Reevaluate the branch channel (July 10, 2008)

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Reevaluate the branch channel (July 10, 2008)

Cost pressures and declining household/branch ratios are forcing banks to rethink their branch strategy and their branch designs

By Gary Stein, partner, and Vanessa Mambrino, senior analyst, Capital Performance Group LLC, Washington, D.C., a management consulting firm providing advisory, planning, analytic, and project management services exclusively to the financial services industry, www.capitalperform.com. Stein can be reached at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it or 202-337-7876. Mambrino can be reached at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it or 202-337-1507.

The branch channel is besieged on all sides. Worsening net interest margins are making banks more reliant upon their branches for core deposit and fee income generation. The industry-wide, median net interest margin declined from 3.87% in the first quarter of 2007 to 3.71% in the first quarter of 2008 marking the fourth consecutive quarter of margin compression. This trend has increased the industry’s needs for low-cost funding and new sources of non-interest income, thereby elevating the importance of the branch’s traditional role as a sales channel.

On the other hand, these same earnings challenges are also driving banks to identify opportunities to reduce expenses and improve efficiency. The median efficiency ratio for all banking institutions shifted from 66.96% in the first quarter of 2006 to 71.32% as of March 31, 2008, and not surprisingly, many banks are scrutinizing their most expensive assets, including their branch networks. National statistics suggest some reason for concern about the branch channel’s ongoing effectiveness. While industry-wide deposit growth continues to exceed branch growth, deposit growth is slowing and the gap between these two growth rates is narrowing. Even more alarming, branch growth throughout the U.S. over the past year has outpaced household growth, leaving some markets saturated and lowering the marginal profitability of additional branches in these areas. As a result, banks are exhibiting more trepidation in making de novo and channel investment decisions.

In sum, banks need to maximize branch channel contribution while simultaneously limiting or even reducing the expense associated with operating the branch network. Branch channel optimization cannot be achieved without skilled staff, competitive products, effective promotion, and streamlined sales and service processes. Most banks, however, will also need to reevaluate two of the more fundamental aspects of branch network management: branch network planning and branch design.

Branch network planning
With limited budget and capital, it is imperative that banks make effective branch placement and investment decisions. Quantitative analysis of market metrics, such as household counts, business population, projected growth, and resident financial product use enables effective comparison of existing markets and potential sites and establishment of a baseline for return on investment calculations. In addition, an objective analysis approach helps to remove human bias and facilitate consensus among decision makers.

Banks that utilize objective practices may nevertheless benefit from the periodic confirmation and refinement of their approaches. This is especially true as banks ratchet down plans to build new branches and the likelihood of a single stellar de novo masking the contribution of underperforming sites diminishes. Specifically, banks should:

1. Assess performance of existing branches to identify opportunities for network consolidation to fund investment in attractive markets. With limited capital and resources, many banks must fund branch network expansion and enhancement projects through divestiture or contraction of existing offices. Branch network optimization, therefore, requires an understanding of branch performance as well as market opportunity. More specifically, banks should leverage market and branch performance information together to identify opportunities to reassign resources—including capital, technology, marketing budgets, and top sales people—from poor performing branches in mediocre, slow-growth markets to both new offices and existing branches in prosperous markets with high-growth expectations and excellent sales momentum.

2. Focus branch performance assessments on direct measures of current-day contribution, such as sales, versus traditional profitability metrics that may reward branches for relationships acquired years ago or that are based upon a debatable customer and balance sheet assignment methodology. Many banks struggle with evaluating branch performance by overemphasizing branch profitability, which relies on an inherent assumption of how customer accounts are assigned to individual branches. These assignments are typically based upon where a customer lives, transacts, or last opened an account, and thus can easily overstate the importance of a single branch when customers in fact use multiple branches or delivery channels, or opened accounts long ago. Banks, instead, should focus more on direct measures of contribution, such as the number and dollar volume of new accounts opened, number of sales referrals to specialists, and other sales metrics that more accurately reflect the current value the branch brings to the bank’s growth efforts.

