Smart Selling

The dichotomy that exists today between consumers’ demands for one-stop shopping and what many say is the most efficient course, developing a niche business, can make the director’s job a tough one when it comes to setting the bank’s long-term marketing strategy. A careful analysis of the bank’s products, infrastructure, and customer service program can help boards find the right fit for their institution.

At a bank analyst meeting about five years ago, the CEO of a regional bank described how mutual funds and other asset management services were going to solve his bank’s revenue momentum problems.

His bank had relationships with a large share of the households in the region but had only a small share of their investment assets. He explained how he planned to offer those customers mutual funds to capture more of those assets and get a big boost in revenues, recalls James McCormick, president of First Manhattan Consulting Group, who was present at the gathering.

Subsequent to the meeting, McCormick analyzed the proposed solution by posing his own question: “If the banking industry bought out the retail mutual fund industry and spread the earnings evenly among all the banks in the country, how much would banks’ income go up?”

The answer? Only three or four percent, says McCormick, explaining that the profit yield from a dollar of mutual fund revenues is significantly less than the profit from a dollar of core deposits. “Depending on the product, it could be as much as 10 times less.”

The CEO listened, but decided to start selling mutual funds through his bank anyway.

About a year later, McCormick was called back to assess how the bank’s strategy was progressing. Although a lot of accounts had been opened, they were relatively small with low margins that were dwarfed by the costs of opening the business, eventually leading to a loss.

A couple years later, on a spike in the stock market, the bank was sold. Now the challenge of revenue momentum belongs to the new institution.

Many bankers today face the same question: “What products should I be selling to stay competitive in the marketplace?” But the issue has gained urgency in the wake of huge mergers in the past year, especially the formation of Citigroup from the merger of Citicorp and Travelers, which affords the new institution the ability to sell everything from loans and mortgages to annuities, insurance, and stock options together under one roof.

Banks of all sizes will be paying careful attention to the unfolding Citigroup saga as a bellwether of what is permissible and what is possible for a banking company to sell. To some, it presents a new paradigm. For all, it turns up the heat.

“It is too early to tell if other banks will feel compelled to imitate Citigroup,” says James McDermott Jr., president of Keefe Bruyette & Woods. In fact, McDermott believes there could be a lull in M&A activity. “There is a lot of digestion going on. There was the market dislocation in September and October, and now there is the year 2000 problem to worry about. But merger activity will pick up again in the future.”

In the meantime, bankers are going to be looking around, wondering how to respond to the changing banking landscape. Many banks began adding investment products and increasing fee-based income years ago. But McDermott believes the Citigroup merger will make them “step on the gas.”

Fleet Financial is a good example, he says, explaining that the Providence-based institution already owns an asset management unit and a discount brokerage and likely will continue to add to its already diverse portfolio.

In November 1998, Fleet spent more than $1 billion for Sanwa’s leasing unit, Crestar Financial’s credit card business, and Merrill Lynch’s specialist unit. These acquisitions added to Fleet’s holdings, which included Quick & Reilly brokerage and Advanta credit cards.

Fleet’s buy-as-you-go approach has been called opportunistic. The $100 billion bank has moved quickly, deploying a strategy that appears to advocate, “Be all things to all customers.” In Fleet’s case, it seems to be paying off. As of third quarter 1998, Fleet had increased fee income to $843 million, a $224 million rise. During the same period, Fleet’s interest income increased by only $35 million, to $79 million.

On the other end of the spectrum, banks are shedding unprofitable businesses and sharpening their focus. “You’re seeing a lot of banks getting out of businesses if they don’t have the scale or market share,” says McDermott. For instance, Mellon Bank Corp. recently announced the selling of its mortgage, credit card, and transaction processing businesses to concentrate on its mutual fund and investment management businesses.

Like many banks, Mellon is putting greater emphasis on generating fee income. But the Pittsburgh banking company is building on a strong foundation. In 1993, Mellon acquired The Boston Company, a specialist in custody and private client services, and in 1994, it acquired Dreyfus Corp., which put it in the top ranks of bank mutual fund managers with $2.2 trillion of assets under custody administration, including $390 billion under management. Mellon now has $50.4 billion in assets and it is the leading bank manager of retail funds assets with $120 billion in its portfolio.

But most banks are not in a position to make acquisitions on such a grand scale. And as McCormick of First Manhattan Consulting points out, “Unless they do, it is not going to add up to a lot.” In many cases, it is hard to see how a bank can sell enough investment products to make a materially significant contribution to the bottom line relative to the services they already offer, he observes.

What many bankers overlook, he says, is that deposits, loans, and other standard bank fare dwarf mutual funds and other types of investment products. “Banks today offer the most materially substantive products based on revenues, profits, or whatever measure you want.”

Of course, there are good reasons for offering a wide range of investment products, even without the potential for powerhouse profits, says McCormicku00e2u20ac”such a tact may be critical in a customer relationship-building sense. But it is important to enter into the business with the understanding that you are doing it to protect relationships and retain customers, rather than make a fast buck.

