Building the Credit Union of the Future Steve Heusuk, Corp. Strategy & Bus. Dev. New Ideas Conference October 10, 2

1. Building the Credit Unionof the FutureSteve Heusuk, Corp. Strategy & Bus. Dev. New Ideas ConferenceOctober 10, 2012

2. First the Good News • The CU system has experienced recent performance gains: • ROA increased to 84 bps at Q2 2012 • Strong member growth (to 95.3M total) • Average net worth = 10.1% • Growing sense the system has “weathered the storm” • However, improvement has not been universal: • 50% of all CUs had negative member growth over past 12 months • 26% of all CUs had negative ROA at 6/30/12

3. Now the Challenges • Despite gains, longer term challenges remain: • Regulatory burden • Renewed spread compression • Caps on fee income • Competitive pressures • Rising operating expenses to fund channel proliferation • Macro-economic threats

4. Our Agenda • Does the CU system need a new strategy? A new business model? • Or is the current model robust enough to survive and thrive for a generation or longer? • Approach: Use the framework of strategic inflection points: • What is a “strategic inflection point”? • Is the CU system at a strategic inflection point? • How can we manage through a strategic inflection point?

5. Strategic Inflection Points • Andy Grove, Chairman of Intel, calls a major shift in an industry’s competitive dynamic a “strategic inflection point” • Others use different names: • “Strategic crossroad” • “Tipping point” • “Critical juncture” • The meaning is the same: The old way of doing business must give way to the new in order to survive

6. Andy Grove on Strategic Inflection Points “A strategic inflection point is when the balance of forces shifts from the old ways of competing, to the new….It is a point where the curve has subtly but profoundly changed, never to change back again.”

7. The Inflection Curve Business goes on to newer heights Inflection Point Business declines Source: Only the Paranoid Survive, Andrew S. Grove, 1996

8. What Causes a Strategic Inflection Point? • Michael Porter: Six forces determine the competitive well-being of any business: • Existing competitors • Suppliers • Customers • Potential competitors • Substitution (i.e. your product/service being built/delivered in a different way) • Regulation • Andy Grove says when any one of these factors undergoes radical change, “all bets are off” • This is the cause of a strategic inflection point

9. Section I Case Studies

10. How Fast Can an Industry Change? • Four case studies: • Music • DVD rentals • Photography • Books

11. Sony introduces Walkman 7/1979 Apple introduces iPod 10/2001 Tower Records Liquidated 8/2006 Music: Wave After Wave of Disruptive Technologies Source: “Publishing in the Digital Era”, Bain & Co., Jan. 2011

12. Case Study: Demise of the Music Industry • A unique strategic inflection point occurred in the music industry on July 15, 2000: • Location: Sun Valley, Idaho • Players present: • Hank Barry CEO, Napster • Edgar Bronfman, Jr. CEO, Universal Studios • Nobuyuki Idei CEO, Sony Corp. • Thomas Middelhof CEO, Bertelsmann • The offer: Hank Barry put $1 billion on the table to convince the music studios to enter into a legal music file-sharing agreement. • The outcome: No deal.

13. Perspectives on the Music Industry’s Decline “The record companies needed to jump off a cliff, and they couldn’t bring themselves to jump.” - Hilary Rosen, CEO, RIAA “We have to collectively understand that times have changed.” - Lyor Cohen, CEO, Warner Music Group

14. Demise of Brick and Mortar DVD Rentals “When the inefficiencies of having retail locations, moving physical inventory, and maintaining overhead/staff are cut out of the ecosystem, far less revenue is needed to support the system.” Dr. Augustine Fou Center for Management Development Rutgers University Source: “Netflix vs Blockbuster – Perfect example of an industry replaced by a more efficient version of itself”, go-Digital Blog, 2/22/2011

15. Digital Photography: 10 Years to Replace Film Source: futuresource consulting

16. The Demise of Eastman Kodak “Kodak first pioneered digital technologies in the 1970s and 1980s but, until relatively recently, the urgency of the challenge was never quite sharp enough to persuade its employees, investors and executives that it had to overhaul – or even sacrifice – time-honored ways of doing business.” - Financial Times, April 4, 2012

17. eBooks Dominate the Book Business Source: “The Incredible Growth Of Amazon's Kindle Book Sales”, businessinsider.com, 9/29/2011

18. Amazon vs. Brick and Mortar Book Stores Source: “Amazon, Barnes & Noble and Book Store Sales Numbers Annual Update“, Foner Books

19. What Can We Learn? • In each case the primary product or content could be digitized • Can money be digitized? • What does your credit union do that cannot be digitized?

20. Section II Is the Credit Union System At a Strategic Inflection Point?

21. Andy Grove on Strategic Inflection Points “Strategic inflection points are not limited to the high-tech industry, nor are they something that only happens to the other guy…..It is at such times of fundamental change that the cliché ‘adapt or die’ takes on its true meaning.”

22. Are We at a Strategic Inflection Point? • Today we will focus on three of the six competitive factors: • Customers • Existing competitors • Potential competitors • How rapidly these are changing? • Where are the opportunities? • Where are the threats?

23. Convergence - 2012 ISIS Mobile Wallet Alt. Payment Providers Walmart Giants MCX Mobile Wallet Retailers (e.g., Target Debit) Mobile Networks Apple / Google Mobile Wallets Starbucks / Square Alliance

24. Sources of Non-Interest Income in 2010 (Large CUs) Source: National Credit Union Roundtable Business Outlook Survey, March 2011 Note: Above results summarize respondents’ evaluations of their own credit union.

