Challenges of the Interaction Economy (part 3) : embracing complexity in the Finance sector

Table of contents

Challenges of the Interaction Economy (part 1)

Challenges of the Interaction Economy (part 2) : embracing complexity in the Public sector

Challenges of the Interaction Economy (part 3) : embracing complexity in the Finance sector

Challenges of the Interaction Economy (part 4) : embracing complexity in the Health care sector

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3.     Finance sector

3.1 Introduction

Financial services can be defined as the products and services offered by institutions like banks of various kinds for the facilitation of various financial transactions and other related activities in the world of finance like loans, insurance, pensions, credit cards, investment opportunities and money management.

For most of the products in financial services, transactions are essentially a set of promises being exchanged between the buyer and the seller. From the buyer’s point of view much depends on what exactly is being promised and the likelihood of such promises being delivered. The financial services sector therefore essentially deals only with one product: TRUST. Trust is literally of vital importance since customers have trusted their money to financial companies to be assured of sufficient means in situations that determine the quality of life, like retiring on a pension, coping with a handicap, relocating or basically being able to consume at the expected standard of living. Without trust, no customers and without customers no business.

Transparency goes hand in hand with trust. Especially the economic crisis has catapulted transparency to the highest level of customer and business interest. The complicated nature of many products makes it hard for the industry to meet the anticipated level of transparency, let alone to provide services that in a pro-active way inform customers about the impact of events and trends on their portfolio.

Financial services are characterized by intangibility (impalpable and difficult for consumers to grasp mentally), inseparability of production and consumption, perishability (need for short distribution channels so that they can be produced on demand) and heterogeneity. Despite the heterogeneity, services are also characterized by fiduciary responsibility and two-way communication. Fiduciary responsibility refers to the implicit responsibility of financial services suppliers for the management of their customers’ funds and the nature of the financial advice supplied to their customers. Two-way communication refers to the fact that financial services, rather than being concerned with one-off purchases, involve a series of regular two-way transactions between buyer and seller usually over an extended period of time.

Financial services tend to be one-off purchases but ones which are required on a recurring basis with the result that there is a clear need for financial services suppliers to establish initial relationships with their prospects while at the same time maintaining and developing long-term relationships with existing customers. Lifecycle management is a must for maintaining good relations and seize opportunities for value upgrade.

Enterprise risk management is of vital importance to meet the trust and confidence levels of the stakeholders. Enterprise risk management deals with risks and opportunities affecting value creation or preservation. Goals are translated into controls which are implemented into the organization. Audits are used to assure that the controls are executed conform standards. Strict operating procedures, sophisticated risk profiles and up to date financial models, like actuarial models, are all means used to manage risks. It follows that proven compliance to internal and external regulations and procedures is also an essential element of the risk management process.

Portfolio management and asset pricing must also be up to date to seize opportunities and prevent risks. Due to the heterogeneity of the sector, portfolios are very diverse but the types of stakeholders that must be serviced is in fact limited. Clients are customers or their employers, other stakeholders are for instance pension funds and similar organizations, shareholders, board members and regulatory supervisors.

The impact of customers and regulators on the corporate performance is high. According to a McKinsey Global Survey contribute customers for 74 percent to the economic value of companies and governments and regulators for 53 percent. In may be expected that these percentages are rather more than less in the financial services sector. Especially on the regulators side is the influence increasing notably. The sector is confronted with a higher importance of using standards and being accountable. Financial regulation is becoming stricter and regulators are more demanding. Also reporting standards, accounting standards, record keeping standards, risk management standards and the frameworks used for complying to the standards, are all having a direct impact on the operations. Examples of such regulations and standards are: Basel II and III, Sarbanes-Oxley, GARP, Dodd-Frank Wall Street Reform and Consumer Protection Act, EMIR, IFRS, GAAP and frameworks like COSO and COBIT.

