Slap an ROI ruler on branch networks
By Paul Seibert, CMC, vice-president financial services EHS Design
The Seattle-based firm provides strategic planning, branch network optimization, branding, and branch business modeling and prototype development.
More than site analysis, design, acquisition, or divestiture alone, you need to analyze your branch network from the viewpoint of its ROI now and for the next seven years
Several industry trends—the down economy, looming restrictions on fee income, new consumer growth opportunities, and changes in market dynamics—suggest that banks need to make a significant shift in branch planning. Yet, over the past ten years, few banks have given much consideration to optimizing the performance and efficiency of the branches and networks they currently have in place. This blind spot costs banks millions in operating costs and lost opportunities.
The term “branching” itself suggests adding more branches, rather than reassessing existing branch locations or reengineering existing networks to enhance profitability or better position an institution to maximize performance.
In the recent past, network growth and profitability was fueled primarily by geographic expansion or acquisition of new branch networks. While expansion by acquisition may currently be very attractive for banks with good capital in this economic environment, most banks need to look to their existing branch networks to increase efficiency, productivity, and return on investment.
Many banks are currently being forced to reengineer their branch networks to counter economic and regulatory adversity, but they should also think about doing it to enhance their ROI. Bank of America announced last year that it will close 10% of its branches. If done correctly, it could be a godsend to the institution, and it could serve as a model for other institutions as well.
Even if a bank is planning to expand its branch network, it ought to study its network efficiency and productivity to ensure that the entire branch platform is making the most of market potential. No longer is it sufficient to understand the value of adding one new branch here or there, or making an acquisition in this or that market. Banks must understand how their current and target markets will evolve over a five- to seven-year planning period, and how they need to reengineer their branch networks toward perfection.
A 3,500-square-foot freestanding branch costs between $2.2 and $3.5 million, depending on location. A 2,500-square-foot leased facility typically ranges between $550,000 and $950,000, and an in-store branch between $250,000 and $450,000. The real cost, though, lies in staffing. Banks need to get the maximum return from every branch location, and there are a number of strategies and tactics they can use.
Markets change, so should branches
Branch network optimization is not the same as location and site analysis. For example, if you want to determine the viability of a new market location, look at the geographic area to assess its market characteristics and potential; traffic patterns; adjacency to where target customers shop; and geocoded customer relationship data.
Most banks employ highly sophisticated data, utilizing up-to-date intelligence generated by marketing strategy software packages such as Pitney Bowes’ AnySite, or Highline Financial’s HighlineFI. These software tools perform predictive analytics and modeling functions based on block-level deposits and loans for consumers and small business, banking preferences, age, income, and many other factors. The resulting rich databases, combined with a bank’s customer relationship information, are the primary types of data used to determine where branches should be placed in existing or new markets.
With tools such as these at their disposal, bank executives are often focused on the next new branch location, rather than on understanding how to evolve the existing branch network to create better market efficiency and productivity. But what they often don’t consider are the impact of the new branch on existing branch performance; market convenience overlaps that may accelerate penetration in good or bad markets; changes in the new branch’s market over time; and the priority of the new branch project compared to other strategies such as relocations, remodels, or closures. The purpose of branch network optimization is to enhance overall network profitability, rather than to solely evaluate the potential of one site.
At issue is not a lack of data or analytical resources, but a lack of internal motivation to weigh the relative value of different market and branch opportunities to improve overall network performance.
Break-even analysis is expected to be part of the due diligence process for every proposed new branch. Bank executives make business projections to understand the market potential for each product and service within each business line. They understand operating costs, define marketing efficiency, and make ROI projections based on detailed market analysis, anticipated rates, and the competitive and regulatory environment. They could be using the same high level of market intelligence and analytical skills to understand the potential of each market and how their bank can maximize its potential with a reengineered network. With a clear view of the cost and return, a bank can then weigh the system-wide value of dissimilar branching opportunities. No more data, just another perspective.
There can be a reluctance, however, to ask tough questions such as “Did we make the right branch location and size decision when we built seven years ago?” Or “Has the market changed, leaving us in the wrong location?”
Last year, our firm completed a statewide analysis for an institution that had been pursuing growth through branch expansion. Our analysis showed that a recently constructed $3.5 million branch was in the wrong location to maximize consumer and small business growth; it would not break even for at least seven to ten years. The board had been reluctant to sell and relocate because of the big investment. For- tunately, they finally realized it was time to sell, and they relocated to two leased retail facilities that subsequently begin to experience fast growth.
The problem with not looking back is that a lot of other factors may have changed during that period. Competition may have evolved and taken new forms. The bank may have changed its delivery strategy, or it may have added new product lines.
If a bank located its branches ten years ago in support of business banking, but consumer banking is now the priority, how successful will the bank be? Have markets improved or declined in a way that would suggest that relocation or reinvestment would be highly productive? Has residential high-rise development occurred next to a commercial branch, and how can the branch take advantage of this new customer opportunity? Some type of change is sure to be impacting every branch location to varying degrees.
