The near-term outlook for middle-market banking is mixed at best. In the face of decreased loan demand, reduced income generated by "free" balances, tough competition, and more demanding customers, many senior managers expect lower returns from this business.

These trends have led to a renewed focus on cost control. In many instances, however, managemfent has traveled this route before.

Substantial costs have already been eliminated. At this point, even hardened cost cutters are becoming concerned about whether another round of cuts will lead to a dangerous decline in quality or customer service.

Banks should consider analyzing how they organize their middle-market business effort, rather than attempting to cut costs either incrementally or across the board.

Segmentation Approach

One substantial opportunity, which can lead to revenue growth and cost reduction, involves a detailed segmentation of the corporate account base and review of how banks are delivering services to their customers. This type of approach has been a natural part of marketing to consumers for many years.

Nonetheless, many banks still don't go far enough in differentiating the products, pricing, and level of service they offer to corporate customers, even those with special needs or those that are in fact unprofitable for the bank.

Furthermore, often the customer who makes the most noise receives extra attention, rather than the one who is the most profitable.

Both the level and type of service offered should depend on the customer's needs, with particular emphasis on the profit potential for the bank. When done effectively, segmenting corporate accounts saves money and improves productivity.

Start with Revenue

To begin the segmentation process, some fairly simple analysis is required. Typically, the first step is to separate the customer base into different size groups.

For example, the first segmentation "buckets" could be: companies with less than $ 10 million in revenues, companies from $10 million to $100 million, and those above $100 million.

Eventually, the number of segments can be increased and refined further, as management understands the specific factors differentiating one group from another. Banks may segment their customers based on industry, geographical focus, whether they are net depositors or borrowers, and other relevant factors.

Broadly speaking, different size companies often have distinct product and service needs. Larger companies require customized products, whether related to cash management, corporate finance, or treasury.

Smaller companies, particularly those below $5 million to $10 million in revenue, have more straightforward deposit and credit needs; they require fewer "bells and whistles."

Returns Can Be Improved

Profitability modeling of these accounts also indicates that standardization and centralization are key factors in generating stronger returns on assets and on equity from servicing the low end of the corporate market.

Products need to be simplified and standardized to the degree possible; banks should consider centralizing the credit approval process as well as back-office functions.

Centralizing the credit function for "community banking" relationships not only saves money and focuses marketing officers on generating new business, but can also strengthen credit quality by focusing small-business credit experts on this business.

Developing a Data Base

Further, it allows for the development of a consumer-credit-like data base, leading to the introduction of actuarial analysis and artificial intelligence that can be used in making credit decisions.

The real value of account segmentation is that it can help managers maintain or enhance past profit levels.

* Banks need to rethink their product offerings. One bank learned that a number of the products in which it had invested, such as a proprietary cash management system, were overly sophisticated; a product that was cheaper to deliver and had fewer features was more than adequate to satisfy clients.

Ultimately, after examining multiple product families with regard to customer needs, this analysis led to some important changes. Product lines were simplified and in anumber of cases the bank reduced the choices -- both in products offered and within product categories -- available to small-business customers.

Bank management based this type of change, which is often resisted both by relationship managers and product specialists, on work which showed that the product features perceived as nonessential by customers were not creating value for the bank.

In fact, on occasion buyers regarded complex products in a negative light. The corporate buyer's perspective is not unlike that of many consumers purchasing a VCR or CD player; simplicity of operation may be a decisive factor.

* Customer service levels should be readjusted. In many banks there is no apparent linkage between the time spent servicing accounts and the profits those customers generate. We know of companies that provide good earnings for banks but are largely ignored by the relationship manager; conversely, other accounts that in effect destroy value for the bank are overserviced. Management should encourage greater differentiation in customer service.

* Begin by focusing on smaller accounts. Serving companies on the low end of the middle market requires a reassessment of how to deliver the products offered. For example, banks often use the same credit approval process for all segments of the middle market; that is, the $150 million company gets the same treatment as the $5 million company.

The fact is, however, that the complexity of the two credit decisions differs dramatically. Typically, if making a loan to the small company began to approach the time involved in the larger deal, it would not make sense for the bank to proceed with the small deal.

Our economic analysis indicates that the lower end of the middle market becomes attractive only when banks provide substantial standardization of products and services.

Account segmentation is hardly a new management concept, but it remains under-utilized by many middle-market bankers. A stagnant or slow-growth economy, such as we appear to be experiencing, necessitates that managers redesign how they deliver services, in order to focus on accounts that offer the greatest potential while maximizing productivity.

Mr. Wendell is vice president at Mercer Management Consulting Inc., New York.

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