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Funding innovation through effective vendor management

By Bob Roth

Based on their experiences inside and outside the banking industry, consumers have ever-higher expectations for innovations from their community banks. In the face of these heightened expectations, community banks face some significant challenges: Unlike innovative competitors outside the industry, community banks are dealing with substantial regulatory hurdles, and unlike large banks, community banks cannot significantly increase their costs to innovate.

Consequently, leading community banks are driving new efficiencies from mature initiatives and funding innovative new products and marketing programs through more aggressive management of their vendor relationships and contracts. Succeeding in this environment takes focus and expertise in vendor and contract management.

How does a community bank lead and fund the latest innovations? What should a community banker’s expectations be for vendors when it comes to funding new technology? Whose responsibility is research and development? How much should the bank be expected to lead, and how much money should the bank be expected to spend? Does technology expense have to be climbing? As a former community bank chief technology officer who led technology rollouts and as a consultant now negotiating hundreds of vendor contracts every year, I’ve addressed these questions countless times.

When a community bank buys a product from a vendor, there is a certain expectation that the product will be maintained and enhanced. The bank should not have to pay for every enhancement to the product, regardless of whether the enhancement is for operational efficiency or regulatory compliance. This would hold true whether purchasing licenses or paying “by the drink” through a service bureau agreement.

On the other hand, there is no expectation that the vendor should provide “breakthrough” technology or totally new products free of charge. New products are often how vendors justify their research and development expenses and their existence. So, both banks and vendors are going to be funding technology innovation.

Careful vendor management can help ensure the community bank’s portion is kept reasonable. Very often we are introduced to banks that bought new products at a “discount,” but their overall spending rate for their products is much higher than that of their peers.

Here are three areas to examine to keep your community bank’s costs allocated toward funding future innovations.

1. Existing commitments. Ensure that your community bank’s vendor makes the enhancements that are expected to be made free of charge. Critical to enforcing a vendor’s commitments is a clear definition in the agreements of the vendor’s responsibilities. Pay close attention to the vendor’s user groups, enhancement logs and vendor roadmaps to make sure the bank is getting the enhancements to current services that stakeholders expect. The current product set should naturally evolve without a commitment by the bank for more and more funds.

2. Awareness for the future. Be aware of what vendors are offering in the way of services to which your community bank does not currently subscribe. This needs to be compared to the latest needs of key stakeholders at the bank. While everyone has their eyes on the newest remote deposit capture and electronic payments proposition, the bank may benefit equally from an operational add-on product such as a data warehouse analytics upgrade or a new high-volume returns system. Knowing what the vendor offers in the way of technology and what innovations the bank needs requires much more effort than most of us realize.

We find that determining what innovations a community bank needs can be facilitated as part of broader strategic planning or dedicated technology or channel planning. Visually charting out proposed innovations by strategic requirement and measurable payoff is helpful. Also, creating a culture that accepts a controlled number of experimental “leaps of faith” in the mix with “business case justified” and “instant winners” is increasingly important.

3. Active negotiations and balance. Once your community bank has determined what innovations are needed, the negotiations come into the picture. At this point, the goal should be to plan and wait for a moment of leverage and to renegotiate existing services down while adding new technology needs into the mix. In effect, this will result in the vendor sharing a certain amount of the cost of new technology. While this process is not strictly “black and white” (that’s why it’s called a negotiation), a balance is usually found between the bank and the vendor.

The bank is trying to reverse the effects of cost of living adjustments, get lower rates that factor in growth, and get some help in funding the innovations important to customers and the bank’s business model. The vendor wants to stabilize its revenue stream, extend client relationships and have opportunities to sell new products.

Vendor Management for Innovation

When vendor management is done correctly, it usually results in a reduction of third-party expenses as prices are negotiated effectively and the bank only subscribes to needed services. Vendor satisfaction is usually higher at banks that manage vendors well, as they have come to the table with their vendors, looked at the vendors’ offerings and installed the solutions that they needed. The vendors also can benefit from good vendor management in that negotiations are not all about money and they have a chance to address recognized needs at the bank.

When vendor management is done correctly, it usually results in a reduction of third-party expenses as prices are negotiated effectively and the bank only subscribes to needed services.

There are underpinnings that make this process work. The primary factor is that banking is a market with a high-entry barrier. This keeps the number of banks fairly stable and the transaction volumes of those that stay in the pool generally increasing. Vendors normally acknowledge this and structure their price charts so that price-per-unit goes down as volumes go up. These growing volumes are continually repositioning banks on the “price/volume” curve for commodity services.

A community bank’s ability to reset itself on this price chart at each negotiation opportunity with a vendor will free up existing expenses that can be repurposed to fund needed innovations. The key to this approach is recognizing negotiation opportunities and understanding market pricing. While performance metrics in banking are ubiquitous, this is not the case with pricing metrics. Buyers sign nondisclosure agreements with vendors, and vendors work hard to keep their pricing confidential and hard to understand. Consultants can assist in determining the market and provide clarity to the opaque pricing world. While confidentiality does not allow this information to be shared, pricing comparison by a consultant to peers using the same vendor’s products can be compelling information.

The best results in the use of market intelligence will come when events occur that significantly alter a bank’s needs (and thus leverage with the vendor). Typical events include acquisitions, the need for significant new products or an upcoming renewal of a current agreement. The bank can also create events through moving services between vendors or consolidating existing vendors.

Because of the steepness of the pricing curve relative to their size, community banks will find more opportunities to repurpose existing expenses for the acquisition of technology than larger banks. A $100 million-asset community bank that acquires a branch can experience a significant bump in assets, which moves the bank along a vendor’s price chart. The same acquisition for a $4 billion-asset community bank would not move the needle at all on the price curve.

According to “The Cornerstone Report: Benchmarks and Best Practices for Mid-Size Banks,” there is a 61 percent gap between low- and high-performing banks (25th and 75th percentiles) when it comes to technology spending as a function of noninterest expense. Despite all the hype about technology costs, community banks are now spending slightly less on technology, as a function of size, than they have historically. Community banks have shifted their spending from more commodity categories like infrastructure and core processing to electronic delivery and strategic systems like analytics and origination systems.

But this shift does not happen automatically. Leading community banks will push the shift, staying ahead of resource reallocations, and innovate faster to better serve their customers and shareholders.


Bob Roth (broth@crnrstone.com) is managing director of contract negotiation services at Cornerstone Advisors Inc., a consulting firm in Scottsdale, Ariz.

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