Business Lines Need Autonomy to Achieve Best Results

Often senior managers will assess performance by looking at a bank as a single unit. They do not analyze the product and market segments they serve, nor do they consider the competitive dynamics of each of these segments.

A bank, in fact, offers a bundle of products and services to meet the financial and financing needs of independent product and market segments, which are managed as a single unit or multiple organizational units.

It stands to reason, therefore, that a bank' success is determined not at the bank level, but as the sum of the successes of its individual lines of business.

Nonbank Competition

This fact will be particularly significant in the '90s and beyond, because nonregulated nonbank financial services firms such as Fidelity Investments, GMAC, GE Capital are taking over the more lucrative customer segments that banks now serve.

They are essentially displacing banks in the financial marketplace. In fact, the share of financial assets held by commercial banks fell from 66% in 1900 to 24% in 1989.

As more and more profitable bank products are captured by nonbanks, it is imperative that managements examine the advantages and disadvantages of serving each product/market segment they currently serve and evaluate their banks' competitive positions.

Developing a game plan must begin with defining lines of business within the bank and their associated target markets.

How to Define Lines

Because the line of business is the primary level at which competition takes place and the laws of the marketplace operate, each line will probably require a different strategy.

The line is also the smallest planning unit to which scarce corporate resources can be allocated sensibly. It is where management responsibility and performance accountability begin.

A line of business may be a combination of existing operating units or components of a single operating unit. It must be sufficiently independent of other lines to permit its management to implement its own business plan and budgets to conform to corporate guidelines.

Basic Operating Unit

Because a line of business is the basic operating unit, it is also the primary level to which resources such as assets, people, and investments are allocated by the corporation.

A line of business is an entity that deals with a core service, or anchor product, and a cluster of related products and support services, and that has a well-defined set of competitors. It may sell to a distinct group of customers or buy from a distinct group of suppliers.

The customers and suppliers may be similar in many respects -- needs, wants, aspirations, benefits sought, financial habits, and levels of financial sophistication.

In many cases, the customers and suppliers of a given line of business differ only in being at different stages of the life cycle. For example, the savings supplied by empty-nesters are sold as mortgages or installment loans to people who are setting up new households.

Meeting Customer Demands

In short, a line of business serves customer requirements by designing products and services, structuring delivery systems, developing marketing and promotional programs, providing auxiliary services, and establishing fees to cover the cost of such services.

To be successful in the long term, a line of business should have control over its own destiny and should be led by its own manager with bottom-line responsibility.

The key, however, is having a say in what customers to target, what to sell, where, and how. The manager of a business line must have the authority to choose, and not merely accept the decisions of others.

Although all core lines of business should be managed as independent management units that control their own destiny, some lines of business may use shared resources such as communication systems, delivery systems, transaction processing, based on the significance of each line of business in achieving total corporate profits. The more significant the line, the less sharing it should have to do.

Cost Centers

Units that support several lines of business and cannot develop their own independent strategies are called resource units or cost centers.

Cost centers typically provide interdepartmental services; they serve other internal departments of the bank, for example, other cost or resource centers or other lines of business, whereas lines of business serve the bank's outside customers.

Some resource centers may themselves be considered lines of business if they sell their services to outside customers in addition to fulfilling their internal responsibilities.

Lines Devoted to Funding

For example, banks may support the back-office processing needs of other banks or other firms in addition to their own. State Street Bank in Boston, for instance, supports the back-office processing for a number of mutual funds.

Another convenient way to view a line of business is in terms of a bank's primary objectives. There are lines whose primary mission is the sourcing of funds from outside the bank. Examples are branch operations that gather deposits, certificates of deposit, and travelers checks.

The primary objective of a second type of business line is the application or the use of funds with a minimum of fund sourcing (for example, a leasing business). A third group includes those engaged in both sourcing and application of funds, such as the corporate lending function.

Finally, there are those lines of business that provide products and support or advisory services for a fee or in return for deposit balances (bundled price). Examples are brokerage and trust services.

Our definition of a line of business so far has centered on the customer. Banks are often faced with the problem of deciding when a product or product line, which by itself does not serve the total needs of a distinct customer group, can be considered a line of business.

Related Products

This implies that there are a number of other related products that are also sought by this customer group in order to satisfy its total needs.

Product-driven lines of business must satisfy two criteria:

1. They must serve several customer-driven lines of business.

2. They must be knowledge or expertise intensive; that is, they must have staff with a high degree of professional skills. Examples are knowledge of complex real estate products, corporate finance, or project finance.

Businesses that serve similar customer groups but exhibit different demographic traits, such as wants, financial sophistication, and value systems, should be called demographic-driven lines.

For example, the demographic characteristics of the metropolitan mass market differ from those of the rural or farm mass market, and regional corporate banking is a separate line from multinational corporate banking.

