DEFINITION OF BANK’S STRATEGIC ALTERNATIVES IN THE PROCESS OF VALUE-BASED STRATEGIC PLANNING

 

 

Nesterenko V.P.,

Postgraduate,

Taras Shevchenko Kyiv National University, Ukraine

DEFINITION OF BANK’S STRATEGIC ALTERNATIVES IN THE PROCESS OF VALUE-BASED STRATEGIC PLANNING


Development and selection of strategic alternatives in the banking business in the process of value-based strategic planning requires the use of theoretical and empirical effective approaches.

The questions of the valuation process and value management were studied by many authors, such as V. Bazilevich [1], A. Damodaran [3], Z. Vasylchenko [2], S. Naumenkova [5] and many others. But still, there are a number of unsolved issues.

To determine the strategic options of the bank, realization of which will ensure maximum positive impact on its value, it is necessary to do focused analysis on the following key positions: competitive advantages, business segmentation and growth potential of individual segments, customer needs (fig. 1).

 

Figure 1. Key aspects of the definition of strategic alternatives in the process of value-based strategic planning in the bank.

We share the opinion that any business can in the long run to operate successfully only if it has certain advantages. In terms of value-based strategic planning this axiom can be interpreted as follows - in the long run business is able to generate stable cash flows that exceed the cost of capital, that create added value, only if it has respective competitive advantages.

We believe that identification, development of competitive advantages and evaluation of its impact on business value is one of the key aspects of the definition of strategic alternatives and value-based strategic planning in bank in general.

Thus, competitive advantage, in our view, could be based on differentiation in terms of costs or prices of banking products and services, as well as the presence of protected positions or opportunities relative to competitors.

  Business segmentation involves identifying individual parts (segments) of the market or the banking business, in which the bank may have certain competitive advantages. Single business segment has separated from adjacent segments the cost structure or the presence of a significant share of this segment-specific costs in terms of which are strong competitors can achieve significant benefits. Therefore, a significant place in determining the strategic options of business development in the process of value-based strategic planning in the bank is reasonable separation and evaluation of the attractiveness of the business segments based on the potential of income, strong or weak position of the bank relative to competitors, the possibility of extending the boundaries of segments.

Thus, a business segment is a area within which measured the relative competitive advantages and growth potential.

Actually, the growth potential is also an important factor in the choice of strategic alternatives and the formation of value-based development strategy of the bank as a whole. The bank can increase the volume of their transactions, while not taking away customers or turns in the competition, when markets or business segments are growing rapidly.

In addition, growth is essential for the stability of business and value creation. However, growth is not enough because:

-       for dynamically growing market business can show significant accounting profits, but after deducting investment cash flow can have a negative value;

-       if competitive advantage not to create a slowdown in growth, profits can disappear and cash flow will remain negative.

Identification of customers are, respectively, the common denominator for a greater understanding of the other three components of the analysis of strategic alternatives. The emergence of unmet customer needs is a driver of future growth market. Customer needs allow you to understand what competitive advantages have the greatest impact on value creation. And, on the other hand, needs and motivations of customers act are a guideline for the selection of limits business segments.

Therefore, in the development of value-based strategy of the bank must first deeply analyze customer needs in every segment of the market, track and predict their evolution, highlight unmet needs and ways of their provision.

Summarizing the above arguments, it should be noted that the business segments, growth, customer needs and competitive advantages are interrelated and form the theoretical and methodological basis for the strategic options of the bank in the process of value-based strategic planning (fig. 2).

 

Figure 2. Logical diagram of choosing of the best bank’s strategic options

Thus, if the bank has weak competitive advantages, generated cash flows are lower than the cost of capital, that is destroying value, the strategy of the bank should focus on the following activities:

-       increase profitability with minimal investment and growth;

-       choose another attractive business segments;

-       focus on better meeting the needs of one or more groups of customers;

-       identification and planning of competitive advantage in the long run in those business segments where specified benefits can be achieved and they are significant.

In contrast, if bank has a competitive advantage and create value and generated cash flows are higher than the cost of raising capital, value-based strategy should focus on strategic alternatives, which include:

-       growth and investment;

-       strengthen and develop competitive advantages within the existing business segments;

-       opportunities increasing value through access to the adjacent segments.

In this context, thus, focus on internal factors profitability, operational improvement is less important areas rather than to growth in business segments where there is a competitive advantage. Since, in this situation, the potential of increasing business value in the long projection is usually more significant.

