A $270 million bank with 180 employees implemented a referral program. Of the 180, 179 made 4,191 referrals, 57.3 % of which resulted in sales.

Return on equity doubled; the average deposit grew from $10,000 to $36,000; the average loan grew from $8,000 to $60,000; pretax income increased between $108,000 and $345,000 per $1 million in assets. Each participating individual contributed an additional $13,000 in pretax income.

These figures illustrate the following points:

* Relationship management pays.

* The power embedded in relationship management can be unlocked by bank employees.

* Bank size is not a requirement for success.

* Customers are our most valuable asset.

If we all agree with the last point, then quality initiatives are critical to protecting that most precious asset.

Cost Factor

The importance of referrals is that they eliminate acquisition costs. Every time an account is opened, be it a deposit account, credit card, or loan, we are in a loss position at account opening. It costs money to bring a customer into the bank.

In the credit card business, the direct mail costs divided by the number of accounts opened yield the acquisition cost per customer. In a deposit account situation, advertising, marketing costs, and business development activity costs are all incorporated to yield the acquisition cost of a deposit account.

In a credit card situation, typical acquisition costs are in the $50 per account range; in deposit acquisitions, $23 to $27.

That explains not only the importance of referrals, but also the relevance of retention. By cross-selling an existing customer (or obtaining a referral versus acquiring a new customer), we eliminate the acquisition cost component of the bank's expense structure, which can be significant if it costs seven times more to acquire a new customer than to cross-sell an existing one.

The profitability dynamics of customer retention is even more compelling than that. Banks make a base profit on the net interest margin on every dollar of the customer's deposits. However, beyond that base profit, there are other benefits. The longer the customer stays with the bank, the greater the profitability associated with increased balances per account.

When customers walk in the door, they usually open an account with a low balance, but as time goes by, they accumulate balances. These balances represent additional profits associated with the longevity of the customer and its tenure with the bank.

Similarly, longer-term customers open more accounts. The greater the number of accounts, the greater the profitability of the relationship.

There are savings associated with the operational efficiencies of having a single customer with multiple accounts. These explain in part the value of customer retention. Existing customers are also the best source of referrals for the bank. Out of all referrals which account for 55% of account openings in many institutions, 40% are referrals by a friend. That friend is our customer.

Each referral represents a new account opened without the acquisition cost, and an enhancement of the bottom line.

Better Quality

Last, but not least, long-term customers have greater price elasticity than new customers. Our research indicates that customers who have been with the bank for five years or longer are prepared to forgo 10% to 15% of the yield on their investment instruments, or pay 10% to 15% more on their loans in order to maintain their relationship. In other words, a long-term customer will not switch banks to gain 10% or even 15% in CD yield.

Improved customer retention, which yields improved profits, is the result of better quality service. Quality, therefore, has a clear quantitative upside in the form of improved customer retention. The absence, on the other hand, of quality has a clear downside, in the form of account closings.

Only 35% of account closings are associated with money or yield. The rest of the reasons for account closings are associated with poor service and errors which try the customer's patience. The customers that are most likely to close the account due to poor quality are the most coveted customers - those with income exceeding $70,000 a year, or the up and coming yuppies (35 to 44 years old). In other words, the price for lack of quality is meaningful as represented by account closings of the best target segments of the business.

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