The Royal Bank of Scotland How do you evaluate the relationship between the corporate centre of RBS and its businesses (

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The Royal Bank of Scotland
How do you evaluate the relationship between the corporate
centre of RBS and its businesses (Parental role)?
Please use this text: The Royal Bank of Scotland Group is now
one of Europe’s leading financial services groups and has a
diversified range of businesses serving personal, business and
corporate customers. It ranks first in Corporate Banking, first in
Private Banking, first in Offshore Banking and second in Retail
Banking in the United Kingdom. Turning to The Royal Bank of
Scotland, we do not want our objectives to become boundaries. Nor
do we believe that we can predict future changes in the
environment. We do not have a Group Vision, in terms of a few
simple words. Our Group objectives cannot be set down in terms of
market shares or financial profits. Our objective is to
continuously create an institution that is capable of delivering
ongoing shareholder value – and as such will be capable of
surviving and prospering, no matter what the future brings.
Corporate strategy must be built around the constant creation of
options for future growth. These strategic options will enable us
to manage across boundaries, and avoid us creating boundaries for
ourselves. Firstly, corporate banking. We have maintained a balance
between retail banking and corporate banking. Not so long ago, it
was suggested that disintermediation by non-banks would lead to a
significant decline in corporate banking. The stock market’s clear
preference for retail banking was shown by the higher
price/earnings ratios on retail banks, which only recently
reversed. We expanded our commitment to corporate banking by
developing a number of specialist corporate banking businesses,
such as acquisi- tion finance, structured finance and sophisticated
treasury products, to augment our core services in payments,
lending and treasury. Our commitment to corporate banking, while
some other banks were becoming more cautious, was one principal
reason for the strong growth in our profits. More recently, the
stock market has become worried about erosion of margins in
personal banking, because of intense competition between existing
players and new entrants, including Internet banks. While we are
still committed to retail banking, we are glad to have a strong
corporate bank. Indeed, without it, we would not have had the
necessary competences and potential synergies to bid for NatWest.
Secondly, retail banking. In retail banking, we have created
strategic options by offering personal financial services under
various brands, including our own brands The Royal Bank of Scotland
and Direct Line, and joint venture brands Tesco Personal Finance
and Virgin Direct Personal Finance; and through various channels:
branches, phone and Internet. This approach has enabled us to
appeal to various customer groups, and to offer product variants
appropriate to the different brands and channels. It gives us
considerable flexibility for the future: we are able to respond
quickly to changing customer needs. Initially, our multi-brand,
multiple channel strategy was not particularly well received by the
City or even by our own staff. City analysts asked why we did not
save costs by combining our retail offerings and our staff asked
why we allowed our various retail businesses to compete with each
other. However, the strategy has proved successful. Between 1992
and 1999 we grew our UK personal customer base from 4 million to 8
million. Thirdly, Europe. Our approach to Europe was an even more
conscious application of strategic options. As a relatively small
bank, at the edge of Europe, we recognised that it would be
difficult to participate in Europe, as things were. But we saw the
importance of European convergence, and wished to retain the option
to participate, if at some stage it seemed appropriate for us to do
so. In 1988, we formed a strategic alliance with Banco Santander –
now BSCH, one of the largest banks in Europe. We took
cross-shareholdings and co-operated on some successful joint
ventures, and have met regularly to exchange experiences, plans and
ideas. This alliance has contributed substantial value to both
partners. The stock market could never understand why we placed so
much importance on this relationship, perhaps because many of its
true benefits are not tangible. However, the NatWest transaction
could not have been carried without both BSCH’s goodwill and £1.7
billion investment in us. To my mind, our alliance with Banco
Santander is a straightforward example of a low-cost strategic
option which has created significant shareholder value. In the
integration of the two banks, we have combined RBS and NatWest
units in a series of customer- facing divisions: Retail Banking,
Corporate Banking and Financial Markets, Wealth Management, and so
on. And we have established a central Manufacturing division, which
supports all our UK banking activities. This approach enables us to
accelerate the integration, with minimum impact on customers.
However, it also gives us important strategic options for the
future: l It enables each of our businesses to have its own
appropriate culture – appropriate for its customers, and
appropriate for its competitive environment. l It enables us to
respond quickly and easily to changing customer requirements and
market developments. l It enables us to maximise efficiency in our
manufacturing activities – and to consider outsourcing or
insourcing of manufacturing activities, where appropriate. l It
positions us well for joint ventures and acquisitions, if and when
opportunities arise. The acquisition of NatWest will also bring
many benefits for our shareholders, customers and staff. In the
first place, as a result of combining market shares, the combined
group will have a very strong position across its core businesses
in UK retail banking, corporate banking and treasury. There will
also be a degree of added synergistic diversification in banking
businesses. For example, we now own Coutts, the leading private
bank in the UK, and Ulster Bank, which is the number two bank in
Northern Ireland and number three in the Republic of Ireland.
