• Nadim Samna

Growth versus profitability, what's best?

Updated: Aug 12, 2019


I remember few years ago, I was arguing with a friend about Amazon’s strategy and whether it was wise to invest all its available cash flow to increase its market share. The main disagreement was about when is the right time for Jeff Bezos to cash the fruits of his success. For me, Bezos had already more money than he could ever spend, so why not pursue his strategy to make history. Last year, he passed ahead of Bill Gates as the richest man on earth and as it may seem as a coincidence Amazon delivered its first important profits in 20 years of public listing.


One of the main elements of strategy is identifying the core performance indicator. Even if balanced scorecards are widely used in today’s top management committees to appreciate the strategy success, there is always a number one key performance indicator (KPI). Strategy will be set to favor this indicator. In the corporate world, it generally falls to only two choices: either revenues or net profit. Successful companies need to perform well on both indicators; but it is not always the case. Like Amazon, Uber is a good example of a company completely driven by revenues and growth. Its value is estimated to $100 billion without generating any profits until now.


While it would be somehow twisted to deliver profits without generating any revenues, management can deliberately cut revenues by terminating less profitable products or business lines. The famous BCG matrix was exactly developed for this purpose. On the opposite, companies driven by revenues tend to focus on Sales and Marketing using the 4 P framework (Product, Price, Place, Promotion).


More than just a major financial indicator, the choice between growth and profitability to drive strategy gives a good indication about the mindset of the company’s top management. We can easily imagine that seeking growth means undertaking higher risks. It also means a higher visibility on the market trends with a very positive outlook.



Monitoring expenditures allows management to arbitrate between revenues and profits


From the top management point of view, expenditures can be divided in 3 categories:

  • Financial expenditures that must be paid such as loans interest, fiscal charges, fines

  • Operational costs to keep the business running

  • Additional investments such as new distribution channels, IT systems, additional marketing, new hires …


Out of the 3 categories, only investments can be easily steered and controlled. This is the reason why most executive committees discussions are around new investments.


"Management can define the expected level of both revenues and profits by adjusting the investments’ budget"


Growth driven companies tend to maximize their investments to boost sales, while companies seeking to increase their profits will reduce their investments to the minimum.


As both models present distinctive benefits, the successful model is probably a hybrid one that maximizes both growth and cash flows. And of course, there’s always the possibility of switching from one model to another based on the economic life cycles and the company’s own financial situation.



How does this apply to banking in Egypt?


Continuing our analysis of the banking distribution in Egypt, we wanted to identify the strategic patterns followed by banks operating in Egypt. It’s important for Stratexis to assist its clients in positioning themselves in their market. For 25 banks operating in Egypt, we compared the number of branches of each bank to their average operational profit per branch. Operational profits were calculated as the difference between operational revenues and administrative expenses extracted from the financial statements. Operational revenues are composed of interest income and commissions revenues. We prefer to use as an indicator the operational profit instead of the net profit because of its stability, particularly after the floatation of the Egyptian pound in 2016.

First, let’s present key facts about the Egyptian banking sector:

  • In 2016, profits of all banks soared by 40% compared to 2015. The first announcements for 2017 show a very solid trend of profits growth

  • 41 banks hold a commercial banking license

  • For the 25 banks under study, the administrative costs represent only 31% of operational revenues. In comparison, the costs of European banks represent up to 70% of their income in average

  • For these 25 banks, revenues per branch reach EGP46 M and revenues per employee reach EGP1.5M in average


These results demonstrate the overall good health and positive trend of the Egyptian banking market.


In the next section of our analysis, we will identify the strategy of each bank, whether it is revenues or profits driven.



Banks operating in Egypt can be categorized in 4 distinctive clusters


According to our analysis, growth driven banks tend to maximize their investments, thus to increase the size of their network. Cash driven banks will increase their productivity thus revenues per branch. The result is shown hereafter. The size of the circles represents the total operational revenues for each bank.



The National Bank of Egypt dominates the Egyptian banking market


1st cluster and 1st finding is that the National Bank of Egypt (NBE) has a really winning strategy because it has already reached the objective of maximizing revenues and profits. NBE succeeds in generating a high average operational profit per branch while continuously investing in opening new branches. Increasing its already high market share to 27%, the largest within all banks in Egypt, is the proof of its successful strategy. NBE is alone in what we can call the sweet spot. The challenge is to maintain this leadership without losing market share to other banks. The next step for NBE would be to explore the opportunity of developing new markets, for example in Africa.



Universal banks need a large network to increase their market share


The 2nd cluster includes only 4 banks demonstrating a strategy driven by revenues and market share: Banque Misr, Banque du Caire, AlexBank and Qatar National Bank (QNB). We can consider that these banks tend to focus on retail customers more than other banks, which makes them closer to becoming universal banks with equilibrated revenues streams generated by several business lines such as retail, corporate and insurance. Targeting the large unbanked population is a key objective; it will gradually shift the banking market revenues from corporate clients to retail clients. A large retail network is a must have to capture those future revenues.


Within the same group, we can clearly distinguish the group of Banque Misr, Banque du Caire and AlexBank from QNB. The first three banks are more aggressive in their strategy than QNB that seems to give more importance to profitability than its peers in this cluster. A QNB branch earn twice as much as branches of the other 3 banks.


