Bank mergers are on the rise, particularly in Europe, where a fragmented landscape of national banks, combined with favorable regulations from the European Union, are spurring cross-border consolidation (Exhibit 1). Unfortunately, the operations and IT systems of most banks are seldom up to the challenge of easily and efficiently integrating the new acquisitions. Most banks run their operations on layers of legacy systems that were built up haphazardly over time without a road map, because of poor planning, disruptive events, or a lack of investment in governance and standardization. When a bank with an unreconstructed operating model attempts to integrate another financial institution, the task of matching up their systems may be so daunting that management continues to operate two virtually separate organizations side by side, failing to produce the cost savings and new revenues that justified the merger.

Some leaders in the European financial sector are taking a different approach: improving their organizations’ operations and IT before mergers happen. Rather than attack one department or function of a bank at a time, these leaders are rethinking an institution’s entire operating model—people, technology, processes, the way they are configured, and who owns them (see “Better operating models for financial institutions”). This operating model can be thought of as all of the work that goes into creating value—specifically, in a bank, account management, customer service, payments, mortgage applications, and any of the other services that banks provide. Improvements to the operating model may include streamlining processes, offshoring tasks, and consolidating shared service centers. Each of these improvements delivers some value on its own, but the impact is much greater when they are combined (Exhibit 2).

Improving any of these processes creates some value—most immediately in cost savings, but also in developing new revenue opportunities (for example, by facilitating product development). However, banks gain much more when they redesign the entire operating model with an eye to making it easier to integrate acquisitions. Besides making better use of current operations, banks with a streamlined operating model free themselves to focus on postmerger synergies and introducing new products rather than integration issues. Spain’s Banco Santander Central Hispano, for instance, made standardization a key feature of renewal in its IT systems and processes, thereby smoothing the integration of newly acquired banks into its existing organization. When it acquired the United Kingdom’s Abbey National, in 2004, it reduced complexity and surpassed its financial targets for merger cost synergies while also transforming Abbey into a broader retail bank. A solid operating model can also help a bank respond quickly to changing customer needs by allowing it to roll out new products and services across markets, thus rapidly capturing new revenues.

Our work with leading banks has enabled us to identify several key steps for ensuring a successful transformation of the operating model. First, senior managers must define a clear vision and implement good governance and transparent metrics to help managers realize it. Second, viewing end-to-end processes by “domains” (logical, manageable components with common attributes), rather than by functional or business units, is also essential. Anything related to payments, for example, would be considered together, even if the people originally handling those tasks were in different departments, such as IT or customer service. Third, banks should choose where they will invest to differentiate themselves and where it makes sense to adopt industry best practices in areas that are unlikely to offer a competitive advantage. Finally, it’s important to notch up some early wins to build momentum while at the same time keeping programs focused on the long-term goals of an operating model optimized for cross-border acquisitions.

Lay the groundwork for a transformation

Redesigning an operating model is a substantial undertaking that can take from three to five years and involve nearly every department in an organization. As such, it demands support from the institution’s top management. Executives should begin by defining what the new model must do to support the organization’s strategic goals, especially as the model pertains to cross-border acquisitions and continuing operations. The vision should help define specifics, such as how centralized and global operations are, who owns them, and whether they are outsourced or provided in house. An optimal redesign for cross-border acquisitions takes into account the fact that banks in different countries have varying strengths and weaknesses; managers must plan their integration strategies accordingly. For example, the operations of banks in Western Europe may be set up to achieve maximum productivity through scale, while those in Eastern Europe may be focused on speed to capitalize on that region’s fast growth.

Senior managers must also establish strong governance, assigning enforcement power to ensure that change actually happens. Without good governance, transformation efforts often fail, sometimes because managers remain focused on day-to-day business and resist difficult decisions that may shake up their departments. This is particularly important in a cross-border context, where processes and jobs may be moving from one location to another. One bank going through a redesign introduced the role of global chief operating officer, a position with strong enforcement power over the operations and IT departments of all business units and geographies affected. The authority of the global COO included budget control over which tasks would be sent to newly created centers of excellence, as well as over how those tasks were received and implemented. Since this executive was in charge of personnel and budgets at both ends of the transfer, he could push hard enough to make things really happen. At the same time, he smoothed the effects of these changes on the quality of service and on budgets for business units in a way that encouraged executives to send their work to these centers. Other banks have fully integrated their IT organizations across national borders, even if they leave the processing centers in several nations.

