Opportunities for Action in Financial Services

Profitable Innovation in Financial Services

Profitable Innovation in Financial Services

At a recent financial-services conference, the topic athand was innovation. Many of the attendees expressedthe common lament that, in financial services, innova-tion is extremely difficult. “What can we come up withthat hasn’t already been done?” was the prevailingsentiment.

Then BCG asked the following question: How manyconference attendees had added a credit card to their wallets within the past year and were using itregularly?

Almost two-thirds of the people in the audienceraised their hands. The reason they added a card,they said, was that a provider had come up with anoffer that somehow appealed to their personal tastesand spending habits. Perhaps it was a matter of affilia-tion with a certain hotel or retail chain, a link to auniversity or sports team, or attractive loyalty benefits.Whatever the specifics, the card provider had createdsomething perceived as new and valuable in a saturat-ed market.

This small vignette illustrates a simple but criticalpoint in financial services: even in highly evolvedproduct areas, there are still myriad ways to inno-vate—and to generate value in the process. The prob-lem is that few financial institutions approach innova-tion in a way that consistently turns new ideas intoprofits.

At The Boston Consulting Group, we believe thatcompanies can take concrete steps to lift their innova-tion performance.

A Clear Need for Improvement

Most financial-services companies recognize that theirinnovation processes need to be upgraded. A recentBCG survey revealed that although innovation is atop-three priority for 62 percent of financial servicescompanies, 61 percent of senior managers are not sat-isfied with the return on their innovation investments.At the same time, 62 percent plan on increasing thoseinvestments.

But why is it, after all, that most new product and ser-vice offerings end up as cash traps that consumefinancial, IT, and human resources but never succeedin the marketplace? In BCG’s view, common reasonsinclude the following:

• Product developers lack a real understanding ofwhat consumers truly want and need, so the wrongproducts end up being launched (and the rightones are rarely identified)

• Products are launched without adequate economicassessment

• Management does not have a clear perspective oninnovation, which leads to inertia and disorganiza-tion in developing new products

• Innovation efforts are not measured well—andtherefore not managed well

Even highly successful companies can get innovationcompletely wrong, as demonstrated by well-knownproduct gaffes in any number of industries. Anarchetypal example is Ford Motor Company’s Edselmodel, which cost millions to develop in the 1950sand flopped badly in the marketplace. Another is

Coca-Cola’s New Coke, a sweeter version of the origi-nal that prompted widespread customer mutinywhen it was launched in 1985—forcing the embar-rassed company to scramble back to its traditionalformula. In financial services, product disasters tendto be less spectacular but no less insidious in hurtingbrand image and draining resources. One recentexample is that of many life insurers in China andTaiwan, which in the late 1990s decided to innovateby writing policies with high guaranteed rates ofreturn in order to gain share and compete with bankdeposits. This made sense in the high-interest-rateclimate that prevailed at the time, but rates droppedquickly—leaving insurers with significant negativespreads on those policies. Because the insurers failedto assess the risk associated with their innovation,they continue to have to fund this loss-making busi-ness today.1

In BCG’s view, innovation must be managed holistical-ly. Anyone can fall on a great idea by chance or byluck, but companies that build and sustain competi-tive advantage have an integrated process in placedesigned to generate new ideas, evaluate them, takethe best ones forward, and aggressively manage newlaunches to achieve profitability. In such an approach,which we call the innovation-to-cash process, each stephas concrete implications for the ones that follow,with go-no-go options at every juncture. (See the ex-hibit “Moving from an Idea to Cash.”) This process islargely the norm in industries such as pharmaceuti-cals and consumer goods but is less evolved in finan-cial services.2

1. See Building Professionalism: The Next Step for Life Insurance inChina, BCG Report, March 2004. Available on www.bcg.com.2. See “The Asset Management Battle: Using Tools of Other Tradesto Win,” BCG Opportunities for Action, January 2004. Available onwww.bcg.com.

Doing It Right (and Wrong)

Leading financial-services companies have shown thatinstituting an innovation-to-cash process can achieveimpressive results. Consider the following examples:

Citigroup. In 2000, Citigroup’s emerging-markets divi-sion was expected to be the company’s growthengine. The problem was that revenues from newproducts in the division were declining. To try toimprove performance, Citigroup launched an innova-tion task force, which eventually came up with threekey findings: the company did not clearly understandcustomer needs and, as a result, innovation ideas wereof low quality; the company’s decision-making processregarding innovation was slow and bureaucratic; andbest practices within the organization that could leadto successful innovation were not being transferredamong regions because communication was bothinformal and infrequent.

Citigroup decided to take action in a variety of ways.First, it stepped up interaction between customersand its product specialists to better grasp what cus-tomers were actually looking for. Second, it increasedtransparency and accountability for innovation deci-sions and instituted mandatory biweekly meetings forkey decision makers. Third, it developed a team of“innovation catalysts” to focus on transferring best-practice information within the company.

