Failure planning: linking plans to performance

Banks’ reported results and investor guidance in recent years don’t make for pleasant reading. Most show us that banks have failed to hit their targets. The consequences can be broad and swift: stock price falls, reputational damage to the bank’s C-suite and a demotivating message to staff.

The question this throws up is: why do banks’ plans so often fail?

I suggest principally because banks’ ability to thrive depends in large part on market forces and changes to the regulatory environment, both of which are notoriously difficult to predict.  A persistent example following the financial crisis was the refusal of interest rates to meet market expectation, squeezing net interest margins. Figure A illustrates this, contrasting expectations from the BoE inflation reports with actual interest rates.

This combination can cripple the reliability of banking plans. A plan that fails to account for unpredictable market forces and is constructed top-down to meet centrally mandated targets may be unachievable from the outset.

Further, it may undermine staff motivation regardless of whether it is overly pessimistic or optimistic. A pessimistic plan encountering a favourable market wind (e.g. rising interest rates) may prematurely push a plan to its desired outcome. A good result, except staff now lack motivation to exceed planned performance. If pay linked performance is achieved, why try harder? By contrast, an over-optimistic plan and unfavourable economic headwinds (e.g. slowdown in economic growth) can make a plan unachievable. This incentivises staff to pursue policies that give short term benefit at the expense of longer term progress (e.g. cutting investment), which can be demotivating to staff and counter-productive to banking performance in the longer term.

So what can be done? Let’s turn for inspiration to the master planners of this world – the military.

“In preparing for battle I have always found that plans are useless, but planning is indispensable”

– Dwight D. Eisenhower

“No plan survives first contact with the enemy”

– Carl von Clausewitz

“We must plan for an enemy’s capabilities, not his intentions”

– The Pentagon

The message to take away from these quotes is that rigid plans that rely on a single scenario of developments in the world don’t work. Instead, the process of planning that identifies the major external drivers and internal levers to be engaged to achieve performance is much richer and more useful.

One approach would be to use the following layered planning structure which tries to separate the financial performance related to the typical major drivers:

1. Flat baseline plan: A baseline plan that does not include change / strategic initiatives where all macro-economic factors are held flat to current levels
2. Macro-economic layer: A layer for application of consensus macroeconomics. A bank may apply further macro-economic layer scenarios where deemed necessary
3. Regulatory layer: A layer for regulation of uncertain timing or magnitude. The impact of existing and known regulation would feature within the baseline plan
4. Change / strategic performance layers: A layer of all costs and associated benefits for change / strategic initiatives. This could be further sub-divided into individual change initiatives where useful

Building the plan in this manner allows senior management to assess the bank’s controllable performance, by understanding the impact of external market forces on performance, and simultaneously enabling direct performance assessment of any change initiative. Further, separating performance targets from external market factors (2. & 3.) creates a more achievable plan. A plan that critically addresses the staff motivation issues linked to typical planning processes.

Following plan creation, a regular and timely ‘plan update’ can maximise the full benefits of this layered approach, through the following steps:

1. Identify reasons for difference of actual performance to plan
2. Determine whether identified reasons justify changing the plan
3. Update the plan to reflect justified differences against plan and any new strategic initiatives

This regular update ensures the plan factors a recent view of external uncontrollable factors and remains both achievable and relevant to the bank’s strategic goals and actual operating environment. Finally, post completion of the planning cycle, a fair assessment of the bank’s performance can be achieved through inputting macro-economic actuals through the planning models to arrive at revised baseline performance, helping provide a better view of whether plan has been met in awarding performance related pay and describing performance to investors.

To support this, banks may need to invest in more sophisticated driver-based modelling approaches that link internal and external drivers with financial performance. Those models can rapidly estimate the impacts of new inputs on strategic initiatives.

The key benefits of this dynamic planning framework are clear:

• External events and internal actions are linked to financial results
• Pay linked to controllable performance, and
• Investor guidance that provides greater transparency over the bank’s underlying performance

Banks plans’ may presently fail to hit the mark but by adopting a more flexible approach as outlined above banks could markedly improve their ability to achieve targets and drive better performance.