For years, banks have treated all their customers pretty much the same despite the astonishing fact that more than 60% of a typical bank's retail consumer base is unprofitable. Indeed, many of their customers actually cost banks money.

[Expanded Picture]"Profitability is unbelievably skewed in the banking business," says James McCormick, president of First Manhattan Consulting Group. "Banks can either lose $150 a year on a checking account, or earn $600 a year." That's because, unlike most retail organizations where selling a product results in an immediate blip to the bottom line, selling a checking account, for example, involves ongoing costs such as processing checks and mailing out statements. Profitability also depends on the number of transactions customers make and whether they transact in the branch or through less expensive methods, such as the telephone.

Anthony LoFrumento, vice president of retail strategic planning at Chemical Banking Corp., doesn't bat an eye when he hears that 60% projection. He estimates that during the "dark" recessionary times of the late 1980s, as much as 75% of the typical bank's customer base was not profitable.

Studies performed by First Manhattan show that three of a typical bank's customer segments distinctly affect profitability. An elite 20% of a bank's households bring in about 60% of its revenues and more than 100% of its pretax income. Meanwhile, a mid-tier 30% segment generates only 9% of revenue while destroying 40% of income. Yet another 30% of households produce 15% of revenues. But this last group performs so many transactions that their costs actually exceed their revenue by two-to-one, and thus wipe out almost all profits.

Given this information, the industry's mission becomes clear. Banks need to retain those very profitable customers, manage the marginally unprofitable ones and change the behavior (or reprice the relationships) of the bottom most segment.

The failure of demographic data and cross-sell ratios to indicate profitability means banks must turn to the rigorous task of collecting and analyzing huge amounts of customer and transaction data. So far, only a handful of the nation's banks have taken any initiative to truly dissect their customer bases. But in McCormick's view, "That evolution is a hundred percent certainty over the next few years."

Chemical is one of the banks leading the evolution. Two years ago, it launched a major profitability project to give its marketing managers better information for creating new retail products.

The danger is that a bank will pull in accounts that add nothing to--or worse, take away from--the bottom line. For example, prior to Chemical's merger with Manufacturers Hanover Corp., the bank's marketing department developed two products designed to attract young customers, StudenPlus and ChemPlus for Young Professionals. The products brought in thousands of new customers, but lost a few million dollars, LoFrumento says.

The low minimum balances and low fees attached to the popular accounts put the bank far from a break-even point, and Chemical discontinued both of them. If the bank had had better profitability information in those pre-merger days, LoFrumento notes, the products could have been designed much differently from the beginning.

These days, Chemical submits new and existing products to vigorous profitability analysis. Recently it adjusted ATM fees and raised minimum balances on its standard ChemPlus accounts, based on information generated through its profitability system. Hard numbers showing accountholders as unprofitable gave the marketing staff greater confidence in making its repricing decisions, LoFrumento notes. So far, repricing has reaped "very positive results."

In addition, the profitability system brings greater precision to Chemical's focused marketing efforts. The bank is able to prioritize the customer segments it targets, based on how profitable they are.

The marketing department is not the only one benefiting from Chemical's profitability efforts. A few blocks away, Chemical's finance department also has sharpened its ability to allocate costs. The bank realized that as customers moved in droves from the teller line to ATMs, for example, the underlying costs associated with those customers were changing.

Now, Chemical makes its financial assumptions with up-to-date information that incorporates those behavioral changes and repricings.

In the finance department, Chemical's profitability system, provided by Treasury Services Inc., works in conjunction with a financial modeling software product called Steps from ASI Financial Services Inc. The collaboration is putting the department in the driver's seat when it comes to financial modeling and cost-allocating.

Steps first captures current transaction information from scores of systems throughout the bank. This data keeps the bank updated on how Chemical's 13 million retail customers are using the bank's ATMs, tellers, telephones and so on. From this information, the department then develops the financial models and assumptions that will drive the profitability calculations. From all the financial and transaction information it collects from a total of 45 different feeds, the Treasury Services system then calculates customer cost allocations.

Where before the bank's marketing, strategic planning and finance departments all were working from a different set of numbers and a different understanding of profitability, now they share a common view.

John Simone, senior vice president and director of finance, and LoFrumento decline to comment on Chemical's total investment, but systems from Treasury Services generally start at around $350,000. In addition, the data-gathering requirements for a customer profitability project are "orders of magnitude" greater than those for product or organizational profitability analysis, notes Katherine Jansen, sales manager at Treasury Services. All told, the typical investment in a largescale customer profitability project is "well over $1 million," Jansen says.

Chemical isn't Alone

Detroit-based NBD Bank, also is in the midst of a detailed customer profitability analysis. In a different approach from Chemical, NBD is using customer profitability information to better plan its retail-delivery strategy.

NBD is working with Troy, MIbased MarkeTech Systems Inc. to analyze its customer base. For NBD, MarkeTech extracted and scrubbed the bank's customer information files. During September 1994 and into October, MarkeTech pulled, on a weekly basis, customer transaction history--from branches, ATMs and the telephone call center--and linked each transaction to data from the bank's CIF.

"Now we have better information in terms of looking at overall customer profitability," says Bill Simmons, second vice president in NBD's retail delivery systems planning group.

From preliminary results, Simmons suspects that valued NBD customers use branches more than expected. "It's politically incorrect to build more branches, but we need to recognize that there is a smart way to downsize the branch system," Rather than close branches, NBD may turn them into, say, drive-throughs.

At their best, profitability systems should challenge long-held views on how to create profitable relationships. Notes LoFrumento of Chemical, "We don't even talk about cross-sell ratios around here anymore." At the least, such systems, LoFrumento says, should help "design products so the bank doesn't take a bath."

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