More and more banks are moving to jump-start growth by building proactive sales cultures, and that’s a very good thing. Or rather, it should be. Unfortunately, too often the banks’ growth strategies will backfire. Companies will spend lots of money to generate sales that, in the end, will cost them money. When all is said and done, those banks would have been better off making no sales initiatives at all.
There are two key reasons why sales efforts blow up: First, in their zeal to sell more, banks often overexpand their offerings, wasting time and money on products that are inherently unprofitable. I’ll talk more about that in a minute. But more important, banks forget that there’s a difference between profitable sales and unprofitable sales. You laughu00e2u20ac”but in financial services, that’s easy to do! In their quest to expand their top lines, banks will end up with too much of the latter and not enough of the former.
First off, let me define what I mean by “profitable sale.” A profitable sale is one that produces a stream of revenue that exceeds expenses incurred in generating the saleu00e2u20ac”including a risk-adjusted capital chargeu00e2u20ac”over the product’s entire life. Sounds straightforward, right? In a manufacturing business, it is. But not so in banking. The reason: In financial services, the revenues and costs from financial products occur over time and depend on how the products are used by individual customers. Often, you won’t know whether a sale is profitable for months, or even years. To illustrate, let’s look at the lifetime profitability profiles of two different types of checking accounts: standard checking and free checking.
On one hand, the profitability profile of the typical standard checking product is pretty basic and easy to predict. Standard checking accounts typically carry higher average balances than free checking accounts do, and have longer average lives, but they generate lower fee income. Free checking, by contrast, is much more of a wild cardu00e2u20ac”especially at banks that are rolling out the product for the first time. Initially, the bank will see a sharp increase in the number of checking accounts it opens and an increase in the average fee income per account, thanks to higher bounced-check charges (the economics of free checking depends on higher NSF charges, remember). Overall deposits will rise.
So the program will be a profits gusher, right? Not so fast. Just because the free checking program causes an initial spurt in revenues doesn’t mean it is creating positive lifetime value for the bank. The reason is that the expense dynamics of free checking, as well as the risk associated with it, are meaningfully different from standard checking accounts. Attrition is much higher, for one thingu00e2u20ac”often 50% higheru00e2u20ac”so the bank has spent a lot of money for a temporary, unprofitable lift. In addition, some institutions find that fee income per account declines as accounts mature, and as customers figure out how costly bounced-check charges can be. Finally, most institutions find the cost of servicing free checking accounts is higher than the cost of servicing standard checking accounts.
Add it all up, and a company that experiences rapid growth via a free checking program may or may not be creating profitable growth. Profitability can only be determined by matching the revenues that an account generates over its life with the expense incurred in opening and maintaining the account.
Too many products sold
So the first key to maximizing profitable sales as a percentage of total sales is to recognize that traditional measures of sales and growth are insufficient and that new metrics need to be developed. The second key to generating profitable sales, I believe, is to reduce the number of products that the financial services provider offers.
I recently read a paper by consultants Mercer Oliver Wyman that made this point vividly. According to the study, at the typical bank, sales of the top 10% most profitable products generate 70% of overall product profits, while the bottom 80% of products contribute less than 1% of profits. The report stresses just how debilitating this profit skew can be: “The majority of products simply consume management time, training, advertising, and sales force focus for very little return. They dilute attention from the few core products that create value.”
Earlier studies, both in and out of financial services, have come to the same conclusion. Invariably, they conclude that the productivity of a sales force declines drastically after product breadth reaches a (fairly narrow) saturation point. Drug companies, for instance, find this point is reached after just four products. I don’t know what the corresponding number is for financial services sales, but I know it’s something well less than 100!
In all, an emphasis on greater proactive selling at banks may seem like a good idea. But the only way sales programs will add to the bottom line is if managers recognize that not all sales are profitable and understand that the simpler the product set is, the more profitable it will be.