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06/01/2011

Operations in Financial Services—An Overview


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Over the past two decades, research in service operations has gained a significant amount of attention. Special issues of Production and Operations Management have focused on services in general (Apte et al. 2008), and various researchers have presented unified theories (Sampson and Froehle 2006), research agendas (Roth and Menor 2003), literature surveys (Smith et al. 2007), strategy ideas (Voss et al. 2008), and have discussed the merits of studying service science as a new discipline (Spohrer and Maglio 2008). A few books and a special issue of Management Science have focused on the operational issues in financial services in particular (see Harker and Zenios 1999, 2000, Melnick et al. 2000). However, financial services have still been given scant attention in much of the literature relative to other service industries such as transportation, health care, entertainment, and hospitality. The dilution of focus, by concentrating on more general distinguishing features does not do justice to financial services where some of these characteristics are not central. (The more general features that are typically being considered include intangibility, heterogeneity, contemporaneous production and consumption, perishability of capacity, waiting lines (rather than inventories), and customer participation in the service delivery.)

In this overview, we mean by financial services primarily firms in retail banking, commercial lending, insurance (other than health), credit cards, mortgage banking, brokerage, investment advisory, and asset management (mutual funds, hedge funds, etc.).

1.1. Importance of Financial Services

Financial services firms are an important part of the service sector in an economy that has been growing rapidly over the past few decades. These firms primarily deal with originating or facilitating financial transactions. The transactions include creation, liquidation, transfer of ownership, and servicing or management of financial assets; they could involve raising funds by taking deposits or issuing securities, making loans, keeping assets in custody or trust, or managing them to generate return, pooling of risk by underwriting insurance and annuities, or providing specialized services to facilitate these transactions.

Services is a large category that encompasses firms as diverse as retail establishments, transportation firms, educational institutions, consulting, information, legal, taxation, and other professional, real estate, and healthcare. Even within financial services, there is a wide variety of firms which are characterized by unique production processes and specialized skills. The processes and skills required for banking are quite distinct from solicitations for credit cards, acquisitions of new insurance accounts, or the handling of equity dividends and proxy voting, for example.

Even though services account for about 84% of the total employment in the economy, only about 4% of this workforce is employed in financial services. This might come as a surprise to some because financial services transactions in one form or another are so ubiquitous in our lives. Not surprisingly, however, the number of financial services firms is about 7% of the total non-farm firms and contributes about 13% of total non-farm sales. Only wholesale trade has a similar employment and number of firms with a larger contribution to sales.

Table 1 provides employment information for the sub-codes within financial services. As can be seen, retail banks, insurance companies, and insurance brokers together employ about two-thirds of the financial services workforce. A cursory look at the table gives a sense of the diversity of the services sector. Clearly operations management problems and approaches used to solve them have to be customized for particular types of services—we already know that what works for manufacturing may not work for services, but by looking at Table 1 we can also realize that what works for retail trade or recreational services may not work for financial services. A quick glance through Monster.com’s job openings for operations managers in financial service firms shows a wide variety of titles, responsibilities, and “products” related to such jobs. This is shown in Table 2, and gives a sense of the wide swath of topics that could be covered in academic research on financial services operations. As financial services are such an important segment of the services economy, we wish to explore whether operations in financial services are indeed unique, or share several characteristics with services in general. That is the motivation for this special issue.

Table 1: Employment within Financial Services

Total Employees
NAICS Code Title within Financial Services Number %
5211 Monetary authorities-central bank (Federal Reserve banks, etc.) 21,510 0.40 
5221 Depository credit intermediation (banks, credit unions, etc.) 1,816,300  30.70 
5222 Non-depository credit intermediation (credit cards, mortgage lending, etc.) 659,930 11.20 
5223 Activities related to credit intermediation (brokers for lending) 294,910 5.00 
5231 Securities and commodity contracts intermediation and brokerage 516,010 8.70 
5232 Securities and commodity exchanges 8,010 0.10 
5239 Other financial investment activities (mutual funds, etc.) 344,950 5.80 
5241 Insurance carriers 1,258,050 21.30 
5242 Agencies, brokerages, and other insurance-related activities 907,880 15.30 
5251 Insurance and employee benefit funds 47,730 0.80 
5259 Other investment pools and funds 41,190 0.70 
    5,916,470 100 

Source: Bureau of Labor Statistics, stat.bls.gov/oes/home.htm, May 2008.

Table 2: A Sample of Financial Service Operations Job Titles, Responsibilities, and Products

Titles Products
Vice President, Operations, Operations Manager, Financial Operations Supervisor, Foreclosure and Bankruptcy Operations Manager, Risk Operations Team Manager, Team Manager Ops Control-Fixed Income, National Director Operations, Hedge Fund Operations Specialist, VP/ Director Of Operations Premiums, Claims, Refunds, Cash flow and treasury management, Customer statements, Loan servicing and support, Trade confirmations, Reconciliations, Tax reporting, Security settlements, Mortgages

Nature of Work/Responsibility
Brokerage operations, Improve customer service, resolves customer issues, Review security pricing, Vendor support, Authorize net settlement, Hand-off of data, ensure data integrity, Verifying transactions, Tracking missing transactions, Leverage technology, Maintain ops controls, update policies, procedures, Backoffice support, Understand regulations, Ensure compliance, Attain profit and revenue benchmarks, Reduce risk, Improve quality, Six sigma, Operational processing efficiency, Problem solving, Ensure best practices, Streamline activities, Manage key expenses, Work management tools, Monitors work flow, Production/testing

Source: Monster.com jobs listings during the week of March 8, 2009.

