Benchmarking and the WildebeestProblem

When you are crafting a strategy, there is value in knowing what your peers are doing. There's also a danger. When your CEO wants an agentic AI strategy, your CFO wants numbers (preferably small ones for the costs and big ones for the savings), and your CISO is wringing her hands and muttering about data exfiltration, it can seem like the fast, safe move is to run a benchmarking exercise.

Without careful thought, benchmarking starts to look like a herd of wildebeest crossing a river during the Great Migration. They clump together and run as quickly as they can. Inevitably, an unseen crocodile surfaces, and one a wildebeest the side or rear of the pack becomes lunch. In the world of the wildebeest, clumping is a good strategy. Staying near the center of the moving herd greatly improves your odds of survival.

Businesses, however, are not wildebeest. If you use a benchmarking exercise to understand not only what each of your competitors is doing, but why, you can uncover valuable insights.

Unfortunately, it's easy to fall into the habit of looking at the industry average for some metric and aiming for outcomes that produce it (or a little better). You're thoughtlessly trying to steer toward the center of the herd. Unfortunately, it's not likely to work.You're setting yourself up to compete against firms that are staking out competitive positions based on their unique strengths. When you make those kinds of choices, you become the crocodile bait.

Following the Herd: Chevy Chase Bank

For many years, Chevy Chase Bank was among the leading bank in the mid-Atlantic. It followed the standard playbook for successful regional banks: build out a strong branch network, offer attentive service, and engage with the local community.

Then came the early 2000s.

The housing boom began to ramp up across the nation. Peers like WAMU, Countrywide, and IndyMac grew rapidly by moving into mortgage origination on a national scale. In the competition for the new, larger pool of customers, they developed increasingly exotic (and risky) financing products and expanded their customer profile to less qualified borrowers. Chevy Chase, in classic wildebeest style, copied their every move.

By late 2007, the mortgage backed security crisis was beginning to unfold. The short term customer acquisition wins were turning into major balance sheet strain. Ratings agencies began to downgrade their debt. The wildebeest had drifted to the edge of the herd.

Enter the Crocodile: Capital One

Two decades earlier, in 1987, Richard Fairbank and Nigel Morris had an idea that was the opposite of herd-following behavior. They reasoned that a credit card issuer could achieve outsize growth and profits if it could customize credit terms for different customer segments.Doing that would require analytical horsepower that banks did not have during those days. In short order, they came up with a credible plan, but they needed a bank to put the plan into action. After shopping the idea around, they signed a deal with Signet Bank in Richmond, VA to start a separate division focused only on credit cards.

The experiment worked. It worked so well, that in 1994, Signet Financial was spun out as a separate company. It went public as Capital One Financial Services. The new firm flourished by staying ruthlessly focused on its own advantage: data, analytics, and disciplined risk segmentation.

Around 2005, Fairbank realized thatCapital One had a problem. Being a single line financial services company was great for focus, but it came with a higher cost of capital than traditional banks. Consumer finance companies raise funds by selling asset backed securities collateralized by their loan portfolio. Traditional banks raise funds for lending mostly by offering very low interest deposit accounts. TheABS approach typically costs 200-300 basis points more than the deposit approach. A benchmarking exercise would have shown that their cost of capital was inline with other consumer finance companies, and led to the conclusion that higher cost of capital was simply the cost of focus.

Instead, good strategic analysis led them to the conclusion that the best option for Capital One's particular strengths and weaknesses was to become a bank. At the time, applying for a new bank charter at the time was a time consuming process with an uncertain chance of success. Capital One needed deposits quickly. So, Fairbank went shopping for a bank. Hibernia Bank was the first acquisition. North Fork Bank followed in 2006.

By 2008, the global financial crisis was in full swing. The federal government was offering incentives for strong banks to purchase weak banks. As a result, Capital One was able to purchase Chevy Chase for less than the tax incentive they got for doing it. The crocodile enjoyed its meal.

Conclusion: From Following the Herdt o Leading the Pack

Not all instances of benchmarking gone wrong have the drama of the Chevy Chase story. Benchmarking done thoughtlessly is more likely to lead to sustained underperformance compared to your capabilities than to an existential threat.

In Playing to Win, A.G. Lafley recounts the moment where Jon Moeller, Proctor & Gamble's CFO at the time, realized that their approach to benchmarking was holding them back. They had always benchmarked themselves against competitors on a straight mathematical basis to see if their overhead was in line with industry norms. One day, Moeller realized they were asking the wrong question. P&G was making intentional choices to maximize advantages that come from scale (for example, negotiating with large retail buyers, negotiating ad buy rates, and so on).Their efficiency should have been higher than their competitors almost by default.

Moeller didn't abandon the notion of benchmarking. He chose to do it in a thoughtful way, by analyzing and modeling how their scale advantage should show up as cost savings in processes across the business. At the time Lafley wrote his book, the initiative was showing success, but Moeller still felt there was room for improvement.

It's wise to know what your competitors are doing. It's foolish to copy it outright, or even to assume that you should score yourself against the exact metrics that they use to measure their success. Find the metrics that indicate whether that your strategy is working and keep your focus on driving those metrics.

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