IT failure contributes to UK bank collapse

A failed business strategy involving a large IT blunder contributed to the collapse of Scotland's largest customer-owned lender, the Dunfermline Building Society. As a result, the Society is writing off a £9.5 million IT loss, despite total profit for the year of only £11 million.

The UK government will pay Nationwide Building Society 1.6 billion pounds ($2.3 billion) in cash to purchase the troubled bank.

The Financial Times reports:

Jim Murphy, Scotland secretary, said the previous management had made "reckless decisions" because of its over-exposure to commercial loans, involvement in the subprime market and unfortunate decisions on technology. Dunfermline was forced to make a £9.5m write-off on last year's £11m profits because of a failed IT system.

Finextra reports that the company lost focus by attempting to establish a software business selling mortgage-processing systems to other banks:

The company poured £31 million into the loss making Dunfermline Solutions unit, which was set up to develop a mortgage IT system that could then be sold to other financial institutions.

Scottish newspaper, The Herald, describes the misguided business strategy behind this software solutions endeavor:

One expert, who has been involved in advising building societies on their accounts for the past 15 years, told The Herald this week: "The Dunfermline was never a particularly profitable organization. The IT loss was pretty huge compared with the size of their profits - so their buffer against further losses is not as good as it could be."

He went on: "They have a good brand, healthy margins on their residential lending, but venturing into anything beyond housing association finance risks losses on property development type loans. It is easy to grow your balance sheet by lending to property developers, but it is quite unusual for that size of institution. If you are anything less than a £10bn society, the solution is not to get involved in anything other than simple basic commercial loans."

THE IT FAILURES ANALYSIS

Dunfermline made several key strategic blunders with respect to this project:

• Selecting a software vendor's unproven product for a mission critical application
• Paying insufficient attention to substantial project risks
• Relying on the promise of customization to backfill functionality gaps in the off-the-shelf software
• Most significantly, becoming distracted away from the organization's core banking business by attempting to convert itself into a specialized software vendor

Unproven software. Despite the scale and strategic importance of Dunfermline's project, the organization selected unproven banking software from Temenos, which may have contributed to the failure. Market analysts, TechMarketView, came upon a 2004 article in the International Banking Systems Journal, describing risks associated with Dunfermline's implementation:

While Darlington [another UK bank society] has opted for a tried and tested solution, Dunfermline Building Society is doing the opposite, having signed for Temenos’ Globus at the end of 2002. This will be the first UK building society to use the system, but the Dunfermline is confident of its applicability, to the extent that it has created a subsidiary company with the intention of marketing the system on an outsource basis to other societies once it is live.

As a development partner hoping to sell the processing services to other societies, the Dunfermline is probably bound to put a positive spin on things, but the flip-side of this is that it is unlikely to have opted for such a project were it not confident of a successful outcome. While there may be more risk attached to this implementation than to that of the Darlington, the Dunfermline may also have potentially more to gain.

Insufficient attention to project risk. An interview with Dunfermline's director of operations, published in the Temenos corporate newsletter, suggests the bank recognized it was taking substantial risk implementing unproven software for this strategic project. This is a rather extraordinary admission, especially in light of the current failure:

The strategic review brought significant changes for the Dunfermline. ‘I would liken it to starting a brand new company with radical changes made to the way we were doing business, including among other things, the adoption of new software. The Society was using a number of in-house systems, with an additional element from Unisys. The review of our IT solutions showed that they couldn’t do everything we needed. We had the business aspirations, but we didn’t have the solution to support our values,’ says [director of operations] Stewart Cooper.

[W]e selected TEMENOS, despite its lack of users in the building society market. Was this a risky decision? We accepted that the selection of any software partner incurs risks. Additionally, we were concerned about the lack of local market knowledge and potential implementation risks, combined with the prospect of being the only UK customer in this market.

Customizing packaged software. Customizing software creates complexity and adds cost to any software project. In addition, adding customizations to standard, off-the-shelf software increases risk, cost, and time during future upgrades. In general, this is a dangerous strategy. The Temenos newsletter describes Dunfermlin's cavalier attitude toward these risks:

To sum it up, we felt that TEMENOS had the best software solution and, in the areas where functionality was missing, it could be developed in partnership to do what we wanted.

Strategic business distraction. Fundamentally, a misguided business strategy guided this poorly conceived project. The Temenos newsletter again offers insight into Dunfermlin's poor judgment as it tried to diversify from banking into becoming software vendor:

[W]e have set up a subsidiary company, Dunfermline Solutions, to enable us to offer the product on an outsource basis. There is clearly nothing in the UK marketplace that can match the system and there is a clear opportunity to offer the product and to provide administration of back office services

My take. In the 200r Temenos newsletter, Dunfermline summarized its view of the project:

In any project you have risks but, provided you identify them and manage them, the project will be successful. We have a major project that covers system and organizational change and a ‘new’ company! At times this has been a roller coaster ride, but we identified the risks and we managed them and I don’t regret it in any way.

Obviously, Dunfermline substantially underestimated the large risks associated with its extravagant business strategy and this mismanaged IT project. This story reminds that human hubris, even among sophisticated men and women, knows no bounds.

[Warm thanks to ZDNet colleague, Dennis Howlett, for bringing this case to my attention. I'm always grateful for anonymous or attributed failure submissions. Image from iStockphoto.]