FUTURE OF RETAIL

Government and market forces have altered the basic retail banking equation of the last decade. New approaches are emerging as banks focus on value creation

By Mary Beth Sullivan and Vanessa Mambrino

The retail banking business model is primed for change. For years, the retail banking earnings equation relied on stand-alone product profitability. Single-service checking customers could be profitable for a bank even if they were not paying a monthly service fee both because overdraft fees could generate noninterest income and because those low-cost deposits funded rapid loan growth. Mortgage or home equity accounts were similarly priced for account-level profitability, albeit in retrospect often without adequate risk compensation. In the current environment, standalone account profitability won’t produce adequate returns for most banks—there simply isn’t enough business to go around and, as such, volume can no longer compensate for low margins.

Deposit account profitability has been impacted by alterations to Reg E and by the rapid decline in customer demand for credit products. Industry wide loan-to-deposit ratios have been dropping since the fourth quarter of 2007, reaching 77% in the third quarter of 2010 (according to the FDIC). Consumers continue to be more interested in saving money than in spending. Demand for credit among small businesses is also low, with 91% of respondents to a survey published by the National Federation of Independent Business in October 2010 reporting that either their credit needs were met or that they were not interested in borrowing. To ensure profitability going forward, banks must adapt to changing retail earnings dynamics.

Fortunately, there are opportunities today to drive earnings growth for retail banking. These opportunities, however, require a different type of business approach.  Future retail banking revenues will depend not on single product sales, but on building customer relationships and creating long-term profitability at the customer level. In this model, checking and other deposit accounts must work alongside other elements that are valued by consumers and small businesses to create profitable, lasting, relationships. 

Begin at the beginning
Free checking certainly had mass appeal. Consumers of all ages, incomes, and backgrounds recognized the value in avoiding a monthly fee—even if many of them paid other fees based on their transaction behavior. Retail banking customers may have been conditioned over the past decade to believe that checking accounts should be free, but big banks are already beginning to change this perception by virtue of introducing new checking products that carry monthly fees unless certain behaviors or balances are met. In addition, changing the nature of the checking account pricing structure is now more possible than ever: the recession has led many consumers and small businesses who valued “free” to now value “safe,” “secure,” “helpful to me/my finances,” and other factors. These customers are now willing to pay for services that deliver what they currently value, and for most that isn’t a higher rate (at least not in the current environment).

In order to reposition the retail banking business toward a value-added model, bankers will need to better understand the needs, preferences, current and potential profitability, and “relationship status” of existing customers. Understanding relationship status may require thinking about the definition of a customer relationship in a different way.

Donna Kimes, senior vice-president and director of marketing at Farmers & Merchants Bankshares, Stuttgart, Ark. (total assets of $562.2 million), notes that a household with a single account may in fact have a strong relationship with the bank—especially as customers choose to simplify their lives by moving from multiple checking accounts to one. Farmers & Merchants now includes services that a household may have but may not be explicitly paying for—internet banking, mobile banking, online bill pay, electronic statements—in its definition of a relationship and its relationship pricing strategy.

Bankers also need to understand sub-segments within both customer and prospect groups in order to better target attitudes, needs, and preferences beyond those tied to price. At a minimum, banks should group households together using traditional geographic and demographic segmentation schemes.

Such segmentation, however, doesn’t provide enough information to build strong value propositions: it enables a bank to find like groups of individuals, but it doesn’t tell the bank what those individuals need. Even individuals within the same broad groups in terms of age and affluence often need different services and place value on different things. Banks must therefore also identify common attitudes, concerns, and behaviors—what they are worried about and what they need or want to do in their financial lives—not just how customers prefer to transact or which channel they prefer.

Perspectives straight from the source
Collecting information on needs, attitudes, and preferences isn’t easy. We spoke with three bankers—Donna Kimes of Farmers & Merchants being one—who stressed the importance of gathering customer feedback through formal surveys and focus groups and also through informal conversations with the customer. “You have to think of the customer perspective first,” says Kimes. As a result of this kind of thinking, Farmers & Merchants has tweaked an existing product and now offers an interest rate on its higher balance MMDAs that matches its lowest CD rates. The product provides the same monetary benefit to the customer as a CD, but is perceived as a different and more appealing product by those individuals who would prefer not to tie their money up for the long term.

