The financial services industry is caught in the de novo branching trap, and the walls are quickly closing in. Tom Brown, founder of Second Curve Capital and bankstocks.com, says the estimated U.S. population growth from 2003-2004 was 5.6 million people. At an average of 3,500 people per branch the country would need 1,600 new branches to keep up with the growth. However, the top 10 U.S. banks planned to open over 2,242 branches, about 40 percent more than required. So why are today's banks implementing de novo strategies that produce more branches than customer demographics can support?
Banks historically have expanded operations by opening branches in anticipation of shifts in demographics. When determining de novo branch expansion, market research typically considers population growth and the potential income from that growth. After all, if a new housing development emerges in an affluent neighborhood, the bank should plan to open a new branch to accommodate the evidently wealthy new population, right? If this logic holds true, then successful retailers would also open new stores to benefit from the potentially profitable demographic shift.
Today's banks routinely identify themselves with the retail industry and aspire to operate and succeed as a typical retail venue would. They attempt to emulate the sales and service strategies of successful retailers but overlook the most important and potentially profitable retail strategy: the expansion strategy. A look at the retail industry's successful players, such as Starbucks, provides us with evidence as to why the standard de novo branching expansion strategies fail most banks.
Starbucks is the epitome of today's successfully expanding retail operation. Nearly every freeway exit, every shopping mall, and every street corner hosts a Starbucks location, whether it is a traditional store or a mini-store located inside a grocery store. Starbucks had 3,500 locations in 2000, and today there are more than 8,300 locations worldwide. Today's highest density of Starbucks can be found in London with a whopping 162 stores in a 5-mile radius. How can companies such as Starbucks successfully accommodate such immense expansion? Do they add new stores based on demographic information as banks are currently doing? No. The key factor to support such tremendous and profitable growth is service capacity.
Every bank branch, just like every Starbucks store, is limited by the service capacity it can support. Service capacity is a function of many factors including square footage of the store, available equipment, staff resources, customer arrival rates, and store layout. For example, each Starbucks location can make a given number of drinks with the resources it has available. Depending on square footage, the number of cash registers and the number of available staff, there is a maximum number of total transactions that the store can accommodate at a particular time.
Store layout and, correspondingly, branch layout also affects service capacity. If you have ever visited a Starbucks in a university town, you may have noticed the abundance of tables, chairs, and couches provided to accommodate the study habits of aspiring scholars, while stores located in business centers typically feature full service drive-up windows to accommodate those customers late for work.
Another major factor in the store's service capacity is the random nature of customer arrival rates. Many of us have walked into a Starbucks store during a peak time, typically in the morning on the way to work, and have witnessed the store operating at near service capacity. Although customer arrivals are random, over time the store can observe patterns in its arrival rates and can schedule staff to accommodate peaks in customer arrivals, such as the typical early-morning coffee rush. Under-scheduling staff for the peak morning hours would cause dissatisfied Starbucks customers, while over-scheduling staff during slow times would be costly. Branches are also subject to patterns in their arrival rates and will incur high costs in both customer dissatisfaction and payroll expenses if they under-staff branches at peak times, such as lunchtime, and overstaff them during slow times.
Therefore, to develop a successful expansion plan, each Starbucks location, retail store, or bank branch must strive to operate at its optimal service capacity. The optimal service capacity is achieved when customer satisfaction is high and operating costs are low throughout the day. Once a Starbucks store exceeds its optimal service capacity, Starbucks customers can rest assured that a new location will open nearby. Does this mean that the population is increasing in these Starbucks-ridden locations? Absolutely not. If Starbucks only considered shifting demographics in its expansion plan, most of its new locations would probably operate under-capacity while its other stores could not support customer demand.
The same logic holds true for today's branch expansion strategies. Branches that reach capacity and can no longer provide acceptable service levels to customers should then open a new branch in a strategic location. Typical de novo branching strategies fail to consider service capacity, the most important aspect of expansion. So how can banks easily analyze service capacity and determine where to open a new branch?
Many banks are now using innovative technologies to build an effective service capacity model that is representative of their branch network. It can include various location-specific attributes such as demographics, seasonality, holidays, economic conditions, and more. These forecasting technologies produce unique forecasts that can be used to predict customer transaction volumes and the resources required to service customers in a timely fashion. In addition, patterns in customer arrival rates are identified and can determine a store's peak times throughout the day. Once peak times are identified, store managers can create staff schedules to accommodate those peak times and still remain within their service capacity. Over time, if a forecast trend shows that more resources are needed than the store has available, it is likely that the branch has exceeded its service capacity and opening a new branch in the area may be necessary.
Dr. Ali Kiran is CEO of Exametric.