1.2. Distinctive Characteristics of Operations in Financial Services

There are several unique operational characteristics that are specific to the financial services industry and that have not been given sufficient attention in the general treatment of services in the extant literature. We list below a number of these unique operational characteristics and elaborate on them in what follows:

  • Fungible products with an extensive use of technology
  • High volumes and heterogeneity of clients
  • Repeated service encounters
  • Long-term contractual relationships between customers and firms
  • Customers’ sense of well-being closely intertwined with services
  • Use of intermediaries
  • Convergence of operations, finance, and marketing.

1.2.1. Fungible Products with an Extensive Use of Technology. One obvious difference between operations in financial services and operations in manufacturing and in other service industries is that the “widgets” in financial services are money, or related financial instruments. As there is a declining use of the physical vestiges of money such as coins, currency, bond, or stock certificates, much of the transactions are in the form of bits and bytes. Thus inventory is fungible and can be transported, broken up, and reconstituted (facilitating securitization, e.g.) in malleable ways that are simply not possible in manufacturing or in other service industries (see, e.g., the recharacterization of bank reserves in Nair and Anderson 2008).

The increased use of online transactions (in brokerages, credit card payments, retail banking, and retirement accounts, e.g.) are forcing fundamental changes in the way operations managers think about capacity issues (for statement mailing and remittance processing, or for transfer of ownership in securities, e.g.). The fact that adoption of online transactions is still growing and has not yet matured and leveled off makes capacity planning a big challenge. Yet we are aware of very little research that would help managers deal with this issue.


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1.2.2. High Volumes and Heterogeneity of Clients. Financial services are characterized by very high volumes of customers and transactions. Furthermore, customers are not all alike. In many firms, a small fraction of the customers generate most of the profits, giving the firms an incentive to view them differently and provide differential treatment, given the firms’ limited resources. For example, high net worth individuals may be treated differently by asset management firms; banking clients who keep high balances in checking accounts and transact heavily may be handled differently from depositors who keep almost all their funds in savings accounts and certificates of deposits (CDs) and transact minimally; revolvers (i.e., customers who carry over balances from one month to thenext) mayberegardeddifferently from transactors (customers whodonot revolve balances) by acredit card firm. In most non-financial services, because of a limited number and sporadic interactions with customers (e.g., in restaurants and amusement parks), one customer is considered, for the most part, similar to the next one in terms of margins and attention required.

1.2.3. Repeated Service Encounters. In contrast to other service industries, where research typically focuses on a single encounter (“the moment of truth,” “when the rubber hits the road”), financial services are characterized by repeated service encounters or potential encounters between the firm and its customers due to regular monthly statements, year-end statements, buy/sell transactions, insurance claims, money transfers, etc. Anecdotal evidence from the brokerage and investment advisory industry suggests that clients with low asset balances and transaction volumes contribute the least to firm revenue and the most to operational cost through calls for customer service. One online bank discouraged calls to customer service because it found that just a few calls by a client could wipe out all the profit from the client’s savings account. Very little research in service operations management has focused on this issue. New customers constitute another major group that is more likely to make calls with billing questions or inquiries regarding their statements. Should billing and statementing to new customers be handled differently, perhaps with more care, than to existing customers? Obviously, if this observation is true, differential handling can reduce the traffic to call centers. Existing call center research usually assumes the call volume to be a given, for the most part, and the focus is on “managing” the traffic. This is akin to traditional manufacturing where it was assumed that large setup times were a given, and a good way to “manage” would be to use an optimal batch size. One learns to live with such a constraint. Not until just in time (JIT) manufacturing came along did managers question why setup times were large and what could be done to reduce them.

At one credit card company, operations managers struggled for years to cope with volatile demand in bill printing, mailing, remittance processing, and call center operations. Daily volumes could fluctuate easily between half a million and one and a half million pieces of mail in remittance processing, and managers were reconciled to high overtimes and idle times because they felt they had no control over when customers mailed in their checks, and reducing float was important. Call volumes at the call centers were similarly volatile, as were volumes in the bill printing and mailing operations. This situation continued until someone recognized that all these problems were interconnected and to a large extent within the control of the firm. As it happens, the portfolio of current customers is distributed into about 25 cycles, one for each working day of the month. For example, customers in the 17th cycle are billed on the 17th working day of the month. Care is taken to ensure that customers in the same zip code are put in the same cycle so volume-mailing discounts from the US postal service can be obtained, and the cycles are level loaded. However, this allocation to cycles was carried out several years back and over time some customers had closed their accounts while new customers had been added to existing cycles, resulting in large differences in the numbers of customers in the various cycles, and in a wide variability in the printing and mailing of monthly statements. On the remittance side, an analysis found that there was less randomness in customer payment behavior than one would expect. There were broadly four cohorts of customers: one that sent in payments on receipt of the statement, a second that mailed checks based on due date, a third that acted based on salary payment date, and a fourth that acted randomly. The first two cohorts, the largest ones, were in fact dependent on the cycles that the firm had set up many years back. Similarly, billing calls were also heaviest soon after the statement was received by the customer, again traffic that was determined by the cycles created by the firm.

