ABC Trends in the Banking Sector

A Practitioners Perspective
Mitchell Max
Managing Partner, DecisionVu
mmax@decisionvu.com

Over ten years ago, in The Information Executives Truly Need, Peter
Drucker observed that service industries including banks have
practically no cost information at all1 . Today, not only has ActivityBased Costing (ABC) become common in the financial services arena,
but it is in the midst of an unprecedented resurgence as organizations
move quickly to replace, revise or extend their ABC systems and
processes. Organizations that have avoided ABC due to perceptions
of it being too complex or not producing enough value relative to
initial and ongoing effort are now embracing ABC as a new weapon in
their arsenals. Individuals with skills in this area are in high demand.
Technology developments and investments are stronger than ever, as
the tools have caught up with the aspirations of leaders in the field,
enabling them to operate in new ways. What is driving this change?
Is this truly an evolution or merely a fad which will pass?
From a practioners perspective, this change is being driven by
a number of critical business needs which are outlined in this
paper. Todays implementers are leveraging advanced technologies
and approaches in new ways to deliver sustained value for their
organizations through Activity-Based Costing information. This
paper seeks to present the reader with a compelling justification for
advancing their ABC initiatives, and an understanding of how the
new technologies and approaches can be effectively leveraged. It
draws on direct experience and interaction with organizations that
are raising the bar for value from their ABC investments and looks
to measure the progress we have made over the past decade, along
with some thoughts for the future.
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The Need for ABC Information

Drucker noted that Enterprises are paid to create wealth, not control
costs. They have to be managed for wealth creation. To do
that requires information that enables executives to make informed
judgments. 2 Todays CFOs are responding to an unprecedented
need for improved, sustained bank performance to meet growing
stakeholder expectations. Sophisticated banks and their stakeholders
realize that improved performance cannot come from cost-cutting
alone. Comprehensive performance management approaches,
systematic management of central costs, razor-sharp pricing and
customer profitability information are emerging by enlightened banks
as the keys to their profitable future.
The demand for actionable, accurate and transparent cost and
profitability information is growing. Bank mergers have promised
significant savings, but obvious resource duplication is only one
source of cost reduction, and scale efficiencies have not materialized
to the extent promised. Technology innovation has also been slow
to dramatically drive down operating costs. As a result, banks are
looking for more comprehensive and deep understanding of cost
information as they strive to meet stakeholder expectations.
Banks have traditionally used average costs as part of their profitability
analysis. For those banks that do use ABC, it often takes the form
of standard unit costs, with some transactional differentiation for
example, using different costs for assisted vs. self-service transactions
applied to channel-specific transaction volumes. While providing
directionally correct information at a high level, accurate costing
often remains elusive to these banks, particularly when viewed at
the detailed level.
As differentiation of service increases in financial institutions, it drives
multiple levels of complexity. In turn, complexity drives highly
different levels of cost consumption, for example:
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 Product customization, which often requires special back-office

processing
Special compliance functions/procedures
Manual reporting/government filings
Significant effort to explain product features to clients
High error rates triggering significant levels of manual adjustments
Degree of online self-service capability
Product complexity driving level of sales/advisory effort
Electronic versus manual transactions
Straight-through vs. manual processing

