Lean Financial Services - Cutting Costs While Reducing RisksPublished: November 11, 2009 in Knowledge@Wharton
The financial services sector has been a laggard in adopting lean tools and practices, perhaps because of their manufacturing origins. But those attitudes are slowly changing. As more banks discover the benefits of lean operations -- such as lower costs, fewer errors, faster cycle times and far greater efficiency -- wide-scale adoption by the industry is just a matter of time. But old habits often die hard, and slowly.
This article, part of a special report from Knowledge@Wharton and The Boston Consulting Group (BCG) on applying lean concepts to service industries, explores why the industry is dragging its feet, and shows what banks can achieve when they go lean.
Opportunity and Challenges
For process-oriented industries such as financial services, lean holds enormous potential. Lower costs and fewer errors are just the beginning. Banks that take on successful lean programs often see a 15% to 25% improvement in efficiency, BCG experts say. Gains in cycle time can be even more dramatic, with improvements of 30% to 60% possible. Lean thinking can even help management understand which customer groups are most profitable and where service can be enhanced most cost-effectively, says Amyn Merchant, a senior partner in BCG's New York office. The results of lean initiatives can be dramatic:
- An international commercial bank discovered the potential for 30% more efficiency in processing customer transactions - while improving customer satisfaction through more differentiated service.
- A lean audit of one North American asset manager uncovered ways to make product pricing 12%-20% more efficient by carefully identifying and eliminating non-value added activities.
- Analysts using a lean approach in one investment bank reportedly gained 20%-30% in analyst productivity - and a 60% reduction in cycle time -- by redefining credit processes.
Given this potential, why hasn't lean made more inroads in the financial services industry? Christian Terwiesch, a professor of operations and information management at Wharton, argues that human nature blocks progress.
Most service companies tend to be in denial that lean applies to their industry, Terwiesch says. Typically, everyone agrees it's great for manufacturing, and then denies it could work in their business. A few years later -- perhaps after a competitor has shown some success with a lean approach -- some managers concede that lean could work, but only in the back office and other lower-value parts of the operation. Finally, years later, the whole workforce will reorganize. "I can't help but see a pattern here," he says.
In fact, lean for manufacturing and lean for finance are not all that different, says Deepak Goyal, a partner in BCG's New York office. "Finance is just a different kind of factory. It is a processing factory, and there's a lot of waste. The basic philosophy doesn't really change."
Becoming lean involves eliminating the "seven deadly sins" of waste in a process -- overproduction, waiting, poor transportation/logistics, over-processing, sub-optimal inventory control, rework, and unneeded movement. People exposed to lean thinking are trained to see and remove these wasteful practices, he says. As superfluous steps are managed away, the process becomes more efficient. Waste begins to disappear. Speed improves and costs drop.
Another key principle of lean is to focus on what's important, what matters to the customer, what delivers value, says Christophe Duthoit, a BCG senior partner who manages lean programs for financial services. Almost everything else should be cut. But understanding what customers value isn't always easy, he notes, especially when functional silos isolate employees from the front line or the marketplace. "Very often, employees get ideas about what's important to the customer based on limited knowledge or an incomplete understanding of customer needs," says Duthoit,
Often, lean thinking helps give executives a broader perspective on a process, making it easier to see possibilities for improvements than a more silo-bound view traditionally did.
Changing Mindsets and Attitudes
Lean thinking is nothing new, of course, but BCG consultants say more banks have talked about it than tried it. Far more common is an attempt to cut costs without undertaking an actual lean program. "Lean isn't simply about cost cutting, but about changing the way you work," says Duthoit.
While the basic idea of lean is familiar to many financial executives, getting them to follow through is another matter. "It's like your diet. You know what to eat, I know what to eat, it's not that hard to know," Terwiesch says. "But you don't eat it. You come home, you're tired from work, and you have a beer. I think the same is true for lean." Old habits are hard to break.
Many banks that have applied lean to back-office processing have reached a steady state followed by diminishing returns. But there's a second stage of opportunity in higher-level processes, such as those that touch the customer in branches or the front-office. Still, many executives in those areas continue to deny that lean can improve their productivity. Notes Terwiesch: "They'll say, `Well, lean doesn't apply to me. It's just the $50,000 a year underwriter, the simple banker in the branch office who should do lean. I am special.'"
Part of the reluctance may have to do with lean's shop-floor origins. Some executives may equate lean to dumbing down a job. Others mistakenly think lean requires standardizing every part of a process. But it doesn't, Duthoit says. "It's more about getting smarter about what you do."
In fact, getting lean often requires creative thinking. For example, when paperwork moves online, the steps of a financial process are often still performed in a sequential order, even when they could be done in parallel, BCG experts say. So forget the assembly line approach. Think more like a race-car pit crew, and process speed can improve dramatically.
This kind of creative thinking often exposes a great deal of waste. Terwiesch, in his recent operations textbook (Matching Supply with Demand, Gerard Cachon, Christian Terwiesch, McGraw-Hill 2008), notes that at one major consumer bank only 40% of the labor that went into loan underwriting added any value. The rest was frittered away on such unproductive activities as processing loans that were unlikely to be accepted by customers because the bank had taken too long to respond, or processing loans that should have been rejected because the applicant's credit status was obviously too low, and trying - repeatedly but unsuccessfully -- to reach customers on the telephone.
