Small business continues to be a hot market segment, with double-digit growth targets, extensive product development, enhanced delivery capabilities, and ever more promotion.

However, if bankers base investment plans on traditional drivers of profitability-deposits and loans-they surely will overlook the effects of the emerging economics of this segment.

Small business is an extraordinarily attractive business for most banks. Business owners traditionally favor their local banks and have a large appetite for all the types of products banks can offer. They want cash management, investment products, trade financing, leasing, insurance, and employee benefit services.

Faced with a more sophisticated customer and a more challenging competitive environment, aggressive banks have changed their go-to-market strategies. No longer are basic checking and loan accounts sufficient product sets.

Though most products are not new to the small-business customer, banks have become quite adept at designing distribution networks to deliver a broad array of products. But therein lies the rub.

Small-business profitability, as in other sectors of banking, continues to be squeezed. Higher marketing costs, broader distribution options, new products, better information systems, and competitive pricing pressures are forcing banks to be more efficient in sales and relationship management.

Margin pressure is a growing concern. Interest on deposits is a foregone conclusion. (Even if not legislated, it certainly will be demanded by more sophisticated customers.) Furthermore, banks' internal measures of deposit value are declining. And these profit pressures will become more severe over the next 24 months.

Are banks asleep at the profit switch? Only partially.

Though bankers spotted these trends and responded with more competitive products, new pricing approaches, and broader marketing tactics, they have not realigned their performance scorecards to match their competitive strategies. Most still plan and measure performance the old-fashioned way- deposit and loan growth. Looking ahead, however, they will not be the drivers of profits and competitive advantage in the future.

Banks intuitively understand that broader product sets mean new types of revenue. But bankers' tendency to focus on short-term performance fixes, such as improving marketing and processing execution, has obscured the basics of performance management. Broad and costly investments in customer- relationship information, both product and profitability, and more effective use of channel alternatives provide more options for the customer, but it is not clear that they benefit the bank's bottom line.

Few bankers have done the math to determine whether the new economics of broad product sets, higher-cost and lower-value deposits, thinner loan margins, more fee income, many distribution alternatives, and new investments in sales and marketing programs are attractive. If the answer is "probably not," what should banks be doing to remake the business or change their expectations for the future?

They will not be prepared to manage according to the new economics if they do not put equal effort into building scorecards that make those new economics work for customers and shareholders.

There are five components of the new economic model for the small- business market:

Broad product sales (deposits, loans, investments, cash management, cards, leasing, trade financing, insurance of all kinds, retirement services, and employee programs).

Customer-profit metrics that measure the full product line, not just deposits, loans, and traditional fees.

Profit and growth forecasts that effectively model the role of fee products in the earnings equation.

Measures of the value proposition that differentiate at the point of sale.

Target-segment penetration and development.

Too few banks are able to consolidate information to manage according to this new profit equation. Why? In part, it has been a low priority because today's profit opportunities are so attractive and improving the economics of the operating model is so challenging.

In the Consumer Bankers Association 1999 Survey of Small-Business Banking, less than 20% of banks said they included trust, leasing, or insurance in the MCIF (marketing customer information file) for small business. Only 35% included retirement or investment products. Equally important, fewer than 40% said they used profitability as the primary measure of performance in this business.

All told, these facts suggest that bankers had better wake up to the management requirements of the new economics before setting the year-2000 business plan.

Formulating the business model around the realities and strategic requirements of this market will ensure that executives are focused on the right questions. Can banks earn sufficient levels of sustainable profits if the advantage of cheap deposits is eliminated? Will customers buy products in sufficient volumes and across multiple product lines in ways that are profitable and sustainable for the bank?

Nonbank competitors believe the answer to both questions is no. It remains to be seen whether banks can execute a profitable, broad, and integrated approach to this market that will make the new economics of small business as attractive as the old.

The chances for success are few if bankers do not restructure performance scorecards to examine the future more carefully today.

Small-business executives understand that the primary factor that drives profits and performance is superb execution. But bankers' all-consuming focus on today's tactics runs the risks of missing the implications of the broader trends in performance economics.

Bankers must use their customer and profitability resources to support a hard look at the economic realities of this market segment while there is adequate time and resources to remake the business for the future. The first step is to invest in new economic models that enable bankers to understand if they are winning or losing-or are at least on the right course. Ms. McClave is practice leader, strategy economics for the Americas, at Tillinghast-Towers Perrin in New York.

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