06/03/2011

The Big Retail Showdown


When someone or something that was supposed to have died refuses to oblige, it is fashionable to quote Mark Twain’s widely known quip-upon hearing that his obituary had been published in the New York Journal-that “the reports of my recent death are greatly exaggerated.” And so it is with the hoary old bank branch-a living anachronism that dates back to Twain’s era and beyond, and whose obit has been written countless times in the financial press ever since the Internet began changing practically everything in the 1980s.

Indeed, not only has the bank branch survived-it has actually thrived in recent years. Fueled by one of the longest economic expansions in U.S. history, and also by the industry’s fierce competition for low-cost consumer deposits, the country’s financial institutions went on a prolonged building spree that saw the number of branches grow 12% from 2000 through 2007, before leveling off in 2008 when the U.S. economy took a sharp downturn. As of June 2009, according to the most recent data from the Federal Deposit Insurance Corp. in Washington, U.S. banks and thrifts had a total of 99,540 domestic branches.

FDIC branch data as of June 30, 2010 was not yet available when this story went to press, but there were warning signs last year that some industry giants’ long-running love affair with the branch might be on the rocks. In July 2009, The Wall Street Journal reported that former Bank of America Corp. CEO Kenneth Lewis told a group of investors in a private meeting that the Charlotte-based company would close about 10% of its 6,100 branches. Possibly fearing a revolt from angry customers who didn’t want their branches to be shuttered, the bank quickly issued a statement claiming that any reductions would be modest and would occur over a three- to five-year period. New York-based Citigroup Inc. also announced in September 2009 that it would close or sell some of its 1,000-plus U.S. branches, which strengthened the perception that some of the country’s largest institutions would start cutting back on brick-and-mortar distribution.

Facing down challenges

There’s no question that banks and thrifts are operating in the toughest economic environment they’ve experienced in years. Although the U.S. economy is technically no longer in a recession, tepid loan demand and continued asset quality problems have placed extraordinary pressure on bank capital and earnings. As if that weren’t trouble enough, new Federal Reserve restrictions on bank overdraft charges will also significantly reduce one of the industry’s most reliable revenue sources, further straining its profitability. And these challenging circumstances have forced many banks to take a closer, harder look at underperforming branches.

Added to this short-term economic pressure is the parallel, although unrelated, change in how many consumers access their banks. After nearly 30 years, remote access banking-which in the early 1980s was referred to as home banking, a term that seems quaint in today’s anywhere, anytime, totally wired world-is seriously competing with traditional branches for transactions and customer loyalty. Whether it’s paying bills online from a laptop computer in a local coffee shop with Internet access or transferring funds from one bank account to another via a Blackberry or iPhone while waiting in line at the supermarket, alternative distribution channels have finally gained critical mass.

And that in turn is forcing the branch to evolve from a quasi-public utility (think “post office”) to the central platform in a highly focused relationship management strategy-which is a game most banks still haven’t learned how to play. But learn they must, because brick and mortar is by far the most expensive distribution channel in retail banking, and in today’s challenging economic environment, any branch that isn’t solidly profitable is a likely candidate for closure.

“We are starting to see banks look at their branch strategies in a different way,” says Nicole Sturgill, research director for delivery channels at The Tower Group Inc., a Needham, Massachusetts-based research firm that specializes in the financial services industry. “They’re asking themselves, ‘Am I getting enough money out of this branch to justify the cost?’”

Make no mistake, the bank branch is neither dead nor dying. For the vast majority of banks and thrifts today, the branch remains the primary channel in their retail distribution network. “Our banking centers are always going to be the core strategy for distribution,” says Bank of America spokesperson Anne Pace-who reiterates that the bank is making no effort to deliberately downsize its branch system. “There is no large-scale plan under way to close banking centers,” she says.

“We have no number in mind.”

The branch retains this foundational role because when most consumers open a new checking or savings account, they strongly prefer to do that transaction in person. “The branch remains the single most important source of new accounts-it’s more than all the other channels combined,” says Richard Hartnack, vice chairman at Minneapolis-based U.S. Bancorp and head of consumer banking. The branch is also important to many local businesses that have to make daily cash deposits. “Retailers continue to use the branch on an undiminished level,” adds Hartnack. And of course, banking is still a people business and the nearby branch remains the one place where customers can go when they have a problem and talk with a banker face to face. In short, the branch continues to be the anchor for most consumer and small-business banking relationships.

In the consumer world, the branch is also a tangible entity that projects a very intangible concept-the institution’s brand identity-into the community where it can be experienced in a very visceral way. And a few banks, like Umpqua Holdings Corp. in Portland, Oregon, have taken this idea very seriously. Most of Umpqua’s 176 branches in Washington, Oregon, and California have been designed to have the look and feel of a café and have electronic bulletin boards that display information about what’s going on in the community. Some Umpqua branches even host neighborhood events in their space as a way of connecting with the community. The message would seem to be that if Umpqua cares about the community, then it must care about the individual consumer.