Another crucial step is establishing metrics that force managers to define goals (including cross-border and synergy targets) clearly, so that business units can make sure they’re working to achieve the right things. Such a definition of goals is important, since (for example) low labor costs are not always the best way to reduce total costs. One bank whose derivatives unit had failed several regulatory audits chose an Australian site to consolidate the back-office processing of its derivatives. While this option was more expensive than some others, in Australia the bank was able to find the talent it needed to improve its operations and thus to reduce the risk of further audit failures.

Organize processes by domains

If banks haven’t already done so, they should use the redesign of the operating model as an opportunity to segment their IT and operations into domains. Some domains are defined as end-to-end processes, from the customer contact all the way to back-office processing. Payments, securities, and accounts can all be viewed in this way (Exhibit 3). Other domains may fall within functions, such as application development or infrastructure management in IT. Properly defined, domains should have little overlap, so that each one can be analyzed and optimized separately, driving down overall complexity costs.

When organizations view each domain independently, differences among them become clear, and managers begin to see how they might be optimized. Offshoring to reduce costs may be the right answer for one domain, while investing in specialized talent might be the correct choice for another. Cross-border differences also quickly become apparent. Payments, for example, may be similar across national boundaries, but mortgage processing may vary both nationally and locally.

When organizations view each domain independently, differences among them become clear, and managers begin to see how they might be optimized

Getting the right degree of granularity is crucial, or a bank may wind up either with too many small domains (creating a daunting new level of complexity) or too few (making domain definitions too vague to be of value). One way to get things right is to look at numbers of staff. For a large global bank, a domain with fewer than 50 employees probably has been defined too narrowly, while one with more than several thousand could be too broad.

Finally, the need to optimize any individual domain must be balanced against the larger picture of what is good for the whole organization. One domain, for example, may require certain kinds of talent to work at one location, but that requirement may make it harder to operate at scale somewhere else.

Choose where to differentiate

Once banks have defined their domains, they must decide where to adopt standard industry practices for the redesign and where to differentiate themselves for competitive advantage. Because adopting established best practices is faster and easier than developing new approaches, the key is to sequence the improvement levers: pragmatically, banks should harvest the gains from good practices while also investing in innovations that take longer to yield returns. Best practices for the transformation journey vary significantly by domain. In mortgages, for instance, we have identified two common models for improvement: optimizing locations and sourcing (more popular among UK and US banks) and streamlining processes and upgrading IT with approaches such as lean operations or efforts to build scale (more popular among continental European banks).

In addition to identifying these archetypes, banks must decide where to break form and seek competitive advantage. One bank, for example, decided that it would only lightly automate its front end and work flow processes and concentrate instead on consolidating its processes offshore. While the relatively light level of automation helped managers gain a handle on the bank’s growing complexity, offshore consolidation focused attention on more significant cost savings over the long term. Such an analysis must be run for each domain separately, since best practices will vary significantly among them; for example, it’s more important to build up scale across borders in handling paper-based payments than in mortgages.

Understanding the characteristics of transformation archetypes can help banks to identify the most suitable areas for international optimization (for example, by building scale in regional centers) and to decide which archetypes they can improve to gain competitive advantage.

Seek short-term gains leading to long-term payoffs

Even if the goals are clear, the vision of the target operating model won’t come into sharp focus until an organization begins moving toward it. To get going, banks must prioritize their efforts and try to score some quick wins, both to realize savings that can be reinvested in these efforts and to maintain momentum for the larger, longer-term transformation. A good program plan reflects this. After identifying the domains, banks can define the target operating model and start working to achieve it. They can then spot opportunities for early wins, such as applying a lean process to mortgages or accounts or offshoring application-development projects.

As projects are implemented, the target operating model may be redefined in light of key insights from early improvement initiatives and the program adapted accordingly. Following a cross-border merger, for example, one bank’s first wave of pilots not only reduced costs but also improved quality, so the bank extended its offshoring effort. When this process of implementation and adaptation is done well, managers become progressively more concrete in defining their targets, improvements are aligned with a bank’s business objectives, and bottom-line results are notched up quickly.

Taken together, these measures will put a bank on a solid footing to redesign its operating model comprehensively. That model, in turn, ensures that the bank’s IT and operations can support its broader strategic ambitions, including cross-border acquisitions.