Is Managing to Metrics Dead After the Wells Fargo Fine?

In the aftermath of Wells Fargo’s fine, many are requesting whether front line incentives and “managing to metrics” will become a thing of the past given the regulatory and reputational risk involved.  We disagree and explain why in this white paper.

Wells Fargo has to pay US$190 million in fines and restitutions because its front-line employees were opening accounts without customer authorization.  The motivation was incentives and metrics that promoted cross-selling under Wells Fargo’s emblematic “Going for Gr8”, a push to have all their retail customer households to have 8 products (note that products included signing up for online banking, so “products” were broadly defined).

In response to the US$190 million penalty, many have proclaimed that “Managing to Metrics Is Dead”. That is a completely wrong assessment.  We could not disagree more!

Did Wells Fargo share responsibility for this debacle? Could they have had better checks and balances? The answer to both is “yes”.  However, the problem was not in the internal control of the incentive program.  The fundamental problem was in its design: its metrics design.

Wells Fargo’s incentive program was based on a “widget-based” program.  It rewarded new accounts being opened (e.g., a new credit card) regardless of the product’s usage or the product’s profitability.  Widget-based incentive programs often lead to the proliferation of “empty” accounts.  They are a perverse incentive to the front line and often lead to the following 4 problems:

  1. Fraud: The opening of accounts without the consent of the customer.

  2. Bad advice: The encouragement to customers to open accounts they do not even need and which they will hardly use.  This exposes the client to the inevitable operational errors and overall operational burden that naturally occur during account opening.

  3. Unnecessary operational burden:  Accounts that are not needed and which are not used add to the operational burden and operational cost without adding profitability.  An empty account has maintenance costs that the bank has to carry.  In the case of Wells Fargo, managing hundreds of thousands of empty/inactive/unprofitable accounts must have required thousands of staff hours from the front line to the back office.

  4. Misalignment with profitability:  The excess cost from the operational burden described above is not the only driver hurting profitability.  An organization incented on widget sales will often mis-price rate and mis-grade risk.  It is easier to sell a savings account if you can offer a higher interest rate.  A loan will be more likely approved if the applicant is coached to lie on its application.

Instead of “Widget-based” incentive systems, banks should use “Value-based” incentive systems.  They are admittedly harder to administer and require more training to the front line than a simple “you get X dollars for each new checking account you open”, but they have the following benefits:

  1. Alignment with shareholder value:  Incenting the front line on profitability ensures their actions are driving ROA and ROE, and not simply adding accounts or balances.

  2. Control against fraud: While it might be easy for a front-line employee to open an empty account that is never used in order to meet their “widget-based” sales goals, such an account will not reward an employee under a “value-based” system that would require balances and/or transaction activity.  It would be much harder to move customer balances behind their backs than it is to open an account that they might never see and never use.

  3. Training: A much less appreciated benefit of value-based systems is that they indirectly train the front line to understand which relationships are profitable.  This ensures they protect the right relationships, hone in their retention efforts, and as a result improve growth performance as well.

The underpinning of these benefits is none other than the fundamental economic reality of banking, and retail banking in particular.  We often make the mistake in retail banking of copying what successful retailers do.  However, there is a core difference on how retailers make money vs. how retail banks make money.  A retailer, whether they sell coffee, clothes, or jewelry, will realize the profit at the time of sale.  The profit is realized at the cash register.  This is not how retail banks make money.  A retail bank has not made one cent at the time the customer opens a new account.  A bank makes money over time depending on the balances, the transactions, and the pricing of the account.

If “value based” systems are the right way, why is not everyone using them?  The reason is that there are complexities and they are harder to administer. For example:

  1. They require an underlying reliable profitability measurement system at the account level that can be used as the yardstick for incentives.

  2. Rules of householding and domiciling must become more robust to avoid gaming among front-line units to “steal” profitable households before a profit-based incentive is paid.

  3. The market-driven movement of Funds Transfer Rates throughout the year make a front-line employee’s goal a moving target; this moving goal-post can be demotivating.

  4. Incentives may not be made at the time of sale but after a period of account activity.  This removes the instant gratification effect of “widget-based” systems.  Value-based systems appeal to a person’s “farmer” mentality and not to their “hunter” mentality.  Most HR systems that hire and train salesforces often select “hunting” and not “farming” DNA.

However, as the Wells Fargo experience once again proved, the right choice is the harder choice.  The right choice is “value-based” incentives.  The right time to start implementing one if you do not have it is today.  The wrong time is to start after all your competitors have established them.

At Delos Advisors we support the practice of Managing to Value-Based Metrics because we believe it is a powerful driver of long term shareholder value and does not create the conditions for the types of front line behaviors that caused Wells Fargo’s problems.

If you agree that a Value-Based incentive system and its underlying components can create shareholder value for your bank, we would be happy to expand more on a conference call or in a meeting.