Hybrid Lines

Some product lines exhibit the characteristics of both a stand-alone line of business and a product that supports the customers' needs of other lines.

For example, a real estate appraisal service may be a major line of business for a large savings bank, whereas the same appraisal service will serve as a product that supports the mortgage lending line of business of a smaller savings bank.

In the former role, it is a stand-alone line of business managed as an independent operating unit with a manager who has control over its future.

In the latter role, the product line will still be managed by a product manager, but solely as a support product satisfying the needs of another operating unit: mortgage lending. Such product lines are called dual-role lines of business.

Cash Management Example

Cash management products marketed by a commercial bank may be both a stand-alone business and a support product. When it is sold as an adjunct to the credit product and sold by loan officers, it performs the role of a support product.

When customers buy cash management services independently -- without regard to other related products, because of their unique features, or other convenience or cost -- cash management performs the role of a stand-alone business.

Associated with each line of business is a target market, that segment of the total potential market on which the business concentrates its efforts.

By the total potential market of a line of business, we mean all the customers in a trade area served by that line of business and all its key competitors offering similar or substitute products.

Beating the Competition

Thus, by knowing whom it is targeting, management can identify the customer's current needs and evaluate trends of change so that products and services and marketing efforts can be fashioned to meet those needs -- customers' preferences, value systems, purchase behavior, and the like -- ahead of the competition.

Otherwise, management will more than likely squander its scarce resources by offering the wrong products or by choosing the wrong sales or promotional methods. It will be like trying to shoot a prowler in the dark without knowing where he is.

To distinguish the target market of a line of business from the total potential market, look for the following characteristics that differentiate your customers from all the various customer groups in the total potential market:

* Customers who emphasize convenience rather than price -- a vendor that emphasizes convenience will tend to have higher servicing costs compared with another vendor that sells its services at a lower price.

* Customers who are located in the same geographic area.

* Customers who seek access to specialized computer packages or financial products.

* Customers who require services from regional, national, or a worldwide network.

* Customers who are defensible from competition, that is, customers you can serve and sustain for the long term. This will depend on your customers' other needs and your long-term market commitment and image in that market compared with those of your key competitors.

For example, a community bank cannot sustain itself for long serving the export financing needs of a major middle-market firm.

Market Realities

If it is still difficult to define precisely what customers your line of business is competing for and what firms your business is competing against, you can try to identify the major components of competition in the market: price, marketing, innovation, and service quality.

Suppose then that the business makes a competitive move such as reducing fees or increasing advertising. Which current or potential customers would respond. It is obvious that those customers and competitors who do not respond are typically not your customers or competitors.

Therefore, careful consideration of these questions may help clarify what the target market is and who the major competitors are. The purpose of subdividing the market is to refine the boundaries until you can map out a singlestrategy that covers all the products and services that the line of business offers to its customer groups. The portion thus defined is the target market.

There are two considerations in determining the right number of lines of business:

There is no point in planning different strategies for two separate lines of business if the businesses are so closely related in an operational sense that separate strategies cannot be implemented.

If the services offered by the two lines are processed and delivered through the same operating unit to similar customer groups, different strategies are difficult to implement.

For example, if a bank offers different brand-name "travel club accounts" to senior citizens, it should not consider formulating different strategies for each brand because these several brands are competing in the same target market.

Customized Approach

It is important to plan different strategies if the markets served are substantially different in structural characteristics such as market growth, share, competitive structure, and market concentration.

For example, if a bank is a dominant player in a fragmented market -- a market consisting of a number of small contenders -- it will have fewer chances to succeed as a price leader than if it were a leading contender in a concentrated market -- a market consisting of a few large banks.

The following questions should be asked when deciding whether two potential lines of business should be considered separately or together.

* Are separate strategies feasible for the two lines of business?

* Could one be given more promotional efforts than the other?

* Would it be possible to increase market share in one and reduce it in the other?

* Can different pricing approaches be implemented without causing undue customer concern?

* Do the two lines of business have different markets?

* Is the identity of their customers and competitors different?

* Do the lines of business have different market positions, that is, does one have substantially stronger market share than the other.

* Are the growth rates of their target markets different?

If the answers to the majority of the questions posed is yes, the two lines of business should be analyzed and managed separately.

It may be noted that, typically, a community bank can be broken down into eight to 10 lines of business, a midsize bank into 10 to 25 lines, and a large bank into 25 to 50 lines.

Summing up, an understanding of the strengths, weaknesses, and market dynamics and performance of the key product/market segments (lines of business) a bank serves, and allocating scarce resources to capitalize on opportunities, is of central importance for success in today's turbulent banking markets.

Mr. Thamara is with FSIC Associates Inc., a consulting firm in North Andover, Mass.

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