“Our branches are a billboard for our differentiation in the marketplace,” says Lani Hayward, the bank’s executive vice president for creative strategies. “We’re building something that goes beyond banking. “[The branch] is part of the community.”

Running a profitable branch system in today’s challenging economic environment requires a clear strategy and strong execution. At Winston-Salem, North Carolina-based BB&T, the financial performance of its 12-state, 1,800-plus branch network is reviewed closely on an ongoing basis. The bank keeps an active list of underperforming branches and is not reluctant to close those where the problem stems from a poor location. “We constantly prune our branches,” says Ricky K. Brown, the bank’s senior executive vice president and banking network manager.

Each BB&T branch has its own balance sheet and profit-and-loss statement, and is run like a separate business. The bank has a demanding sales culture where each branch has sales goals that are tracked obsessively. The weekly sales cycle kicks off Monday morning with a bankwide sales meeting, continues through the week with various other meetings as the progress of each branch and each sales associate is tracked against their goals, and concludes with a bankwide debriefing on Friday. “And Monday morning we get up and do it again,” says Brown. “It’s an intense system of management each week.”

U.S. Bancorp also runs each of its 3,000-plus branches, which cover a 24-state territory from Ohio to California, as separate profit centers. “Our people are accountable for the businesses they run,” says Hartnack. Every branch has certain fixed costs, which generally include the cost of the building, land, and equipment, along with personnel costs and shared overhead for such corporate activities as compliance and auditing. The bank has tried to lower its branch overhead in recent years by building smaller units that average about 3,000 square feet in size, and it uses inexpensive furnishings similar to what one would find in a mid-level national hotel chain. “People are still building 5,000 square-foot branches, which doesn’t make sense to us,” says Hartnack.

The revenue strategy at U.S. Bancorp is relatively simple: Build a franchise of consumer and small-business checking accounts and use those to develop a deeper relationship with the customer. “Once you’ve got that in place, it’s all about trying to get a bigger piece of their wallet,” Hartnack says. “It’s basic blocking and tackling-good execution, good sales, and service at the customer point of contact.”

Integrating the retail strategy

In addition to the branch, there are four other primary distribution channels in retail banking: ATMs, call centers, online access through the Internet, and mobile access through a handheld device like a Blackberry or iPhone. ATMs have been around for a long time, as have call centers, and both have contributed to a steady decline in branch traffic over the last several years. The rapid expansion of the online channel in recent years has also shifted a significant volume of transactions away from the branch. And the projected strong growth rate for mobile banking will reduce branch transaction volume even further while creating new product opportunities for banks. Fiserv Inc. has a person-to-person payment service in pilot now with approximately 60 financial institutions that customers can access through their mobile phones. “We’ve done a lot of research and we think it’s something that banks can charge a fee for,” says Erich Litch, senior vice president and general manager of Fiserv’s Electronic Banking Services unit in Hillsboro, Oregon.

“[A]lthough deposits have increased dramatically (almost 13% from 2007 to 2009 as consumers left the stock market), the number of branch transactions-the bulk of which are teller transactions-increased only 2% between 2008 and 2009,” TowerGroup’s Sturgill wrote in a February 2010 white paper on the future of the branch. “Compared to the growth in online banking transactions at 18.2%, it is clear that consumers are shifting basic transaction activity to self-service channels.”

The pace of technology spending to support the various alternative distribution channels has slowed in recent years as the industry’s profitability has declined. “Financial institutions say, ‘This is great, got to have it, call me Jan. 1, 2011,’” says Jeff Marshall, vice president of strategic technologies at Harland Financial Solutions in Lake Mary, Florida. Right now, “banks just don’t have the money.”

And yet spending to these channels will most likely increase as the economy recovers. TowerGroup projects that mobile and online transaction volume will have a compound average growth rate of 116% and 8.5%, respectively, from 2009 to 2013. Branch transaction volume, on the other hand, is expected to grow just 0.07% over the same period.

The steady decline in branch transactions is evident at Cherry Hill, New Jersey-based TD Bank-the U.S. subsidiary of TD Bank Financial Group Inc. of Toronto, Canada. According to Fred Graziano, TD Bank’s president for regional retail banking, the branch is still the single largest source of transactions, at approximately 43%. But online, ATM, and call center channels combined account for about 57% of TD’s total retail banking transactions. And since all of these alternative channels can process transactions more cheaply than branches, the shift in their favor has yielded a significant cost savings to the bank. TD does not currently offer mobile access, but Graziano estimates that the cost of a mobile transaction is only 8 cents, compared to $4 in the branch, so adding mobile to its mix of channels would drive down TD’s distribution costs even further.

But the proliferation of distribution channels has a downside as well, since it becomes expensive for banks to offer all of these options unless they are able to recapture some of the associated capital expenditures and operating expenses by lowering their branch costs accordingly. Yet that doesn’t mean they can initiate large-scale branch closures because even many heavy Internet users still want the security of having easy access to a nearby branch.