Two factors that are often overlooked in a comparative analysis of market and customer characteristics are critical mass and convenience overlap. (See the map on page 22.)
These factors should carry a good deal of weight. For example, our firm studied a market where four branches were having trouble building more than 5% market share. Analysis projected that the addition of two properly placed branches would allow them to grow to 9% market share. They would reach critical mass with these two additional branches. In this case, critical mass was defined by the ability of branches to provide 3-mile-radius convenience coverage of target markets; adjacency to retail hubs and transit centers; and 5-mile convenience overlaps in target markets.
Our studies indicate that convenience radius overlaps can increase market penetration by 30% to 50%, with equal increases in profitability, if the overlaps are located in target markets. Creating critical mass with two branches may be more productive for a network than building four new branches in new markets in another state.
Branching perfection should be the goal in every market. But is perfection attainable in any market? Probably not, because of constant evolution, competitors, and many other factors. But we find that the process of pursuing branching perfection leads to decisions that can substantially improve market performance.
“Zero-base branching” is the key. This methodology looks at existing and desirable new markets as though there were no branch locations yet in existence. Each market is evaluated and prioritized based on its ability to maximize the return from each business line (consumer banking, mortgage, small business, investment, commercial banking, private banking, wealth management). The potential performance of each product and service can then be mapped and scored. Potential income and profitability follow, with projections for each market down to the block level (approximately 400 + households).
As previously stated, the level of market data today is exceptional and can enhance profitability if it is manipulated properly. But data alone is not enough. Before you place branches or alternative delivery systems in a market, you need on-the-ground intelligence. This comes from savvy commercial real estate agents, city planners, transportation officials, Chambers of Commerce, and developers. By investigating markets through these resources, you get an additional layer of information that can mean the difference between high and modest branch performance.
Then you can answer key questions, such as: Which malls are prospering, and where will new malls or strip center concentrations be placed? What is the direction of new housing growth? Will new roads be added and existing traffic patterns changed?
The next step in the zero-base branching process is to create the perfect branching array by positioning branches at the most productive locations in terms of business line delivery and market potential, both today and over the next five to seven years. The analysis generates an understanding of how convenience overlaps at 3 and 5 miles will enhance overall network performance. You can then determine branch sizes, staffing, delivery types, investment, and the implications of leasing versus owning for each location.
Finally, you overlay the existing branch network on the perfect branching array and pinpoint needed adjustments. Then develop strategies to evolve the current array into a high-performance network in five to seven years.
Mix of resources needed
The same analytical and on-the-ground research process should be used to understand the value or potential value of a bank acquisition. There may be greater value in a branch market than is projected by the existing branch network. A bank may be able to double market penetration by adding or relocating a few branches. Large, expensive branches that under-serve their geographic area can be sold; small branches built or leased; and customer convenience, share of wallet, and household and business penetration significantly improved.
Large banks have the resources to pay for in-house expertise and purchase access to expensive data sources.
Small banks, on the other hand, can gain the same level of information and expertise by combining in-house staff skills with data sources and consultant resources. The cost of a full branch network optimization study can be covered by discovery and implementation of one or two improvement opportunities.
Purchasing location analyses from one of the many vendors can provide very good data, but raw information alone is not enough. Real estate agents can provide market data as well, but banks should pay attention to how the data is presented. Are the market characteristics presented in a circle around a new branch location, by drive time, or by block group? Knowing the exact location of target market groups can drive the right real estate decisions. Firms such as Weber Marketing Group, EHS Design, AnySite, Bancography, and Mapping Analytics can help banks analyze markets. They can recommend the most productive branch locations and offer strategies on how to increase market and network efficiency.
Regional retail banking and facilities managers receive a constant barrage of recommendations for “hot” potential sites from Realtors and developers. These typically take the form of a site plan with general demographic information and aerial photos to help sell the piece of property. The same sites are generally offered to competitors as well.
Banks all want to be first to claim the best site, but they do not want to be forced into reacting under pressure. If you have not already defined the location as a target, how do you know if it is viable, or how it will impact the entire branch network? Having a strategic branch plan in place prepares you for these opportunities.
Network’s yearly check-up
Optimizing the performance of branch networks requires constant tuning. Retail and residential concentrations shift; market quality changes; acquisitions add branches to the network; competitors make unforeseen moves. You may add products and services. And your business focus may change.
Most branch network optimization plans cover a five- to seven-year planning period. But much can happen in that time. Branch network planning and the resulting strategies should be revisited annually. This will help ensure top performance year after year, while guiding branch investments in the most productive direction.
Bill Gates predicted the demise of bank branches by 2005, but that year has passed and branches are still around. In fact, many industry experts estimate there will actually be more financial institution branches in five years. Since branches are here for the foreseeable future and their cost is high, let’s generate the highest possible return by delivering a unique and highly productive customer and staff experience and savvy branch network optimization. BJ
The electronic version of this article available at: http://www.nxtbook.com/nxtbooks/sb/ababj0110/index.php?startid=22