About this SBT pre-reading:

The following page will set the scene for

the case that we will be using during
Summer Basics Training (SBT)

The memo is representative of a Letter of
Proposal (LOP) that a Partner leading a
McKinsey engagement team would send
to the Senior Client Sponsor to propose a
solution around the clients current issue

The structure of the LOP allows you to get
a sense of how we would initiate work with
our clients

This case will take you back in time!
but its a great example of a classic
McKinsey study, similar to one you could
do in your first year at the Firm. Its also a
topic thats relevant across a variety of
industries
Welcome to PIONEER Bank



You are part of a high-profile engagement
team tasked with reversing the recent
profit erosions of PIONEER Banks retail
operations

The project team is internally headed by
Peggy Holland, EVP of Service
Operations

Peggy is part of the Executive Leadership
team and reports directly to Tim Bolden,
CEO of PIONEER Bank






McKinsey & Company
















Memorandum

To: Tim Bolden, CEO, PIONEER BANK
Cc: Executive Leadership Team, Peggy Holland, EVP Service Operations,
PIONEER BANK



From: Partner, McKinsey & Company
Date: J une 3, 2003


Letter of Proposal (LOP)

Addressing Recent Profit Erosion in PIONEER Banks
Retail Operations

In our last Executive Leadership meeting you asked our team to assist you in
reversing the recent profit erosion of PIONEER Banks retail operations.
Although PIONEER achieved overall profits (before taxes) of approximately $85
million in 1999, this sum was less than 20% of the banks profits in 1996 and
comes after three years of successive declines. By your own estimates,
PIONEER will face a $100 million loss in 2001, unless the bank can reverse this
trend. This increased profit pressure comes despite steps taken to address twin
challenges of increasing competition from traditional and nontraditional banking
players and changing customer needs and expectations.

Our engagement team will come up with recommendations for reversing the
recent profit erosion in the retail operations areas.

The remainder of this memo describes our perspectives on the issues at hand
and discusses how we plan to approach them. This memo is organized into
three sections:

Background and objectives

Issues to address

Proposed approach


BACKGROUND AND OBJECTIVES

As you have acknowledged, PIONEER Bank is in a precarious position. The
market seems to believe that most banks, including PIONEER, have relatively
less attractive long-term prospects and are valuing them accordingly. Investing
heavily in long-term growth initiatives, however, increases the risk that PIONEER
will miss another short term earnings target. Falling short of market expectations
carries an outsized penalty at this time: a recent industry report observed that
missing targets by 5% can provoke a 20% price decline, while exceeding them
by 5% may yield only a 1 or 2% price rise.

As we look to improve profitability and the banks long-term prospects
PIONEER is faced with significant external and internal challenges.

Externally, and increasingly difficult environment for
Incumbent regional banks

Changes in the banking environment have made the competition landscape more
difficult for PIONEER. The bank faces greater competition and increasingly
demanding and sophisticated consumers.

Increased competition. PIONEER appears to be at risk of getting caught in the
no-mans land of the evolving financial service landscape. Traditional and non-
traditional players in the banking arena are challenging incumbent regional banks
like PIONEER with scale advantages and new propositions.

The repeal of the Glass-Steagall Act is only the latest event in two decades of
change. The emergence of Citigroup represents a new breed of large-scale,
cross-industry financial holding companies with the potential to transform
financial services the way The Home Depot and Walmart have transformed
retailing in the U.S. The industry may be moving towards an era of 8 to 10
super-regional or even nationwide behemoths that will compete aggressively
using their scale advantages in operations or marketing.

At the same time, the heavier regulatory cost burdens that traditional banks
continue to bear are creating opportunities for non-traditional players. Charles
Schwab and others are competing on new propositions or on price. Your
Executive Leadership team has observed and our studies have shown this as
well that emerging internet banks like Sycamore Bank, can have as much as a
50% operating advantage over PIONEER, with a significantly higher level of per-
employee productivity.




More sophisticated customers. Over this period, consumers have grown
increasingly willing to take advantage of the offers from nationally branded
entrants or niche players, such as Charles Schwab. These more sophisticated
customers are showing greater price sensitivity and are increasingly diversifying
assets, moving savings to asset managers and mutual funds. The impact on
PIONEER has been a persistent decline in profits per household.


Internally, declining profitability at PIONEER

The Executive Leadership team has taken significant steps to increase the
PIONEER franchise during this period of change. The unintended consequence
of these moves has been a declining profitability mainly due to a strong increase
in the cost base, a declining sales force effectiveness, rapidly declining balances
per customer, slowed decision making, and change fatigue.