“Customers want it all,” says Dave Kaytes, managing director and founder at Novantas LLC, a New York-based research firm. “They want all the channels available to them. But while customers in the aggregate want it all, customers individually just want what they want.” In other words, an older customer may only use the branch for transactions, while another may use the branch and online channels-and a third might rely mostly on the online and mobile channels but want accessto a branch, just in case.

Making the economics work

In a perfect world, a majority of customers would only use the branch for high-value transactions, like applying for a mortgage loan. Low-value transactions, like paying bills or making deposits, would be handled through less-expensive channels like online bill pay or ATMs with imaging technology that lower item-processing costs.

“You do have to provide all the channels to be competitive,” says Graziano. “But the trick is how you get the customer to use the right channel.” In other words, how do you get customers to use a self-service channel like online for simple transactions and reserve the branch for high-value activities that produce revenue?

“It’s a mistake to try to push people out of the branch,” says Litch at Fiserv. “People have their preferences and there are things they will and will not do.” Litch says banks need a migration strategy that encourages the preferred behavior, but does not mandate it. He points out that the best source of new potential online users is the branch, which only makes sense since the branch is where most new accounts are opened. But there is a relatively small window in which new customers can be encouraged to use other products and services like online bill payment-only about 45 days, according to Litch. Indeed, it makes sense to try to introduce new branch-based checking account customers to all of the bank’s alternative delivery channels when they first open their account.

The benefits of a successful migration strategy show up on the bank’s bottom line. “The profitability of [online] customers is definitely higher than offline customers,” says Litch. “They’re cheaper to serve and they’re more reluctant to leave your institution than offline customers.”

One of the more challenging aspects of managing a multichannel distribution strategy is delivering the same level of consistency across the spectrum. “You need high quality in all your channels,” says Graziano at TD Bank. And for an alternative channel like online, “It has to be simple. It has to be fast. And it has to be secure.”

But providing a consistent level of service quality requires that all the channels be consolidated. Banks have done a better job of linking the separate systems that support their consumer loan, savings, and checking account products, so that an account executive in the branch could sit with a customer and call up a summary of that customer’s entire relationship with the bank. “But if a customer walked into the branch and said they had heard about a new product that was being advertised, [the executive] might not know what they were talking about,” says Marshall at Harland. “It’s really important that all the channels work together. Not too many banks have that capability today.”

According to Marshall, many of Harland’s clients are looking for more cross-channel integration so that if a person started filling out a loan application online and then ran into trouble, he or she could come to the branch and finish the application with the assistance of a customer service representative.

Branching’s continual evolution

As transactions continue to shift from the branch to online and mobile channels, the branch will need to redefine its role. And as alternative channels siphon off an increasingly greater percentage of low-value transactions, that should free up the branch to concentrate on higher value transactions that offer greater revenue potential to the bank. This would allow branch personnel to pursue a relationship management strategy that would transform the branch into more of a consultative sales center rather than a transaction site.

Sounds logical enough-except that most banks aren’t anywhere near ready to adopt this strategy. Kaytes at Novantas says that traditionally banks have sold a narrow set of products-checking accounts, savings accounts, and certificates of deposits-through their branch networks. What most banks haven’t done well is integrate the sales and marketing of their other core consumer products-credit cards, home mortgages, and investment advice, to name three-into the branch environment.

“In Europe, bank branches are clearly multiproduct environments,” says Kaytes. “In the U.S., historically branches have focused on a much narrower product range.”

Another problem is that the checking account has heretofore been the core relational product between the customer and the bank, but the steady growth of the online channel has been luring an increasingly greater number of those transactions away from the branch. This becomes an issue when an institution decides to shift its branch strategy to more of a relationship management approach because the payments vehicle-which includes the old tried-and-true checking account, a debit card linked to that account, and a credit card-drives many of the other consumer products that banks sell and helps them to understand the financial patterns and tendencies of the customer.

“The payment vehicle is the only product that bankers have that is a repeating event,” says Kaytes.

The challenge then for banks is to use the branch as the primary vehicle in developing a deeper relationship with the customer in an environment in which transactions that are tied to the traditional core product-the checking account-are increasingly moving offline.

One institution that is attempting to make this challenging transition is Bank of America. According to Pace, the bank has altered the compensation philosophy in its banking centers from one that was “product centric” to something that is “relationship centric.” “Now we’re more driven by ‘How can we deepen the relationship with the customer?’” she says. As part of that strategic shift, Bank of America will over time integrate its mortgage banking and investment management capabilities-which were greatly augmented by its 2008 acquisitions of Countrywide Financial Corp. and Merrill Lynch & Co.-into those banking centers that are located in demographically favorable markets.

The transformation of the branch from a transaction to a relationship hub won’t be an easy one. It will require branch personnel to sell in more of a consultative capacity where they take the time to fully understand the customer’s needs. “We have a lot of work to do to get our associates comfortable with that model,” says Pace. But if Bank of America and the rest of the industry can pull off that transformation, it will create a new lease on life for an iconic industry symbol whose obituary has been written countless times in recent years.

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