Even amid mounting earnings pressures and nonbank competition, retail banks have a unique opportunity to reassert historical strengths and reclaim market leadership positions, experts said last week.

It sounds easier said than done. Banks' struggles to make sense of technology, alter their mixes of electronic and personal modes of service delivery, and build data bases to improve customer knowledge can only get harder as the business cycle turns downward.

But attention to some banking fundamentals-and some fundamental market realities-can go a long way toward maintaining if not improving on the profit growth and returns to which shareholders became accustomed in the recent fat years.

Alarms were sounded, and remedies optimistically proposed, from various sources within the temporary community of 9,000 gathered in Las Vegas for the Bank Administration Institute's Retail Delivery '98 conference.

Perhaps most weighty among them was James M. McCormick, president of First Manhattan Consulting Group, an influential adviser to many of the biggest banks and a longtime critic of bank pricing and other policies that failed to change with the times.

Focusing on the bread-and-butter business of deposit-taking, easily neglected amid all the talk about mutual funds and other product diversification, Mr. McCormick concluded that banks are sitting on a massive golden egg that is theirs to lose, worth $500 billion in market capitalization.

"That will be a magnet for interlopers who want to be the billionaires of tomorrow," he said. "We are optimistic because banks have all the ingredients needed to win"-products, access to customers, and branches and other delivery channels.

Managing director Peter Carroll of Oliver, Wyman & Co., another New York-based consulting firm, said small-business and retail banking can be responsible for two-thirds of a bank's market value. A strong small- business advocate, Mr. Carroll said the combination of small businesses' accounts and those of their owners can produce 50% of profits.

"It is a rare bank that gives small-business that kind of emphasis" in management, Mr. Carroll said. Like Mr. McCormick, he advocated various market-segmentation and "migration" strategies-changing price structures and automating more of some customers' transactions to improve overall profitability.

Underlying these messages were calls for more radical measures, whether instilling sales cultures or doing the kind of more sweeping restructuring that Mr. McCormick described as "unbundling business systems."

Mr. McCormick said the "consumer franchise" produces 32% of U.S. banking profits. "The forgotten segment" of small-business banking is responsible for another 10%. Of the consumer profits, 87% come from core deposits, mainly checking, savings, and money market accounts. The figure for small business is 90%.

"This doesn't mean they shouldn't do mutual funds," Mr. McCormick said. "But deposits are the dominant source of profitability." And deposit profits grew at a 6% compound annual rate from 1993 to 1997, hardly a "dying business," he said.

Boosting core deposits by just a few percentage points can produce "a phenomenal swing" in profitability while adding to a retail bank's already sizable contribution to market value.

"This is sweet business if we can grow it," said Mr. McCormick.

One cloud on this horizon is the fact that retail banks made much of their progress in recent years simply by raising prices. In fact, Mr. McCormick said spread and fee pricing, as opposed to core balances, was responsible for the entire "revenue lift" over the past five years, and there may be limits.

"We have been exercising some market power as an industry," he said. "Is it sustainable? Our view is we have pushed the pricing lever about as far as we can." Beyond that critical point, "the more we push, the more growth will decline."

Robert B. Hedges, managing director of retail distribution at Fleet Financial Group of Boston, said "the public has limits as to how much (fees) will be tolerated."

"There is definitely a question of tolerance in the marketplace," said Robert E. Hall, chief executive officer of Action Systems Inc., Dallas. "We've been telling people that mergers and technology will make things more efficient, but they're not seeing benefits."

In an interview, Mr. Hedges said he and Fleet colleagues are doing some deep thinking about the implications of lower interest rates on retail revenues. If further fee increases are closed off, "it creates an extraordinarily challenging revenue dynamic," especially for a bank heavily dependent on the retail side. He said Fleet is going to be prepared, but "I don't think this has settled in yet with a lot of people."

