As the industry cleans up its problem loans, many commercial and community banks are falling prey to the same thinking that caused them.

Under the banner of cutting costs, these banks are virtually halting all initiatives to develop new products and services.

Though reducing costs is appropriate, necessary development initiatives are losing steam.

Since only limited profit improvement can result from cost cutting alone, the exploration of product and service improvements -- for private banking as well as mainstream retail banking -- should not be ignored.

Manufactures Lead the Way

Some trends among manufacturers of consumer packaged goods can provide cues for banks.

As consumer companies seek to pay down their debt they have turned away from "major breakthroughs." Instead these companies aim to improve existing product lines through incremental product development.

The idea is that such a strategy will do more to increase shorter-term profitability.

One example is RJR Nabisco's dropping such "breakthrough" initiatives as smokeless cigarettes in favor of line extensions, such as Double-Stuft Oreos. Another example is Colgate's move toward putting its Irish Spring soap scent into deodorant and shaving cream.

Successful breakthroughs provide bigger benefits than the incremental approach, and higher rates of return. But the breakthrough strategy also involves higher risks.

When the main objective is more stable earnings, the search for modest improvements is a practical approach.

Banking Applications

Incremental product development is under way at a number of financial institutions. For example the move to integrate accounts into relationship packages has intensified during the past seven years.

Citibank introduced its Citi-One account in 1985; Chemical Bank's ChemPlus followed. This year, Citibank extended its reach into investments incrementally by launching Citibank Investment Services, an extensive mutual fund offering, at its branches.

Copycat Approach

Another example of incremental product development is automated voice response. First used as a way to reach corporate clients, the technique recently has been adapted for consumers. Banks find that it offsets phone-inquiry traffic as well as offers 24-hour customer service, an important point of differentiation in many local markets.

Although virtually all banks are developing products to respond to competitive threats, many have been hesitant to adopt the methodology of incremental product development.

In fact, they have relied largely on the trailblazing instincts of bankers in other markets. This has allowed many to skip the early stages of development and move straight to implementation.

Though this copycat approach has saved money, it also has deprived banks of the opportunity to learn how to adapt products and services for the customers in their markets better and more profitably.

The product development process consists of two major phases: development and market test.

Getting Started

The development phase typically begins with a brainstorming exercise to ensure that the pros and cons of all ideas are reviewed.

Once ideas have been listed they can be assessed against a number of criteria. For example, comparing the results of exploratory customer research, on the one hand, with analysis of competitive offerings, on the other, can help uncover customers' unmet needs.

Valley National Corp. of Arizona used this type of analysis to define a buyer protection program for its checking customers. The bank looked at a similar feature in the bank card marketplace and found the same consumer need for purchases made by check.

A bank's ability to meet these needs is constrained by its internal strengths and weaknesses.

The effects of such constraints can seen in the failure of many banks to capture "critical mass" volume (and thereby realize their profit objectives) with their discount brokerage operations.

Qualitative Research

These failures have resulted largely from insufficient skill in marketing and operating such a service, which requires skills different from mainstream retail banking.

The principal output of the early development process is a set of specific opportunities.

These are the input for the qualitative research phase, whose first objective is to refine the opportunities into product and service concepts that can be presented to consumers for their reaction.

The research phase relies heavily on the use of product and service prototypes, in part because the value of a specific product feature must be presented to consumers in the context of the more complete product offering.

Since financial services are more intangible, every step taken to present a concrete example of the feature being reviewed serves to enrich the response that consumers can provide.

It is far easier for consumers to react to questions like "What do you think of this new integrated statement?" than to "What do you think should be on an integrated statement?"

Most important, prototyping lets banks enlist consumers in reviewing the benefits of potentially expensive or complex features before funds have been invested on implementation.

Financial Analysis

The output of qualitative development -- that is, product requirements -- is the input for analysis of revenue, expense, and profit potential.

Revenue projections are the most direct extension of qualitative research. Questions are asked of a large enough group (typically more than 400) to provide a conclusion that can be statistically projected.

The revenue projection derives from consumers' responses to two types of questions: on their intent to purchase the service and on their willingness to pay a given price for it. This measure of price sensitivity is used with the results of the expense projections to set the price at a level that yields an acceptable rate of profit.

Together with revenue projections, operating-expense projections can be used to develop a pro-forma income statement. This is used with an estimate of implementation expense to make the investment decision.

Various approaches are used to make this decision, including the discounted cash flow model, break-even analysis, payback period, and return on investment.

Testing and Tracking

A decision to invest in a particular product improvement is the gateway to the market test phase, which includes implementation, marketing, and tracking plans.

The backbone of the market test is usually the implementation plan, which grows directly out of the prototype created during development. This plan also comes from a review of the quantitative research.

The goal of the marketing plan is to communicate the customer benefits identified through research. What is needed is a good balance of science, to clearly communicate the benefits delivered, and art, to break through the clutter of other messages in a customer's communication channels.

Finally, a tracking plan is derived from the profit and investment models that were used to support the decision to proceed to market test. Though the models will undoubtedly have inaccuracies, these tend to offset each other if adequate study went into the modeling.

The tracking plan provides an objective measure of success or failure.

Commitment and Consensus

Finally, two keys are absolutely critical to the development of a successful project plan: senior management commitment to its success and consensus among the organizations responsible.

Without senior management commitment, implementation will be sluggish, or just won't happen at all.

Without consensus, the tension typically will cause repeated delays, due to dropped balls and missed signals, significantly diminishing the potential return. Mr. Brumley is vice president for strategic program implementation at Citibank. Mr. Dinkin is managing principal of NBW Consulting. New York, a subsidiary of Nationar.

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