05
Value Based Cost Reduction:
Finding the Optimal Strategy
for Revenue Growth
Value Based Cost Reduction:
Finding the Optimal Strategy
for Revenue Growth
05
In Short
Estimated Average Cost-to-Income Ratio
in Investment Banking in 2015
Five “Hot Topics” in Cost Reduction
Despite significant transformation efforts over the past eight years,
investment banks have seen only modest improvements in their
cost-income ratios. For many firms, this metric remains near 70
percent (see Figure 1). How could this be the case when banks
have reduced costs by billions of dollars in recent years?
At least half of the answer lies in the challenge of driving income in
markets that have been drastically altered by regulation and capital
charges. A decline in the denominator of the cost-income calculation
has caused the entire ratio to suffer. As this year’s Top 10 Challenges
series goes to print, recent announcements by Deutsche Bank and
Credit Suisse suggest that some firms are taking further steps to
(re)define the right mix of their businesses.1 Certainly, each bank must
identify an optimal strategy for its lines of business, scale and capital
deployment that maximizes income opportunities within risk and
volatility parameters that are acceptable to management and stakeholders.
This paper addresses the other half of the equation: cost reduction.
We have written extensively about significant cost reduction actions
by major investment banks over the past eight years, yet new cost
reduction targets continue to be announced. Many of these new
targets are directly related to decisions to exit or scale back selected
lines of business. While these actions can produce—and have
produced—significant savings for individual firms, they seem to have
been insufficient to return the industry to reasonable profitability.
Take Action
The legacy of past efforts
By taking a holistic view of business
line costs—comparing internal ownership
and outsourcing options, and evaluating
the profit potential of each—banks can
gain fresh perspective on optimization.
Our research and discussions with industry leaders indicate that,
assuming current investment banking income remains somewhat
static, the largest investment banks will collectively need to further
reduce costs by up to $20 billion if they intend to significantly improve
the average return on equity. More specifically:
Figure 1: Average cost-to-income ratio in investment banking
0.74
0.72
0.70
0.68
0.66
0.64
0.62
0.60
0.58
0.56
2010
2011
2012
2013
2014
2015*
* Accenture estimate
Source: Accenture Research
• All firms have increased their compliance activities. Some large
firms have added several thousand full-time equivalents (FTEs) to their
compliance functions, largely offsetting other cost-reduction activities.
According to data from TheCityUK, reported in the Financial Times in
October 2015, investment banking jobs in London hit a record high
of 730,000, with the bulk of recent growth in compliance and legal.2
• Cost reduction has largely taken place within the four walls
of banks. Firms have optimized the processes they can control,
including parts of the securities settlement cycle and reference
data management. That still leaves significant reconciliation and
other “hands-off” activities involved in connecting to clients,
trading partners, depositories and custodians.
• Improved virtualization and cheaper computing power have
helped to reduce IT costs. Many firms have also worked hard to
retire legacy systems, but there are still opportunities (see Challenge
2: Investment Banking Technology: Jettisoning Legacy Architectures).
• Firms have largely focused on reducing “unit costs.”
These improvements in the cost per labor hour have typically been
achieved through offshoring, outsourcing and process improvements.
As one investment banking executive recently said in a client meeting,
“I think we have squeezed this lemon dry. There is no way to continue
with historical cost-reduction activities and expect more savings or
any sustainable cost advantage. We need to solve this differently—
with industry-wide cooperation and with different techniques within
our institutions.”
What’s hot in cost reduction?
Cost benchmarking and bank-to-bank comparisons are notoriously
difficult due to allocation methods, nomenclature and structure, but
Figure 2 gives a sense of typical ratios at a large investment bank.
