When we were growing up, water was one of those things that was just there. Coming out of streams, lakes and faucets, water was free and clean. Imagine if you were a CEO back in the 70's and prosposed bottling water and selling it at a price higher, per fluid once, more than the price of gas - you would have been laughed out of the smoke filled board room.
These days, despite environmental concerns and evidence that bottled water may be even more harmful than tap water (it is tested a lot less), our kids scoff at water out of a faucet. This is a mistake as we tested a radom sample of bottled water and found hidous things with our microscope (see picture). Despite these problems, bottled water remains a multi-billion dollar industry all because some CEO in the 80's took a chance.
Back in September of 2007, many bank boards said they plan on doing what they have been doing for 2008. 2 months into the year, we can see clearly that strategy is not going to work. Many banks are convening an ad hoc strategic planning meeting to at least ask the question how can they better take advatage of the current market opportunities. Many more banks are taking another look at how they can re-adjust their lending, deposit and new customer acquisition focus.
Top performing banks ask and re-ask tough questions about how sustainable their high margin products and services will be and what are they can do to replace them, knowing that only 1 in 5 new ventures will exceed expectations. In order to help in strategic planning, some banks use a "Real Options" methodology. Unlike the traditional Net Present Value ("NPV") calculation that finance executives typically lean on, the Real Options model looks at various cash flows of a potential new venture, considers different outcomes, and assigns probabilities to each one. The key to Real Options is to identify the risks associated with a capital investment and the range of options or critical decisions that address those risks. Each option can then be assessed and factored into an overall value for the investment.
In this market, many banks are finding that by limiting risk, giving up short-term growth potential, accepting lower margins and reducing overhead expenses, would leave them the best chance to increase their probability of success in each new venture. By intuitively using the Real Options model for evaluating strategic objectives, banks sometimes find that by making a number of small investments in both new products and markets creates the best probability of success. Other banks will choose to focus their energy on a single area because that strategy, while the highest risk, presents the best long-run return.
Regardless of which path banks choose, it is helpful to think of strategic decisions as an investment. Banks know that while some investments will produce spectacular returns, most will produce average returns and many will fail. It is also interesting to note that the average top performing bank develops 3 to 10 projects every year, in the hopes of initiating 1 or 2 good ideas. This is the antithesis of many banks, that choose to do the same thing year in and year out. The crazy thing is that despite poor performance some banks are still planning to stay the course.
We highly recommend that banks call an additional offsite strategy meeting in the next couple of months and take another look at their portfolio of initiatives for the future. Portfolio planning works in loans and securities, so why not use the same theories in strategic planning? Like bottled water, an idea that seemed totally crazy last year, just may end up making you a lot of money in 2008.