If the cycles could now be level loaded, many of these problems would disappear (similar to what happened in manufacturing when setup times were dramatically reduced thereby enabling lean operations). But there was a problem—the firm needed to inform each customer if their cycles were moved, for good reason because customers needed to plan their finances. However, this notification was not necessary if the move was to be within ± 3 days from their current cycle. An optimization model found that this constrained move was sufficient to take care of the vast majority of moves that were initially thought to be necessary.

This example illustrates how stepping back and taking a broader view of the situation and collaborating across processes can have a major impact on financial service operations, something that is lacking in the current literature.

1.2.4. Long-Term Contractual Relationships Between Customers and Firms. Connected to the previous characteristic of repeat encounters is the recognition that, unlike in other services, in financial services the firm and the customer have a relatively long-term contractual arrangement. However, technology and information availability makes comparison shopping easy, resulting in easy switching between firms, and thereforehighattrition.Thislossofcustomers makesthe acquisition process very important to the continued growth and profitability of the firm. Similarly, loyalty programs (such as rewards and balance transfer programs in the credit card business) are important to stanch the bleeding. The design and execution of these programs are based on complicated processes that need to consider risks, costs, redemptions, incremental sales, scheduling and sequencing of offers, etc. Researchers in financial services operations, by not making their presence felt in these areas, are missing the boat with regard to issues that are the most important (“must do” activities) for the firm, and may be paying instead too much attention to relatively mundane and low-impact issues (“good to do” activities).

Just as the above processes aim at increasing revenue, there may be other processes that are put in place to reduce unnecessary costs. In the insurance business, for example, the claims processes may primarily revolve around a call center, which has attracted sufficient attention in the literature as we will see later. But unnecessary costs can be reduced by fraud prevention and detection, and subrogation activities (money the firm pays out but is owed to it by other carriers). Timely intervention can avoid expiry of opportunities to collect dollars owed, and more attention could be paid to even small opportunities. There is an extensive literature in risk and insurance journals on scoring for fraud prevention and detection, but leveraging that information in the claims process can benefit from an operations perspective.

Another example from the insurance industry concerns worker’s compensation claims, where the process for handling workplace injury can have long tails spanning several years before the claim is closed. The process is complicated with interactions between the worker, the employer, medical practitioners, hospitals, state authorities, and lawyers (both on the staff of the insurance firm and panel counsel, i.e., lawyers who are hired on an ad hoc basis). There are several opportunities here (Jewell 1974) to speed up the process (and speed up the workers’ return to work, which is in the insurance firm’s interest), reduce costs, detect fraud, ensure that review triggers are not overlooked, increase the utilization of staff counsel compared with panel counsel by better scheduling of appearances for hearings, etc. We are unaware of any recent operations management literature in this area.

1.2.5. Customers’ Sense of Well-Being Closely Intertwined with Services. Along with the ease of manipulating the putty at the core of the financial services process comes the responsibility of working with something that is so close to the customer’s sense of well-being and worth. Poor operations management that results in delays, quality issues, or sloppiness can and will attract regulatory scrutiny and unfavorable publicity, and will generate immediate rebukes from the customer in the form of calls, complaints, and because the account can be easily moved around, customer attrition. At least two factors make the detection of errors due to operational faults and their exposure to the clients relatively easy in financial services:

(i) the amount, frequency, and detail of communication and disclosure as required by regulation, and

(ii) the clients’ heightened propensity and incentive to check for error in something so closely linked to their livelihood and sense of security.

Because of the above, tolerance for error is significantly lower than in other industries. For example, faulty processes resulting in incorrect calculations of interest amounts in savings, mortgage loan, or credit card accounts, or in inappropriate handling of stock dividend payments, become obvious immediately after monthly statements are sent out.

The above customer service issues are distinct from the perceived quality of the performance of individual customer brokerage portfolios, retirement accounts, annuities, mutual funds, and interest accrued in retail banking. With the plethora of information available comparing a customer’s firm with others in the same space, moving an account to the competition is only a few clicks away. Eventhoughperformance may depend on the economy, the stock market, investment research, and fund manager performance, recognizing the costs (Schneider 2010) and capacity issues (the increased transactions during market turbulence, e.g.) are important operations management concerns that have received little attention.

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Emmanuel D. (Manos) Hatzakis, Suresh K. Nair, and Michael Pinedo

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