Building the Credit Union of the Future Steve Heusuk, Corp. Strategy & Bus. Dev. New Ideas Conference October 10, 2012

CUNA Mutual Group Proprietary Reproduction, Adaptation or Distribution Prohibited © CUNA Mutual Group

Building the Credit Unionof the Future

Steve Heusuk, Corp. Strategy & Bus. Dev.

New Ideas ConferenceOctober 10, 2012

2

First the Good News

• The CU system has experienced recent performance gains:

– ROA increased to 84 bps at Q2 2012

– Strong member growth (to 95.3M total)

– Average net worth = 10.1%

• Growing sense the system has “weathered the storm”

• However, improvement has not been universal:

– 50% of all CUs had negative member growth over past 12 months

– 26% of all CUs had negative ROA at 6/30/12

3

Now the Challenges

• Despite gains, longer term challenges remain:– Regulatory burden

– Renewed spread compression

– Caps on fee income

– Competitive pressures

– Rising operating expenses to fund channel proliferation

– Macro-economic threats

4

Our Agenda

• Does the CU system need a new strategy? A new business model?

• Or is the current model robust enough to survive and thrive for a generation or longer?

• Approach: Use the framework of strategic inflection points:– What is a “strategic inflection point”?

– Is the CU system at a strategic inflection point?

– How can we manage through a strategic inflection point?

5

Strategic Inflection Points

• Andy Grove, Chairman of Intel, calls a major shift in an industry’s competitive dynamic a “strategic inflection point”

• Others use different names:– “Strategic crossroad”

– “Tipping point”

– “Critical juncture”

• The meaning is the same: The old way of doing business must give way to the new in order to survive

6

Andy Grove on Strategic Inflection Points

“A strategic inflection point is when the balance of forces shifts from the old ways of competing, to the new….It is a point where the curve has subtly but profoundly changed, never to change back again.”

7

The Inflection Curve

Inflection Point Business declines

Business goes on to newer heights

Source: Only the Paranoid Survive, Andrew S. Grove, 1996

8

What Causes a Strategic Inflection Point?

• Michael Porter: Six forces determine the competitive well-being of any business:– Existing competitors

– Suppliers

– Customers

– Potential competitors

– Substitution (i.e. your product/service being built/delivered in a different way)

– Regulation

• Andy Grove says when any one of these factors undergoes radical change, “all bets are off”– This is the cause of a strategic inflection point

9

Section ICase Studies

10

How Fast Can an Industry Change?

• Four case studies:– Music

– DVD rentals

– Photography

– Books

11

Music: Wave After Wave of Disruptive Technologies

Tower Records

Liquidated8/2006

Apple introduces

iPod10/2001

Sony introduces Walkman

7/1979

Source: “Publishing in the Digital Era”, Bain & Co., Jan. 2011

12

Case Study: Demise of the Music Industry

• A unique strategic inflection point occurred in the music industry on July 15, 2000:– Location: Sun Valley, Idaho– Players present:

• Hank Barry CEO, Napster• Edgar Bronfman, Jr. CEO, Universal Studios• Nobuyuki Idei CEO, Sony Corp.• Thomas Middelhof CEO, Bertelsmann

– The offer: Hank Barry put $1 billion on the table to convince the music studios to enter into a legal music file-sharing agreement.

– The outcome: No deal.

13

Perspectives on the Music Industry’s Decline

“The record companies needed to jump off a cliff, and they couldn’t bring themselves to jump.”

- Hilary Rosen, CEO, RIAA

“We have to collectively understand that times have changed.”

- Lyor Cohen, CEO, Warner Music Group

14

Demise of Brick and Mortar DVD Rentals

“When the inefficiencies of having retail locations, moving physical inventory, and maintaining overhead/staff are cut out of the ecosystem, far less revenue is needed to support the system.”

Dr. Augustine Fou Center for Management Development

Rutgers University

Source: “Netflix vs Blockbuster – Perfect example of an industry replaced by a more efficient version of itself”, go-Digital Blog, 2/22/2011

15

Digital Photography: 10 Years to Replace Film

Source: futuresource consulting

16

The Demise of Eastman Kodak

“Kodak first pioneered digital technologies in the 1970s and 1980s but, until relatively recently, the urgency of the challenge was never quite sharp enough to persuade its employees, investors and executives that it had to overhaul – or even sacrifice – time-honored ways of doing business.”

- Financial Times, April 4, 2012

17

eBooks Dominate the Book Business

Source: “The Incredible Growth Of Amazon's Kindle Book Sales”, businessinsider.com, 9/29/2011

18

Amazon vs. Brick and Mortar Book Stores

Source: “Amazon, Barnes & Noble and Book Store Sales Numbers Annual Update“, Foner Books

19

What Can We Learn?

• In each case the primary product or content could be digitized

• Can money be digitized?

• What does your credit union do that cannot be digitized?

20

Section IIIs the Credit Union System

At a Strategic Inflection Point?

21

Andy Grove on Strategic Inflection Points

“Strategic inflection points are not limited to the high-tech industry, nor are they something that only happens to the other guy…..It is at such times of fundamental change that the cliché ‘adapt or die’ takes on its true meaning.”

22

Are We at a Strategic Inflection Point?

• Today we will focus on three of the six competitive factors: – Customers

– Existing competitors

– Potential competitors

• How rapidly these are changing?– Where are the opportunities?

– Where are the threats?

