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Reimagining Retail Banking

Executive leaders must reexamine their franchises at an elemental level and consider the strategies and strengths needed for a permanently changed market.

At this juncture in U.S. retail banking, it is clear that the industry has to revise its traditional business model. Yet a new era is unfolding that will present historic opportunities. The question is how to build upon core strengths while at the same time effecting transformative change.

The good news is that banking still constitutes a valuable franchise with many unique attributes. These include extensive branch networks; deep relationships with myriad core customers; and an excellent range of customer information. Together, these strengths put banks in a different league altogether from specialized players.

The complication is that the traditional economics of the business have been altered, likely never returning to pre-recession conditions. The litany of pains grows ever longer as a Fed-enforced flat rate environment stretches interminably ahead; revenues are squeezed by slack demand and regulatory constraints; and branches increasingly become wasting assets as customers flock to alternative channels.

This is an environment where executive leaders will need to think differently. The industry has been thrust into a “New Normal,” which, while still containing familiar landmarks, also has much new terrain. As banks look for opportunities, leaders will need to make bold choices, some even counter-intuitive.

For example, one of the biggest industry questions is what to do about the collective branch system, which is fundamentally in a state of overcapacity. Conventional wisdom says that core regional networks must be preserved at all costs. But often the strongest markets should be the first in line for a thorough overhaul.

The objective is to substantially reduce cost while maintaining market share, principally by promoting remote banking channels as complete substitutes for the branch. In addition to repositioning core markets for future growth, such initiatives will free up resources needed to strengthen second-tier markets still having growth potential, which often are starved for resources in difficult times.

Beyond taking costs out of the network, banks must rise to the challenge of harnessing direct channels and voluminous customer information to engage the new generation of “virtual domiciled” customers. Even as the customer online migration creates a crisis in the branch network as lobby traffic dwindles, it also creates a need to effectively “engage” customers in the virtual space. This will require more extensive and comprehensive use of internal and external customer data.

In each of these areas, the advantage will go to banks that can dispassionately assess their changed circumstances; shift the mindset from coping tactics to transformation; and respond innovatively, mapping the specific strategies and skills needed to move ahead. At the time when up to a fourth of the pre-recession branch network is at risk, there really is no other choice.

No Turning Back

It is clear that the context for U.S. banking has changed following the recession. While executives have been relieved to see the industry stabilize following the mortgage debt crisis, they now face a sweeping challenge of a different sort — restructuring for a de-leveraging economy where far less overall banking capacity will be needed.

In the expansion decades, the household debt bubble spurred unprecedented growth in banking profits and branch infrastructure, reflecting the industry‘s central role in financial intermediation. Between 1990 and 2007, home mortgages and consumer debt rose from a combined 78% to 126% of U.S. personal disposable income. That ratio had already fallen to 103% by mid-year 2012 and probably has still further to go.

According to Federal Reserve statistics, there has been a more than $1 trillion, or 10%, decline in household home mortgage balances (including home equity) between yearend 2007 and mid-year 2012. Specifically in home equity lending, balances have declined by more than $300 billion, or 28%, between yearend 2007 and mid-2012.

Looking ahead, retail growth opportunities will be far more selective and probably less profitable for some time to come. Banks will compete heavily to win new business, and the Fed‘s stimulus moves could hold margins flat for three to five more years. Meanwhile new regulations — on credit cards, checking overdraft coverage and debit interchange — have slashed other major sources of revenue that supported the expensive branch infrastructure.

As if all of this wasn‘t enough, the whole configuration of retail distribution now must be re-examined as customers forsake traditional branches and conduct more of their banking business via online and mobile banking, automated teller machines and contact centers. While banks have excelled at facilitating remote transactions, the industry still is struggling with marketing and sales to virtual customers. Meanwhile, confusion reigns on how to configure distribution in local markets and allocate resources among them.

The point of this is not to suggest hopelessness, but rather to suggest the need for much more innovative solutions for the challenges that regional banking companies face. In a steady state environment, it makes more sense to emphasize incremental improvements year over year. But we believe the industry has reached an inflection point. Because the outlook is so discontinuous from pre-recession norms, executive leaders now must think in terms of transformative change, with the goal of assuring healthy future growth in a permanently changed market.

Multi-Channel Strategy

Under historical customer shopping behavior, people first selected a nearby bank, chose among the available accounts and gradually became familiar with the staff. From there, they went on to select additional products from that bank over time. The result was a fairly direct relationship between branch network presence in a local market and the ability to win market share of deposits and loans. Market share could even exceed branch share with the right coverage model and network density.

In the new world, however, Internet-enabled customers increasingly think first about their banking product needs and then search for a provider — a fundamental change in shopping behavior and the requirements to manage what the customer sees and evaluates. When that search begins, the nearby branch may or may not be the prime consideration. For the first time, in fact, Novantas research shows that the quality of the online banking experience is slightly more important than branch presence to high net worth customers—an astonishing reversal of historical considerations in choosing banks.

This raises the whole question of how banks are going to acquire, expand and retain customer relationships as branches have fewer opportunities to market, counsel and sell in a face-to-face setting. For day-to-day banking, consumer preferences are trending strongly online and to mobile devices, and in-branch traffic in many markets is falling at rates of 7% or more annually.

