Banking: The IT Paradox: Despite Much Higher IT Outlays by the Retail-Banking Industry, Its Labor Productivity Growth Rates Have Actually Dropped. What Went Wrong?
Olazabal, Nedda Gabriela, The McKinsey Quarterly
During the late 1990s, productivity trends in retail banking (1) stood in contrast to those in much of the rest of the economy: the industry's information technology investments accelerated substantially, but its labor productivity growth rates, though higher than the economy-wide average, actually declined (Exhibit 1, on the next page), from 5.5 percent (1987-95) to 4.1 percent (after 1995). Research into this paradox reveals that the relationship between IT and labor productivity is more complicated than merely adding the former to lift the latter.
The nature of IT investments
Throughout the 1990s, the focus of many retail banks on revenue growth resulted in major new IT investments, the largest involving services and marketing tools for customer information management and support (Exhibit 2). Financial institutions have traditionally been organized around product lines, such as deposit accounts, loans, and credit cards. Coordination among departments was loose, and customer information did not flow easily across the organization.
To remedy this problem, banks attempted to create a single customer interface, which forced them to integrate their databases and IT systems. Once this was accomplished, banks adopted applications--or, more precisely, customer-relationship-management tools--to improve their customer retention and to facilitate up-selling and cross-selling. All of this required significant investments in personal computers for branch employees and call-center representatives, as well as the integration of complex systems. At the same time, rapid changes in operating systems in the late 1990s caused banks to update their servers and PCs frequently.
In a further effort to attract customers, banks increased the number of product combinations and pricing options available. One credit card executive explains, "In 1994 and 1995, there were a couple of credit cards, one at 17 percent interest and the other at 19 percent interest. When I left [in 1999] there were 43,000 pricing combinations." Of course, these much more complex product options required vastly more computing power.
At the same time, bank mergers were getting larger. Although the industry consolidated at a steady pace before and after 1995, the size of the banks engaged in mergers grew, largely because of a 1997 regulatory change that lifted the prohibition against interstate bank mergers, which tend to involve larger players. The average assets of bank merger participants increased from $700 million (1994-96) to $1.4 billion (1997-99). Naturally, the integration of larger systems involves greater complexity.
Finally, banks began investing in the Internet as a sales channel during the late 1990s. New entrants into on-line banking had to make large IT investments to compete with traditional players, which in turn were forced to invest in on-line services to avoid losing market share.
A disappointing impact
Most, though not all, of these IT investments had a disappointing impact on productivity. Some produced benefits--such as the convenience of conducting transactions on-line and the improved account information available through call centers, automated teller machines, and World Wide Web sites--that were not captured by productivity data. (Output is measured by the number of transactions and does not reflect the quality of transactions.) However, since on-line transactions accounted for only 2 percent and information transactions for only 7.5 percent of the total number of transactions processed in 1999, unmeasured improvements would not be large enough to reverse the industry-wide decline in productivity growth.
What went wrong? Many post-1995 technology investments were designed less to reduce labor costs than to increase revenue, and this is inherently more difficult in a mature industry: managers don't know whether the substantial investment in …
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Publication information: Article title: Banking: The IT Paradox: Despite Much Higher IT Outlays by the Retail-Banking Industry, Its Labor Productivity Growth Rates Have Actually Dropped. What Went Wrong?. Contributors: Olazabal, Nedda Gabriela - Author. Journal title: The McKinsey Quarterly. Publication date: Winter 2002. Page number: 47+. © 1991 McKinsey & Company, Inc. COPYRIGHT 2002 Gale Group.