July 27, 2023

The Hidden Costs of Innovation by Patrick Sells

By equipping bankers with the right data about tech vendors, thousands of hours’ worth of effort and expense could be redeployed more productively.

Technology is the great enabler, affording undeniable advancement opportunities to the financial services industry. However, banks also risk becoming beholden to technology vendors. For some, this means unintentionally losing control of one of their most valuable commodities: their time.

It’s uniquely challenging and multidimensionally complex to operate one of the nation’s financial charters. It requires many different skill sets and is further complicated by regulatory nuances and compliance pressures.

These challenges are being compounded by economic pressures, including declining deposits and historically fast increases in interest rates that are compressing net interest margins and causing liquidity concerns. Labor expenses, along with the need for more technology, are skyrocketing. The visible cost of adapting to this new economy is printed in black and white – or red – on the income statements of every financial institution.

Navigating legacy technology vendors and the multitude of regulations and policies is incredibly time-consuming. Discovering new and emerging technology partners, determining necessary integrations, and evaluating the safety and soundness of each new solution takes even more time.

Most of these vendors don’t understand the banker’s perspective. Additionally, there is an incentive to say almost anything to get a contract signed and appease venture capitalists. The burden of determining how and with whom to innovate is entirely at the expense of the bank. This is the hidden cost of innovation.

Uncovering the hidden cost

To better understand this hidden cost, consider the following: How many different technology vendors does each employee at a bank speak to in a year?

Think about all of the conferences, introductions, cold calls and emails. Based on previous experience, for every $1 billion in assets, an institution is exploring working with, on average, at least 20 new vendors. How many hours are dedicated to vetting each of these potential vendors?

Think about all the hours spent researching vendors and their competitors, attending demos, finding references, conducting due diligence, and ensuring compatibility with existing applications. This does not include the additional hours spent to ensure compliance, identify risks and develop plans to mitigate those risks.

Now multiply the number of hours by the different number of stakeholders required to complete each step. Remember, this isn’t just for the vendors with which you end up partnering – it’s for all of the vendors engaged, regardless of the outcome. On average, banks dedicate more than 150 hours to vetting each new potential vendor.

The true cost of innovation

For every $1 billion in assets, multiply the number of vendors explored (20) by the number of hours invested to fully understand each vendor (150), that’s 3,000 hours. And for every 20 vendors explored, only an average of three new vendor partnerships are formed every year at best. Most fizzle out because it’s not possible to integrate, the promised product isn’t fully built, or the risk profile makes it impossible to move forward.

This leads us to face the ugly reality that more than 2,500 hours were wasted. Assume the average all-in cost of one of those hours is $40 – this means there is a $100,000 expense deeply hidden in the non-interest expense bucket for every $1 billion in assets. This is a conservative estimate – it’s likely more than what is being spent annually with multiple vendors.

So, why is this happening, and what can banks do to avoid the hidden costs? First, bankers need access to the right data – applicable, focused and actionable – throughout the process. There are several places to get data, facts, and descriptions, but often it’s not what the banker needs.

If bankers were equipped with the right data about technology vendors, thousands of hours’ worth of effort and expense could be redeployed in more productive ways, more vendor partnerships would be formed, and the industry’s pace of innovation would be massively accelerated.

The inertia of abandoned projects crushes culture, especially a culture of innovation, in a way far more devastating over the long term than even the hidden cost of innovation. Providing this type of data and support to address the hidden cost of innovation is key to the future success of financial institutions.

Note: This information was originally shared via BAI.