However, we sold a number of businesses, such as Gartmore, the fund
managers, which were not core to us and which we believed would be
worth more to ‘better owners’. Secondly, the transaction will make
possible substantial cost savings and income benefits. In our bid
document last year, we promised £1.2 billion per annum cost savings
over three years, the largest part coming from the elimination of
duplication in central functions, processing and technology. We
also promised £390 million per annum income benefits – and we said
we thought we could do better than this. We were always more
excited about the long-term income opportunities than the one-off
cost savings. We continue to feel optimistic about achieving these
targets. The synergy benefits I mentioned may seem large – but
because of the similarity between the two groups across retail
banking and corporate banking, this transaction can deliver more
de-duplication cost savings and more overall synergies than any
other combination of banks in the UK. For example, Barclays, in
buying the Woolwich, is promis- ing synergies of only about £200
million per annum. Diversification, cost savings and revenue growth
are also obvious ways in which to increase shareholder value. But
we also saw an opportunity to create additional value in future
through having enhanced strategic options. We always saw the bid as
creating a company with a wealth of future choices and options. I
could list a number of areas in which the enlarged group has
enhanced strategic options, but I shall mention just two: l
Acquisitions: The larger group will be more able than either the
Royal Bank or NatWest alone to create value through further
acquisitions, through both financial muscle and ability to achieve
synergies across a variety of activities. l Europe: Now that the
Royal Bank and BSCH are two of the largest banks in Europe, we
obviously have increased potential to do things there together. The
acquisition of NatWest has enabled us to cross an important
boundary of size. A year ago our market capitalisation was about
£12 billion and our annual profit before tax was around £1.2
billion. We had many good ideas for growing our business, but were
sometimes frustrated that we could not implement them – usually
because, although they would create value over a period, they would
reduce our profits too much in the short term. Following the
acquisition of NatWest, our market capitalisation is now £36
billion. We are the second largest bank in the UK. Only HSBC is
larger. From the particular to the general Now, moving from the
particular to the general, the examples which I discussed of the
benefits RBSG gained from the acquisition of NatWest illustrate
where, for any Group, strategic opportunities fit into a hierarchy
of value-creating opportunities. l At the bottom of the hierarchy,
we have diversification – aimed at improving the quality of the
Group’s earnings – that is, reducing their volatility.
Diversification will not by itself add to earnings growth – it will
produce the weighted average of the growth rates of the two
diversified activities. And diversification should not be a reason
for retaining businesses which could be sold to a ‘better owner’. l
Next, there is the opportunity to improve earnings growth by
creating value through synergies between the two diversified
activities – for example, by selling the products of one business
to the customers of the other. l Then there could be maximisation
of the synergies. In this case, the Group would be the best owner,
or best parent, of its subsidiaries: they would clearly be worth
more to the Group than to any other owner. l Lastly, at the top of
the hierarchy, there would be the creation of strategic options.
For example, ownership by the Group of the two subsidiary
businesses might put it in a uniquely competitive position to make
further acquisitions in the future – this value does not appear in
the analysts’ spreadsheets. We believe that an organisation capable
of creating long-term value is not an end point but a dynamic which
can only be achieved through constant renewal. Because of this, a
corporate strategy of creating ongoing shareholder value through
the continuous creation of strategic options brings its own chal-
lenges for the business – there is no one goal – no one end point –
it is a continuous journey – there is no ultimate arrival – goals
such as the achievement of market shares or financial returns are
temporary and subordinate goals – contributing to the delivery of
shareholder value, but they are only the means to an end – the true
objective. Obviously shareholder value depends on the stock market.
We are competing for investors’ funds. Nowadays this is almost
entirely decided by the investors’ views of your prospects for
growth – growth is the god – the holy grail. So for an organisation
to create ongoing shareholder value, investors must perceive and
continue to perceive that the business has growth opportunities.
They must believe that the organisation has a growth culture and
has the ability to keep creating – on an ongoing basis –
opportunities for growth. In time, a single focused strategy must
run up against market limits or indeed regulatory limits and
competition problems unless the stock market sees the market for
your product as infinite – as they would currently appear to
believe of some technology companies. Companies with a single focus
do not, in general, last as independent entities – unless they are
very large whereupon they may continue but create little
shareholder value. It is only the ongoing creation of strategic
options that can ensure that opportunities for growth will continue
to emerge. I have mentioned the difficulty of communicating an
option-creating strategy to a market which has, in the past, put a
higher value on focus and clarity. Potential cost-cutting was
valued above potential income growth, because it was more tangible.
There seems to be an assumed incompatibility between focus on
implementation excellence and a strategy of option creation, rather
than a recognition of their mutual necessity for long-term
survival. I believe some of this follows from the difficulty in
valuing future choices and that this presents a challenge to the
management theorists that are here today. I am aware of the work
that has been recently done on real options and I think that if a
method making the value of strategic options more accessible to the
market could be developed it could be a significant contribution to
communicating value. Although it is clearly difficult to develop a
model for the valu- ation of strategic options, the City may now be
showing greater recognition of them than I would have expected, in
the valuation of shares in UK banks. There has been concern about
increased competition in retail banking, partly because of the
Internet, but there has been greater awareness of the ongoing
opportunities in corporate banking. Over the period from the
beginning of 1999 until 12 September 2000, the share prices of the
large commercial banks, The Royal Bank of Scotland and Barclays,
have both risen by over 30 per cent. The share prices of the retail
banks – the converted building societies, Halifax and Abbey
National – have fallen by more than 30 per cent. And Lloyds TSB,
which is much more retail than corporate, has declined by 28 per
cent. The stock market does seem to be showing some recognition of
the value of strategic options.