Mr. Hall said there is an "addictive" aspect to fees. Banks get an immediate boost to earnings, but over a six- to 18-month period customers react and some desirable ones leave.

"We must have a process for aligning pricing with value propositions," Mr. Hall said. "Until then, the fee game is the only game in town, and that's where the problem is."

Mr. Hall, as he has for years, recited the mantra of customer relationship management. He wrote a paper titled "Putting the 'R' Back in CRM" on the premise that banks have been so focused on building data base systems that they have not met the ultimate objective of knowing and serving customers better.

CRM may almost be getting stale as a buzzword, but systems are said to be improving after many years on the learning curve. Mr. Hall's firm has teamed up with Hewlett-Packard Co. and others to get data-base intelligence out to points of customer contact.

Fair, Isaac & Co., working with HP and other allies, trumpeted a new phase of personalization proficiency at the BAI conference. Fair, Isaac vice president Patricia Hudson said CRM delivers "personal banking for the other 80%" who do not get one-on-one human attention. She said it can result in "better than old-fashioned service."

That ability to treat customers differently, according to profitability and other characteristics, is a key to deposit growth, Mr. McCormick said.

Profitable customers should be courted incessantly and relationships with them expanded. "If revenue stagnation occurs here," he said, "it may be the thing that tips a bank into a decision to be sold."

Unprofitable accounts, which the consultant termed "problem children," require a very different response, a combination of increased fees and lowered overhead. "For low-value customers, you've got to think like E- Trade," Mr. McCormick said, referring to the mass-market on-line brokerage.

Treating customers differently and individually requires "unbundling."

"You need two rooms-one with people thinking about the high-value customers, the other about low-value customers," Mr. McCormick said. That means two of everything-technology strategies, branch systems, sales agendas, staffs, and back offices.

Mr. McCormick told the cautionary tale of price sensitivity in the cigarette business, where brand names could no longer sustain automatic price increases in the face of low-cost generic competition. Internet brokers like E-Trade have similarly roiled that industry. But in hotels, Marriott developed a portfolio of brands, ranging from Ritz-Carlton to Fairfield Inn, and boosted revenues dramatically.

Mr. Hedges said he sees another parallel in airline deregulation, which led to a degradation of service. "We have to get prepared to deal with costs and with the disconnect between the economics of our business and what the customers like."

Mr. Carroll of Oliver Wyman said the solution is not as simple as adding lower-cost delivery channels.

In a study of 50 major banks, Oliver Wyman found that 45% of those in the United States and 33% of the Europeans deployed alternate delivery channels such as on-line banking and call centers expecting to reduce costs. But 87% of them were disappointed-costs increased. At the 13% that were able to reduce costs, the average savings was 3%.

Customers only partially migrated to the new channels. In addition, overall transaction volumes increased, even within the branches, the research showed.

Every one of the banker respondents said they should be able to use alternate channels to increase sales by 2003. Only 57% said they thought these new distribution systems will help them lower costs by that time.

Sophisticated segmenting technology can let banks can send different messages to customers and get "rifle-shot targeting" via the different channels, Mr. Carroll said.

The challenge lies in understanding customer behavior well enough to know what "sticks or carrots" will get certain types to move to lower-cost channels, he said. "That's not being done well yet."

Oliver Wyman's testing of various incentives found that when it comes to getting customers to move to new channels, sticks are more effective than carrots. Small charges slapped on certain transactions got better results than payments rewarding customers for using a given channel.

On the sales side too, even low-value incentives such as three-month teaser rates tend to be effective.

Such simple incentives can induce 20% to 25% of customers to move to new channels, Mr. Carroll said. "Even better are differentiated incentives," he said, which can persuade 30% to 35% to switch.

The huge effort of identifying and motivating individuals is the greatest challenge banks face in preserving their deposit franchise. Said Mr. McCormick, "vision and leadership are crucial. It is very hard to think of an industry where reinvention has come from the incumbents."

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