The struggle for growth

The struggle for growth

The struggle for growth

Growth is back on the agenda for the financial services industry. But this time around, it is tempered by a continuing focus on cost containment. The growth frenzy of the 1990s – and subsequent rollback – has led most financial institutions to adopt a more cautious and measured approach to growing their business. What is striking is that the pressures faced in the retail and capital-market areas of financial services are so similar: the majority of firms are claiming that they will grow quicker than the market.

Investors are becoming increasingly hard to convince that all financial institutions can deliver on this promise. The combination of the maturing of financial markets and slow-growing economies raises the issue of the sustainability of the business models of some financial institutions.

Yet the pressure to grow is as great as ever. Share-price appreciation is driven largely by future expectations, with past and present performance merely an indicator of what is to come. In fact, more than 70 percent of a company’s total shareholder value is generally attributable to revenue growth.

Analysis underscores the point, showing an unmistakable relationship between share price and revenue growth. Over the past four years, the five financial services companies with the fastest-growing revenues saw their stock prices shoot up an average of 91 percent. That is four-and-one-half times better than the industry average (19 percent), and twice that of the industry’s largest revenue takers (46 percent; see Figure 1).

Figure 1 Deloitte. Eyes on the prize …

Everyone agrees that revenue growth is essential for maximizing shareholder value. The real question is how to achieve it, particularly in a way that is profitable and sustainable. Answering that question is the focus of much attention.

In the financial services industry, product innovation is the predominant growth strategy. Yet most companies see very little return on their development investment. Research shows that only 10 percent of new financial products are actually profitable; and those that succeed in the marketplace are quickly copied by the competition (usually in less than three months), negating any competitive advantage. Plans to grow through increased “share of wallet” also have gone largely unfulfilled, with cross-sell ratios for the global industry hovering a little over one product per customer.

The latest evidence suggests that companies are learning to use innovation more effectively, reallocating their innovation investments to drive differentiation and top-line growth. This expands the focus from product innovations, which are easily replicated, to process and service innovations, which are much harder for competitors to copy. The goal is to create a “virtuous spiral” – attracting and retaining customers through process and service innovations, then using those gains to fund additional innovations – leading to sustained differentiation and an enduring competitive advantage.

In the 1990s, acquisition was the growth strategy of choice. But today, the industry’s focus is shifting back to organic growth – growing businesses from within. That is not to say that we will not see further consolidation in major markets such as the USA and Europe in the medium term. However, in many markets there is a dwindling pool of attractive and viable merger candidates. Also, there is mounting evidence that mergers and acquisitions – unless flawlessly executed – are not the best way to create lasting shareholder value.

To achieve their goals for increasing revenue and total shareholder returns, financial services companies must relearn the growth habit. Furthermore, they must do so quickly. Put another way, firms should be patient for growth, but impatient for profits.

Over the past few years, the industry’s organic growth has been largely stagnant, often barely keeping pace with gross domestic product (GDP). Financial institutions in every region and sector face a wide range of obstacles, including:

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  Maturing markets and product saturation.

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  Slow-growing economies that increase risk while reducing overall demand for financial services.

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  Increasingly sophisticated customers, who are more demanding, informed and cautious.

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  Capital shortages stemming from underperforming investment markets.

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  Increased margin pressure.

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  Competition from new players with different business models and distribution networks (e.g. monoline, retailers, financial advisers, insurers), often with greater brand recognition and superior sales and marketing capabilities.

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  Similar customer-segmentation strategies, with a common focus on high-revenue segments, and minimal differentiation among companies.

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  Limited contact with end-customers, reducing the opportunities for customer intimacy, brand building, and cross selling.

In contrast to these numerous barriers to growth, it is worth noting that emerging markets such as Brazil, Mexico, China, and India offer potentially quicker growth opportunities than redesigning existing businesses, but have their own set of unique challenges and risks. In addition, in many parts of the world, government regulation has added to the problem, stifling innovation and growth by creating barriers to entry since economies of scale are increasingly required to cope with the costs of compliance.

Going forward, the struggle for growth will be a key differentia among financial institutions. The fight for survival will be fought around the ability to grow the top-line organically. The path for many will be determined by their ability to shed the fixation with product innovation and reallocate investment resources towards service and process innovations, locking in customers, cutting costs, and ending the struggle for growth.

Chris Gentle Director at Deloitte. He can be contacted at cgentle@deloitte.co.uk)