23

Convergence - 2012

ISIS Mobile Wallet Walmart

Apple / GoogleMobile Wallets

Mobile Networks

Retailers(e.g., Target Debit)

Giants

Alt. Payment Providers

MCXMobile Wallet

Starbucks / Square Alliance

24

Sources of Non-Interest Income in 2010 (Large CUs)

NSF/Courtesy Pay Fees

28%

Other Misc. Fees16% Other Credit

Card Fees2%

Other Checking Account Fees

4%

Insurance and Retail Investment Services Income

6%

Mortgage Fees11% Debit Card

Interchange Fees21%

Credit Card Interchange Fees

12%Source: National Credit Union Roundtable Business Outlook Survey, March 2011Note: Above results summarize respondents’ evaluations of their own credit union.

25

Typical Credit Card Transaction

Source: United States Government Accountability Office

26

Typical ACH Debit Transaction

Source: “Understanding The Ach Network: An Ach Primer”, NACHA, CUNA Mutual Group analysis

Originating DFI Receiving DFIACH Operators

$$

$

Merchant Customer Account

27

Target’s Push into Payments

•Linked to Checking Account•5% Off & Up to $40 Cash withdrawal

•Free shipping for purchases made on Target.com

• “Take Charge of Education” donations to school of choice

•Target Pharmacy® Rewards – additional 5% off after 5 prescriptions

Source: Target.com

28

Retailer Benefits of Decoupled Debit Cards

Source: Finventures Blog

• Eliminates interchange fees• Builds loyalty• Offers merchant-designed promotions• Drives more store sales• Enables targeting of specific customer segments • Leverages ‘spend information’

29

REDcard Increases Engagement

• REDcard customers compared to non-REDcard customers: – Shop Target 21 times more per year– Shop 2.5 more departments per week

Source: Target presentation at ISI Group Inc. Retail Summit, 4/17/12

REDcard Debit:

Share of New Card Accounts: 67%Incremental spend lift: +52%

REDcard Credit:

Share of New Card Accounts: 33%Incremental spend lift: +57%

30

How Do Payments Support Target’s Mission?

“The full integration of our financial services operation and core retail business helps ensure that we’re focusing our efforts on financial products that deliver the most value for our guests and the company.”

-Terry Scully, President, Financial and Retail Services, Target

31

Target and Other Retailers Announce New Mobile Wallet

Source: MCX.com

32

Technologies for Making Mobile Payments

QR Codes / Bar Codes NFC – Near Field Communications

SMS Text Messages

Payments Apps

NFC – P2P Mobile Browser

P2P Online / In-Store

33

Mobile Payments – Select Competitors

34

Channel Shifts: Forecast to 2015

35

Teller Transactions: Volume Declining – Costs Rising

36

Coastal FCU Leads Branch Transformation

Source: Banks Join the Do-It-Yourself Craze, Wall Street Journal, 5/15/12

37

CUNA Mutual’s Smartphone Loan Program

38

Section IIIHow Do We Manage ThroughA Strategic Inflection Point?

39

Making Strategic Choices

• Strategy is iterative - strategies of the past may not work in the future– Complacency is not an option

• Strategy is about making choices:– What are the prerequisites to compete (i.e. table stakes)?

– Where will you invest to excel and differentiate?

– What will you choose to not do?

• Von Clausewitz: “He who defends all borders defends none.”

40

The Role Of Strategy

Vision

Values

Mission

Objectives

Strategy

Action Plan

Measurement

Controls

Iteration

41

The Cooperative Principles

• Voluntary, open membership: Open to all without gender, social, racial, political, or religious discrimination.

• Democratic member control: One member, one vote. • Member economic participation: Members contribute equitably to, and

democratically control, the capital of the cooperative. The economic benefits are returned to the members, reinvested in the co-op, or used to provide member services.

• Autonomy and independence: Cooperatives are autonomous, self-help organizations controlled by their members.

• Education, training and information: Cooperatives provide education and training for members so they can contribute effectively to the development of their cooperatives.

• Cooperation among cooperatives: Cooperatives serve their members and strengthen the cooperative movement by working together through local, regional, national and international structures.

• Concern for the community: Cooperatives work for the sustainable development of their communities through policies accepted by their members.

Source: International Co-operative Alliance (ICA)

42

Strategy Options: What Customer Value to Lead in?

Product Innovation

LeadershipWe win because the market perceives our brand as having the cutting-edge (often overkill) products with superior features – justifying premium prices.Example: Apple Computer

Operational Efficiency LeadershipWe win because the market perceives us as having the lowest prices. Based on cost and process efficiencies that still allow us to return profits.Example: Dell Computer

Customer Solutions LeadershipWe win because we are so customer-intimate that we are already there when the customer need arises. We offer tailored solutions before the customer feels like shopping around.Example: IBM w/ enterprise customers.

Middle ground of mediocrity:Trying to lead on all fronts

To compete, a business needs to perform in all three disciplines.To become a market leader, it must outperform competitors in one discipline.

Source: “The Discipline of Market Leaders”, Michael Treacy and Fred Wiersema, 1995

43

Points to Consider

• The cooperative model provides credit unions with powerful competitive advantages:– Customer-friendly ownership structure: one member, one vote

– Ability to take long-term view

– Focus on community

– Transparency

– Reasonable rates and fees

• Challenge: Adapt to the new competitive dynamic without sacrificing core values and attributes

44

The Final Word

“Directors ought to keep asking themselves this question: What is our Kodak moment, and how can we avoid it?”

Financial Times, April 4, 2012

45

Important Disclaimer

CUNA Mutual’s analysis is based upon certain publicly available information and data, including NCUA 5300 Reports, and is subject to risks, uncertainties and other factors which could cause actual results or performance to differ from the future results or performance expressed or implied in this analysis. We disclaim any representation or warranty, express or implied, as to the accuracy or completeness of our analysis, as well as any obligation to update our analysis. Each recipient should conduct its own independent analysis of relevant information and data, and should base any business decisions upon such independent analysis.

www.sustainablegrowthblog.blogspot.com