Small-business banking is generally good business, earning returns on equity in the 35% to 40% range. But it could be even better, earning ROEs over 60% with above-market growth rates. The key is a combination of (a) quick fixes and (b) longer-term initiatives that deepen and weave into the organizational fabric the progress achieved by the former.

There are three quick fixes:

Retain the best customers. The top 30% typically create more than 100% of shareholder value derived from small business. Identify and thank them. Then provide added value services, such as planning support and benchmark financial information for their industry, size, and growth rate. Also handle their problems before those of anyone else. Finally, give them priority access to branch and call-center services and, of course, prompt credit-line renewal.

Turn around the worst customers. The bottom 20% of customers can destroy roughly half the value created by the rest. "Curing" them typically requires fee or rate penalties when credit problems arise; a specialized counseling/collection unit; and appropriate limits on free transactions (teller, ATM, VRU, and checks).

Treat low-revenue customers like prospects. Roughly 50% of all customers are marginally profitable or unprofitable but can consume costly relationship resources if not managed effectively. Once again, identify them and determine why they are marginal (they are either splitting their business or simply using too few services); understand the cause (e.g., a competitor is offering better value, more product, or lower prices); and expand the relationship with an effective counteroffer or move to a lower-cost service model until you can win more of their business.

There are five longer-term initiatives:

Segment customers according to behavior to improve value propositions and sales effectiveness. Customer buying behavior and product usage are driven by needs, which are a function of type of business and its life stage, and attitudes. Understanding the principal segments (clusters of customers with similar needs and attitudes) improves product design and sales effectiveness because it helps you know what to sell, when to sell it, and how to best position the product to solve customer problems. It also makes successful selling less dependent on the individual skill of relationship managers.

Effective segmentation cannot be achieved from an armchair; it often requires interaction with customers. That is because publicly available data are usually insufficient to provide much insight into a businesses life stage and the attitude of the decision maker. Phone-based research, in conjunction with the analysis of profitability data, can significantly enhance the quality and actionability of segment information.

Expand your share of the customer's wallet. Offer more services, including financial or related services not usually provided by banks. Small businesses generally seek ways to lower bill-presentment, payments, and accounting costs; obtain advice on tax preparation; and provide retirement services, life and health insurance, and bank-at-work facilities for employees. Many of these services are natural adjuncts to basic banking, and they help leverage the distribution system.

In addition, Internet distribution may provide a cost-effective way for banks to deliver an extended range of product or related information tailored to each small business segment. Essential is the capacity to design a compelling value proposition without being confined by current distribution or product limitations. Banks can also use alliances or joint ventures to provide nontraditional or low-volume products.

Prequalify all sales calls. Here again, telephone screening can prove useful, reducing the hours to qualify and sell a new account from 20 to 30 to five or six. Used properly, telephone prospecting builds brand awareness and avoids calls to unreceptive prospects. Developing an effective telephone capability to support both segmentation and the prequalification effort takes time. That's because most banks are not experienced in capturing information from a complex discussion and then relating it to customer characteristics such as probable profitability.

First Manhattan Consulting Group uses proprietary software to capture customer responses to the various parts of the script -- engaging the prospect, assessing needs, and closing the sale. This information is analyzed in conjunction with current customer profitability and behavior data to create a fact-based perspective on what works best for each segment at each stage of a typical sales call. Supported by advanced statistical techniques and a lot of practical experience, this approach is significantly faster than conventional mail or phone surveys.

Align RM skills to customer opportunities. First Manhattan's analysis of customer profitability shows distinct skews in employee ability to generate new business. Some relationship managers prefer to nurture existing relationships. A smaller percentage is able to sell effectively. Arranging the RM force in teams, with designated people responsible for selling, helps match responsibilities to skills; provides the customer with better service continuity; and allows the salesperson to reenter the relationship, if needed, to address major new opportunities.

Develop customer and business-unit profitability information. This capability underpins success in other initiatives. Customer-based profitability data requires collecting revenue, risk, and cost information by product, then aggregating to a customer or household level after factoring in overhead and relationship expenses. A frequent stumbling block is lack of understanding of the costs incurred at each step in the value chain from customer acquisition to service delivery.

An actionable understanding of costs takes time to build because of the need to measure each type of transaction, sales, and service event. Benchmark data can be a stop-gap alternative while the methodology is being developed and the information collected. This approach will allow the bank to identify and address structural inefficiency as well as skews in profitability. It will enable it to move with much greater speed than otherwise would be the case.

Pursue this combination of quick and more considered initiatives, and your small-business ROE will begin to rise noticeably.

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