The main challenge facing banks in this group is controlling logistics costs. They should work on streamlining their business processes and develop several models for branches to be adapted to different commercial areas (high density Vs low density, rural Vs urban, commercial zones Vs residential, etc…). All these actions will pull the average revenues per branch up to a higher level.



Niche banks target mainly corporate and high net worth individuals (HNWI) clients


The 3rd cluster, which has a strategy seeking profitability, contains 6 banks: Arab African International Bank (AAIB), Société Arabe Internationale de Banque (SAIB), HSBC, Faisal Islamic bank, commercial international bank (CIB) and National Bank of Kuwait (NBK). These banks are mainly niche players targeting specific clients’ segments: corporates for AAIB and SAIB, low income banking for Faisal and HNWI for HSBC. The main target of these banks is to increase productivity per branch, thus its profitability. As we analyzed earlier, companies driven by profits tend to minimize their investments. For example, HSBC intentionally reduced its retail network to keep its logistical costs under control, thus increased its productivity and profits per branch.


Within this cluster, we would like to highlight 2 banks: CIB and NBK. CIB has been going through a shift in its strategy for several years. After being a niche player focused on corporate clients, CIB is currently shifting towards increasing its market share of retail customers. It will be very interesting to watch the evolution of CIB and compare it to its main competitor QNB. In 2016, CIB was leading by a large margin.


"CIB generated in average 50% more profit per branch than QNB"


NBK is also a very interesting case because it was able to join the profits cluster although its revenues can be considered as very small compared to its peers in the same cluster. NBK was able to accelerate its development and make a difference with other banks, with smaller market share.


While on several indicators, banks in this group are performing extremely well –AAIB is the champion of revenues per branch and per employee- but their growth potential will be limited if they keep the same strategy. As the average revenues per branch is already high, commercial teams lack the needed capacity to launch additional commercial actions and acquire new customers. Their revenues streams could be very well saturated by existing clients’ operations. In a highly dynamic market such as Egypt, it’s important to capture the market growth to protect market share. At Stratexis, we predict that the market growth will be mainly stimulated by SME and retail clients. The more growth, the more these banks will struggle. If they keep the same strategy, they will be easily surpassed by other banks with larger networks.


Digital can be an alternative axis of investments to boost productivity, which leads to increase revenues without investing in new branches. Digital investments seem to be fully integrated in the strategy of CIB and HSBC, but it is not that obvious for other banks in this cluster.



The main message for banks driven by profits is:


"Limiting investments in new branches and in digital services will eventually lead to losing market share"


It could fine to limit investments for few years if profits are kept at an important level, but eventually customers will shift to market leaders. This behavior was proven each time market shares are overhauled. So, these banks will not only lose market share, they will begin to lose customers and consequently their profits will melt.



The experience curve is slowing the growth of smaller banks


The 4th cluster encompasses the rest of the banks. They are clearly struggling to develop their market share. Credit Agricole Egypt (CAE) is the only bank in this group making it to the Top 10 in terms of revenues with almost EGP 1B behind SAIB the 9th bank. The main challenge for these banks is to select an adapted strategy to their situation. Most banks conducted expansion programs by opening new branches to capture the market growth. An update of this analysis, once 2017 figures are released, will clearly distinguish winners and losers in the banking race.


Given the market growth driven by retail clients, winners will be those who invested the most; they will be rewarded by higher growth than other banks. Banks still focused only on corporate clients or HNWI will not be able to cope with the market growth. They will quickly reach saturation as their target clients are already banked. Either they remain satisfied by capturing a small portion of their clients’ business or they will need to be aggressive in their pricing which in return will eat their margins.


At Stratexis, we assist our clients in structuring 3 to 5 years adapted strategies. We consider several factors and indicators to determine the best solutions for our clients and to issue our recommendations. For banks in the 4th group, the main idea is to differentiate their value proposal compared to other banks by building on their strengths. A complete framework including commercial organization, marketing, business processes and corporate culture is required to ensure success.


The current market conditions make almost all banks very profitable. The median cost to income ratio stands at 36% which is considered low by international standards. In Europe it stands at 70% in average. The first results released by listed banks for 2017 (CIB and CAE) show robust growth of revenues and profits. Nevertheless, the market is evolving so quickly that some players will be forced to exit before they start losing money. This growing cash flow is an opportunity for all banks to prepare long term strategy plans that include investments in Digital and physical distribution.

Our final recommendation is to focus on improving customers experience. It is the key success factor to acquire sustainable growth. The challenge is to offer the best experience without increasing operational costs. It will require several articles to present our recommendations about this large topic :)

Author


Nadim Samna

Managing Partner


#HSBC #NationalbankofAbuDhabi #BanqueduCaire #AlexBank #commercialinternationalbank #Qatarnationalbank #NationalbankofEgypt #Distribution #NationalbankofGreece #EgyptianGulfBank #BanqueMisr #Businessdevelopment #Egypt #Emergingmarkets #Digitalbanking #AbuDhabiIslamicbank #Digital #Retailbanking #Strategy #Banking #Amazon #Microsoft #JeffBezos #Uber #NationalBankofKuwait

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