Business innovation proves to be a real challenge for many actors in the financial services sector. This relates to the IT infrastructure as well to innovation of products and services. As a result, managers are now challenged to innovate along multiple axes at the same time. The most visible axis is innovation in customer centric services. Product out thinking has to be replaced by customer in thinking. This results in offering 24/7 services. Self-service is becoming increasingly important in the sector as a means to meet customer demands and reduce costs.

The sector has found out the hard way that this kind of services does not stop at the front office. An integrated front- and back office process is required to deliver the by customers expected quality of service. Service is not anymore a department but has to become an attitude. Moreover, by offering online services, the competitor is only one mouse click away. New service providers offer prospects the opportunity to compare products and to read reviews of these products. Products that were presented in the past as being unique turn out to be comparable and assessable. Commoditization is inevitable.

The self-service trend will not lead to the complete dissolving of the traditionally approach of offering services via direct writing or intermediary brokers. Online services and face-to-face services must both be supported by the same set of rules and appropriate instruments.

The financial services sector is also looking for new business models that can make a difference in the competitive field. New models for emerging markets like micro banking is one of the examples of this trend.

3.2 Facing complexity

The financial services industry is very dependent on how it reacts to social complexity. Reputation, expectation and perception must be totally in line to outperform competitors and meet the customers’ demands. The sector is struck quite heavily by the economic crisis, since this crisis is in essence a crisis of values. The societal reaction is twofold: at the one hand an ongoing sweeping wave of regulations, and at the other hand cynicism and mistrust of customers, eroding customer loyalty. Both have a severe impact that fundamentally affect the operations and profit generation capacity of the financial services industry.

Financial services are based on customer trust and confidence, not only in the organization supplying these services but also particularly in the customer contact employees themselves. Because of the intangibility, inseparability and heterogeneity of services, there are fewer tangible cues to base decisions on prior to purchase and therefore greater reliance is placed on experience qualities during information and transaction, as well as after purchase and during consumption. This requires a customer centric approach in which every customer is treated as being unique during his whole lifecycle. The service suppliers must be able to handle an almost infinitely number of combinations, which is not supported by the current practices and tools. This process of me, as it is coined by Gartner, requires besides sophisticated information systems also attentive and knowledgeable agents in the call centers as well in the direct customer facing contacts.

Transparency of what is being offered as well of what the financial impact for the supplying intermediary is, requires an openness that was not common in the sector. In order to provide this transparency revenue sharing models have to be adapted and therefore contracts with intermediary brokers have to be renegotiated too. This can create commotion in an important part of the sales channels.

Direct writers and intermediary brokers need more insight in the customer decision making process in order to provide the service that matches the customers value system and behavior pattern. Segmentation along value and behavioral lines is however in many cases not a standard element in the existing customer segmentation approach.

Organizations must get the governance of their policies right. They have to make sure that the appropriate policies are always applied correctly by their staff and automated processes. This relates directly to the dynamic complexity the financial services industry faces. Financial products and services are in general complex and increasingly subject to all sorts of regulations. This leads to the situation where financial services companies are confronted with a variety of rules and regulations from different sources. Complying with these rules proves to be a complex matter, even with the simplest of activities. In addition, they are confronted with frequent changes in these rules and regulations which are to be implemented in their processes, systems and their communication with clients.

Keeping the focus on efficiency and effectiveness-oriented activities, together with activities that make public service delivery more coherent, is difficult if the interdependency between the parts of the system is unclear. This interdependency is one of the characteristics of dynamic complexity. Insight and oversight of cause and effect relations within the own organization and within the network in which one operates is hard to obtain, let alone to maintain. The same applies to productivity, since increasingly complex legislation leads to more and more complex applications and business processes to execute these laws. Productivity gains can be flushed away by new political and legislative demands. Standardized processes are forced to accept exceptions which lead to the creation of new processes and laborious exception handling.

The large volumes of customers and products require a level of mass customization that is hard to meet. There is a need to increase the value upgrade potential for customers and move from Straight Through Processing (STP) of mass processes to STP of mass customization processes. At the same time there is a need to decrease the variation complexity. In traditional concepts this is done by reducing the variability.

