Brimming with profits and emboldened by big-ticket mergers, bankers are full of optimism.

Although many experts still see their future as one of financial irrelevance, banks have been generously rewarding their shareholders recently. During 1995, for example, the stocks of major regional banks and money-center banks easily outpaced the 34% rise in the S&P 500. "Deaf, dumb, and blind," one bank analyst remarked, "you could pick winners in the bank stock world last year."

However, this rosy glow of health is deceptive. Too many banks are measuring the wrong things and pursuing doomed strategies.

In fact, these ill-advised strategies will be as disastrous for U.S. banks as Third World loans and hyperbolic real estate developers were for them in the 1980s.

Banks' share of total assets of all financial firms has fallen from 65% in 1950 to about 34% today, and nonbanks continue to erode banks' share of personal financial assets.

Very simply, these nonbank institutions - which include mutual funds, discount brokers, and credit card firms, among others - are issuing better products at lower prices and rapidly responding to changing customer needs.

The fact that nonbanks are beating banks is not news. What is news is that most U.S. banks are responding ineffectively. Bankers have embraced a number of myths which, instead of offering them a window to the future, are actually consigning them to further decline. Here are five of the most persistent - and pernicious - of these myths:

Myth No. 1: Customer service is a key competitive factor; "service with a smile" will push back the nonbank intruders.

Reality: Although some customers might be lost due to poor service, the only real factors that generate customer value in financial services are price, selection, and convenience. An emphasis on "old-fashioned" customer service is merely an excuse to avoid having to innovate and respond directly to the nonbanks.

You might call this myth "the Nordstrom's curse." Charmed by the famous levels of service at the Seattle-based department store chain, some banks have decided that what customers most desire is "good customer service," which is loosely defined as short lines, friendly smiles, and free coffee served in Styrofoam cups.

Obviously, many community banks do this out of necessity, but a surprising number of large banks have bought this nonsense.

Unfortunately, this "banking like it used to be" approach is entirely without merit at the end of the 20th century.

Customers don't want to think about banking. Unlike retailing, where the "shopping experience" is a key driver of the purchase, the ultimate customer experience in financial services is no experience at all.

For transactions in the midst of work, shopping, or taking Junior to soccer practice, customers want banking that is automated, rapid, and simple. The last thing they want to deal with is a teller, smiling or otherwise.

It's been proven that customers who have been properly trained and encouraged to use automated teller machines actually prefer them to tellers. In some banks, more than 50% of deposits and 90% of cash withdrawals are made through the ATM, with 20% of all payments and deposits entirely automated.

When they do need interaction with a human being, customers want competent, anonymous service. It sounds harsh, but within a decade, the only customers that the "friendly banker" approach will attract are pensioners and the illiterate.

Furthermore, the advertising campaigns that endeavor to draw dissatisfied customers by offering great customer service ("Turned off by your big bank? Come see us!") only skim the least profitable customers - those with small accounts who nevertheless require the most service.

Myth No. 2: The branch network is an albatross - a huge fixed cost that confines a bank's ability to compete with nonbanks.

Reality: The physical distribution network is the single greatest competitive advantage that banks have over nonbanks.

Let's be clear - the banking branch system as currently configured is an anachronism. But the potential that banks have to leverage their extensive physical presence is another story entirely. Other than federal deposit insurance, the only lasting advantage banks have over nonbanks is prime real estate. Because of their branches, banks are much more convenient for opening and servicing accounts than most nonbanks today.

Retailers have long known that they are in the real estate business - not only the physical building but also the space on the shelves. Bankers need to view their physical distribution channels (traditional branches, in-store branches, off-site ATMs, etc.) as retailers do. They need to optimize the physical distribution network to penetrate a market area and find ways to use effectively every square foot of physical space - preferably to maximize sales, not service, capabilities.

The answer, then, is not to close branches indiscriminately. The critical point to understand is that not all branches are created equal. A branch that is primarily used for account servicing is a high-cost luxury, while a branch that is a magnet for account opening is a vital profit center. The branch network must be reevaluated from the perspective of sales and overall market impact - in other words, making it less of a static resource, like a post office, and more of a sales and distribution venue, like a Wal-Mart.

Bank branches, underused and overstaffed as they are, attract new customers and allow banks to access their customers in a way nonbanks can only dream of.

If banks close down too many branches, they will have changed their cost structure, but they will not have improved their competitive position against nonbanks.

Myth No. 3: "Relationship banking" will help banks sell customers more products.

Reality: Banks have neither competence nor credibility in the broader arena of financial services. The only feasible strategy is to sell other people's products, rather than develop their own.