Simply creating new channel capabilities for the self motivated customers to use won‘t be enough. There is a critical need to create brand awareness and customer consideration before the sales process can begin.

This creates a three-part marketing and sales challenge in multi-channel strategy: 1) how to create the right market awareness and get into the consideration set for potential customers who are often shopping online; 2) how to present the right products to the right customers at the right time for cross-selling multi-channel customers; and 3) how to engage customers and build loyalty in effective and efficient ways, considering the full range of customer touch points.

As these revenue-related issues are addressed, banks will need a concurrent effort to reduce overhead even further. A strict bet on revenue growth simply is not prudent in today‘s economy.

The situation has a major strategic implication that is counter-intuitive to regional banking executives. Many instinctively will want to protect and invest in locales with the most dominant branch networks while further squeezing second-tier and clearly unprofitable markets.

This “circle the wagons” mentality has several drawbacks. First, the big markets with dense networks have the largest operating expenses, providing the greatest potential for efficiency improvement if costs can be cut while maintaining market share. Second, too much economizing within second-tier markets can cripple them at a time when they should be nurtured for growth and innovative outreach to new customers.

For the good of the overall franchise, the higher path is to strongly accelerate the deployment and customer usage of alternative channels in dense markets; capitalize on channel migration to slash expenses for traditional branches; and use the savings to reinvigorate second-tier markets having the best growth potential (Figure 2).

Importantly, some banks are already having success with elements of this strategy. One institution, for example, has succeeded in notably reducing the branch count in several major markets while preserving market share of deposits, primarily by coaxing customers into more extensive use of ATMs as a substitute for branch transaction services and by providing more on the ground small business bankers and a superior online capability. This type of progress will be needed across the industry.


No one can predict exactly how retail banking‘s burning issues will play out, but there is one certainty: an advanced ability to manage and analyze customer information will be absolutely essential. One example is tracking channel behaviors (branch vs. ATM vs. Internet vs. contact center).

Historically, banks have not been sophisticated in analyzing this data, but now there is an opportunity for adept banks to harness channel analytics for both sales improvement and cost reduction. The urgency is underscored by the fact that today, on average, retail banking customers conduct only one of seven transactions at a branch, with the majority accomplished through alternative channels (Figure 3).

This migration has introduced some serious skews in customer engagement. Novantas research shows that banks are far less effective at developing relationships and selling products to customers who seldom use the branch. For example, banking customers who predominately use the phone have only half the cross-sell penetration of consumer credit as branch-dominant customers.

Despite such lost opportunities, most banks continue to concentrate on the branch as their primary sales channel. Systematic programs to convert service interactions into sales opportunities, though common in the branch for decades, are still relatively rare in call centers, and far less sophisticated.

Banks have a formidable information advantage in meeting these challenges. For at least 15 years, ever since the proliferation of data warehouse technology, retail banks have been honing the use of in-depth information on their core customers. The list of benefits is long and includes customer segmentation and targeting; product development and pricing; sales productivity; and underwriting and risk management.

Now, however, further progress is being challenged by accelerated growth in the volume and complexity of customer data that banks must digest. As has happened in many other industries, banking has been thrust unprepared into an era of “360°data,” which offers an exciting new world of possibilities, yet has overwhelmed the current state of the art in managing and applying information.

There is a wider variety of salient activity to track as ever more consumers transition from physical financial services to virtual. People are downplaying branches in favor of multi-channel banking, including the Internet, phone, ATM, and increasingly, mobile technologies. And they also are favoring electronic media — debit, credit, online bill payments — over cash and paper checks.

These shifts have produced an ocean of new information. Yet while cross-sell-hungry banks are under increasing pressure to analyze and synthesize customer behavior across the full scope of the relationship, today‘s most analytically rigorous data applications frequently support only specific products or channels, or integrate only limited aspects of relationships.

It is time for banks to flesh out a formal “analytics” strategy (including architecture, data requirements, partnership/vendor strategies and execution capabilities) that will properly equip the institution for multi-channel competition. For example, a more comprehensive “longitudinal” view of customers and their channel behaviors provides a better understanding of both current and emerging needs and opportunities.

At this critical juncture, banks need to rethink their approach and investments in 360°data to ensure its potential is tangibly realized in higher customer revenue and lower customer costs. To prepare for these opportunities, banks should be considering pilot programs that: 1) refine the understanding of how 360°data can be harnessed for tangible performance improvement (initially we recommend in the areas of marketing and credit decisioning); and 2) identify the attributes of the business system that will be needed to support rollout and long-term momentum, including the infrastructure plan, the analytical plan and delivery channels.

Segment-Based Strategy

The more customers deal in direct channels, the more that segment-based targeting and product customization is essential. Historically, the challenge of conveying subtle segment differences via front line staff in large branch networks limited the ability to customize products and service delivery.

As customers migrate to direct channels, there is an urgent need to rebuild the sales outreach so that relevant and timely offers find their way to target customer segments via their preferred channels. The good news is that the banks that successfully make this transition will have a much more precise and effective way to customize offers, far beyond what can be done by sales generalists in the traditional branch environment.

