Banks must renew their commitment to mass market customers, whose business is essential to support the fixed cost of the branch network.
As banking leaders work to fully restore industry profitability following the prolonged recession, a key question is what to do about mass market consumer banking.
Formerly a pillar of retail profitability, this market segment has been buffeted by new fee regulations, slack margins, weak loan demand and extensive credit aftershocks from the debt crisis. What remains of bank profitability in the mass market has further suffered since most consumer households do not carry high deposit balances and balances in general are not worth as much as they used to be.
While many banks have retreated from the mass market as a tactical reaction to the trying circumstances, some are now going a step further by altering retail strategy as well. Along with formalizing a redoubled commitment to high-end consumers, they are consciously downplaying mass market account acquisition and retention. As justification, they cite a lack of customer relationship profitability – why carry a boatload of underwater accounts that can’t fully justify the costly overhead?
Though perhaps understandable given the circumstances, this up-market movement now threatens to create its own set of problems, primarily in covering the high fixed cost of branch networks. Even though branches are steadily losing customer traffic in the overall trend toward online and remote banking, networks are stubbornly resistant to quick and widespread closures, given the enormous attendant costs.
A Novantas analysis of the entire U.S. branch system estimates that fully one fourth of the collective network is eligible for near-term closure, given trends in customer online migration and the altered economics of retail banking. But our research indicates that swift action would carry a steep price tag of upwards of $30 billion, essentially a full year’s worth of earnings for the depressed retail banking line of business.
Even more frustrating for banks, many customers remain wedded to local branch presence even as their actual usage decreases. Particularly for high-value transactions, such as applying for mortgage credit or solving a problem, people still want lobby service, and branch presence still influences the selection of a bank. Costs aside, branches are a customer safety net that cannot be suddenly yanked.
Thus the more likely scenario is that the industry will close branches at a slower pace over a period of years. This pay-as-you-go approach avoids a big financial hit and minimizes customer disruption, but extends the pain of carrying excess capacity. In the meantime, mass market patronage will be essential in keeping networks afloat.
Rather than scaling back with mass market consumers, retail banks must actively seek constructive ways to grow this book of business. Along with more actively promoting traditional credit and deposit products, winning banks will focus on product innovation as well, particularly in consumer credit and household cash management.
The executive hang-up in embracing this point of view is the powerful allure of top-tier customers. In the search for revenues, corporations naturally focus on the highest paying opportunities. For banks, the sweet spot lies with mass affluent and affluent customers, roughly the top 20% in customer relationship profitability, who typically are five to 10 times more valuable than the average.
But there simply are not enough rich people to pay for the massive branch infrastructure that banks have built. Today, retail banking’s so-called unprofitable customers still pay for roughly 70% of the fixed costs of branch networks, a reflection of the fact that the revenues from their accounts and activities still exceed the variable costs associated with their patronage. Thus, the Economics 101 lesson is alive and well: companies with high fixed costs should still be willing to sell to some customers who do not cover fully-loaded costs, so long as marginal revenues exceed marginal expenses.
A Spectrum of Customer Needs
Previously mass market customers generated a significant fee revenue stream: they used their debit cards to generate merchant bank fees, and a small segment made strong use of checking overdraft coverage. With these revenue streams now truncated by new regulations, banks have experimented with revisions to the “free checking” model, either to boost revenue elsewhere or lower the cost to serve, but with mixed results.
Attempts to impose new fees and/or restrict the use of bank channels have sowed substantial dissatisfaction among mass market customers. For banks, the risks include outright defection (if prices are raised or branch service is disrupted) and a weakened ability to acquire new accounts and relationships.
It is a delicate situation to be sure, yet there are real opportunities to improve the mass market outreach with a changed orientation. One of the top opportunities is consumer credit, a field that is still being picked apart by national monoline and non-bank players even though local banks have deeper customer ties and customer knowledge.
Despite the travails of the housing collapse and recessionary impacts on employment and household finances, mass market customers still have a spectrum of credit needs, including consumer installment and revolving credit – and even a select growing demand for mortgages. For the analytically adept bank there are substantial pockets of opportunity, both in particular markets and with particular customer profiles.
This includes new product permutations, such as the unsecured line of credit, which plugs a financing gap for responsible households that lost home equity as housing prices fell. Other opportunities include money transfer services, person-to-person payments, and alternative forms of checking overdraft coverage.
Eventually the industry will likely evolve to a much more efficient “thin network,” with a select remainder of iconic branches supported by a lattice of reconfigured outlets offering limited service or standalone self-service. Such a network will be able to support the relatively simple service needs of the mass market as well as the more in-depth service requirements of mass affluent and affluent customers.
But the banking industry must tread a careful path to this destination. Essentially banks will need to earn their way out of the fixed cost overhang. In this multi-year quest, the now-less-profitable mass market consumers must not be abandoned, but rather embraced as necessary for covering the lion’s share of fixed bank branch costs.
Rick Spitler is a Managing Director at Novantas Inc., a management consultancy based in New York City. He can be reached at firstname.lastname@example.org.