Logical-block diagram of choosing the best strategic options of the bank provides the possibility of using at each stage of the relevant analytical tools.

In particular, during the identification of sources of competitive advantages and value drivers, managers of the bank can use such tools as profitability analysis, matrix environment, the definition of capacity and the dynamics of market growth, ratio analysis, revenue drivers and factors of value creation, assessment of competitiveness, strategic audit, analysis of price premiums and costs, the supply curve and others.

To assess future changes in the sources of competitive advantage and position of the bank are used: analysis of growth and volatility, studying the evolution of costs, consumption patterns, customers economic, external trends (PEST-analysis, analogy to other business segments).

Search and developing strategic options of the bank can occur with the use of financial analysis, comparison of costs, evaluation processes, modeling of prices, the analysis of demand and unmet needs.

The choice of strategic alternatives provides audit capabilities of their practical implementation in terms of intention-commitment opportunities, scenario planning, risk analysis, comparing the costs and benefits of modeling the behavior of competitors (evaluation scenario, the theory of games, etc.), assessment of impact of alternatives on the value of the bank.

Thus, the competitive advantage of the bank can be described at several levels: the nature of benefits, sources and drivers benefit (fig. 3).

 

Figure. 3. The levels of competitive advantages of the bank

Fundamentally, all sources of competitive advantage are divided into those that provide lower costs and those that form a higher value for the consumer. Hence, business segments are characterized by cost-based competition or based on the value to consumers or by those and others.

In the segment of the cost-based competition the main goal is to reduce costs relative to price. Otherwise, competition is based on trying to achieve better price realization.

As the A. Kireev and J. Zaruba, in broad service offerings and slightly lower demand from customers, which is typical of the situation in the domestic banking market, focus on cost minimization goal is transformed into an effective cost management, which involves ranking quotations based on groups of consumers of banking products and services, including the prestigious, medium-priced and relatively inexpensive [4, p. 27].

Competition for cost occurs when there is little differentiation in price and small differences in products and services. On the other hand, competition for value to the consumer is determined significant differences in the price of products and services, stable consumer preferences between sentences in similar price levels, the presence of clear differences in the offered products and services, significant cost of sales and marketing.

Defining sources of competitive advantage involves solving the following tasks:

-       defining planes in which competitors can differentiate themselves;

-       evaluation of the potential size of benefits, including the difference between the strongest and weakest competitors;

-       identify areas that have the greatest impact on profitability in the segment;

-       score relative competitive advantages of the bank in terms of achievements and potential implementation.

The sources of cost advantages can be:

-       economies of scale (sales of products, total experience, production capacity, focus on components of the value chain, customer segments, etc.);

-       high efficiency processes (working capital management, distribution, technology);

-       lower cost of production factors (wages of employees, the cost of raising capital, access to information);

-       possession of unique assets (due to regulatory restrictions, patents).

Benefits based on the value for the consumer, are formed due to higher product quality (simplicity, reliability), the impact on system use, high-quality customer service (convenience, speed of execution, skilled personnel), a wide range of products (cross selling), differential pricing, better access (distribution channels), a stronger relationship (customer relationships) and formed the brand (image, prestige).

Defining resources advantages the bank should further identify how these advantages were created, that is, install the drivers of competitive advantage.

Competitive advantage requires exceptional position in the relevant sources of benefits. These drivers provide power advantages that can not be easily copied by competitors because the segment is not attractive or because of related high costs.

To create value bank should form a source of benefits that allow it to be low cost or receive a price premium or an additional increment of sales. Thus, the value for shareholders will accumulate provided stability advantages over a certain time.

Drivers of sustainable competitive advantage can be divided into three categories:

-       possession of unique resources (patents, unique location of branches);

-       possession of scarce resources for which requires substantial costs;

-       availability features: knowledge (understanding consumers, creativity), processes (speed, operational and organizational excellence, risk management), agility (sensitivity, adaptability, ability to transform).

To select strategic alternatives of bank development in the process of value-based strategic planning we suggest using the following methodical approach (fig. 4).

 

Figure 4. Factors formation and selection of strategic alternatives

At this stage in the process of value-based strategic planning we can estimate selected strategic alternatives in terms of their impact on the value of the bank.