In more contemporary concepts this is achieved by a component based approach. The more sophisticated concepts even enable to achieve one to one processing of individual cases by the same mechanism as the mass customization mechanism. However, most IT-systems lack the sophistication to deliver this level of customer and processing benefits.
The fourth quadrant in the image is identified in a Harvard Business review article as the quadrant of nascent or broken processes. These are processes that are emerging or that are not or inadequate functioning. These have either to be removed or embedded in one of the three quadrants.

Financial products and services are complex because they can consist of multiple components and corresponding contract conditions that are brought together in a certain moment in time. Components and conditions can change over time. Products can be combined, extended or split up. Conditions can change due to economic or legislative requirements or to changes in the customers’ situation. Packages of products can be bundled and treated (and also traded) as a portfolio. The complexity of the products makes it difficult to keep track of the interdependencies between products, portfolios, rights and obligations. Mergers and acquisitions, as well as demergers, add additional complexity in becoming and maintaining a clear overview of the portfolios and their value and risks. This has of course also an impact on the efforts that are needed for risk management.

Traditionally, financial services companies have used a technology-driven approach to IT. Software is purchased based on features, rather than the role the software could play in the bigger picture. Not only does that lead to duplication of functionality (and license costs), IT departments also have to spend too much time configuring this functionality, building interfaces to existing systems and maintaining these increasingly complicated systems. This leads to more and more problems in execution, rising IT-costs and failing projects. IT-complexity has become too high because rules are buried in software code, hiding manageable policies behind vast amounts of software, processes, manuals and other systems. This frustrates the insight, transparency and manageability of processes and the ability to swiftly adapt to changes.

The extent to which organizations are able to cope with unanticipated events that change the arena is crucial for their success in complex environments. Also the financial services industry has to deal with emergent complexity. Emerging complexity is characterized by disruptive change. The sector faces challenges to which the solution is unknown. It can even be that the problem itself is still unfolding and not yet totally clear. The greater the emerging complexity, the less organizations can rely on past experience. One has to deal with situations as they evolve. This requires an adaptive approach and also calls for competences, methods and instruments that are oriented towards continuous change. New business models, new entrants, new alliances and new channels are on the verge and require a capacity to adapt and adopt and preferably also to generate for instance a new playing field. Scenario planning can be one of the instruments to be prepared for various events and outcomes.

Dealing with multi-reality is one of the greatest challenges financial services organizations face. They have to cope with new regulative requirements and the time versions that arise from new legislation. Old cases have to dealt with according to the old procedure and new according to the new procedure. Services have to be provided across multiple channels while users can switch between channels in between their process. New channels evolve due to for instance the mobility of customers, while old ‘paper based’ services remain intact. New product can be offered, while old are still in place. The sector must be able to assemble very quickly new product combinations, develop a high standard in variants management and embed a kind of compliance in its operations that is change resistant. Commoditization and individualization have to be supported at the same time. Coping with multi-reality and combining ‘the old’ and ‘the new’ is a challenge of which the sector is not yet very well prepared. The organizational transformation process will have a large impact.

In line with the approach for dealing with the variation in processes there is also a component based approach required for accelerating product innovation. Ideally should the business itself be able to assemble new products and offer them via one or more channels. Liability risks are then already checked at the component level and need to be only checked at aggregation level.

It has to be said, however, that new business models, like micro banking or equivalent services for insurance, are hard to introduce in an increasingly risk avoiding culture. Emerging complexity calls for leadership that can deal with uncertainty, that is forward and outward looking. It must be able to respond to unforeseen situations. This type of leadership must be able to adapt, to influence and to generate.

3.3 Looking at the finance sector from the blank canvas viewpoint: examples

From a purely objective point of view do many financial sector processes only consist of a few steps. If we take for instance the insurance process, we can see that the process basically consists out of four steps: Informing or orientation about the requirements and options, advising about which option fits best in the specific context, offering and contracting, followed by servicing.