Strong increase in cost base. The cost base at PIONEER has risen
dramatically due in large measure to a greater number of channels
(branches, mail, ATMs, Points of Sale, telephone, and internet), greater
transaction volume, and persistent difficulty in optimizing the physical
channel assets. Customer service levels have risen, as witnessed by the
doubling of transactions per household from 1979 through 1999, but the
bank has not been able to improve its cost base, or clearly define how
each channel serves which segments in what way. As a consequence the
cost-income ration went up from 70% to 90%: In 1999, PIONEER thus
incurred 90 cents of cost for each dollar in revenues. This indicates that
the bank has a problem both in operating and non-operating expenses.

Organizational complexity and declining sales force effectiveness.
The organization at PIONEER has grown more complex over the years,
and may be impeding the banks flexibility and responsiveness. In the
marketing area alone, defining 12 customer segments has resulted in 12
segment managers and organizations. The number of sales people has
roughly stayed constant (around 3000 over the past years) while the
number of customers has grown. However, both the balance per sales
person (loan and deposit volume) and net income per sales person have
declined by 14% and 80% respectively. This could indicate a sales force
that is too small to absorb the additional customers or a lack of skills or
tools to effectively cross-sell products.

Rapidly declining average balance per customer. With 7% growth
since 1996, PIONEER Bank has been able to attract a lot of new
customers to its bank. However, the loan and deposit volume (balance)
per customer has declined by 19% from $27.291 to $21.995. This could
be due to the acquisition of less attractive customer segments or the
withdrawal of assets and transformation into mutual funds, for example.
Slowed decision making. In the 1980s, PIONEER made numerous
acquisitions, requiring repeated efforts to integrate and blend multiple
organizational cultures. One outcome of this process appears to be a
decision-making culture characterized by consensus. While this
preference can produce strong results when there is time to align
everyones interests, it can result in decisions being deferred too long or
never made when consensus is hard to reach.

Change fatigue. Over the past few years, PIONEER has undergone a
series of reorganizations to respond to maker conditions. Switching from
a product and geography focused organization to a customer-segment
orientation alone represents a major shift. The result of non-organic
growth and of major change efforts can be significant change fatigue,
which PIONEER Banks leadership has detected.

In this context, we propose that the objectives for our special initiative be two
fold:

Identify revenue enhancements and efficiency improvements that will
enable PIONEER to close its $100 million profitability gap by 2001.

Define, at a high level, the strategic, organizational, and operational steps
necessary for PIONEER to create a sustainable economic platform for the
future.


ISSUES TO ADDRESS

Closing the profitability gap and building a sustainable platform for the future will
require PIONEER to address a number of difficult, but important issues in the
course of this engagement. Our focus will be on internal improvements, which
can and should be addressed, regardless of the Executive Leadership teams
decisions on the long-term direction of the bank:

Is $100 million the right target for PIONEER? This amount will be close to
the gap expected in 2001, but it may not be sufficiently ambitious to
support the long-term growth of the bank. Our team will need to confirm:

State of core earnings and trajectory of the bank on a business-as-
usual basis, given current trends, margins, and costs.

Amount of funding PIONEER will need for growth, given
expectations and possible initiatives to enhance long-term
prospects.

What are PIONEERs highest priority opportunities to improve revenues
and reduce costs, within the current lines of business and geographies?

What set of initiatives will be most appropriate for PIONEER to close this
performance gap? In collaboration with you and the Executive Leadership
team, we will define what initiative(s) PIONEER should take in each of the
following areas:

Sales quota initiatives

Pricing

Networking and distribution

Operations and IT

Overhead and purchasing management

Credit and collections.

How should the initiatives be sequenced in an overall performance
improvement program, based on potential impact, ease of implementation,
and possible role as a precursor to a later initiative? We will need to
assess:

Organizational capacity to manage several initiatives at once

Linkages and interdependencies between these initiatives

Level of decision making authority needed for which sorts of
decisions

Coordinating mechanisms needed to ensure integration across the
initiatives

Appropriate measures to track and lock in full capture of the
benefits

What to communicate when and how, to:

- Various parts of the organization, to build awareness of the
need for change, foster conviction that these changes will
close the gap, instill the courage to act decisively in the face
of potential lack of consensus, and ensure that actions are
taken and adhered to

- Market analysts, shareholders, and other external parties, to
begin the process of changing expectations about
PIONEERs long-term growth prospects.


PROPOSED APPROACH

We propose to address these issues in three phases, recognizing that multiple
waves of initiatives may have to be launched.

Phase 1: Diagnostic to identify and prioritize key profitability levers

Phase 2: Develop implementation plan, including choosing pilots in key
representative markets

Phase 3: Pilot the recommended changes and refine in preparation for roll
out

NEXT STEPS

Discuss project approach in next Executive Leadership meeting
Schedule an offsite meeting where our McKinsey engagement team can
present its initial findings and discuss possible implications


My team and I are excited about the opportunity to work closely with you and the
rest of the Executive Leadership team at PIONEER to design a profit
improvement program that will strengthen the banks performance and create a
sustainable economic platform for the future.