As a result of these and related actions, revenues fromnew products in the emerging-markets division grewfrom $400 million to nearly $1 billion between 2000and 2002, and the number of new-product launchesnearly doubled.

Bank of America. Until relatively recently, Bank ofAmerica had never made innovation a priority. It

lacked any formal infrastructure for developing newideas. However, recognizing several years ago that itneeded to improve its innovation performance, thebank decided to create a new corporate unit calledthe innovation and development (I&D) team.

In order to test new ideas in the field, the I&D teamcreated an “innovation market” within Bank ofAmerica’s existing branch network, consisting of 25branches (out of roughly 200) in a major urban area.The team worked closely with the managers of thesebranches to set up product trials and developed a five-stage process to conceive and execute experiments:

• Generate and evaluate product ideas

• Design and plan possible trials

• Roll out certain products within the test branches

• Measure customer response over a given period

• Recommend launches in wider test markets

Bank of America even set up a prototype branch torehearse experiments and work out glitches. In thereal test branches, the company worked hard to attainrapid feedback from customers and make quick deci-sions regarding which new products and services werewell received and had the highest profit potential.The program ultimately resulted in roughly 20 inno-vations recommended for national rollout.

Several factors were crucial for the success of both theCitigroup and the Bank of America initiatives. First,top management was involved and engaged. In addi-tion, the innovation teams were made up of peoplewho possessed deep organizational knowledge. Also,specific metrics were established and were actively

vices, for example, one well-known camera companyhas failed at all three approaches over the past tenyears, leading to the collapse of its share price andbankruptcy. As an integrator, the company focused ondeveloping high-end digital-camera hardware forcommercial use, betting that the consumer segmentwould not “go digital.” Not only did the companymake the wrong bet, but its method was slow and cost-ly because it was required to develop all the necessarytechnologies and products itself. Then, as an orches-trator, the company pursued the consumer market byleveraging its brand name and opting to outsourcethe production of digital cameras. But it came late tothe game with no appreciable advantage, encoun-tered intense competition, and ended up with zeroprofits. The company also attempted to license itsimage-processing software to other digital-cameraplayers, but by the time it pursued this path, its offer-ing was not deemed worthy of the requested premi-um price.

used to track the progress of innovation initiatives.Finally, local execution was crisp and effective.

It is also important to note that these two institutionsadopted what BCG refers to as the integrator approachto innovation—executing all steps of the processinternally. Other companies have chosen what we callthe orchestrator model, typically serving as a brand stew-ard and innovation driver while outsourcing the actu-al development and manufacturing of new products.Several major financial institutions have pursued thispath in the annuity market, for example. Still othercompanies have taken a licensor approach, leveragingproprietary technology across many applications,although this tack is less prevalent in financial ser-vices. Clearly, each model has its own potential risksand rewards.

Moreover, knowing how to apply the models is criticalto achieving positive results. Outside of financial ser-

Management process

Research/innovationportfolio

management

New-product or

servicedevelopment

Infra-structurebuilding

Training andcapability

development

Product orservicelaunch

Marketing,sales

strategy, andexecution

Lifecycle

managementNew ideas

Idea generation

and screening

Concept development

Concept evaluation

Technical product/ service

development

Business evaluation

Market launch

preparation

SOURCE: BCG analysis.

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Profitable Innovation 4/29/04 10:32 AM Page 8

The Fruits of Innovation

The financial services landscape is dotted with compa-nies whose innovation processes have produced high-ly successful products and services differentiated byelements such as convenience, price, and responsive-ness to consumers’ true needs. What’s interesting isthat the appeal of some of these offerings, once theywere launched, seemed so obvious that other pro-viders wondered why they hadn’t come up with theideas themselves.

One such idea came from MBNA, the U.S.-basedcompany that specializes in lending through creditcards (an innovation in itself). MBNA perceived anuntapped consumer need when it realized that manypeople like an element of group identification ontheir bankcards. MBNA has evolved into the industryleader in so-called affinity marketing—selling to peo-ple with a specific common interest, such as profes-sional societies, alumni associations, and sports clubs.Much like the attendees of our aforementioned finan-cial conference—each of whom held more than sevencards on average—many consumers have added thistype of card to a wallet that is already full of cards.MBNA is now endorsed by more than 5,000 member-ship organizations in the United States, the UnitedKingdom, Canada, and Ireland, and it has a growingcustomer base.

The concept of bundling products and services hasalso fueled successful innovation. For example, theso-called wrap account, which typically offers a bas-ket of investment products and services for one flatfee, has been successful for some leading banks.Another example is the U.K. mortgage providerNorthern Rock’s Together account, which bundles asecured mortgage with an unsecured cash reserve at

the same interest rate. In addition, Merrill Lynch’sextremely successful cash-management accountbundles securities transactions, electronic transfercapabilities, a Visa card, check writing, and otherfeatures.

