A Project Study Report on Retail Industry in Global Environment

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Financial Institutions Center

Innovation in Retail Banking
by Frances X. Frei Patrick T. Harker Larry W. Hunter 97-48-B

THE WHARTON FINANCIAL INSTITUTIONS CENTER

The Wharton Financial Institutions Center provides a multi-disciplinary research approach to the problems and opportunities facing the financial services industry in its search for competitive excellence. The Center's research focuses on the issues related to managing risk at the firm level as well as ways to improve productivity and performance. The Center fosters the development of a community of faculty, visiting scholars and Ph.D. candidates whose research interests complement and support the mission of the Center. The Center works closely with industry executives and practitioners to ensure that its research is informed by the operating realities and competitive demands facing industry participants as they pursue competitive excellence. Copies of the working papers summarized here are available from the Center. If you would like to learn more about the Center or become a member of our research community, please let us know of your interest.

Anthony M. Santomero Director

The Working Paper Series is made possible by a generous grant from the Alfred P. Sloan Foundation

Innovation in Retail Banking Revised: January 1998

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Abst ract: How does a retail bank innovate? Traditional innovation literature would suggest that organizations innovate by getting new and/or improved products to market. However, in a service, the product is the process. Thus, innovation in banking lies more in process and organizational changes than in new product development in a traditional sense. This paper reviews a multi-year research effort on innovation and efficiency in retail banking, and discusses both the means by which innovation occurs along with the factors that make one institution better than another in innovation. Implications of these results to the study of the broader service sector will be drawn as well.

Frances X. Frei is at the Simon School of Business, University of Rochester, Rochester, NY 14627, frei@mail.ssb.rochester.edu Patrick T. Harker and Larry W. Hunter are at the Financial Institutions Center, The Wharton School, University of Pennsylvania, Philadelphia, PA 19104-6366 harker@wharton.upenn.edu hunter@management.wharton.upenn.edu

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1. The Innovation Challenge in Financial Services
Financial services comprise over 4% of the Gross Domestic Product in the United States as well as employing over 5.4 million people, more than double the combined number of people employed in the manufacture of apparel, automobiles, computers, pharmaceuticals, and steel2. While impressive, these numbers belie the much larger role that this industry plays in the economy (Herring and Santomero, 1991). Financial services firms provide the payment services and

financial products that enable households and firms to participate in the broader economy. By offering vehicles for investment of savings, extension of credit, and risk management, they fuel the modern capitalistic society. While the essential functions performed by the organizations that make up the industry (the provision of payment services and facilitation of the allocation of economic resources over time and space) have remained relatively constant over the past several decades, the structure of the industry has undergone dramatic change. Liberalized domestic regulation, intensified

international competition, rapid innovations in new financial instruments, and the explosive growth in information technology fuel this change. With this change has come increasing pressure on managers and workers to dramatically improve productivity and financial performance. Competition has created a fast-paced industry where firms must change in order to survive. Nowhere is this force of change felt more strongly than in retail consumer financial services. Once the sole domain of the bank, mutual funds,...
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