Frontline staff is also a good source of customer insight. Staff at the branches or in the call center interact with customers every day and can provide powerful insights into what customers are worried about, what they like about their current interactions with the bank and its products, what they would like to see improved, etc. These employees may also have ideas about how to effectively use these customer insights.

“The frontline staff will try to turn existing products into solutions” for the customer, according to Mark Erhardt, customer segmentation director at Fifth Third Bank of Cincinnati. These one-off efforts may yield an idea that could be of benefit to the entire customer base.

Build responses to customer values
Fifth Third Bank has spent a great deal of time developing a better understanding of customers’ primary concerns—particularly those that resonate with one of the bank’s chief target segments: the mass market consumer in its core midwestern footprint. In addition, the bank has looked at what out-of-footprint competitors have done to increase overall customer profitability and has adopted a strategy of packaging deposit accounts with other value-added services, rather than selling the two separately.

The bank has already received a great deal of publicity for its Secure Checking package, which incorporates both a checking account and the company’s proprietary Identity Alert service for both the primary account holder and one secondary account holder for a monthly fee of $7.50. This package was designed to address a very real concern of Fifth Third’s customers—the security of their finances.

Other products at the bank were either created or adapted to help customers feel more secure. The company has taken steps to make its rewards program more attractive, for example, given changed customer preferences in the wake of the recession. In 2010, Fifth Third introduced “Real Life Rewards,” an updated program that allowed customers to translate the rewards points they had earned into practical solutions to key customer problems. One was: “Worried about saving enough for a rainy day? Your points can be used to make a contribution to a savings account, a 529 plan, or an IRA.” Another was: “Concerned about paying down debt? Rewards points can be used to make prepayments on the principal of a mortgage.”

Make a two-way commitment
NewAlliance Bank of New Haven, Conn. (total assets of $8.8 billion), introduced a new consumer deposit product set during 2010. In developing the products, the bank conducted a great deal of primary customer research, working to identify the key wants and frustrations of the people who chose to bank with it. At the end of this effort, the bank arrived at a suite of five products: a free checking account, a student account, and three packages. All five products were designed to help the customer leverage behaviors in which he or she already engaged to “do more” with their money—either through avoiding the payment of fees or receiving relationship pricing on deposit and credit products.

Each product provides benefits to customers for engaging in specific activities or bringing more business to the bank. “We believe that if a customer makes a commitment to us, we should make a commitment to them,” says Mark Gibson, the bank’s chief marketing officer. Customers who demonstrate their commitment in tangible ways now see some of the “most irritating” bank fees disappear. In keeping with NewAlliance Bank’s “Do Your Thing” brand positioning, customers can choose the method of demonstrating their commitment to the bank that best suits their needs and financial situation. For example, a customer with the new DoMore checking account can avoid both monthly fees and foreign ATM fees by either setting up direct deposit, maintaining an average balance of $1,500, or completing 15 signature debit card transactions per month.

The most important result to come out of NewAlliance Bank’s research was the reminder that customers do not think about bank products in the same way that bankers do. “Customers view themselves not as buying a bank product, but … using a bank,” notes Gibson. The product is one piece of a larger experience that involves the ease with which the account can be opened and funded, the ability to engage in transactions when and where the customer wants, the ability to read and easily understand statements (online or paper), and the ability to find information quickly and access it conveniently. To the customer, these elements are just as important as explicit product features and prices.

The sum total of an individual customer’s experiences with a company either creates or destroys value for that customer. The dramatic changes to the banking model in the U.S., while putting serious pressure on profitability, are also driving managers to focus on value creation—in products, delivery channels, and in customer’s day-to-day experiences with bank “brands.” Those banks that make the shift away from product-centered competition to understanding the broader customer value chain and providing a greater array of benefits at reasonable prices will find they’ve positioned themselves to succeed. â– 

Mary Beth Sullivan is managing partner and Vanessa Mambrino is a consultant with Capital Performance Group LLC, Washington, D.C. The firm provides advisory, planning, analytic, and project management services.

The electronic version of this article available at: http://www.nxtbook.com/nxtbooks/sb/ababj1210/index.php?startid=26

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