Of 'Microsegments' and Other Data-Mining Booty

More than a show of the latest in electronic banking equipment and approaches, the Retail Delivery '96 conference in Dallas was a gold mine for data hounds.

Bankers who tried to absorb it all were likely to come away with two dismal conclusions: about how little they know, and how unprepared their industry is for the rapid changes ahead in consumer and small-business markets.

These messages may have been by design. The Bank Administration Institute, sponsor of the early December conference, has advocated the rigorous, data-crunching approach to understanding customer preferences and profitability and setting strategies accordingly.

The BAI's publication with First Manhattan Consulting Group of the landmark "Retail Delivery Systems" report three years ago opened many bankers' eyes to the hidden wonders of data mining. The pursuit has advanced exponentially from the original conclusion that more transactions take place by telephone and automated teller machine than in bank branches.

MasterCard International, whose president, H. Eugene Lockhart, formerly worked at First Manhattan, has begun publishing its own reports on the intricate relationships between customers' profitability and their transaction habits.

At the retail delivery conference, Anne Ko of MasterCard offered insights on the linkage of profitability with behavior indicating how far these methodologies have come since 1993. For example, her study separated credit card customers into nine "microsegments" of varying profit (or loss) contribution.

MasterCard has also divided U.S. households into "attitudinal segments" with names like poor me, anonymously borrowing, and struggling for control (these are the unprofitable ones) and "relationship profit drivers" like high liability balance, traditionalists, heavy borrowers, and branch lite (these are profitable).

Moving customers into self-service can be highly rewarding and should become more so as younger, computer-literate people mature, MasterCard concluded. But on average, people who only use branches are still more profitable than self-service or "mixed-channel" users.

The BAI used Retail Delivery '96 to unveil two more studies of its own initiative - "Marketing Excellence: The Retail Banking Imperative" with First Manhattan, and "Unlocking Winning Strategies to Serve Small Businesses" with McKinsey & Co.

They pulled no punches in assessing the banking industry's state of preparedness. They also clearly prescribed what needs to be done.

"You have to wonder what is going to happen to banks that haven't gotten started" down the knowledge-based strategy road, said David Van L. Taylor, executive vice president of Chicago-based BAI. "They may be too far behind to catch up."

He said commercial bankers put their small-business market share as high as 70%. But banks seem a lot less dominant when leasing, payroll processing, tax services, and other activities picked off by nonbanks are thrown into the mix.

"The small-business market is bigger than it now appears to banks," said the BAI-McKinsey preliminary report. Small businesses, defined as those with less than $10 million in annual revenue, each generate an average $14,000 a year in financial services net revenues, almost triple the $5,000 banks are getting.

"Nonbanks have brands, access to customers, and other attributes, and not the millstones banks have," said Jeffrey S. Brown, the McKinsey & Co. director who worked on the small-business study. "The game isn't over, but it's progressing a lot faster than many people realize.

"We have encountered some complacency - a feeling that banks have this market and will be able to keep it."

Too many banks also overlook the fact that "owners of small businesses are also great retail customers," Mr. Taylor said.

The report said the owners, who tend to be wealthy and demanding, provide $27 billion of revenue and $8 billion of profit to the personal financial services industry. Their employees bring another $83 billion of revenue and $19 billion of net income.

"Close to 40% of customers keep (personal and business accounts) separate (and are) a great prize for banks," said the report.

Mr. Brown said the personal-small business nexus may be getting short shrift as bankers tackle the complexities of branch reconfiguration with only the mass consumer in mind. "Put the small-business and personal account together, and they'd be the first people I'd serve," he said. "Most (retail) bankers don't have that mind-set - but they're getting better."

Les Dinkin, managing principal of NBW Consulting in Westport, Conn., calls for the same type of behavioral and channel-usage analysis for small businesses that the BAI and First Manhattan initially applied to consumers. He has found that households with both consumer and commercial accounts are the most profitable for retail banks.

The BAI-McKinsey study painted a bleak picture of emerging trends: the advent of highly specialized and efficient nonbank competitors, the rising costs of attracting and retaining customers versus those competitors, the banks' increasingly tenuous hold on the payment systems.

But the report also laid out the strategic choices, drawing on examples from related fields. One option would be that of "category killer." In that way, Money Store, GE Capital Services, Automatic Data Processing Inc., and Wells Fargo Bank have locked up some aspects of small business.

Other "winning strategies," not necessarily mutually exclusive, are relationship orientation (with strong advisory capability, which Merrill Lynch is known for, or focused on a narrow market or segment, like USAA); discount distribution (Wal-Mart-style retailing); product aggregation (a variation on Charles Schwab's mutual fund supermarket); and payments integration (a role Checkfree Corp., ADP, and others are aspiring to).

"The risk for traditional banks is that they become like department stores, which have lost half of their market share to new-format competitors since 1980," said the BAI-McKinsey document.

An outward-looking "best practices" analysis also underlays the BAI- First Manhattan "Marketing Excellence" project. Their conviction was that "the difference between winners and losers will be marketing" - not just selling and support but "becoming the brains of the operation" through understanding customers and their profitability, said BAI executive vice president Rockwell F. Clancy 2d.

Mr. Clancy and First Manhattan senior consultant Christopher B. Kuenne drew from interviews at 12 companies they believe epitomize marketing excellence, including Banc One, BankAmerica, Capital One, Huntington Bancshares, KeyCorp, American Express, Fidelity Investments, and Charles Schwab.

Again, banking's deficiencies are legion: Cross-selling and low-rate or price promotions bring in mostly undesirable accounts, retention programs fail to target the customers most worth keeping, high-tech delivery channels like call centers create new cost layers without displacing old ones.

A few simple steps, like cutting back on fee waivers to "whiners" and more effective sales targeting, can boost a bank's operating profit more than 50% (see chart above). First Manhattan delineated four levels of marketing excellence; at the ultimate, business gains result from being "truly knowledgeable about customers' needs and values." No bank is at Level IV yet; mutual funds are close. Most banks are still at "ground zero," where marketing is just a support function and adds few if any insights.

Said First Manhattan president James M. McCormick: "We tell clients, 'Look at all the money spent on discretionary resources. How much will pass the test of profitable sales?' That kind of thinking hasn't been done."

"The good news is that banks can now assemble much greater knowledge of the customer's profitability, behaviors that drive the economics, and needs that underpin these behaviors," the report said. "The insights can be translated into initiatives that provide substantial earnings impacts and success in the market."

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