But McCormick counsels against moving too quickly. “There are a couple of things banks should do before they have a knee-jerk reaction to the Citigroup merger,” he explains. “First, on the back of an envelope they should figure out what the potential increment of costs and revenues will be.”

Typically banks find that they already offer some “gorilla products”u00e2u20ac”those that have considerably more revenue and profit potential than the new ones they are examining. McCormick cites such old standards as checking, savings, and money market accounts, which often bring in more than 80% of the profits attributable to consumer accounts in a retail banking unit. In overall profits for a typical regional bank, such standard fare earns nearly 40% of the profits for the consumer and small-business units.

“Second, a bank should take care that it is not attracting the wrong segment of the business,” continues McCormick. “In most businessesu00e2u20ac”and banking is no differentu00e2u20ac”the top 20% of customers provide up to 100% of the profits.

“When banks first went into the mutual fund business,” he says, “they looked at what to sell and how to sell, and they thought, ‘We’ll go after all those people who do not already have mutual funds.’ Inadvertently they targeted low-balance and, therefore, marginally profitable accounts, and they did not get their fair share of the business required to make it profitable. It is important to get a clear picture of the revenues and costs and to understand how to obtain your fair share of the most attractive segments of the marketu00e2u20ac”not simply to open up a lot of accounts.”

Half empty, half full

To Kenneth Kehrer, of consulting firm Kenneth Kehrer Associates in Princeton, New Jersey, it is not simply a question of being profitable or unprofitable. “The mutual fund business is very profitable,” he states matter of factly, “there just are not enough profits.”

“Banks are doing very well in the mutual funds business and in other types of investment services,” says Kehrer, “but they were misled in their expectations. They were being told they could get 25% of the mutual fund or insurance business. There was no basis for that.”

In addition, he explains, “Banks were told that they could control the mutual fund business. There was also no basis for that.” Banks currently have between 12% and 15% of the mutual fund market, but 50 banks sell two-thirds of the mutual funds sold by banks, notes Kehrer.

One of the mantras repeated to banks by consultants has been, “If you can’t control the business, you shouldn’t be in it.” But Kehrer questions the wisdom of that approach. “We’ve heard a lot of that kind of religion, but you don’t have to dominate a market for it to be a good business,” he argues.

On the contrary, banks have penetrated the investment services market at an average rate of about 1% a year. That is, they have been successful in selling investment products to about 1% of their customer base for every year they are in a given business. So in nine years, a bank typically will be successful in selling about 9% of its customers a new investment service or product. In 15 years, banks will win over 15% of their customer base.

Is that a good business? “It depends on your expectations,” says Kehrer. “It is good, steady performance, but is the glass half-full or half-empty?”

For most banks, investment products are a very good business. “It requires no capital, or at least relatively little capital, so the returns are high,” Kehrer points out. And, finally, “it brings a lot to the bottom line on a percentage basis,” he says. The problem is it might not bring a lot in terms of absolute dollars.”

To make his point, Kehrer estimates that the typical regional brokerage firm’s profit margins are one-half to one-third the profit margins of a bank brokerage. This is partly because banks have carved out the most profitable part of the business, such as packaged products like mutual funds and annuities, instead of selling stocks and bonds on an individual basis. “Mutual funds sales have four, five, and six times the profit margins that stock or bond sales do,” he says.

Banks also can pay their sales staff less than a brokerage does because banks provide their salespeople with prospects. Banks also use salaried employees such as tellers, in addition to commissioned sales staff, to bring in business. And banks do not have to support the highly paid research staff that many brokerages firms do.

In all, staff costs at a bank brokerage are typically 10% of revenues, notes Kehrer. At a brokerage firm they are about 33% of revenues, and at a regional brokerage they can be as high as 40% to 45%.

But there is another factor driving banks to diversify their product mixes. “Banking has become a growth industry,” Kehrer says. “And banks are trying to figure out how to take it to the next level by buying brokerages or by licensing branch staff.”

This has been brought on in part by the unprecedented bull market of the past decade, which has prompted consolidation of the industry’s institutions and diversification of product portfolios.

“Banking is an earnings-starved business right now,” explains Kehrer. “Many banks are buying regional investment firms in an effort to boost their earnings and get their stock prices up even higher.”

Meeting consumer

(and shareholder) demand

But before a bank rushes out to acquire new revenue centers and add product lines, consultants agree that special attention should be paid to what products customers will buy.

For an institution like Citigroup it makes sense to house all those functions under one roof, says Chris Quackenbush, principal with Sandler O’Neill & Partners in New York. “But two-thirds to three-quarters of all banks do not have the same clients as Citi.

“Large banks will behave like Citi because they are going after large, sophisticated customers,” he observes. “But that is not going to work for all banks.”

“What has happened, is that because of competitive forces, banks have realized that they are wasting their time trying to sell just one product,” Quackenbush says. Banks of every size have realized that it is the relationship that counts.

