Jeff Judy

Jeff's Thoughts May 8, 2013

Inefficient Efficiency

Those of you who have been at my presentations or in my classes know that I have some favorite, and some not-so-favorite words. For example, I would much rather talk about "credit" than about "lending," and I'm an advocate of "best outcomes" rather than "best practices."

One word I'm not very fond of, in banking, is "efficiency." It seems to be a word I'm hearing a lot lately. Naturally, the recession has put pressure on banks to cut costs, and that feeds directly into what many managers define as "efficiency." With the slow pace of the recovery, those same managers feel continued pressure to cut to the bone.

Problem is, I don't think the leadership teams at many of those banks have a deep understanding of efficiency, and that's why I get uncomfortable with this word. As a concept, it is fine, the idea that one uses resources wisely, that a bank invests in staff and computing power and all the rest with an aim of getting a good return on those investments.

But "efficiency" is rarely used as a concept. Like so many things in banking, it has been reduced to a number in the minds of management (and other stakeholders) at many institutions.

And that just hits another one of my hot buttons. I'm a strong believer that measurement is good, that finding ways to measure outcomes and activities can be very helpful. I just think that the resulting numbers should be inputs to thinking, not substitutes for thinking.

There are two ways to interpret an efficiency ratio, after all, two questions you can ask that may seem the same, but that are very different in their impact on management decisions and business strategies:

The first is associated with the "how low can you go" crowd, people who believe that the lower the efficiency ratio, the better the bank. There is a host of problems with that kind of thinking.

After all, if you think about your own business customers -- and especially, about the potential customers you decline to work with -- you'll quickly realize that at some point failure to invest in activities and resources that support product and services will hurt the business. Just think about the last time you spent the night in a ratty motel, ate at a restaurant where the staff obviously received no training in customer service, or waited and waited for a transaction to be processed at a place where their computers were always slow or breaking down.

Take the "how low can you go" thinking to its logical conclusion and you eventually get to an efficiency ratio of 0%. But you'll be out of business long before then.

The wiser managers are looking for optimal efficiency. They do not want to waste resources, and they are firm on that. But they see those operating expenses as investments in creating and delivering services, in finding leads and landing new business. They recognize that a little higher investment -- that is, a slightly "worse" efficiency ratio -- may attract customers who are loyal and who provide word-of-mouth marketing, rather than customers who are just shopping on price, or even location.

Efficiency is important. It is something you should manage for the best results.

And it is the product of thoughtful judgment. It is not simply a number.