As with Retail, SME customers are now vulnerable to disruption and national consolidation. To grow this segment, banks will need to align their value proposition, operating model, and capabilities to their target segment.
The Small & Medium Enterprise (SME) banking model is a priority growth area for mid-sized and regional banks. Not only has loan growth returned to its his- toric growth rates, but the market is also rich in low cost, LCR friendly deposits— an often-missed opportunity with credit focused small business bankers.
Extracting pro tability from this segment, however, will require changes to the traditional SME branch and bank- er-based model. As with Retail, SME customers are now vulnerable to digital disruption and national consolidation. The keys to success are targeting the right segments with the right value propositions and digitally enabling the bank.
Growth Challenge in the SME Segment
There are significant untapped loan and deposit opportunities in the SME segment. There are over 10MM SMEs in the US (defined as companies ≤$20MM in annual sales) with over $750B in deposits. These SME deposits represent 20%-25% of branch-based deposits. Loans are growing at a predictable and healthy 6% a year. Despite this, branch-based SME sales volumes have decreased 9% (Q3 ’14 – Q3 ’16). The traditional SME banking model is broken and many regional banks, while focused on modest growth lending, are missing the larger opportunity of SME deposits.
Fundamentally, the challenge is around cost to serve. SME companies are more complex and heterogeneous in their needs than consumers. At the same time, their individual wallets are not large enough to warrant the tailored, individualized treatment provided to the larger Commercial customers. It is a classic, “caught in the middle” problem. Given this challenge, many regional banks struggle to provide scalable advice and solutions, and thus many SMEs are underserved.
What SME Businesses Want from Their Bank
Following the trend in Retail, SME owner attitudes and preferences are shifting to digital and direct channels. The upshot of this is that banks need a more virtual offering for the SME market place if they are to maintain their current presence in the segment. Novantas’s 2017 Business Banking Segmentation research reflects this growing preference for digital. For example, routine check deposits for SMEs, one of the historical drivers of the need to be physically proximate to a bank, is rapidly shifting to digital channels (Figure 1: Digital Channel Preference – 2015 vs. 2017). To be sure, SMEs in the near term remain dependent on the branch channel when compared to Retail. But this dependence varies dramatically by industry segment and suggests the need for a coordinated digital and market segmentation approach.
Soon, dependency on the branch channel, unless modified, will challenge the economics of the business. With the ongoing consolidation of the branch network, driven primarily by Retail abandoning branches, branch cost structure will increasingly be attributed to the more branch dependent businesses (e.g. SME), which will increase pressure on SME profitability. Also, fewer physical locations and decreasing overall branch traffic will result in fewer branch referrals for SME. Finally, there is the risk of increased SME attrition stemming from branch closures. Novantas’s analysis indicates that an SME is 2-3X more likely than a Retail customer to attrite when the primary branch is closed.
A New Value Proposition is Required
Historically, the economic challenges of serving the SME segment required a level of standardization across sales and service. Banks typically employed sales size as a practical indicator to drive the product offering and the sales and service model. However, sales size is a blunt instrument and it masks the underlying variability in customer behaviors, needs and preferences. Identifying the types of SME customers that drive profitability, that are best served by the bank’s current SME product and channel capabilities, and that are responsive to the bank’s brand image is a critical step in crafting a new SME strategy.
In response to the changing SME banking behaviors, Novantas initiated research in Q1 2017 focused on SME attitudes and motivations towards banking. A surprising diversity of SME needs, preferences and attitudes was uncovered. Novantas identified a set of five distinct segments based on SME attitudes and motivations towards primary bank selection and engagement. More importantly, the five segments cut across the traditional sales sizes, industries and maturity:
- Top-Shelf Leaders — They demand best-in-class products and services from banks and lean into bank relationships. They are looking for a strategic partner to help them grow their business for the long term.
- Aspiring Builders — They are a growth-oriented segment, but pessimistic about their financial future. They do not have a lot of financial expertise and are most likely to be open to advice directly from the bank.
- Efficient Operators — A branch-detached segment, so digital capabilities are key for servicing them. They have overall straightforward needs, and want banking to be easy and accounts to be consolidated within a single bank.
- Traditionalists — They are transactional and branch-dependent, as
well as most likely prefer local banks, but not very digitally-savvy in terms of banking relationships.
- Detached Controllers — They are bank-detached and overall apathetic about their banking relationships. While they shop on rate and fees, they still show some willingness to pay for value.
The segments provide important insights regarding how to acquire and profitably manage SME relationships, as well as an opportunity to develop a differentiated approach to the SME market.
Take, for example, the “Top-Shelf Leaders.” This segment is one of the more important ones and amounts to a quarter of all SME customers and almost a third of loans and deposits. These customers are multi-channel, have complex banking needs, and seek partnerships with banks knowledgeable about their business. These high-value, high-potential SMEs are distributed across a broad range of industries, sales sizes, and lifecycle stages, limiting the ability of the old model to effectively target this segment. Different segments, on the other hand, place far less value on partnership, advice and range of services, preferring “cheap and cheerful” self-service cash management. The stark contrasts in segments underscore the importance of choosing the right SME segments and value proposition to drive a particular bank’s growth.
An Updated, More Efficient Coverage Model
In addition to targeting segments and tailoring value propositions, the bank needs to address the cost to acquire and serve customers in a new digitally enabled sales/service model. Small business owners have begun to embrace digital forms of interaction with banks—less face-to-face interactions and more text messages, emails and phone calls. Updating the coverage model will require the bank to not only build new products and digital self-service capabilities, but also to redesign roles and responsibilities and incorporate new technologies across call centers, branches, back-office and frontline staff.
There is significant opportunity for banks to streamline and enable complex servicing and tailored advice delivery through enhanced channels. It requires rethinking the roles and tech support of different channels. For example, at some banks, phone centers supply the core relationship development role for some segments, with person-to-person visits reserved for the assigned bankers and undertaken for only limited purposes. In other cases, the focus is on making interactions as self-service as possible.
Making Hard Decisions
Driving profitable growth in SME requires commitment and hard decisions. The path to success requires following the changing needs of the customer (Figure 2: Key Questions for SME Banking). The design of the new SME business model is not a tweak of the traditional approach, but rather a new conceptualization of the value proposition, target segments, product capabilities and the sales and service model. This change will require an objective and unflinching view of the customer needs, an honest evaluation of the bank’s current delivery capabilities, and strong commitment across the organization.
Managing Director, Chicago
Principal, New York
VP of Market Research, Chicago