It's nice to have a relationship with a banking customer. But what is there to sell? New and improved checking accounts?

Banks have not fully left the days when hyper-regulation controlled interest rates and effectively eliminated competition.

As a result, banks today are just terrible places to invest your money. To paraphrase Gertrude Stein, there's no there there in bank products.

Unfortunately, instead of improving their products, banks are spending millions on so-called "data mining" systems, which are intended to cull more personal information about their customers in useful ways.

For example, data mining will tell a bank manager that you have children of college age, or that you are nearing your 50th birthday, or that demographics make you likely to buy a second home. After finding this out, however, all banks can offer you are the same inferior loans, CDs, or mortgages that they've always offered.

Banks are reluctant to distribute any product that is not home-grown and traditionally have insisted on a totally vertically integrated corporate structure.

Today it would be difficult to name another U.S. industry that is as vertically integrated as banking. Even the utility industry, with its massive investments in power generation and distribution capabilities, is becoming more open to market forces, with common carriers distributing power generated at any number of power plants.

Banks must make this leap as well and think of their distribution network as a financial emporium rather than a warehouse.

Retail chains such as Barnes & Noble (books) and HMV (recorded music) realized that offering low-cost and high-turn items wasn't enough for today's demanding consumer. They needed to provide a wide selection in a pleasant environment, where customers felt comfortable browsing for the most appealing items.

These companies have struck an intelligent balance among inventory and space management, customer comfort, and product layout.

For banks it should be easier - there are no inventory carrying costs - so merchandise selection and placement become primary. In fact, a bank could beat Charles Schwab and Fidelity at their own game by offering a broad selection of not only mutual funds but also mortgages, loans, credit cards, and other financial products.

Myth No. 4: Internet banking will be a boon for banks. It will enable them to reduce their physical investment and help them attract customers.

Reality: Nonbanks are far better equipped to leverage new technologies and attract electronic customers than banks.

It's still too early to tell how much of electronic commerce is hype and how much is valid. But it is a safe bet that the people who ultimately make money in Internet banking will not be traditional bankers.

Banks don't have the technological savvy or marketing power to be powerful players on the Internet. The most that some have is a strong regional brand name, which could be a valuable chip in forming alliances with true Internet competitors such as Microsoft, Intuit, Netscape, or MCI.

Banks need to look upon the Internet as a way to change customer behavior - and reduce their costs - rather than as a revenue stream. If a basic transaction by a teller costs a bank $1 and an ATM withdrawal costs the bank 25 cents, then an electronic transaction from home costs the bank mere pennies. Customers want to have those savings passed along to them, rather than paying $7 or more per month for the experience. Banks should offer electronic banking at no cost (as most of them now offer free ATM use to account holders) in order to wean customers away from high-cost branch and teller transactions.

Myth No. 5: Customers need banks.

Reality: Banks, more than ever, need customers, and it's going to take real customer value to keep them.

According to the Treasury Department, upward of 20% of U.S. families (including almost one-third of minority families) lack bank accounts. These are primarily families with low incomes who use nonbanks such as check cashers and pawnbrokers to cash benefit checks. However, at the top end, Schwab, Fidelity, and others are aggressively moving to capture the entire financial relationship of customers from banks.

Why is this? Unfortunately, banks have not fully left the days when they had no effective competition.

As a result, nonbanks have been able easily to offer greater value to price-sensitive customers. This is worsened by banks that, fearful of losing profitable core deposit balances, have limited the number of alternative investment products they offer, essentially pushing profitable customers to the nonbanks.

Consumers of financial services are much more sophisticated about what they buy, and a whole industry has developed in the media to give them advice.

Banks need to be willing to drop fees and raise interest rates for top customers to make their products competitive in a world where the average consumer can have direct paycheck deposit into a low-cost S&P 500 index fund with an average 12% return.

Some banks will survive as distribution companies, some as product innovators, and some as targeted niche servers, but none will survive if they look as they do today.


Banks aren't doomed - if they are willing to change.

With pricing so important, banks must also be careful about "bundling" products - that is, obliging customers to buy a group of products and services at one price, regardless of whether they want or need all the components.

The rest of the world is becoming "unbundled" as customers browse the global market and resist paying for items they don't want. Unless a bank can make a compelling case for the baseline value of its bundled package, it is better off making each product and service a separate unit at a low relative price.

Banks actually are well positioned to expand their financial relationships with customers, provided they have the right products to sell and they optimize their physical and electronic distribution channels.

In addition, they must break the destructive habit of basing business strategies on myths and begin developing realistic plans based on customer value.

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