3. Utilize competitive density and saturation metrics, such as households per bank branch, in market evaluation. Most analysts will consider population and competition in assessing market attractiveness. While helpful on a stand-alone basis, these metrics can be significantly more insightful when combined into ratios. Households per bank branch is a useful measure for institutions targeting consumers as it provides a way to compare the competitive opportunity of small markets against larger, more popular ones. Clearly, higher ratios indicate more attractive markets. While the national ratio is 1,186 households per branch, local ratios vary considerably. Markets with ratios of 1,500 are typically considered attractive, while markets with ratios below 800 are considered competitive. That said, low ratios should not necessarily deter market entrance or expansion, but rather, indicate a need for an aggressive penetration strategy. Other useful density metrics include businesses per bank branch, target-segment households or businesses per bank branch, and bank branches per square mile.

4. Quantify performance requirements for achieving targeted paybacks on branch investments, and, ideally, use these metrics to help prioritize investment or de novo candidates. Establishing measurable performance objectives and assessing return on investment (ROI) are critical steps in successful planning efforts, and especially important when considering the current environment and the magnitude of outlays required for building or refitting branches. Banks need to take this approach one step further by converting financial goals into everyday performance measures to evaluate the viability of reaching ROI hurdles. For example, how many checking and other accounts will a branch sales associate need to open per month to achieve deposit growth objectives?

5. Overlay local market knowledge and timely, qualitative information from municipal development plans and company announcements on top of potentially less current census and survey data. Although market survey and other quantitative data can provide robust insight, this information can become somewhat dated, especially when markets are in turmoil or undergoing significant change. Building activity, residential growth, business market entries and exits, and governmental relief and development projects can start, stop, slow, and accelerate very quickly. Annual studies and survey data can be slow to reflect these changes. Luckily, most banks have internal resources—specifically, commercial real estate and construction lenders—that monitor local markets diligently and can provide valuable insight. These individuals should be consulted or made members of retail planning teams.

Above: A sample matrix for use in branch performance assessment. Branches are assigned a grade of A thru F for office performance (sales, transaction activity, etc.). These grades, shown on the horizontal axis, are then compared to the market potential of the branch’s trade area (measured by household growth, median income, etc.). Combined, a branch’s two grades will place it into one of five buckets: Branches with an “A” office-performance grade and an “A” market-potential grade should be targets for greater investment, while branches with a “C” or below office-performance grade in markets that also rate a “C” or below should be targets for cost-control measures. Extremely low-performing branches in poor markets should be candidates for either consolidation or exit.

Branch design
Along with optimizing branch placement and allocation of branch network resources, banks need to determine how to make best use of facility space. In addition, as de novo activity slows—and indeed, the industry is on pace to build about 27% fewer new branches in 2008 than in 2007—many banks are increasing the proportion of their channel investment budgets devoted to enhancing existing offices. Bank products, alternative delivery channels, and customer expectations have evolved considerably in recent years, and the mammoth, traditional teller window-dominated layout of most branches has become somewhat inappropriate. In essence, banks should incorporate design tactics that:

1. Devote the majority of branch space to support the branch’s present-day role. Specifically, most banks will need to ensure that facility layouts are conducive to sales and emphasize relationship management services over transaction processing.

Since the advent of the ATM, bankers have predicted a day in which branches would become unnecessary; however, branches remain a key, if not the most important, component of bank distribution systems. While alternative delivery channels have gained in popularity, a 2007 ABA consumer survey found that 36% of respondents use branches more than online banking, ATMs, or telephone banking. In addition, the majority of consumers in virtually every segment prefer face-to-face interaction when opening bank accounts. Younger consumers (those in Generations X and Y) are becoming increasingly comfortable purchasing simple bank services over the internet. For more complex products, however, such as a mortgage, most consumers will confine their web activity to research and come to a branch or meet with a loan officer to apply for the loan. Branches also continue to be the channel of choice for problem resolution and complex customer service issues.