Figure 2: Typical non-interest expense structure for a large broker-dealer
Third-party
software
3.7%
IT
infrastructure
7.1%
Market and
reference data
9.2%
Market
infrastructure
10.1%
Third-party
advice
4.6%
Brokerage
6.1%
Real
estate
2.6%
Testing, assurance
and evaluation
0.7%
Depreciation and
amortization
4.6%
Management and
office administration
0.5%
Control and advisory
base compensation
3.7%
Sales and trading
base compensation
33.6%
Notes: Figures are based on the average cost structure at large broker-dealers over the past three years. Not all cost categories are consumed by all business lines.
Certain categories may be larger for broker-dealers that receive an overhead cost share from a parent banking group. Some banks include certain brokerage activities
as contra-revenue items. Figures exclude bonuses, operational losses and taxes.
Source: Accenture Research
Technology and change
base compensation
10.9%
Product and client servicing
base compensation
2.8%
“
Accenture research shows that
regulatory change alone can
reduce a tier-one investment
bank’s return on equity by
“
approximately 500 basis points.
Depreciation and
amortization
Consumables
Travel and
expenses
Real estate
Third-party advice
Brokerage
Market and
reference data
Market
infrastructure
Third-party
software
IT infrastructure
Product and client
servicing base
compensation
Control and
advisory base
compensation
Technology and
change base
compensation
Sales and trading
base compensation
Figure 3: Example of a full system cost resizing
Full system cost resizing packages
Visibility and ownership
Closed-loop/zero-based budgeting
Spans and layers
Balance sheet impairment
Workforce location
Effort, defects and waste
Automation
IT rationalization
Value-chain/operating model
Source: Accenture Research
Delving deeper, there are five “hot topics” or recurrent themes
in cost reduction that we believe are worth noting:
1. Broker use is increasing as a result of remediated broker
policy and controls, and a shift in the role of inter-dealer
brokers in the over-the-counter (OTC) market.
2. Market data use is increasingly driven by proactive
enforcement of usage agreements by data vendors.
3. Sales and trading workforces are being resized to
accommodate ongoing electronification across asset
classes and changing market conditions.
4. Control workforces, particularly compliance and
risk departments, are growing as a result of new rules
regarding conduct and supervision.
5. Technology is being simplified, driven by increased
consumption of change, IT infrastructure and third-party
application services.
What else is there?
Although cost-cutting alone is not the answer, more can be
done to achieve a sustainable cost structure. In the next wave
of cost reduction, banks should:
• Shift their focus from process optimization to outcomes.
• Adopt a factory approach to legacy application retirement
(see Challenge 2: Investment Banking Technology: Jettisoning
Legacy Architectures).
• Embrace utilities (see our 2015 Challenge 10 on Utilities and recent
announcements, such as the SmartStream Reference Data Utility).3
• Implement technologies like robotic process automation for routine
tasks, such as reconciliations.
• Adopt techniques that have been used successfully in other
industries, including zero-based budgeting.
Accenture believes this last idea, in particular, is of growing interest to
the investment banking industry. Therefore, let’s take a closer look at it.
Figure 4: The closed loop package
1
Visibility
2
Category ownership
1. Visibility - Provide transparency on “who-spends-how-much-on-what” through transactional data analysis
2. Category ownership - Create an accountability matrix to ensure dual ownership of every expense
3. Value targeting - Define expense policies and procurement initiatives to reduce both consumption and price
3
Value targeting
4
Zero-based
budgeting
6
Control and
monitoring
Closed loop
4. Zero-based budgeting - Budget from zero annually to expose and eliminate unproductive expenses
5. Procurement - Execute strategic sourcing events and buying operations to realize price reductions with suppliers
6. Control and monitoring - Conduct monthly reviews to identify and resolve budget variances
5
Procurement
Source: Accenture Research
Starting at zero
• Use cost savings to fuel growth. The true effect of cost
reduction and zero-based budgeting can only be measured if
Zero-based budgeting and spending has started to make waves across
savings are reinvested to drive growth, innovation, talent and
different industries and has the potential to radically alter the investment
productivity. To achieve a profitable end state, investment banks
banking industry. Introduced by the US government more than 50 years ago,
need to design transformation programs based on sustainable
zero-based budgeting involves justifying the need for each budget item,
operating models that promote efficiency and cost savings.
