Being the first to branch in a developing market has advantages, but research shows that followers are often better off
By Brian Diepold, Ph.D., senior manager, client services, Pitney Bowes MapInfo—Financial Services Practice
[This article was posted June 24, 2008, on the home page of ABA
Banking Journal, www.ababj.com, and is copyright 2008 by the American
Bankers Association.]
Bankers often are faced with uncertainty when making decisions about
branching into newly developing markets. High growth projections and
lucrative development plans can be hard to ignore, and in most markets
new developments are the only opportunities left for a bank to be first
to market. A further consideration is that the concept of a first-mover
advantage has been prominent in theory and practice for decades. The
reasons are fairly intuitive and simple—the first mover can quickly
gain and hold share, potentially grow faster and retain a lasting
advantage. But do data support that belief?
Branch expansion is a risky endeavor. While the
recent boom in the number of branches appears rational based on deposit
and population growth, there are risks involved with the high capital
expense required. As a result, banks are rewarded for placing a high
value on the performance of their branches as the central hub for
customer service and product delivery. In turn, banks consistently seek
to gain a competitive advantage through branch decisions.
It often feels like a good strategy to be the first
bank to open a branch in a newly developing part of the market.
Intuitively, one might reason that the first branch could benefit from
early brand awareness, capturing sticky customers, and by having the
first option of location. But, not everything is clear on the first
pass.
In the case of branch banking, many other factors
are important to understanding whether there is a benefit to entering a
new market first. For example, the costs to customers to switch banks
are decreasing, resulting in less loyalty, more price-chasing behavior,
and ultimately more opportunity for follower banks in the market to
capture customers.
Additionally, there may be more information
available to later entrants in a new or previously underserved market
area. The first mover may locate its branch in a new development that
is expected to provide them entry to new growth in the marketplace.
Over time, however, that market may develop differently than they
expected and a later entrant could open a branch in a better location
based on those market developments.
Another possibility is that the market-level
first-mover advantages typically seen in banking may not apply at the
micro level, where each branch’s performance is dependent upon its
competitiveness with other nearby offerings.
What does the research say?
What bankers want to know, of
course, is whether there really is a first-mover advantage to be gained
in branch banking. Pitney Bowes MapInfo produced a statistical analysis
of whether this advantage exists. Using the Branch Source Dataset from
Highline Data, we identified a sample of first-mover and follower
branches that opened from 1993 to 2000. From this, we analyzed the
growth history of the branches opened in the same markets.
The findings indicate that there are some short-term
advantages available for the first movers, but over time the followers
are able to attract a greater level of deposits compared to their
incumbent peers, and the latter effect appears sustainable over the
long term. The first chart depicts the change in the first-mover
advantage ratio based on the age of the branch. Each first mover and
follower is compared at the same ages rather than at the same point in
time to allow for equal maturation of the follower compared to the
first mover. The results show that first-mover branches achieve
relatively higher deposits than followers in the early years after
opening, but are soon outpaced by follower branches. First movers
outperform their followers where the bars in the graph are below the
line representing equal performance, while the followers are performing
better beginning in the fourth year where the bars are above the equal
performance line.
These results suggest a long-term advantage to
follower branches. We also performed a simple net present value
analysis based on these findings. Assuming constant revenue-to-deposit
ratios for all branches, 12% discount rate and common expenses, first
movers generate a lower net present value.
Lone entrants under perform
Earlier we mentioned that decreasing customer switching costs and a
high degree of information availability could limit potential
first-mover advantages. In addition to those, banking products are
infrequent purchases, such that it may not be a significant advantage
for a bank to open their branch a year or two earlier than a competitor
because that may not yield them access to superior sales opportunities.
If the typical customer makes a banking decision once every 3.5 years,
then there should be sales opportunities available to the branch
whether it is the first to a local market or not.
Most importantly, the first-mover branches assume
greater risk than the followers. The first clue that significant risk
exists in acting first is that our study identified 214 first movers
with followers compared to 1,072 lone entrants. The five-to-one ratio
of lone entrants to first movers suggests that most of the markets
entered were not as fruitful as those banks initially believed. In one
sense, the followers have the opportunity to observe which markets have
been entered and potentially which markets have been entered
successfully.
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This is further supported by the lackluster
performance of the lone entrants. For example, after operating in the
market for five years (see second chart), the average first mover has
deposits equal to approximately 39% of the average U.S. branch, while
the typical follower branch deposits has equal to 43%, and the lone
entrants a meager 24% of the average U.S. branch. This data combined
with the net present value advantage to follower branches is strong
support of acting patiently when entering new or developing markets.
Lone entrants—or first movers without followers—are not only a common
occurrence, but their performance is far inferior to other new
branches.
It is certainly possible that followers are able to gain knowledge of
the market potential by observing the performance of the first-mover
branch. Evidence of this learning potential for followers
was found in the research.
The results suggest that the order of
followers is positively related to the advantage ratio, meaning that
the second follower to the market gains a greater advantage relative to
the first mover than the first follower in a market. This is interpreted as evidence of opportunities for followers to gain
knowledge from the actions of the first movers and from the development
of the market.
This knowledge allows the follower branch to avoid
much of the downside risk of entering less profitable markets. Once
this additional knowledge is coupled with the commodity-like nature of
retail banking, the result is that follower branches have at least
equal opportunity as their first-mover peers, with less risk involved.
Patience and planning
In many markets today, the most likely option for being the first
branch to market is to be part of a new development. This can be a
particularly risky approach given the dependence on developer’s plans
and new households being occupied early enough in the life of the
branch to make it profitable. To the extent that
development and retail use patterns shift over time, the follower
branch could benefit by having more information before entering the
market and be able to gain an advantage over the first-mover branch
that has assumed the initial risk of the market.
The issue cannot be simplified to a set of rules
that suggests always or never open the first branch in a new market.
But, the findings suggest there is no evidence of long-term first-mover
advantages in branch banking, and that should be enough to remind banks
that they need to put location-intelligent research behind branch
planning decisions. BJ
[This article was posted June 24, 2008, on the home page of ABA
Banking Journal, www.ababj.com, and is copyright 2008 by the American
Bankers Association.]
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