Technological advances also fuel innovation. Onlinebanking is earning high profits for banks that havemanaged both to get an appreciable percentage oftheir customers active online and to integrate theirInternet offerings with other channels. The U.K.institution First Direct, which began as a telephonebank in the late 1980s, has achieved success with atelephone- and Internet-based business model.

Of course, one of the first innovations in modernfinancial services was discount brokerage, pioneeredby Charles Schwab & Co. The company also launchedOneSource, the first open-architecture, no-load-fundsupermarket, in the early 1990s. Then, a few yearslater, when Schwab perceived that affluent consumerswanted more personalized service, it created a portfo-lio of products for each ascending wealth category,priced accordingly. In another type of innovation,Bendigo Bank, a small retail institution in Australia,targeted the opposite type of consumer: nonaffluent,rural residents. Bendigo challenged conventional wis-dom by proving that this previously “unbanked” seg-ment would pay for banking services—and be prof-itable—if approached creatively.3

It is important to note that many of the above com-panies have created leadership positions with theirinnovations. Their experiences defy the adage that

3. See “Dare to Be Different,” BCG Opportunities for Action,December 2002. Available on www.bcg.com.

any profitable innovation in financial services isimmediately copied by competitors with the samedegree of success. Given that first-mover advantageindeed exists in financial services, companies withsuccessful innovations need to take forceful steps tomaximize their head start and create longer-lastingcompetitive advantage. Such steps can include tak-ing branding initiatives to entrench the company’sposition, driving capabilities vigorously to stay sever-al steps ahead of the game, and building IT supportthat others may find difficult to copy. Indeed,extending and optimizing the value of successfulinnovation are critical in the overall innovation-to-cash process.

Clearly, the annals of innovation in financial servicesover the past 20 years are replete with success stories.But being a part of them in the future will requireworking actively to foster a fertile innovation environ-ment in your organization.

Taking Action

Although relatively few financial-services companiesinnovate well and consistently, those that do reap dis-proportionate rewards. Extremely profitable anddefensible positions can be built, some enduring for adecade or longer. But strong leadership from seniorexecutives is required for success.

Beyond actually believing that innovation is critical—when it comes to products, services, processes, busi-ness models, or any other area—successful companiesalso know that they can manage it. Innovation is aprocess—an act, not an idea—that must be subjected tothe same managerial rigor and commitment that anyother process receives.

To begin improving the process of innovation, wetherefore urge financial executives to ask themselvesthe following questions:

• Are my investments in innovation having theimpact they should?

• Am I more innovative—with the financial results toprove it—than my competitors?

• Do I know what my innovation pipeline will deliver,and when?

• Do I know why my last innovation “failure”occurred, and did I learn from the experience?

• Does everyone in my organization know the rolehe or she plays in innovation, and is performancemeasured and rewarded?

• Is my company capable of innovating quickly inresponse to regulatory changes, consumerpressure, or fluctuations in the overall businessclimate?

If the majority of your answers are “no” rather than“yes,” your institution can probably improve its in-novation performance substantially. Steps must firstbe taken to better understand the needs of yourcustomers in every segment. Potentially high-valueopportunities should receive the most attention. Butabove all, a holistic process must be put in placewhose raison d’être is to improve innovation per-formance.

Companies that fail to make innovation a priority endup perpetuating the myth that, at least in their ownorganizations, innovation is of little value in financial

services. Institutions that approach innovation aggres-sively, comprehensively, and strategically reap the ben-efits of turning ideas into cash.

Which kind of organization would yours like to be?

James P. AndrewCharmian Caines

Thomas Klotz

James P. Andrew is a senior vice president and director inthe Chicago office of The Boston Consulting Group andhead of the innovation and commercialization area for thefirm’s Operations practice. Charmian Caines is a vice presi-dent and director in BCG’s London office. Thomas Klotz isa vice president and director in the firm’s Hong Kong office.

You may contact the authors by e-mail at:

andrew.james@bcg.com

caines.charmian@bcg.com

klotz.thomas@bcg.com

To receive future publications in electronic form about this

topic or others, please visit our subscription Web site at

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© The Boston Consulting Group, Inc. 2004. All rights reserved.

This article is part of a continuing series of publicationsabout BCG’s innovation-to-cash approach. Other publica-tions on the topic include:

“Innovation to Cash: Orchestrating in the Consumer Industry,”BCG Opportunities for Action, February 2004

“Innovating for Cash: Lessons from the Handset Wars,”BCG Opportunities for Action, January 2004

“Innovating for Cash,” BCG Perspectives, December 2003

Raising the Return on Innovation: Innovation-to-Cash Survey 2003, A BCG Senior Management Survey, December 2003

“Innovating for Cash,” Harvard Business Review, September 2003

“Innovation to Cash: Orchestrating the Process,” BCG Opportunities for Action, September 2003

“Boosting Innovation Productivity,”BCG Opportunities for Action, April 2003

To request copies or to comment on these or other publica-tions, please contact BCG by e-mail at imc-info@bcg.com.

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