If preferred the process can be drawn in more detail by adding aspects like gathering information, assessing or making quoting a separate step. But even then only a short list of steps remains. Every step consists of a limited set of activities, that can be executed multiple times. In the center of the process resides the case file that connects the results of the activities. After each step the dossier will be in a specific state, like ‘requested’, ‘approved’, ‘rejected’, ‘checked’ or ‘claim closed’. The rules that determine which activities are allowed by whom, which deadlines apply and which regulations apply to the specific request are managed separately and infused into the process at runtime. Exceptions do not exist anymore; they are caught in the business rules. Data that are needed in the request and that reside in insurance databases are also fused into the process, in order to prevent asking information that the insurance company already knows.

A proven way of defining the context of the requester is the use of life events. These are common events like birth, study, marriage, work, moving, being unemployed etcetera. In line with these life events, also other events and appropriate scenarios can be defined that are specific for a certain type of service. By identifying the actor and event we can reason about the rules that apply to the specific combination.  This simple concept of ‘life events’ can be easily specified by using the “I am, I want/need” approach. For instance, “I am a one-man company and want to insure my health risk” or “I am an independent consultant and need a pension plan”. Life events can also be a trigger to re-evaluate the customer’s portfolio and suggest appropriate conversion options. Risk profiles can be applied, based upon the context of the requester. Similar to risk profiles, companies can also apply behavior profiles to identified customers. The information provided and the way it is provided will in this case depend on the behavioral type of customer, e.g. risk avoider, snap decision maker, detail researcher or camp follower.

One of the great benefits of this approach is that financial services can be offered as self-service to individuals and businesses. The users are addressed in a language that they understand. Their replies and context is mapped upon the ‘finance’ speak in a very transparent and manageable way. This type of semantic interoperability is also vital for specialists of diverse practices that have to work together in for instance a claim handling or complex contract handling situation.

The productivity of processing cases can benefit from building a hybrid process in which cases are handled via Straight Through Processing. Exceptions can be moved to a manual step if for instance human interpretation is required. After the interpretation step the case is re-injected into the STP-process.

Figure 8 Hybrid processing based upon STP

The interdependency between regulations and processes can be managed by using a regulatory framework for the implementation and compliance of regulations and policies.

Figure 9 Knowledge base with integrated legal source browser

The framework contains the regulations and policies, the topics that have to be taken care of, the requirements for these topics and the controls that are implemented in the specific processes to meet these requirements. The basis of this framework is an authentic source in which the regulations are execution-independent stored and maintained. From this source they are related to the processes, actors, departments, products etcetera to which they apply. Changes in a rule can directly be related to all instances in which this rule is applied.

The Regulatory Framework can also be used an instrument to identify and improve governance and e.g. accounting policies, risk processes and data quality. The same applies also to risk profiles. However, risk profiles can also be developed for e.g. market risks, credit risks or securitization mitigation.

3.4 Empowerment by embracing complexity

By embracing complexity financial sector organizations become capable of empowering their stakeholders, leverage first class services and closing the gap between strategy and execution.

Organizations can bring their knowledge from the traditional back-office applications to the front-office and to the internet (self-service). This delivers organizations huge cost savings (customers now do what normally is done by expensive personnel), improved customer satisfaction (faster response, better advice, more individual treatment), simpler registrations and therefore more flexibility.

The service consistency improves regardless of the service channel: all channels use the same rules which are centrally managed. There is no uncontrolled proliferation of knowledge (product definitions, operating rules, etc.). Context sensitive and event-driven advice and other services deliver the “it’s about me” experience.

Stakeholders can be serviced in a tailor made way. For instance, participants of a pension scheme get a clear view on their built up rights over their working life. They can understand the future perspective at retirement and the gaps that need to be managed; and understand what decisions to make to manage the acceptable target levels of future income. While employers get a clear view on the current and future costs and obligations which enables them to deliver added value to their employees and to be compliant with (changes in) rules and regulations. They can make better decisions for the optimal premium structure and organizing pension schemes that will be effective and attractive for the future retirements of their employees. And finally Pension Fund committees get a clear view on the current and future obligations, working capital (liquidity) and get the ability to manage proactively on asset and liability management, yield and portfolio investment strategy.

