In the past two decades, bankers have fallen in love with the idea of target marketing: Going after that he of the market that they have been told will provide them the greatest opportunity to make the biggest buck.
What's wrong with that? Everyone wants to make the biggest buck with the least amount of effort. And, in a highly competitive banking world, an efficient strategy like that certainly makes a great deal of sense.
But it can cause you to mistake unprofitable households for profitable ones, and unprofitable product lines for moneymakers. It can cause you to spend money developing special programs designed for people you'd rather not even have as customers, and too much of that can cost you everything you've got.
To understand how this works, let's start by tracing the history of the target marketing movement in retail banking.
Identifying Good Customers
First we had the 80-20 rule, which said that 20% of customers provided 80% of your profits. The key then was to figure out which ones were the good ones -- and bankers thought that the little old ladies in the trust department and the rich old men that shuffled in for donuts and coffee with their Social Security check on Thursday afternoons were the good ones.
The problem was that those 20% didn't provide 80% of the profits -- only the balances -- and there weren't enough to even justify running branches just for them.
This led to the movement to target the affluent, who were defined primarily by balances available to sit in the vault. Fees were waived for the affluent who maintained certain balance levels. And explicit pricing was instituted to make nonaffluent customers pay their own freight.
After the affluent-marketing movement came the push for relationship banking. The idea behind it was that the more accounts someone maintained, the more profitable they would be.
Along with this came an emphasis on the "mature market," which occurred when someone figured out that older people were net savers, not net borrowers, and so keep more money on deposit in the bank. Again, it was all about balances.
Finally, with increased emphasis on technology came a desire for precision in target marketing, which gave rise to the cluster code craze. Sophisticated demographers -- many of whom know nothing about banking -- group together information about income, homeownership, age, and other data and cross-reference it by census tract to suggest the perfect "target markets" within your financial institution's particular market area.
A Little Matter of Profit
The one thing these demographers forget to factor in is profit, which, whether they know it or hot, is a very important component of the banking business.
Does targeting rich people -- no matter what fancy name you call them by -- insure they'll provide your bank the most profit of any market segment? No. Only a sophisticated analysis of individual account and household profitability can do that.
As a matter of fact, rich people as a market segment generally don't provide banks with the greatest net profit. Overall, we've found that, in most of the banks we've analyzed, only 54% of the households are profitable. And the largest portion -- two fifths -- of that profitable 54% is made up of households that generate up to $200 a year in net profit, compared with about a fifth that generate over $1,000 a year in profits.
You could call these $200-a-year households the "downscale mass market." Although the actual products they have and balances they keep differ from one financial institution to the next, the "downscales" typically average around $4,000 in their savings accounts and have a high-balance loan and a low-balance checking account that generates fees.
As a group they are the most profitable market segment the bank has because there are more of them than other, richer, market segments that might, on an individual household basis, provide higher net profits.
Another myth -- that high-balance customers are the most profitable ones -- proves false when accounts are analyzed for profitability. The deposit relationship could be the unprofitable part of the equation and the loan relationship could be highly profitable.
For example, one household we know has three CDs totaling $228,560 in balances that produce an annual $970 profit, while another has seven accounts with $15,723 in deposit balances and loans and produces $1,060 a year in profit.
Finally, the concept that the more accounts a household maintains, the more profitable the relationship, is not always true. We've found that the households that cost the bank $100 or more a year (net loss) generally have a higher number of accounts than those that earn up to $500 a year (net profit).
Relationship pricing programs -- offering free checking when the customer keeps as much as $5,000 in a combination of accounts -- are tantamount to marketing suicide, because the break-even balance for many deposit products is between $3,000 and $5,000 in one account alone.
Prudent bankers seem to have gone over a very simplistic edge in swallowing the target market trend without questioning its viability. It isn't necessary to throw the baby out with the bathwater. Looking at individual account and household profit can add depth to already existing niche marketing programs.
For example, a banker we know identified the 10 most valuable cluster codes in his market area from 40 segment cluster codes supplied by a demographics marketer. After running our profitability analysis program, he found that, of the 10 identified, only two were in the bank's actual top 10 profit groupings.
Knowing which customers and products yield the greatest profits can help you redesign old, unprofitable products, develop new, profitable ones, and price your products and services to reflect how customers view their financial relationships -- in totality and not according to the bank's individual profits centers.
The message is: Beware! Market segmentation without profitability information can be hazardous to your bank's health.