One example is deposit pricing. While banks have made great strides in pricing sophistication, few have successfully reached the level of segment-based responsiveness. There is a clear rationale for developing this capability going into 2013, given the compelling need for artful engagement with select groups of core deposit customers in special circumstances (Figure 4).

Compared with the aggressive Web-only banks, retail banks have a significant competitive advantage in targeted rate competition, in that they are able to draw on the rich information stream generated by in-depth customers, including patterns with automated clearinghouse (ACH) transactions and debit and credit cards.

For example, one bank identified a set of ACH transaction patterns that not only signaled the presence of “off-us” balances, but also propensity to respond to a rate-based offer and propensity to stay at the bank after the promotion expires. These markers were used to identify a distinct group of customers who then were targeted with special offers.

A second example is improved handling of portfolio pricing for established accounts. The goal is to make efficient use of rates to ensure the retention of more price-sensitive core customers while de-emphasizing price with less sensitive segments.

One specific application is the use of segment-level offers with renewal promotions on certificates of deposit. While the least price-sensitive accounts will renew into standard products, more sensitive accounts are targeted with either liquid offers (i.e. money market or savings accounts) or promotional CDs.

Leading banks use similar tactics to manage liquid accounts after introductory rates expire. By analyzing likely price elasticity at a customer segment level, the bank can identify the proper pricing levels required to retain balances at a granular level. A number of leading banks identify segments that will receive automatic exception pricing, or that will be offered an alternative product at a more competitive price point.

These strategies are critical in maximize profitability in the current portfolio. And they are just a few examples of the opportunities to engage customers in a more personalized and tailored way in banking‘s emerging virtual marketplace.

Demand Management

Historically as bankers concentrated on building more delivery channels and options, they accepted overlapping customer usage as a fact of life. New channels seldom replaced existing ones, but rather improved ease of access and provided greater utility. Customer convenience was improved, in other words, but bank efficiency was not.

Fortunately, there are strong indications that many retail banking customers would now willingly accept alternative channels as true branch substitutes, permitting the additional cost reduction that banks so badly need. Over the long run, customers are becoming “virtually domiciled,” preferring to interact with the bank through direct channels and using branches only as occasional backstops.

Winning banks will use a “carrot and stick” combination of approaches to move more customer activity out of the branch. These include deployment and promotion of image-enabled ATMS; customer incentives and fees; staff training to encourage and facilitate customers as they adopt alternative channels as true substitutes; and ultimately video. This is the path to drive down costs and better utilize branch resources for revenue-producing activities rather than expense-producing transactions.

Already in the industry, for example, some banks are making tangible progress in coaxing customers into extensive use of advanced ATMs, significantly shifting everyday deposit transaction activity out of the branch. Spread across this industry, this kind of true channel substitution could potentially permit an additional 10% to 15% reduction in branch network overhead over a period of three to five years. And these savings are critically needed as economic and regulatory headwinds continue to gust.

At the next level of channel substitution, banks will have opportunities to extend the self service model to account opening (many current customers would prefer to open additional accounts online rather than in the branch); problem resolution; and ultimately highly advice-oriented areas such as mortgages and/or investments.

These progressions herald a new era of “demand management,” where banks much more proactively guide customers into fuller and more permanent remote banking arrangements — online, mobile, automated teller machines, contact centers — such that they become true substitutes for branch service. This is the place where bankers can take meaningful action now to realize substantial additional network savings, yet in a way that will actually increase customer satisfaction.

The Case for Transformative Change

For several years now, retail bankers have looked for a ray of hope in the market outlook, particularly a strengthening of margins and household loan demand. Many needed improvements have been put on hold as the industry waited for a rising tide to lift all boats. Now, however, it is quite clear that executives will have to proceed with industry transformation in advance of a market rebound.

Across the organization, there are many skilled teams that will strive for incremental improvement in their various domains. That is especially good when there are favorable sailing conditions; less so in storm conditions where quick and broadly coordinated responses are needed to deal with unfolding challenges.

The challenge for executive leadership is look beyond the customary borders of incremental improvement and grasp opportunities for transformative change. It is not a matter of forsaking all traditional strengths; but rather of melding the old and the new in a way that will assure stability and healthy growth in future markets.

In Paris, France there is a startling discontinuity in the architecture of the original Louvre Museum compared with the glass-and-steel Louvre Pyramid, as designed by I.M Pei and completed in 1989. Some degree of controversy extends to this day over whether the elegant old building and the futuristic pyramid entrance exactly belong together, yet millions of visitors have come to prefer this juxtaposition, and it certainly is distinctive.

There is a lesson in this for bankers as they contemplate the future. Perhaps many old wings of the traditional banking edifice can be mostly preserved; but that can be only part of the story. Joined to this foundation and structure now must be many new wings that, if not extending the aesthetic, certainly extend the functionality and relevancy of the overall enterprise. That is the big picture for innovation in these challenging times.

Rick Spitler is a Managing Partner in the New York office of Novantas LLC, a management consultancy.

For more information, contact Novantas Marketing

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