To preserve franchise revenue potential, banks need a reinvestment strategy that will sustain customer relationships and sales momentum as branch count shrinks.
The U.S. banking industry has embarked on a historic branch consolidation, forced by an accelerating migration of customers to digital channels and unrelenting industry profit headwinds. At most banks, the pressure is on to close branches in light of shrinking in-store transactions and sales.
The magnitude of required change is underscored by a recent Novantas analysis which estimates that up to 30% of the current U.S. bank branch system – roughly 27,000 out of a 90,000 total – is underwater (Figure 1: Crisis in Branch Economics and Sales Productivity). Even considering initial closure costs and lost revenues over a five-year horizon, many are worth more shuttered than open.
But even as pressure builds for action, so too does the risk of crippling side effects. Along with significant dollars saved, branch closures can mean significant opportunity lost – in terms of valuable balances and customer relationships as well as future sales. Depending on how branch closures are carried out, banks could face two starkly different outcomes
in a local market:
- Cuts focus on cost savings that help the bottom line, but at the expense of dwindling customer relationships and permanently reduced local market sales, or;
- A concurrent program of cuts and reinvestment, with less net savings but a more sustainable outlook for customer retention and sales.
In the market-by-market quest to rebuild the revenue and relationship model in an age of digital disruption, cost savings from consolidation is just one factor. For sustainable results, savvy reinvestment will be just as important as branch overhead cuts.
Novantas research concludes that for every $10 million in savings via local market branch consolidation, the typical regional bank should be prepared to reinvest $3 million, or 30%, in marketing, sales and alternative distribution, to sustain local momentum as the branch footprint contracts. And the commitment does not stop there: an additional reinvestment of at least 5% may be needed for corporate-level initiatives in marketing and digital banking, particularly account acquisition and cross-sell.
The upshot is that the bank needs to build a market-by-market roadmap for network repositioning, not just considering cost reduction in isolation, but also strategies and reinvestments needed to preserve balances, relationships and sales momentum going forward.
This roadmap has two major components:
Revenue potential. Looking market-by-market and branch-by-branch, the bank needs to pinpoint its priorities in light of sales potential and balance impacts, using an immediate snapshot and a medium-term metric (such as five-year net present value) to clarify near-term vs. long-term tradeoffs.
Market game plan. Each local market has its own requirements. For successful network repositioning, the bank needs to ascertain the correct blend of levers by market —branches, staffing, automated teller machines, marketing strategy and ad spend, etc. — that will maximize core deposits for a given level of capacity and resource commitment.
Such preparation is essential in repositioning networks for both cost savings and ongoing competitiveness. Reinvestment plans and execution components must be put in place prior to visible reductions in physical branch presence; otherwise franchise revenue potential will be unnecessarily harmed.
At many banks, executive conversations on network strategy have tended to center on reaching cost reduction targets rather than truly repositioning the bank for a more sustainable form of future growth and competitiveness. The distribution team winds up with narrow task assignments, for example, “Find a $10 million reduction in annual operating expenses with a write-off of less than $2 million.” But even when teams meet reduction targets to the dime, this exercise has many drawbacks:
It is reactive. Branch consolidation decisions tend to be made on the basis of current balances, omitting future implications for sales, customer acquisition and retention. Cost cuts may yield positive returns in the first year or two, but then the fuller revenue consequences become apparent. Lost sales and customers can progressively drag down the cumulative result, to breakeven and then underwater.
It is not diagnostic. Instead of thoroughly assessing the state of the network, the bank only looks for enough branch consolidations to meet targeted cost savings. Victory is declared, but meanwhile potentially many other marginal branches limp along untreated, posing future challenges that rightfully should be addressed today.
It is over-concerned with lease renewals. Consolidation discussions are too often couched in terms of upcoming lease renewals, while holding ongoing leases sacrosanct and completely ignoring owned branches. Assuming a network with one-quarter owned branches and lease durations between five and 10 years, a narrow lease renewal orientation only allows for the review of 10% to 15% of the branches each year.
For effective network reconfiguration versus mere branch closure, the bank should be looking at the interplay between clusters of branches in a given trade area. The justification for selective lease cancellations and even closures of owned branches becomes apparent from this perspective, despite the incremental one-time expense.
Lack of reinvestment. Absent plans and investments to rebuild the future revenue stream, a decision to cut branches essentially becomes a decision to shrink the bank. With the revenue needle stuck or even falling, every year the bank is left looking for additional cost savings, not realizing that results will likely continue to disappoint without reinvestment – creating a slow death spiral.