Operational excellence can be achieved by automating operational processes and decisions to a high degree. The efficiency increases; less human effort is required to generate the same number or even more decisions than before. This improves the potential for managing the organization and creates opportunities for improving business operations. Applying goal driven and event driven approaches to process management allows organizations to derive processes dynamically from the context of the case. The rules decide how cases will be processed: may a case be processed automatically or must the case pass the desk of an employee. Furthermore, the rules dynamically decide which tasks must be executed to solve a case, thus avoiding unnecessary activities. Where possible decisions are taken automatically (straight through processing). When necessary – due to subjective criteria, high risks, missing information - human decision makers can manually handle the cases (case management combined with decision support).

The high level of STP, in combination with decision support for knowledge intensive manual operations ensures the correct application of rules, and prevents making mistakes, leading to reduction of errors and less rework.

Figure 10 Value drivers for stakeholder empowerment

Applying compliance and risk management rules and regulations directly in the operational process enforces the right and consistent appliance of these rules, thus guaranteeing compliant execution. Automatic recording of all activities and rule based decisions on all cases enables to trace “who has done what, when and why” at all times. Compliance and traceability are embedded into the case handling process.

This leads to less education & training efforts. Employees are context specific and timely informed about changes in laws and regulations, customer agreements, regulations, etcetera. Staff can be allocated at their own strength: experienced employees with much knowledge can concentrate on handling exceptions, and focus on the execution of complex tasks which are difficult to automate. And less experienced employees are able to deliver high quality, faultless output, due to the embedded knowledge and decision support. This all resulting in improved employee satisfaction. Routine operations are fully automated: the nature of the manual work changes considerably. As STP increases, the manual activities that remain are more oriented to what people can do better than computers: judge subjective situations.

Existing value chains become even more valuable and new value chains can be created. Interoperability problems between autonomous organizations are solved by introducing semantic interoperability and dynamic case management support.

The use of a Regulatory Framework and the introduction of rule governance leverages the re-use potential of data and policies. Interdependency becomes visible and the impact of change scan be analyzed before introducing the change into the service.

Policy scenarios can be drafted and simulated. Policy targets can be compared with the realized outcomes and provide valuable feedback for continuous improvement. Portfolios can be analyzed too and risks can be better mitigated. Transparency improves considerably for all stakeholders, including regulators. For instance, banks can assess the future profitability of their existing businesses based on the likely impact of the new regulatory requirements and the mitigation potentials. In some instances, banks may want to explore opportunities to amend prices and reduce costs to continue operating profitably. If that does not prove sufficient, banks may wish to consider exit strategies, even if that implies a significant reduction of their total volume of activity.

By using the blank canvas approach to IT the huge cost saving potential of removing complicatedness becomes clear. TCO-costs will implode. At the same time the business can act more agile because they are empowered to define products and services and their conditions themselves. Changes in products and services, regulations, work instructions are implemented fast and consistently. When a change is modeled, it can be executed directly.

This will become increasingly important, since the greatest shift in the way we view innovation will be that the innovation of business models will need to be as continuous a process as the innovation of products has been over the last hundred years. It’s here that the greatest payback and value of innovation has yet to be fully understood and exploited.

Managers are able to implement an expertise network that is tasked with design and continuity responsibility. This network will keep distilling the essence of the operations and focusing on supporting the essence in order to prevent the creation of new complicatedness. It will support the transformation process of the organization and the overall management. It will support business and ICT in working together to continuous improve the service quality and manage the lifecycle of services.

Managers can sleep comfortable at night because they have embedded and embodied complexity in their organization.


Note: This series is a republication of a paper that I wrote in 2011.