: Eurohypo

Specialized Service Provider

Specialists is concentrating on one specific business segment thus being able to generate economies of scale and skill.

Examples: IBM, Aareal Hypotheken Management

  • vs.

http://www.efinancelab.de/

make vs buy decision
Make vs. Buy Decision

Make

-

+

Cost Function

Scope economies

Transaction costs

vs.

Buy

+

+

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
Make vs. Share Decision

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/

slide25

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 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/

literature
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

Production bank

  • IT- and Transaction Management
  • „manufacturer“ for clearing, settlement, payments and other transaction related business

Salesbank

  • Marketing management
  • Multichannel mangement
  • Distribution of products to private and corporate customers

Portfolio bank

  • Risk Management and term transfor-mation
  • Issuance and advisory business
  • Building and allocation of special financial know-how
Model of three banks
  • 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
Steffens (2002) expects special distribution, transaction and product banks

Distribution

  • Distribution specialists concen-trating on sales channels like Charels Schwab, MLP or American Express.

Products

  • Product specialists like Credit Card, Credit and Asset Management companies provide their products to universal banks resp. global players

Transaction

  • Transaction banks provide clearing and settlement, payment, trading and custody facilities
  • 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/