Studies have shown unit cost factors, due to differing demand intensity
impacting consumption, to be in some cases 5 or 10 times higher or
lower than the average. As a result, average costs have never been
more inappropriate! In fact, the level of cost differentiation has become
so significant that even business unit executives are rejecting the use
of average costs as a basis for decision-making. Only when costs are
based on actual consumption, and demonstrated in a transparent fashion,
will they be truly accepted by all parts of the business. In fact, when
presented in a transparent way, cost information forms a powerful tool
in dialog with customers.
New Applications for ABC
Todays banks are identifying new and unique ways to leverage cost
and profitability information, including:
Activity-Based Pricing, particularly for Business-to-Business
services;
Linking ABC information into Performance Management scorecards
and processes;
Providing information on a process view of costs, both to support
cost improvement needs and to enable ongoing accountability for
management by business process; and
Information on the profitability of discrete customer relationships.
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Activity-Based Pricing
Financial services organizations are recognizing that significant value
can be derived from pricing which leverages ABC information. In
situations where pricing is determined solely by reference to the market,
organizations can do little but select and nurture customer relationships
with high yields and lower cost to serve. There are many situations
however, where pricing can and must be based on an understanding of
the cost to serve for each product and customer. In particular, business
tobusiness services have significant potential for profit optimization
when the cost to serve can be transparently calculated, and in many
cases discussed with clients during price negotiation. As a result, there
is great demand for accurate, transparent and reliable cost information
by the customer facing sides of the business.
In one case, a transaction processing outsourcer has been highly
successful in using this information to target specific clients and,
through training of its sales force has begun to improve the profitability
of client relationships. Previously, discussions could only refer
subjectively to the level of complexity of their interactions. With new
information, specific measures of transaction intensity can be described
with clients, and additional opportunities to capture pricing for special
value-added services become more evident.

Integrating ABC and Performance Management

In their initial work with ABC, most banks focused their implementations
narrowly, developing isolated unit costs, product cost data and
departmental cost studies, with a focus on understanding specific unit
costs generally focused on product and organizational profitability.
Many of these studies were static, and quickly became outdated.
Increasingly, we are witnessing a need to develop more comprehensive
cost and profitability information, looking for example at the cost of an
entire business process which now encompasses multiple channels and
organizational units. Further, organizations recognize the significant
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value that can be derived from weaving cost and profitability

information into more comprehensive and integrated performance
management applications across the organization. Cost data now
forms an integral part of Balanced Scorecard applications, and
internal performance benchmarks are used to identify opportunities
for performance improvement. The need for external benchmarking
is growing rapidly. Cost and profitability are now critical elements
in assessing and managing the ongoing performance of branches,
channels and customers.
As a result, banks are experiencing the need to develop linkages
between ABC tools, data warehouses and Corporate Performance
Management (CPM) platforms. IT groups are becoming more directly
involved in ABC applications, as they begin to treat cost information
as a corporate asset, and identify the way it is foundational to
other information such as CRM data or CPM applications. This
technical data integration is expected to continue at an increasing
pace as CPM rises in prominence due to a heightened focus by
many of the technology analysts. New approaches to Performance
Management, such as Beyond Budgeting3 , are reinforcing the need
for the integration of these components by demonstrating the need for
open and transparent information as the basis for relative performance
management and interactive control processes.

The New Goalpost: True Customer Profitability

Studies continue to show that banks that manage the profitability
of customer relationships outperform banks managing without this
data. Experience has demonstrated that non-profitability-based
segmentation (e.g., based on revenue, balances or number of products)
can produce behaviors that reward retention of high touch - and
generally less profitable - customers. (One retail broker found that
over 20% of their high target customers were in the lowest two
profitability deciles.)

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The sheer fact that customers have multiple channel and process
options for sales and service interaction with banks, means that only
by understanding and managing customer demand can cost and
profitability be understood and managed. Best practice organizations
explicitly measure and manage the true profitability of each customer
relationship.
All banks recognize the criticality of customer profitability
information. The information is increasingly used in developing and
executing customer acquisition and retention strategies, with leading
organizations incorporating this information into their customer
relationship management (CRM) systems. As the more sophisticated
banks divest themselves of low-profitability customers, other banks
must be wary of accepting their hand-me-down accounts. Banks
that market free checking models run the risk of being selected
by the very low-profitability customers that have terminated
relationships with other banks. Consequently, profitability analysis
at the customer level is no longer optional.
Accurate analysis across multiple dimensions requires cost assignment
down to the lowest cost object levelthe account. The best way to
understand costs across dimensionsincluding customer, product and
channel dimensionsis to actually cost them out at the account level.
Understanding that lowest level and then developing rollups of the
information across all cost object dimensions results in truly accurate
information that can be used across the organization. Traditional
applications which cascade costs from one profitability dimension
to another (organizational, product, channel, and customer) do not
meet the test of accuracy.
Based on these observations, it is anticipated that:

Large banks will continue to refine and extend their customer

profitability platforms. Many of the largest banks calculate standard
unit costs for each channel specific transaction type, and multiply
those costs by transaction volumes to determine and store customer
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profitability information in massive data warehouses. While these

solutions continue to meet many of the profitability analysis needs
within those large banks, such as supporting CRM solutions, they
do not address the operational cost management needs, or the cross
functional process costing analysis requirements for these complex
organizations. With new, more scalable costing technology offerings
becoming available, larger organizations, with tens or hundreds of
millions of customers, are looking towards newer solutions in meeting
their costing needs. One major brokerage company, for example,
recently converted their in-house ABC application to a commercial
software product, enabling them to efficiently and effectively prepare
and analyze the profitability of each of its 8 million customers on a
monthly basis. By integrating their previously separate unit cost and
profitability models, they are able to better use more discrete (and
hence, more accurate) cost information and provide more transparent
profitability measures to their business segments.

Mid-size banks and non-retail lines of business in large banks also

require scalable customer profitability platforms. Mid-size banks

and non-retail lines of business need access to comparable customer
profitability tools scaled to support customer levels in the ten-million
range. Newer ABC tools are making this possible.

Need for effective integration of transactional information across

the organization. Pulling data into large data warehouses and

understanding how to use and leverage it effectively will ultimately
determine the success of the financial institutions customer
profitability initiative. As organizations begin to collect and manage
a variety of information at the customer level, there is an increasing
need to optimize not only the physical storage of this but also the
leveraging of this related data amongst all information consumers
within the bank.
An end to the separation of cost and profitability information at the
customer level. Increasingly, banks now look to solutions which
combine unit cost and customer profitability, along with other
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profitability measures, in a single product or model. While this was

previously not possible, advances in technology have begun to open
this solution up to all but the largest banks. One regional bank has
retained the use of its A/LM package for Funds Transfer Pricing at
a customer level, and is linking it to customer-level cost data from a
new ABC system.

Managing the Bank as an Economic Unit

Financial services organizations are clearly becoming more
sophisticated about how they manage costs. As banks expand and
enhance their costing capabilities, we are witnessing a return to the
use of Activity-Based Management as a key weapon in the war on
costs. Over their history, banks have inadvertently made ABM more
difficult to implement, by breaking up their operations into discrete
organizational units in the drive for consolidation and efficiency.
This has made it difficult to manage activities as an entire process.
For example, customer transactions are handled in one area, branch
back-offices are often consolidated in a geographic area, major
processing is handled in a central unit or outsourced. Understanding
and managing total economic costs through process swim lanes has
become a major undertaking.
Banks are beginning to apply process management techniques. More
recently, as they seek innovative ways to reduce costs, banks have
begun to organize around processes and look at costs from a customer
perspective, including recognition that costs will cross multiple sales
and delivery channels. Early analysis here often focuses on the
total cost of a process (i.e. mortgage origination cost). Since most
banks continue to organize and operate in functional silos, ABM
information is increasingly in demand, and ABC software is being
utilized increasingly to tag activities by business process regardless
of where it resides for organizational convenience.
At the same time, process improvement techniques are becoming more
sophisticated, with an increasing prevalence of Six Sigma and other
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detailed process techniques. The Six Sigma approaches popularized

by such companies as Motorola and GE are now being embraced
by the financial services sector; back-office processing facilities are
starting to introduce Lean Manufacturing techniques. At one large
transaction processor, multi-disciplinary ABC project teams include
Black Belts, who drive their teams towards more discrete and
detailed measures of process performance. This forces a greater level
of interest in true qualitative cost drivers (e.g., the level of training)
and on process performance measures (e.g., error rates) which in
some cases can force additional detail into ABC models. While this
is not news to our manufacturing colleagues, this is a clear shift in
emphasis as banks realize the degree to which some parts of their
organizations resemble factory operations.
This trend creates a number of demands on costing systems and
professionals:

Greater need for process costing information and management.