25. Typical Credit Card Transaction Source: United States Government Accountability Office

26. $ $ $ Typical ACH Debit Transaction ACH Operators Originating DFI Receiving DFI Merchant Customer Account Source: “Understanding The Ach Network: An Ach Primer”, NACHA, CUNA Mutual Group analysis

27. Target’s Push into Payments • Linked to Checking Account • 5% Off & Up to $40 Cash withdrawal • Free shipping for purchases made on Target.com • “Take Charge of Education” donations to school of choice • Target Pharmacy® Rewards – additional 5% off after 5 prescriptions Source: Target.com

28. Retailer Benefits of Decoupled Debit Cards • Eliminates interchange fees • Builds loyalty • Offers merchant-designed promotions • Drives more store sales • Enables targeting of specific customer segments • Leverages ‘spend information’ Source: Finventures Blog

29. REDcard Increases Engagement • REDcard customers compared to non-REDcard customers: • Shop Target 21 times more per year • Shop 2.5 more departments per week REDcard Debit: Share of New Card Accounts: 67% Incremental spend lift: +52% REDcard Credit: Share of New Card Accounts: 33% Incremental spend lift: +57% Source: Target presentation at ISI Group Inc. Retail Summit, 4/17/12

30. How Do Payments Support Target’s Mission? • “The full integration of our financial services operation and core retail business helps ensure that we’re focusing our efforts on financial products that deliver the most value for our guests and the company.” • -Terry Scully, President, Financial and Retail Services, Target

31. Target and Other Retailers Announce New Mobile Wallet Source: MCX.com

32. Technologies for Making Mobile Payments Payments Apps NFC – Near Field Communications QR Codes / Bar Codes P2P Online / In-Store SMS Text Messages NFC – P2P Mobile Browser

33. Mobile Payments – Select Competitors

34. Channel Shifts: Forecast to 2015

35. Teller Transactions: Volume Declining – Costs Rising

36. Coastal FCU Leads Branch Transformation Source: Banks Join the Do-It-Yourself Craze, Wall Street Journal, 5/15/12

37. CUNA Mutual’s Smartphone Loan Program

38. Section III How Do We Manage Through A Strategic Inflection Point?

39. Making Strategic Choices • Strategy is iterative - strategies of the past may not work in the future • Complacency is not an option • Strategy is about making choices: • What are the prerequisites to compete (i.e. table stakes)? • Where will you invest to excel and differentiate? • What will you choose to not do? • Von Clausewitz: “He who defends all borders defends none.”

40. The Role Of Strategy Vision Values Mission Objectives Strategy Action Plan Measurement Controls Iteration

41. The Cooperative Principles • Voluntary, open membership:Open to all without gender, social, racial, political, or religious discrimination. • Democratic member control:One member, one vote. • Member economic participation:Members contribute equitably to, and democratically control, the capital of the cooperative. The economic benefits are returned to the members, reinvested in the co-op, or used to provide member services. • Autonomy and independence:Cooperatives are autonomous, self-help organizations controlled by their members. • Education, training and information:Cooperatives provide education and training for members so they can contribute effectively to the development of their cooperatives. • Cooperation among cooperatives:Cooperatives serve their members and strengthen the cooperative movement by working together through local, regional, national and international structures. • Concern for the community:Cooperatives work for the sustainable development of their communities through policies accepted by their members. Source: International Co-operative Alliance (ICA)

42. Strategy Options: What Customer Value to Lead in? Product Innovation Leadership We win because the market perceives our brand as having the cutting-edge (often overkill) products with superior features – justifying premium prices.Example: Apple Computer To compete, a business needs to perform in all three disciplines. To become a market leader, it must outperform competitors in one discipline. Customer Solutions Leadership We win because we are so customer-intimate that we are already there when the customer need arises. We offer tailored solutions before the customer feels like shopping around. Example: IBM w/ enterprise customers. Middle ground of mediocrity: Trying to lead on all fronts Operational Efficiency Leadership We win because the market perceives us as having the lowest prices. Based on cost and process efficiencies that still allow us to return profits. Example: Dell Computer Source: “The Discipline of Market Leaders”, Michael Treacy and Fred Wiersema, 1995

43. Points to Consider • The cooperative model provides credit unions with powerful competitive advantages: • Customer-friendly ownership structure: one member, one vote • Ability to take long-term view • Focus on community • Transparency • Reasonable rates and fees • Challenge: Adapt to the new competitive dynamic without sacrificing core values and attributes

44. The Final Word “Directors ought to keep asking themselves this question: What is our Kodak moment, and how can we avoid it?” Financial Times, April 4, 2012

45. Important Disclaimer CUNA Mutual’s analysis is based upon certain publicly available information and data, including NCUA 5300 Reports, and is subject to risks, uncertainties and other factors which could cause actual results or performance to differ from the future results or performance expressed or implied in this analysis. We disclaim any representation or warranty, express or implied, as to the accuracy or completeness of our analysis, as well as any obligation to update our analysis. Each recipient should conduct its own independent analysis of relevant information and data, and should base any business decisions upon such independent analysis. www.sustainablegrowthblog.blogspot.com