In that respect, it matters which customers are being targeted. Commercial customers, for instance, are likely candidates for insurance and cash management products to assist in capturing and managing their free cash flow. On the consumer side, more emphasis should be put on mutual fund and annuity products. “You have to know the customer. You have to make a menu of products and not be shy about selling them,” advises Quackenbush. In a word, banks have to cross-sell products across business-unit lines.

Despite all the talk about cross selling, consultants agree that banks have not done very well at it. The concept seems simple enough, even obvious: sell homeowner’s insurance to someone who is taking out a mortgage or sell car insurance to an auto loan customer.

The problem, says Quackenbush, is that a lot of banks do a poor job of cross selling. “They are doing poorly because they lack focus, and they just haven’t tried hard enough. You can’t just do a statement stuffer. That tends to annoy customers.” Corey Yulinsky, vice president, financial services industry practice with Mercer Management Consulting in New York, agrees banks are only just beginning to catch on.

“Banks are transfixed by cross selling as it is measured by the number of relationships or the number of profitable relationships,” says Yulinsky. “But the customer measures his or her interaction with the bank as an experience. Until a banker understands this, he is not going to be good at cross selling.”

Banks have to improve what Yulinsky calls “customer relationship management.” He cites a situation in which a bank customer calls a customer-service phone line. The customer receives the information and later goes to the branch to finalize the transaction. However, when he gets to the bank, he cannot find anyone who knows what he is talking about.

The disjunction between the service the customer desires and what he experiences is frustrating, annoying, and time-consuming. But it is all too common; many people have had a similar, if not identical, experience. “This kind of disconnect puts off a customer,” warns Yulinsky.

Finding synergies

Another impediment to cross selling is the way in which banks measure success. At too many banks, performance is based on the results of an individual business unit. This encourages a person working for one part of the bank to ignore opportunities that would benefit other business units. The result is that revenue opportunities are lost. To address this, some banks have begun to link performance and compensation to the overall profitability of the bank. And they are finding that it is beginning to have an impact: An employee is more likely to take extra effort to steer his auto loan customer to the person who sells auto insurance when incentives are in place.

Another key ingredient to successful cross selling is enhancing the skills of the staff. Banks have been laying off a lot of people, but they are also hiring new workers, people with more analytical skills who are better prepared to explain the full range of banking and investment products being offered to customers.

“Banks are all striving to build broad product lines,” says Yulinsky. “But they are going to have to work on more than that. The largest institutions, which now have customer bases of 20 million to 25 million people, will have to build credibility and profitability as well,” he says, because selling more products often does not translate into earning more profits.

A recent study by Mercer Management showed that the 80-20 rule of customer profitability often turns into a 110-20 rule when applied to financial services. The 80-20 rule states that the top 20% of customers generate all the profits, in effect cross-subsidizing the remaining 80% who are either marginally profitable or unprofitable.

“Although it is practically impossible to prevent some sort of skewing in terms of profitability, it can be managed aggressively and more effectively,” says Yulinsky. There is now software on the market that enables banks to create sophisticated models of customer purchasing patterns and behavior, which can be used to segment customers according to usage and profit potential. Banks can use these models to develop targeted pricing structures that link prices to each customer’s buying behavior. “These programs are like using a high-powered microscope compared with using an old-fashioned magnifying glass,” says Yulinsky.

In the end, banks are not just looking to sell more products, they are looking for more profit-generating revenues. And while size is important, it is not paramount. Dominating the market or simply offering more investment products will not guarantee profitability.

In this respect, a bank does not have to be gargantuan to offer all the products and services needed to retain the best, most profitable customers.

In fact, as Yulinsky notes, “it is going to be harder and harder for any bank to just stick with the simple loan and deposit business. That would put them in a pretty small box.” But it is the customers’ needs and not bank size that is driving banks’ move to the investment management business, says Quackenbush.

And believe it or not, consultant Kehrer points out that some small banks have better penetration of mutual funds than large or mid-sized banks (see sidebar). According to a study by his firm in 1997u00e2u20ac”the most recent figures availableu00e2u20ac”community banks (assets of $2 billion or less) had deposit revenue penetration of $1,502 of investment products sales per $1 million of retail deposits. That compares with $1,263 per $1 million of retail deposits for regional banks (assets of $7 billion to $25 billion). And not all of that is done through third-party sales of financial services, says Kehrer. The fact of the matter is that “some small banks have a better ability to focus on their customers.”

In that respect, Yulinsky recalls the lesson of a banker who has been through a lot of mergers. “At first he was obsessed with getting the cost side right, and thought he could do the customer piece later. But he found that if you don’t take care of the customers, you lose them. You have to work on all of itu00e2u20ac”the customer, the relationship, the costsu00e2u20ac”at once.”

Join OUr Community

Bank Director’s annual Bank Services Membership Program combines Bank Director’s extensive online library of director training materials, conferences, our quarterly publication, and access to FinXTech Connect.

Become a Member

Our commitment to those leaders who believe a strong board makes a strong bank never wavers.