Organizations need more detailed process costing information for
management reporting. ABC models need to be able to report on
costs both by department and process. As banks begin to appoint
process owners, information on the cost of business processes is
being increasingly demanded in addition to traditional departmental
cost data.

Need for better, ongoing measures of performance. When it comes

to measuring performance, financial institutions need more granular,
rigorous, accurate and timely information. A shift is on to better
understand the factors of cost causation, including qualitative cost
drivers and the management of demand intensity.

Linkages from ABC foundations to other initiatives. Scorecards,

performance measurements, and other components of the CPM tool

sets are linked to ABC and changes in costingand are thus becoming
more critical. Software vendors are becoming increasingly aware of
the need to demonstrate integration amongst the various performance
management tools.
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 Strain between detail required for ABC and causal factors needed

for reengineering and Six Sigma programs. As financial institutions

take more strategic approaches to building costing systems, they
need to develop ABC information at a level of detail that will
support the causal factor requirements of reengineering and Six
Sigma programs. This granularity is much lower than that required
for strategic (product, channel) cost analysis. Greater care and the
use of professional judgment are needed in the development of cost
models to meet these often-conflicting scenarios.
New Challenges for ABC Implementations
The new needs presented above are matched with a new set of
challenges facing ABC implementers.
While the need for this information is rising, the appetite for spending
on ABC systems and supporting infrastructure is clearly waning as
finance continually looks to optimize the value it provides to the
bank. ABC groups are being constantly challenged to do more
with less:

Need for regular updates and ongoing reporting is driving the need

for lower total cost of ownership (TCO). Early adopters of ABC were
plagued by the size of the staff groups that were needed to maintain
their systems; without large staff complements, ABC models quickly
became outdated. It is not uncommon to find ABC teams with over
20 people, plus a dedicated systems group supporting them. As a
result, frustration with the significant maintenance costs associated
with ABC has become rampant. As ABC becomes more critical to
success and corporations are increasingly in flux, organizations are
focusing on how they can develop and maintain accurate costing
systems while keeping down costsparticularly ongoing labor costs.
Time-based cost models and strong data automation, discussed later
in this paper, are supporting a renewed ABC approach with a lower
ongoing cost of ownership.
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 Survey tools falling out of favor. Surveys have traditionally been used
to capture the assignment of resources to activities in ABC models.
With variable staffing models on the rise, and the frequency of
organizational change, survey information has become increasingly
inaccurate and requires significant maintenance resources. Different
approaches are needed.

Focus on data integrity for external and regular management reporting.

As line-of-business profitability and costing information increasingly

finds its way into externally published reports, organizations will need
to ensure that the information meets generally accepted accounting
principles (GAAP) and regulatory requirements and complies with
Sarbanes-Oxley legislation. Tying ABC information to authoritative
and certified back-office systems is becoming a new theme in advanced
applications. CFOs must demonstrate that the information presented
in segmented reporting has the same integrity as that presented under
the GAAP statements. The same standards apply to the use of ABC
information in supporting decisions made by management or the
board. ABC practitioners are now coming to realize that cost systems
must be as complete and accurate as the information produced for
external and other internal reporting, and that compliance will be
fully required. Approximates or estimates are coming under greater
scrutiny when used as the basis for cost allocation.
At the same time, changes in the structure of bank operations are
presenting new challenges to ABC implementers, both for initial
design and also for ongoing application maintenance:

Use of non-banking concepts in cost modeling. Banks combine both

product manufacturing (marketing, operations) and distribution

(sales and service channels). As they reorganize, banks have
increasingly been working to separate these functions, and separate
cost information is required to support the accountabilities that
management is introducing. The traditional non-banking approach of
separating product manufacturing from service fulfillment/delivery
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allows greater flexibility in costing than the single model approach

which has been historically employed. With separate accountabilities,
the organization can discretely flow costs between different parts of
the organization. For example, mortgage applications and mortgage
processing on the product side would be kept separate from loan
distribution. Standard costs at the transfer point can be used to
measure the efficiency of each group separately. This is a new
approach to cost modeling which is being addressed. Trace-back of
costs through these separate models is a requirement of many new
systems.

Shared Services are here to stay. Banks are unique in the high levels

of common cost base and infrastructure which is used to support its

products and customers. When costs are fully allocated to branches,
many banks find that the level of indirect costs is over 50% of total
non-interest costs. To better measure and manage this high level of
common costs, Shared Service approaches are becoming commonplace
in banks. IT, HR, financial and customer service applications are
being centralized and shared. Accountabilities are created for cost
and profitability information at discrete levels in the organization.
Best practice execution of shared services methodologies require
cost allocation models tuned to the organizations culture taking it
out of the technical implementation approach and relying to a much
greater extent on the use of Change Management specialists.

The need to reflect a systemic view of costs. A financial institution

cannot manage technology without considering operations, and vice

versa. When examining the cost of processing a mortgage application,
for example, a bank needs to consider both the technology and labor
costs of the activity or process. If a bank wants to know how much it
will cost to process an ATM deposit, it needs to look at the technology
costs of running the machines, the costs of servicing the machines,
and the costs of the courier systems and item processing areas that
handle deposit slips.

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Interestingly, many banks have begun a move to combine organizational

responsibility for technology and back-office operations. These new
Chief Technology and Operations Officers need new information on
the total cost of transaction or service handling if they are to make
effective decisions. Costs must therefore flow together to support
this ongoing analysis for example, by helping to analyze the
business case for a technology investment in terms of its ability to
reduce manual effort and to track the achievement of benefits postimplementation. This requires a more integrated approach to modeling
than is done when the items are treated in distinct models silos.

Banks change fasttraditional costing systems cant keep up! To a

greater degree than ever before, change is the only constant.

As a result, banks are seeking ABC platforms that can meet a wide
variety of needs concurrently and over time. No one ABC approach
or model design will fit all parts of an organization. The organization
must find tools flexible enough to meet a variety of needs and evolve
as those needs change. Limitations in software design are tolerated
less than ever before, simply because the future is so unknown.
Change Management Impacts
In addition to the systems changes that these needs and challenges
drive, a number of organizational and people impacts are becoming
prevalent:

More widespread use and greater access to ABC models and

information. ABC no longer lives predominantly in the realm of
finance. Learning that usage and sponsorship are critical to driving
value from ABC, Operations, Marketing, HR and IT departmentsas
well as various lines of businessare increasingly driving the
application of ABC with Finance in a supporting role.

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 Need for broad change management and links to regular decision-

making. Bringing ABC information more broadly into the organization

shifts the focus from costing as an accounting science to costing as a
management and behavioral science. ABC departments are beginning
to re-tool, building competencies in training and change management
to augment the purely technical modeling and analysis skills.

