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Strategic Budgeting/Forecasting Questions: Establish Appropriate Measures of Success

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The fourth entry in our 6 blog series about Strategic Budgeting/Forecasting Questions addresses measures of success, and how they should connect to the budget or forecast.

Question 4 – Are our financial measures of success handcuffing the credit union strategically?

There are many examples of appropriate and inappropriate measures of success as they relate to the budget and strategy. Some measures even come with unintended consequences. Measures should reflect, as closely as possible, what the credit union is really trying to accomplish, such as more engaged members or a profitable structure. Sometimes, measures that have existed in that past are kept as a matter of habit and simply aren’t updated in accordance with the plan.

Let’s assume that a credit union has a strategy to target members in their mid 20s to 30s to serve as a pipeline for the future. Beyond ROA and net worth, here are examples of some common measures of success:

  • Low delinquency: Choosing to target younger members is likely to come with more credit risk, so a measure of success that keeps delinquency at the same or lower levels may be in conflict with the plan. Not all younger members have higher credit risk, but focusing on low delinquency could lead the credit union to say no to the very members it is trying to attract, damaging its reputation with this group who likes to share their experiences. Setting this measure to realistic levels at the outset also helps stakeholders be more comfortable when higher delinquencies appear. It may be reasonable, in this situation, to budget a higher PLL
  • Products per member (PPM) or products per household (PPH): A strategy that aims to bring in new members is likely to reduce PPM and PPH. New members tend to have fewer products early on. An organization that is trying to increase PPM and PPH will be intent on getting existing members to do more business with the credit union, which could create little motivation to capture the target group. Consider measuring new members or households separately if measuring PPM or PPH
  • Member satisfaction/Net Promoter Score (NPS): A credit union that is successful in attracting younger members could find their overall member satisfaction or NPS dropping. Many credit unions find that, after segmenting by age, scores for younger members are much lower than for older members. Telling the organization to improve member satisfaction or NPS could work against the strategy to attract younger members. Consider measuring score trends segmented by age
  • Asset growth: Younger members usually don’t bring a lot of deposit dollars and deposit growth usually drives asset growth. If the asset growth measure requires special effort to be successful, those efforts will reasonably be focused on older members, pushing the target group to a lower priority
  • Loan growth: Similar to asset growth, younger people usually don’t bring a lot of loans to the credit union. Loan dollars borrowed per member is usually heaviest for people in their 50s. A push for loan growth will also push the target group to a lower priority

Other considerations to keep in mind when setting measures of success:

  • Member growth: When measuring the number of new members, remember that it’s easy to grow $5 member accounts, so consider whether that’s really success when setting measures for this strategy
  • Member growth and indirect lending: Growth in indirect lending could increase membership in the target group, but is that a good thing? Indirect members often have a single product (an indirect loan) and it is commonly acknowledged that it is difficult to convert those members to “real” members who use other credit union products. Including these members in member growth measures could show an uptick while failing the strategy of filling the pipeline. Consider measuring members that come from the indirect lending channel separately from direct members
  • Member growth and PPM/PPH loopholes: By not purging inactive members, growth will look better. At the same time, purging inactive members can make PPM and PPH increase without accomplishing anything. Consider adding caveats to measures that can be easily improved without actually getting any closer to the strategy
  • Member engagement: Don’t just focus on products when evaluating engagement; consider services, especially those from other areas of the credit union, such as insurance or wealth management

Assuming the budget reflects the strategic initiatives, which we discussed in the second blog in this series, stakeholders should view the measures of success through the lens of the budget. If it’s not clear how the budget leads to the measures, or if the measures are in conflict with the budget or the strategy, stakeholders should be asking questions. The goal is for everyone to emerge from the budgeting and strategic planning processes with a realistic view of what success looks like.

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Strategic Budgeting/Forecasting Questions: Consider Key Forces

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This is the third entry in our 6 blog series about Strategic Budgeting/Forecasting Questions.

Question 3 – What key forces could impact our forecast?

Every good forecast should have a sound rationale and basis for the assumptions. If the current forecasting approach involves simply taking last year’s growth rates and assuming they continue, that will not be good enough going forward. A better approach is to identify key forces that could impact the budget/forecast and use this discussion as the rationale for the forecast assumptions.

It is important to understand that both internal and external forces have the ability to impact the forecast. Internal forces are largely driven by the strategic plan and initiatives set forth by the credit union, as well as the ability to execute (see the first and second blogs in this series for more).

Then there are external forces that have the ability to act as headwinds, which put pressure on the strategy, or tailwinds, which help move the strategy forward. The focus here will be on external forces. What is going on in the world around the credit union that could impact the forecast?

Start by getting decision-makers into a room and brainstorming different external forces that could impact the forecast. The list of forces can be quite extensive, so go through a process of prioritization. Group the ideas into two separate categories, headwinds and tailwinds as seen in the table below.

External Forces

The value is always in the discussion.  Take the top headwinds and tailwinds, study recent trends, and use this business intelligence to inform your forecast assumptions.  Take the potential auto sales headwind as an example.

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Source: macrotrends

Study historical data and discuss as a group. Auto sales have accelerated from 2010 to 2016. More recently, they have slowed. This trend should be incorporated into the forecast, especially on how it might impact the credit union’s strategic initiatives.

What about real estate? Are home values a key force that could impact your real estate lending and ultimately the forecast? Using the S&P CoreLogic Case-Shiller or another market source, decision-makers can understand what property values are doing in the area. If your area has experienced price increases well above national averages and prices are now above previous peaks, maybe that leads the group to assuming a slight decrease in new volume.