while respecting strict policies and top-down targets set by cost category
Simultaneously, they must scrutinize their business models to
owners. Today, it has the potential to play a pivotal role in helping banks
design growth strategies that focus attention where they can and
make effective, value-adding investments to continually refuel for growth.
want to be profitable and successful. Cost savings from those areas
deemed unnecessary or unprofitable should be viewed as fuel for
Investment banks must first complete a one-off “greenfield” cost-resizing
growth initiatives.
exercise before transitioning to an ongoing spend- and performancemanagement technique, such as closed-loop or zero-based budgeting.
Conclusion
While many banks have begun to examine cost-resizing, the latter requires
further exploration. Accenture believes this fundamental shift is paramount Investment banks may feel as though they face diminishing rates of return
for growth. Starting from zero helps to ensure that the past does not dictate when it comes to cost reduction, but there remain opportunities to
improve return on equity and use savings for growth initiatives. By taking
the future, and weaves accountability for the numerator (costs) and
a holistic view of business line costs—comparing internal ownership and
denominator (income) into decision making at all levels of the bank.
outsourcing options, and evaluating the profit potential of each—banks
A new way of managing costs
can gain fresh perspective on optimization. Zero-based budgeting is one
Banks can take the following steps to help increase cost-base transparency, approach that can help optimize cost reduction beyond the initial
cost-cutting phase. The main objective for further cost take-out should be
determine how to reallocate capital and optimize return on investment:
aimed at looking at the challenge through a different lens at all levels of
• Take an outside-in view to create visibility and insight into costs. cost ownership within the organization rather than the “functional” (cost)
In other words, wherever possible, compare how much it would cost to versus “product” (revenue) methods employed to date.
house a specific function outside the bank with how much it costs to
Cost-cutting measures that emphasize near-term financial
maintain it internally. Increasing transparency and using it to identify
cost drivers and develop key metrics, including fully loaded cost-to-serve performance can produce benefits that are fleeting, forcing banks to
start the cycle all over again—usually with mixed results. Investment
by business line, will be critical in this regard. A “product” view of
banks need to begin closing the loop. Once identified, cost-saving
revenue and a “functional” view of costs do not support the kind of
opportunities should be converted to long-term investments in new
insights required for change.
products, services and financial technology (FinTech) initiatives.
• Build an end-to-end governance model that drives accountability
to the rightful owners. To complement increased transparency related
to cost drivers and their impact, a governance model that establishes
dual expense ownership and rewards shifts from unproductive to
1
http://www.bloomberg.com/news/articles/2015-10-29/more-pain-slow-gain-as-europe-s-new-
productive spend can help establish accountability across the entire
bank-ceos-expect-grim-years
organization. The governance model, along with its related financial
2
http://www.ft.com/intl/cms/s/0/22ce28a8-73ed-11e5-bdb1-e6e4767162cc.html#axzz3qZiW0BcI
3
controls and performance incentives, plays a key role in ultimately
https://www.accenture.com/us-en/10-challenges-investment-banks-2015-utilities;
http://www.smartstream-stp.com/Solutions/What_Do_You_Need/Reference_Data
shifting the mindset to allow sustainable change for the bank.
About Accenture
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Disclaimer
This report has been prepared by and is distributed
by Accenture. This document is for information
purposes. No part of this document may be
reproduced in any manner without the written
permission of Accenture. While we take precautions
to ensure that the source and the information
we base our judgments on is reliable, we do not
represent that this information is accurate or
complete and it should not be relied upon as such. It
is provided with the understanding that Accenture is
not acting in a fiduciary capacity. Opinions expressed
herein are subject to change without notice.
Bob Gach
New York
[email protected]
Andreas Traum
Frankfurt
[email protected]
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