Branch Value, Cuts and Consequences
In approaching network reconfiguration, banks must analyze “value at risk” along with “savings in sight.” Core branch strengths can be broken down into three key elements:
- Marketing value – each branch acts as a billboard for the bank, anchoring market awareness and customer perceptions of local accessibility and convenience.
- Sales value – the branch remains the primary channel for new account growth and cross-sell, albeit a shrinking one. Absent a proactive and well-executed plan, removing a branch also removes the future sales stream; replacement in other channels or branches is not automatic, especially when it comes to winning new-to-bank sales.
- Retention value – Some institutions mistakenly assume that branch retention value applies to all of a store’s customers, leading to staggering all-in cost estimates for closures and unnecessary preservation of marginal units. The reality is that a growing share of customers would settle for a nearby local alternative or prefer digital channels almost entirely. Hence, the retention question should focus on the subset of customers who are actually at risk of switching banks if that branch is closed.
To understand how well branches are “earning their keep” by upholding these strengths, we examined a diversified subset of roughly half of the 13,000 U.S. branches in the Novantas SalesScape benchmarking database. After analyzing these units we then extrapolated the findings to the entire U.S. banking network of about 90,000 branches.
The headline is that roughly 30% of U.S. branches are not breaking even, as measured by a five-year net present value calculation that considered individual branch sales and retention value in relation to the branch’s marginal operating cost. Collectively, these branches incur nearly $12 billion in annual operating expenses – a tempting target in an era of limping profitability and digital disruption.
To our point, however, undiscerning closures may well be counter-productive, both in terms of balance retention and origination volume. Looking at the 30th percentile branch ranked in a five-year NPV, the year-to-year breakdown is telling. While there are net cost savings in Year One, even accounting for one-time retention losses, over time the compounding impact of unchecked lost sales can swamp savings after Year Five. Unmanaged, this can create a downward spiral (Figure 2: Absent a Revenue Plan, Closures can Backfire).
This is where incremental investment creates value. What is the value of reinvesting a portion of branch closure savings? What can be done to offset Year One retention losses and ongoing lost sales? Examples include:
- Expand local ATM network coverage, either bank-serviced locations or via partnerships;
- Increase local marketing spend;
- Conduct special campaigns to retain closure-affected customers likely to leave;
- Open “fit for purpose” smaller branches in areas affected by closures of larger installations; and
- Implement “two-into-one” consolidations.
In the more analytic approach to network reconfiguration, the bank consciously designates a portion of consolidation cost-saves for reinvestment. Instead of closing, say, 20 branches and “letting the chips fall where they may” in terms of retention and future sales, the bank might decide to target an even more aggressive 30 closures, earmarking extra savings for items such as new small-footprint branches; expanded ATM presence; enhanced marketing and advertising; digital initiatives, etc. (Figure 3: Reinvesting for the Future). Resources may flow back into the markets where closures occurred, redirected to other markets, or used for corporate-level initiatives.
In this scenario, instead of shrinking post-consolidation, the bank can leverage an upgraded distribution and marketing formula to recover and eventually even surpass account origination volume previously booked at under-performing branches. Each major institution will have its unique considerations relative to strategy, footprint, customer mix, etc., but overall this type of consolidation-with-reinvestment framework will be essential in developing the sustainable path.
Key management questions in this journey include:
“What is our local market position and strategy?” The bank needs a clear picture of the network setting for each major market within the franchise footprint, supported by a balanced evaluation of each branch’s contribution and consolidation potential.
“What are our revenue levers beyond the branch?” This is a question that needs to be asked at the highest levels of the organization. To put it bluntly, the major bank that does not have a digital- and marketing-based revenue strategy is in trouble today and headed for a lot more tomorrow. Only by trading off the physical network with other sales levers can the bank maintain customer and balance growth while shrinking branch count and expenses. Marketing-savvy online niche players are circling.
“How do we need to migrate the branch footprint, function and staffing model?” As basic daily banking transactions flood into digital channels, the role of the branch is shifting more to supporting small business and high-value sales, advice and service. The future footprint will be much tighter; the staffing model will be different; and technology will be even more prominent in facilitating remaining transaction activity. Here again, sustainable efficiency improvement is not strictly about cost reduction, but also about repositioning.
Brandon Larson and Andrew Hovet are Directors in the New York office of Novantas. Also contributing was Morgen Lerner, a Senior Associate in New York. They can be reached at firstname.lastname@example.org, email@example.com, and firstname.lastname@example.org.