In addition, evaluation and implementation of selected strategic options of bank development in the process of value-based strategic planning, in our opinion, should be considered and take place in the context of project management. Indeed, the achievement of the planned strategic objectives of the bank, such as assets growth and market share involves implementing a portfolio of internal projects of the bank associated with the creation and marketing of new products to target customers, effective marketing, development of distribution channels, access to additional market segments and others. On the other hand, the bank may participate in projects related to the strategy of its clients, ensuring adequate funding and, thus, realizing the external projects.

In this regard, the bank can act as an initiator of the project (internal bank projects, including: the development of value-based strategy development, new products and services, expand branch network, etc.) and project participant (external projects).

When selecting strategic options of bank development in the process of value-based strategic planning important theoretical and empirical task is to assess the impact of potential impact of  internal or external projects on the bank value. That is, there is a need to evaluate how the implementation of possible projects under certain strategic alternatives will help create value-added business.

Impacts of external and internal projects on the bank’s value are based on the differentiation of cash flows for the following components: cash flow generated by business excluding new projects, and cash flows generated by the perspective projects of the bank in the future.

The formula for determining the value of the bank in this case will look like:

,      (formula 1)

where V – value of the bank,

V0 – value of the bank with starting parameters of business,

Vр – additional costs associated with implementation of new projects of bank,

NPVi (net present value) – net present value of cash flows from the project,

i – code of project.

Hence, if NPV> 0, the value of the bank increases and, conversely, if NPV <0, the realization of this project will lead to the destruction of the value of the bank.

To determine the overall impact of projects on the value of the bank modified formula is:

,                      (formula 2)

where t1, t2 – period from the date of the valuation of the bank in the first year of the project,

NPV1, NPV2 – calculated value of NPV projects of bank,

i – discount rate used in valuing the bank.

In addition, A. Damodaran justifies correlation parameters EVA and NPV of the project, noting that "the net present value of the project is given the project added economic value for its period" [3, p. 1154]:

,                (formula 3)

where EVAt – economic value added of the project in time t,

WACC – average cost of bank capital.

Then, the cost is determined by adding the bank invested capital (IC0) and market value added (MVA), which formed the existing assets of the bank and future prospective projects:

,     (formula 4)

where PV(EVAa) – present value of economic value added created by the existing assets of the bank,

PV(EVAр)  – present value of economic value added created by future projects of the bank.

However, due to the fact that, as already mentioned, for banks more reasonable is to calculate its value through the definition of free cash flow on its own (share) capital using of  EVA can be modified to calculations based on the shareholder added value (SVA).

Thus, the bank should participate in the project if:

-       it fits the strategy and investment policy of the bank, their criteria;

-       IRR of the project exceeds the value of WACC bank;

-       ratio of NPV of the project to its value higher than for other projects;

-       MVA and SVA project - positive and sufficiently resistant to changes in external factors values ​​[6, p. 215].

Thus, using the proposed methodology to identify strategic alternatives will facilitate the formation of effective value-based development strategies of the bank, aimed at maximizing its value for the existing conditions of external and internal environment.

Literature:

  1. Базилевич В. Системна реструктуризація банківського сектору та її вплив на макроекономічний розвиток: Досвід 24 країн / В. Базилевич, І. Дорошенко [Текст].  // Економіст. – 2000. – № 4. – С. 26-35.
  2. Васильченко, З.М. Комерційні банки: реструктуризація та реорганізація [Текст]. / З.М. Васильченко. – К.: Кондор, 2009. – 528 с.
  3. Дамодаран Асват. Инвестиционная оценка: Инструменты  и методы оценки любых активов [Текст]. / Дамодаран Асват ; пер. с англ. — [2-е изд., исправл.]. — М.: Альпина Бизнес Букс, 2005. — 1341 с.
  4. Кірєєв О., Заруба Ю. Підвищення конкурентоспроможності банку: стратегічний підхід [Текст]. // Вісник НБУ. – 2003. – № 11. – с. 24-27.
  5. Науменкова С. В. Зарубіжний досвід організації систем регулювання й нагляду за діяльністю фінансових установ [Текст]. / С. В. Науменкова // Фінанси України. - 2009. - № 12. - С. 20-27.
  6. Стратегия и стоимость коммерческого банка [Текст]. / И.А. Никонова, Р.Н. Шамгунов, 3-е изд. – М.: «Альпина Бизнес Букс», 2007. – 304 с.