Still, the branch’s dominance over certain consumer behaviors is waning. Respondents preferring branches in the ABA survey tend to skew older, and younger bank customers are primarily dependent upon online banking. Businesses, too, have less need for branch transaction processing as electronic payment vehicles claim a greater share of total volumes and as services like remote deposit capture take hold. Altogether, some banks have reported as much as a 10% year-over-year reduction in branch transaction activity. Nevertheless, most banks are still very much wed to their branches. Many facilities and even some de novo designs may, however, be allocating too much space to teller lines and not enough for consultative discussion.

2. Utilize technologies that expedite and lower the cost of teller transactions, enable focus on more critical customer interactions, and facilitate more dynamic branch staffing. Given the diminishing need for transaction processing and the inherently greater opportunity associated with sales discussions, banks should aim to conduct the former as efficiently as possible and maximize flexibility and resource availability for the sales discussions. Technology can help significantly to enable this strategy. Modern branches now often utilize universal work stations that enable branch staff to cover both teller and platform roles as well as cash counters, dispensers, and recyclers that speed teller transactions and reduce cash-drawer shortages.

3. Enhance branch accessibility, preserve customer privacy, and enable desired traffic flows and customer behavior through effective design and placement of office furniture, modular walls, and creative design. Evolving concepts in interior design also help to promote and facilitate value-added customer interactions. According to Bill Stata, vice-president of business development for The Frerichs Group, banks are increasingly opting for open branch configurations with movable walls that maximize retail space and flexible accommodation of large and small parties for advisory consultations and credit applications. Effective lighting and inviting windows help to draw customers into the branch, and sleek yet functional furniture helps to open traffic lanes and direct customers past merchandising displays. Most banks can make significant inroads with relatively little investment by simply looking to reorient existing furniture and clear lobby obstacles.

Additionally, banks should consider access in converting and designing facilities. In recent years, banks began extending branch hours in an attempt to cater to business owners and other segments that require early morning or evening access to branch staff. This tactic can add significant incremental staff expense as most banks require at least two employees on duty when public access to the lobby, teller lines, and vault is permitted. Consequently, some banks are reversing decisions to extend branch hours due to low traffic and perceived lack of customer demand, thus once again limiting access to potentially lucrative customers and prospects. Instead, banks might consider building new branches and refitting existing offices in attractive business markets with branch manager offices that have doors that open both to the street and the lobby. Such offices would allow branch managers to meet with customers during off hours while lobby doors remain locked, thus eliminating a need for dual control and the expense of an additional resource working overtime.

4. Reflect the brand and value proposition of the bank and establish the branch as a relevant destination for targeted customer segments. Importantly, banks need to ensure their branches help to attract the right types of customers and effectively drive traffic. Many banks have attempted to turn their branches into financial coffee shops with the hope that customers would lounge in the lobbies and visit more frequently. While this might have some appeal with some consumers, most banks would do better to consider the needs of the specific segments they target and look to leverage the branch facility to meet these needs.

Banks that targets small businesses, for example, should aim to meet business owner needs. Viking Financial Services Corp. of Seattle, offers its clients the option of reserving community conference rooms during or after branch hours. Use of space like this for client meetings, WiFi zones, and access to printers and copiers are particularly attractive to the growing segment of SOHO (small office/home office) businesses.

Finally, banks should ensure that the design of their branches reflects the company’s brand. Often, de novo branches exhibit a bank’s current image well, but older branches do not. Banks need to assess the design of existing branches periodically for design consistency with both other branches in the network as well as with the look and feel of the bank’s alternative delivery channels. BJ

[This article was posted July 10, 2008, on the website of ABA Banking Journal, www.ababj.com, and is copyright 2008 by the American Bankers Association.]

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