Centers of excellence approach to ABC support. Centralized costing

groups actively encourage the use of ABC information across the

organization, changing the way that information is used and deployed.
This reinforces the need for improved training, and also for leveraging
technologies which support distributed cost modeling and analysis.
Closing the Gap: New Approaches and Technologies
ABC approaches and technologies are responding to the challenges
presented above. While history doesnt always exactly repeat itself,
some concepts do re-emerge when the time is right. Advances in ABC
technologies have facilitated a return to original principles in costing
in financial services.
Resurfacing of time-based approach. Over the past 10 years, ABC
implementation approaches have shifted from the use of time-based
standards to the use of periodic (or often continuous) survey tools. The
high level of effort associated with maintaining survey information
on resource consumption which frequently changes is often cited
as a reason for abandonment of ABC initiatives. The tide has now
turned: in recent implementations, we have begun to see engineeringstyle estimates for time standardsonce the basis for leading banking
applications - returning into vogue as part of the ABC lexicon. This
approach is consistent with a more rigorous and scientific approach
to the use of metrics in operations. In fact, a natural linkage exists
between time-based analysis and productivity standards in back-office
operations (e.g., daily applications processed per FTE), which have
become stronger as a result of centralization. This approach is only
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now feasible with the technological innovations that allow for time to
be dynamically assigned based on transactional activity in operational
areas.
Awareness and management of key capacity efficiency drivers. The
use of time-based costing is also facilitating a renewed interest in
the cost of capacity. More sophisticated than a simple fixed/variable
cost analysis, our clients are increasingly looking to better measure
and manage capacity, both in order to support more refined pricing,
and to find ways to focus the organization on developing more
flexible platforms. One major organization, for example, has begun
to look at alternatives to internal technology capacity as a result of
this newly focused attention, with the potential savings of millions
of dollars annually. Similarly, significant capacity exists in fixed
staffing models; organizations that are able to create flexible work
environments can better respond to dynamically changing business
volumes and price more aggressively in the market.
Flexible, less specialized business models require adaptive ABC
approaches. In the recent past, organizations focused on fixed,
specialized business models. As organizations look to better leverage
their investment in human capital in a rapidly changing environment,
there is a movement back towards flexibilityparticularly with
staffing models that must incorporate such trends as job sharing,
flexible hours, cross training and seasonality. As staffing needs change
daily or even hourly, fixed percentages are increasingly irrelevant in
allocating resource costs.
Weights and estimates are arbitrary. ABC practitioners have long used
weights and estimates as proxies for average complexity. However,
each customer drives distinct consumption levels based on product/
channel/service mix. Only systems and approaches based on actual
behavior and costs derived from real transactions - using the actual
sales or delivery usage by the customer - will give the most accurate,
reliable and supportable cost and profitability information.
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Conclusions
Clearly, ABC is becoming the sophisticated foundation for enterprise
performance management in the financial services sector. The movement
of ABC into the mainstream, the renewal of earlier costing ideas, the
emergence of process management and new business models, the
intensification of differentiation, and attainable customer profitability
all highlight a renewed need for accurate costing implementations.
We have come a long way from Druckers original challenge. While it
is difficult to predict the future, ABC software vendors and consultants
report an increasing level of interest from banks in dramatically advancing
their cost and performance management capabilities. As bank mergers
continue, and stakeholders performance expectations continue to rise,
the demand for and investment in costing resources, processes and
technologies will also be sustained.
Improved technologies and new financial leadership are critical in
supporting this new evolution. Technology is delivering on the promise of
ABC that practitioners have looked forward to for many years. However,
technology alone cant completely fulfill ABCs potential. ABC thought
leaders and practitioners must continue to use ABC-generated information
to capture value that supports more investments in the technology.
The true value of ABC is limited only by the creativity of practitioners and
the support of corporate leadership. Thankfully, more CFOs, COOs and
CIOs now understand the value of this information. With their support,
financial institutions can continue to invest in the technology and human
resources that will lead to even more successful ABC initiatives, and
ultimately, sustained performance improvement of their organizations.*
*

Reprinted from Journal of Performance Management, Volume 17, No. 3. At the time of
the original article Mitch Max was the Managing Partner of the Performax Group.

Drucker, Peter F., The Information Executives Truly Need, Harvard Business Review, January-February 1995
Ibid.
3
For more information, see Max, Mitchell, Budgeting Revisited: Cracks in the Foundation of Bank Performance
Management, Journal of Bank Cost and Management Accounting, Vol. 15 No. 3; and also www.bbrt.org
1
2

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