The combination of identifying key external forces, studying history, and having a discussion will better inform the forecast. Continue to use the what-if capabilities of your forecasting model to stress test the financial impact of changes in key market forces. Following this process will help decision-makers understand how external forces can impact the financial direction of strategic initiatives.

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Strategic Budgeting/Forecasting Questions: Connect Strategic Initiatives with Financial Direction

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Strategic initiatives impact results – members may be better served and membership may grow, assets may grow, and earnings and net worth may increase. Some strategies may cause temporary or long-term reductions in membership, assets, earnings, or net worth. Budgets and forecasts should incorporate the anticipated impacts of strategic initiatives and establish common expectations for results. Connecting the dots to better understand the financial implications of strategic initiatives can lead to greater success.

In this and subsequent blogs, we will review 6 questions strategic boards can discuss during the budgeting and forecasting process to better connect the dots. These 6 questions are merely a starting point and will undoubtedly lead to more questions during the process, creating more thorough communication and a greater understanding of strategic plans.

Question 1 – What is the expected financial direction of each strategic initiative?

Begin with a simple, high-level assessment of strategic initiatives. Identify each strategic initiative with a short description. Then, consider what you believe will be the earnings impact next year and in the following years. For this exercise don’t focus on the numbers, just consider the direction of the impact. Draw a quick table or use a spreadsheet as follows:

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Consider that not all strategic initiatives will generate increases to earnings. The important point is to understand why. Some initiatives may hurt earnings in the short term to achieve longer-term improvements, while others might only reduce earnings. For example, a strategy might be to increase member giveback through reduced overdraft fees or installing additional ATMs for improved member access.

In this example, initiative #1 is to become the lending machine – perhaps to make the process more efficient and create capacity – or to generate more loans for the credit union. This initiative may include a project to implement new technology or acquire talent. In Year 1, the project is expected to incur costs that would reduce earnings, or the ROA. We indicate that in the chart with a downward arrow. By Year 2, however, we expect to see some additional loans or experience cost savings that would improve ROA. We show that with an upward arrow.

Continue to complete the chart.

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In Year 3 and beyond, the impact to ROA of the lending machine strategic initiative is expected to continuously increase.  We can use multiple arrows to show the additional impact expected.

For strategic initiative #2, to decrease account opening time, there’s no hard dollar costs in Year 1 as the credit union conducts an internal review and designs process improvements.  In Year 2 and beyond, the efficiencies are expected to lower costs and drive some additional new accounts, thereby increasing ROA.

Beyond looking at each strategic initiative, notice that now the aggregate expected impact of all initiatives can begin to be understood.  If all or a significant number of initiatives have negative ROA impacts, that can be an indication of needing to consider other, offsetting strategies to generate additional revenue.  Or, it may make sense to accept lower earnings for some period.  That would be important to recognize and to make sure that everyone, including the board and management, is on the same page with the expectation so there are no surprises.

After completing this exercise, board members and management can be better prepared to review the budget with a high-level expectation for how it may look.  If projections don’t align with expectations, more “why” questions can be asked and differences understood.  As financial results occur and new budgets are created, this can be a great tool to keep as a reference.  Strategic initiatives can be reassessed for what was originally expected versus what actually happened, and to determine what changed and why.

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The Strategic Plan is Only the Beginning

This is the time of year when many credit unions are putting a bow on strategic and financial plans while breathing a big sigh of relief. Do we have a realistic strategic plan that leads to desired financial performance? Check! Is the budget aligned with the strategic plan? Check! Now the fun begins.

“Plans are only good intentions unless they immediately degenerate into hard work.” —Peter F. Drucker

One of the biggest enemies to well-executed strategic initiatives is normal day-to-day activities. For management this can mean daily firefighting, handling immediate and pressing issues before working on longer-term commitments. For board it often takes the form of spending precious board meeting time reviewing financials and operational issues, leaving little time to address strategy.

To combat this, consider including the following elements in execution plans:

  • Invest the time in making detailed execution plans that include timelines, responsible parties and work estimates.
  • Make a realistic assessment of whether the people responsible for executing strategic initiatives have the necessary time and resources. Reprioritize and reassign duties as required.
  • Build regular check-ins into the plans. This should include reporting on progress as well as budget to actual comparisons for both dollars and hours. For the board, the check-ins might be quarterly with high level progress and budget updates. For management, the check-ins should be more detailed.

Strategic initiatives represent the organization’s highest priorities. Appropriate tracking and follow-up are key to their effective execution and, ultimately, moving the credit union toward its strategic goals.

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Corporate Shuffle: Questions To Ask When Searching For Alternative Providers

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Many credit unions rely on the corporate credit union system for mission-critical functions; however, changes in the corporate system are imminent.

Alternative providers could possibly include other corporates, newly formed CUSOs, the Federal Reserve, large banks and publicly held companies.  It is important to objectively evaluate each on their real merits.

Following are just a few questions you may want to consider:

  • What are the three top decision drivers for evaluating various service providers?
  • What are potential threats to your credit union’s business model?  (e.g., if your credit union has high loan demand and your corporate provided a line of credit, what are alternatives?
  • What strategic initiatives are you willing to forego during this service conversion?
  • What will be the hard-dollar cost of the conversion?  Have you budgeted for it?
  • Will the shift be transparent or nearly transparent to members?

Invest the appropriate time to create an RFP that details your requirements and rank them in importance with a weighting system, such as a scale of 1 to 10.  A few examples of requirements you may consider weighting include:

  • Necessity of investing upfront capital to receive services
  • Cost to process ACH transactions
  • At least __ years of previous demonstrated financial strength