First National Toyota

Over the past decade, US banks have improved their productivity by about 1 percent a year. They have done so mainly through short sharp shocks: one-off initiatives focused on cutting costs and reducing headcount [ILLUSTRATION FOR EXHIBIT 1 OMITTED]. Though unpleasant, these exercises proved effective in boosting earnings, and hence stock price. Once they were completed, however, life usually returned to normal. Productivity often stagnated or even slid back until the next wave of cost cuts. So while substantial costs have been taken out of the US banking system, scope remains to raise productivity further; indeed, much of the merger and acquisition activity of the past two years has been based on this premise. Though variations in business mix justify some structural differences in operating costs, the size of the gap between the absolute efficiency and improvement rates of the best-performing banks and those of the rest of the pack gives some indication of the potential [ILLUSTRATION FOR EXHIBIT 2 OMITTED]. How then should banks go about capturing the extra productivity? The answer is: by looking at how manufacturers do it. Rates of improvement recorded by world-class manufacturing companies far exceed those attained by banks [ILLUSTRATION FOR EXHIBIT 3 OMITTED]. Much of the reason can be found in lean manufacturing, a system of operational management developed by the Japanese car maker Toyota. At the heart of lean manufacturing lies the belief that simultaneous improvement in quality and efficiency is not a one-off goal, but a continuous pursuit that leads naturally to lower manufacturing cost. Lean manufacturing has reshaped industries from steel to semiconductors, bringing about dramatic shifts in costs, market share, and profitability. Leading practitioners enjoy lasting advantages in terms of both processes (quality, inventory, and lead times, for instance) and output (cost, customer satisfaction, and market share). Though the analogy between banks and manufacturing companies may seem tenuous, many areas of banking share important characteristics with manufacturing. Good manufacturers ensure that each of their plants operates at maximum productivity by regularly measuring performance and sharing ways of doing things better. Labor-intensive banking operations offer similar scope for measurement and improvement. The codification and transfer of best practices can raise productivity in credit evaluation and call centers, for instance, while the standardization of maintenance schedules and operator practices can lead to big improvements in machine-based activities such as check sorting. World-class manufacturers are also masters at wringing every last unit of capacity from their operations before they commit further investment. In pursuit of the same goal, banks need to move toward viewing lending officers as a fixed pool of capacity that can be used for various tasks, including direct interaction with customers and selling. (Admittedly, optimizing this capacity may call for changes in organization, technology, and the way officers spend their time.) Another parallel between the two industries is the need for rapid delivery. For purchasers of manufactured goods, this is often a key buying factor, while for banks, compressing the time it takes, say, to approve a mortgage can confer competitive advantage. In our experience, a typical consumer-oriented bank can realize one-off improvements in its efficiency ratio of 2 to 5 percentage points by applying lean manufacturing techniques in areas such as check processing, credit application and approval, and call centers. A disciplined focus on operational effectiveness may yield an additional year-on-year productivity increase; manufacturing companies proficient at continuous improvement regularly log annual increases of 5 percent. As pressure on the drivers of profitability intensifies, we believe banks should act quickly to embrace these techniques and move toward continuous productivity improvement. …