One of the most serious challenges banks face today is achieving profitable revenue growth. A look at recent bank merger activity and the current stock tables shows that the market rewards banks that have proven their ability to increase revenues.

The average bank stock currently trades at a price-to-earnings multiple of 17. Some bank stocks are trading well above that range and with market- to-book ratios in the neighborhood of four.

Even discounting for the excesses of the current bull market and acquisition premiums built into a number of stocks, the difference between the equity leaders and laggards is largely found in their ability to generate profitable revenue growth.

Banks are aware that the need to increase revenues profitably is immediate. However, they must select from among a bewildering array of choices. Some, regrettably, are experiencing paralysis, and many others are not sure they are on the right path. It is important that banks begin to act now, before the window of opportunity closes, to identify and carry out the right plan for achieving profitable growth.

At first glance, banks have performed well in recent years. From 1991 through 1996 bank income rose, assets and capital grew much faster than the economy, and stock returns outpaced the U.S. market.

But a more focused look reveals that growth in banking lags that in most industries, contributing to a low market valuation on bank shares. Bank revenues are actually decreasing, and profits have been sustained only by rigorous expense controls and low loan losses. Commercial lending, with modest growth in balances and a 28% decline in spreads over the last five years, illustrates the problem.

While the 1996 market-to-book ratio of the top 100 U.S. banking companies shows clearly that the market rewards banks that increase revenues, it is equally clear that acquisitions are not the proper response to lackluster revenue growth. Not only have banks that rely on acquisitions not generated superior returns, but also the 1996 return on equity of the top 100 U.S. banks showed no correlation with aggressive deal-making.

What, then, must a bank do to grow profitably? It must address several fundamental issues.

First, it must decide on which customer segments to serve and generate the insights on customer needs and behavior that enable the bank to develop products and services that are targeted, not me-too commodities.

Using tools such as data warehousing and behavior modeling to assess customer profitability (current and potential) and better understand customer needs will identify profitable growth opportunities. True customer focus, one that constantly listens for and anticipates customer needs, will always support revenue growth.

Second, it must determine how it will go to market with its products by selecting the appropriate range of distribution channels and markets. Adding a range of distribution channels is critical to enhance convenience for customers in markets where the bank sees opportunity.

The key is understanding how to sequence the channel offerings, how to configure them to meet customer needs, and how to stimulate profitable use.

Third, it must configure support functions to align operations, technology, and organizational structure. Successful strategy implementation will not happen without a proper alignment of the support infrastructure, including performance measures and compensation mechanisms that support execution of the strategy.

Finally, it must ensure that its business mix is appropriate and that it is leveraging its competitive advantages in serving its market and the value proposition versus competitors in serving customers.

The first decision a bank must make on the road to increasing revenue is where to focus resources to be sure that growth is profitable. This growth dilemma demands that the bank examine all its strategic growth options - building internally, making acquisitions, or borrowing through joint ventures or alliances.

For example, KeyCorp's consumer finance business is building a strong growth success story by pushing initiatives in several areas simultaneously. The business inherited a good foundation from a series of acquisitions but was underleveraging its potential. The business adopted growth initiatives on multiple fronts:

Targeting bank customer relationships and bringing new lending customers into the bank.

Expanding product lines and geographies served.

Using bank branches and adding delivery channels.

Focusing on the bank's "footprint" and expanding nationally.

Promoting growth internally and pursuing acquisitions.

Piloting multiple new efforts, expanding those that succeed, and modifying or curtailing less successful efforts.

Revamping a number of organizational, operational, and technology support elements to fuel the growth engine.

As a result, KeyCorp has increased revenues and profits.

First Tennessee's strategy for growth in profitable revenues and shareholder value has been to build national businesses in niche and fee- based services. It has developed its strategy around understanding and delivering on the needs of key customers and experimenting with new ways to expand businesses.

For example, it has built a strong business in underwriting callable debt based on its historical relationships with the federal government- sponsored enterprises. The bank experimented with hiring accountants to advise regional banks on the financial implications of investing in agency debt. The experiment succeeded and has helped First Tennessee expand its market position.

It has also built a strong position in check clearing, based on understanding and meeting the needs of one of its important hometown customers, Federal Express.

As a result, First Tennessee has been one of the strongest revenue- growth performers among large banks in the last five years, and its fee income accounts for 55% of total revenues, well above the U.S. bank average.

Growth is often the result of a series of choices that a management team has made to expand its strategic options along a number of dimensions. Expanding the served market, targeting additional customer segments, and adding distribution channels are ways to break out of the growth trap.

Intelligent research and controlled experimentation in the marketplace can yield predictive results quickly from live pilot tests, while minimizing investment. Misapplying an emphasis on strategic focus can too easily stifle growth. On the other hand, bet-the-company initiatives can too easily sink the company; achieving growth in a series of steps has proven a surer path to success.

Piloting these new initiatives often requires a shift in mind-set for many banks. They need to stretch their thinking on the possibilities for growth and then implement several that have the most promise. The time to begin-or accelerate-efforts toward profitable growth is now. While excellent opportunities for growth exist today, the market is crowded and becoming even more competitive. And the stakes are high.

Banks need to increase profitability or move out of the way of growing financial services firms. By waiting for perfect conditions to accelerate growth, banks may well see their market position erode past the point of redemption. u

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