Cost Inefficiency – An Industry Plague

By Aaron M. Silva, President Paladin fs, LLC
asilva@paladin-fs.com

Free economic theory defines price efficiency and inefficiency as a general measure of how much or how little the government meddles in a particular market.  Bankers may then easily argue their efficiency ratio is negatively impacted – and they are by definition less efficient – simply because of the sheer amount of regulation and compliance demand the government places upon them. Banks and credit unions would be much more efficient if they did not have the Non-Interest Expense associated with these endeavors.

A market can be said to reach allocative efficiency if the price of a product or service that the market is supplying is equal to the value the buyers place upon it, represented by marginal cost.  Community financial institutions may have certainly reached a level of price efficiency with respect to Net Interest Income (margin) because on average the entire market may float between 2.5% - 4% at any given time.  This is driven by the cost of money, the consumer demand and competition – free market forces.  The loan market is efficient and allocative.

To the contrary the costs that institutions pay Core and IT service providers is terribly inefficient.  So inefficient that it is varies wildly from buyer to buyer, geography to geography and it doesn’t seem to matter the demographic, type or size of the institution. A new national survey by the Business Performance and Innovation Network (BPI Network) released this July, within a report called The Core Way Forward, provides startling insight into this problem and also some concept of why the inefficiency exists in the first place, as well as what can be done about it. When asked whether or not they were satisfied with the “value” associated with their current core vendor products and services – only 1/3 believed they were commensurate to the premium paid. Remember, the perception of value determines how efficient a market is and denotes when the marginal premium paid is acceptable (or not).

So why is this happening?  How can effectively 66% of the community banks and credit unions be convinced or unsure of the value they are paying for these multi-year, multi-million dollar contracts?  The first part of the answer can be found in the next survey question posed to C-suite leaders.  Do you believe you’re paying too much for core and complementary IT services?  67% of respondents are certain they are paying too much or simply don’t have the information to know better.  And therein lies the key – lack of data, market information and pricing standards puts the entire industry on its heels and systemically inefficient.   The majority of Bankers feel they are not receiving value and are most certainly paying too much anyway.  There are plenty of theories I have as to why we are here.

• For years vendors have implemented a “take what you can get” approach to positioning and selling services and new products.  Their business development folks are highly incentivized on top line revenue and margin.  As a result they have a lot of latitude on what they can ask.  Bankers aren’t technically allowed to compare their contracts with other peers and so they are left in the dark.
• Lack of competition as a result of vendor consolidation.  This makes the most sense.  The big 3 (Fiserv, FIS, Jack Henry) have gobbled up a vast number of vendors and there is virtually no competitive bid process available to drive down contract renewals.  Bankers are tied into older agreements for years at higher premiums until a renewal window is made available.  When the opportunity is available to restructure they lack the information or experience to negotiate a fair deal.
• Lack of Experience.  Fact is bankers only get to negotiate renewal agreements once every 5-7 years.  Vendors negotiate deals daily and they easily outgun the typical CEO or CFO.

The facts are the facts but it doesn’t change the reality that these service providers delivery a very valuable and critical services.  Without them, it’s not possible to open your doors and be either a credit union or a bank. The industry issue of over payment and inefficiency has reached epidemic proportions.  Leaders need to focus on strategies and tactics necessary to get these agreements more favorable to the franchise rather than the vendor. Going to the table without hard market data and the experience of an expert on your side is a real fiduciary concern.C

Coming Soon: You will be able to find this article and more in the not yet published bi-monthly magazine from Western Independent Bankers. Click here to view WIB's publications.