The outflow of bank deposits to brokerage houses, insurance companies, and mutual funds that began in the late 1970s has continued unabated.
Customer relationship management has been offered to traditional depository institutions as a better way to manage customers according to their relative profit contribution. The theory is that giving better treatment to profitable customers will make them even more profitable and, miraculously, will somehow make the formerly unprofitable ones profitable.
It is a common belief among card-carrying CRM advocates that 80% of a financial institutions profits come from 20% of its customers. This is an adaptation of Paretos Law. Improved relationship management will enable a financial institution to improve the profitability of all customers, the advocates say.
If Paretos Law were always true, it would be futile to try to change the 80-20 breakdown. Dropping the 80% of customers who are supposedly insufficiently profitable would not help; 80% of the remaining 20% would wind up being marginally profitable. The pattern would continue until only one customer was left.
Whats a bank to do? Are we stuck forever with carrying 80% of our customers on the backs of the 20% who are supposedly profitable?
The problem with all this lies in the basic assumptions that led us to the 80-20 conclusion. The issue of what portion of our profits comes from what segment of our customers is worthy of study, but not for the purpose of penalizing some customers.
It is unlikely, after all, that 80% of customers are unprofitable. Please read that last sentence again, carefully.
The overwhelming majority of costs in a financial institution are either fixed or step-fixed over a relevant range of activity. That is, we invest up front in resources that have the ability to handle some volume of activity before we must invest in the next incremental resource. This includes branches, processing equipment, tellers, and customer service representatives.
There is something to be learned from the airlines. Why is an airline willing to sell certain seats at what appears to be less than fully absorbed costs? The reason is that the costs are incurred whether the seat is filled or not. What appears to be a below-cost fare at that point is incremental revenue that helps to offset the fixed costs of an airplane once it takes off.
The same applies to the financial services environment. The costs of branches, ATM networks, and other delivery channels are, to some extent, variable. But very high levels of fixed and step-fixed costs exist whether we have any customers in the branch or not.
At some point, forcing unprofitable customers away would result in the loss of more incremental revenue than expenses.
There is something more important to learn from the airlines in this regard. Once the airplane seat is sold, at whatever price, the service that each passenger receives within each cabin is the same. Those passengers who bought their ticket at a discount are given the same beverage and meal service as those who paid full fare.
There are class-of-service differences, with better service offered in first and business class than in coach. But it is the customers choice to pay (one way or another) for the class of service he or she wishes to receive.
Rather than penalizing customers who buy discount fares, the airlines try very hard to encourage repeat business. Frequent-flier programs are designed to build customer loyalty, regardless of how much a customer pays for a ticket. The objective is to get more of the customers business, not penalize those who paid less for their seat. In fact, it is quite easy for an airlines best customers to always purchase discount fares, sit in better seats and, as a result, never be profitable on a fully absorbed cost basis.
Rather than worry about designing programs that penalize customers who appear (inaccurately) to be unprofitable, maybe traditional depository institutions should concentrate on acquiring more of a particular customers business to help offset fixed and step-fixed costs.
Maybe, by treating all customers better, banks can build the type of customer loyalty that will increase the share of wallet that a customer chooses to bring to his or her local, full-service bank.
Besides, whose fault is it if a customer is unprofitable? Customers use products and services in the way that the bank allows them to be used.
Maybe the responsibility rests with the bank to price its products and services in a way that will result in improved profitability. But this has to result from a better understanding of the true behavior of fixed and step-fixed costs that make up the majority of operating expenses in a bank. It should not result from the blind application of Paretos Law in a fashion that Pareto himself would have never imagined.
None of this is to suggest that CRM is of no value to commercial banks. But the blind application of the 80-20 rule must yield to a more accurate understanding of costs and customer buying behavior if banks are ever to win back the customers who have been lost in the last 25 years.
Mr. Weiner is chairman and chief executive officer of IPS-Sendero, an Atlanta provider of asset/liability management, profitability measurement, and financial management and planning software.