Like any major improvement effort, lean is not risk-free. As systems grow more efficient, warns Eric Clemons, a Wharton professor of operations and information management, quality control and risk management must improve along with them.
In a system with no slack, a single defect in one item can easily snowball into a much larger problem. Just as manufacturers that work on a lean, zero-inventory basis must have assurances from suppliers that their parts will have zero defects, banks with lean operations must put in place strict quality controls, Clemons says. In particular, automatic systems must be watched closely to ensure that they don't exacerbate a difficult market by, say, withdrawing credit at the wrong time.
But Goyal believes that lean most often reduces risk. "Lean is one of the very effective ways to actually mitigate operational risk, much of which arises from errors at the front line," he notes. By standardizing processes and empowering front-line people, managers can cut out a lot of that risk.
Standardization can also reduce errors. For example, in cash reconciliations: "You're basically taking two entries, trying to compare them, and lowering the bank's exposure if there's a mismatch," Goyal says. In the average big bank, many small groups perform separate reconciliations, "using different technologies, processes and standards." That can lead to mistakes.
This lack of coordination can be costly, particularly when allowed to continue long-term. "With lean, you can standardize, you can homogenize, you can roll up uniform processes and significantly cut exposure," says Goyal.
Getting It Right
The best way to begin a lean program is to map an entire end-to-end process, then look for ways to streamline it. "You're much more likely to be successful carving up and defining specific processes with a beginning point and an endpoint," says Simon Bartletta, a partner in BCG's Boston office.
"You need to focus first on some pragmatic, easily implemented and meaningful applications of change," Duthoit adds. "Once these are shown to be a success, you can build momentum. It's a marathon."
But analysis and implementation are extremely different. "In theory, lean tools and techniques are pretty simple," says Bartletta. "But the execution -- getting to success -- is complex." One reason: "It's a people process, and it requires a big change in the culture and in the way you manage activities."
Although implementing lean begins as an operations issue, it quickly becomes a change management exercise that requires companies to deal with workers in new, unfamiliar ways. For instance, the lean principle of engaging employees in problem-solving means that workers involved in a process must be asked how it might be simplified or improved. "You can't just say, 'Let's run this exercise and we'll worry about the people dimension later,'" notes Duthoit. "Managing change and people's behaviors is a continuous process that must be addressed from day one," he adds. Managers may see this as slowing down the lean effort, but ultimately it can simplify their task and improve the eventual outcome. "Employees are more likely to resist new approaches if they don't understand how they can help improve the process overall or how their effort adds value," he explains.
While it might be tempting to simply issue an edict and try to order a lean program, Bartletta says that what works best is to engage workers early on. "Lean works best as a balanced top-down and bottom-up effort," he explains. "The organization needs to share a common goal and set of expectations of value that the lean program will deliver, and have the executive commitment and appropriate governance to enable its success. However, you also want to heavily involve front-line workers and encourage them to share their ideas. You want to let them know that it's okay for them to speak up, and that they should drive the definition, testing and validation of the new process."
Done right, lean isn't a one-off project but instead a pervasive approach to operations that brings lasting cultural change. It transforms the way employees view their work by encouraging them to continually think about ways to improve it, notes Bartletta. "They're not just there to punch the clock and do what they're told." He warns not to overlook this need for change management. "It's incredibly important to do. Otherwise, lean just becomes a project and a one-time event, and the costs and the risks will creep back in a few years."
Limits of Lean
Lean does have its limits. One of its core principles and a key part of process optimization is to minimize variability, which reduces errors and improves quality. But going lean would not be a good way to run a fire department, Terwiesch says. "You might say it's totally inefficient that these guys are getting paid to sit in the station 80% of the time. Wouldn't it be better to make sure that they're always busy and that the fire truck is fully utilized? But it just doesn't work that way, because unless you're the one causing the fires, a fire department needs to hold excess capacity."
What's more, he adds, "an extremely lean system is very vulnerable to external shocks to the system -- strikes or traffic jams, bad weather, earthquakes, whatever messes up the system."
The challenge of using lean in a service business is that the customer is much more closely connected to what's being produced. In effect, the customer is often the object moving through a service process, and that complicates matters immensely.
"Imagine you're running a travel office," says Terwiesch. "The perfect lean team might get its processes right and do everything consistently, but suppose a customer wants to talk for 30 minutes before booking a flight?" The process may not allow for such lengthy conversations. "That's why, intrinsically, the application of lean is harder in services."
For many banks, the first item on the lean agenda may be to increase the value and productivity of a merger or an acquisition. "People are revisiting those partially integrated units, looking for next-generation synergies in operating models and work processes," says Bartletta.
Lean thinking may also be moving up the value chain in finance, as it has in other service industries. As an example, lean thinking could be applied to investment operations to streamline processes and speed up decision-making, notes Terwiesch. "I see absolutely no reason why lean tools shouldn't be applied to more knowledge-intensive processes."