The retail product distribution system needs to be fundamentally redesigned. In my judgment, the change process is taking too long, and this is putting the banking industry's retail franchise at risk.

Retail banking must focus much more creatively on how it sells and services products. And when it comes up with exciting and creative service concepts, it must merchandise them as aggressively as any product it might sell.

This is a necessary, new "customer value proposition," much like what Microsoft has taught the computer industry, what Home Depot is teaching retailers, what Fidelity has taught the securities industry. They are all trying to teach us this lesson, and as an industry, we are stalling.

Top managements know that the branch-dominated distribution system is a drag on profitability. Banking's unit costs do not compare favorably with those of other retailers, particularly the brokerage industry. And we all know that strong spreads have masked the underlying -- and not very favorable -- expense dynamics of retail banking.

The hard reality is that most top managers are reluctant to pull the trigger and change from the branch as their dominating reference point.

Management's preference to grow through acquisition is only deepening this dilemma.

One reason is that the branch is at the center of the only system of delivery we have known.

Thus, it has become a symbol as well as a production system. Departing from this dominant paradigm is not easy, even though the economics are flawed.

Second, management strongly resists changes that would fundamentally and rapidly diminish the importance of the branch.

Management clings to a belief that customer loyalty is linked to the branch-centered system of delivery, which implies that top management does not fully understand that a new usage and economic paradigm is emerging within the delivery system.

For example, they believe that the telephone center has been hugely successful in terms of customer usage, but they are not sure that, in the last analysis, it represents anything more than added operating expense.

They also do not know which customers are conducting the activity, what they are doing, and whether the resulting transactions are supporting revenue flows that create profits.

They are told that many customers do not use the branches and that these customers produce larger profits for the bank. They do not know who these people are, or where to find them, or how to communicate with them, or what to say to them if they found them.

But habit and lack of incisive knowledge about customer behavior are not the only factors getting in the way of change.

Most management compensation schemes are linked, in some fashion, to the branch system. The culture, quite naturally, fights changes that would threaten compensation rewards.

In addition, senior managements of American banks are coming off the most profitable year in history.

Although they know that the expense indicators are alarming, they have a lot to lose if the transition to a new reference point disrupts current earnings, which it might very well do.

Finally, we worry about the homogenization of the delivery system, as if our commitment to branches will somehow reduce this risk.

The mainframe did not protect IBM from the PC or from Microsoft. The branch will not protect the banking industry from the type of financial service innovation that is immediately on the horizon.

But instead of cannibalizing our own product with the next-generation offering, as world-class competitors must do, we continue to tinker with an old design.

Instead of redesigning the distribution system, many banks are simply adding new channels. Unfortunately, a system cannot be replaced with a channel. And individual channels cannot be cost effective when the system is put together incorrectly.

I worry that, for too many banks, consolidation economics and cost control have become a substitute for strategic action.

In addition, equities, particularly mutual funds, have captured most of the incremental disposable dollars in recent years, with only a small amount ending up in bank deposit accounts.

We are going to be in big trouble when our out-of-industry competitors figure out a way to get to our transaction-based deposit accounts. Merrill Lynch almost pulled this off with the CMA account.

Beyond the competitive threats that are already known, there is the intangible asset of imagination, which Microsoft is proving to be a viable means of reaping profits. The Internet is probably the most potent symbol of this imagination.

Is there reason to believe that the banking industry will transfigure itself gracefully? Can it manage this change in a slow, evolutionary fashion?

Or will it be overcome by outside competitive forces that bring about fundamental, systemic change, but with the essential drivers coming from outside our industry?

Only time will tell. We have seen what could happen when smart ex-bankers go to work for companies that are not burdened by our historical infrastructure and operating culture.

AT&T, Sears/Discover, General Motors, and Ford are only the more obvious examples. What might happen if a really smart exbanker went to work for Microsoft, a company with a great deal of imagination and absolutely no stake in our historical structures of delivery?

What are we waiting for? There are always risks with the introduction of new concepts, but I believe the risks are overestimated.

To begin with, the customer base is thoroughly prepared to entertain a new value proposition from the banking industry.

Consumers have been trained to fend for themselves. We shop in hypermarts. We pump our own gasoline. We hold down jobs and attempt to parent children at the same time. We own or regularly use computers.

Bankers are not getting the message. Most believe that 20% to 30% of their customers seldom go near a branch.

These are the early adapters. Many experts believe that the earnings from these households are greater than from those who regularly use the branch.

These early adapters have created a new paradigm for retail banking. But, in fact, the customer discovered it and, indeed, invented it.

The banks supplied the pieces -- the telephone, the ATMs, ACH, etc. -- but the consumer put them together. The banks do not know how to reach this group and do not even know who they are, much less how to market to them or learn from them.

I also believe there is a second, much larger group of people -- discriminating adapters -- who are not as perceptive as the early adapters, nor perhaps as forgiving of the design inadequacies of systems that have been reengineered piecemeal.

The early adapters forgive such discrepancies -- as when ATM deposits are not handled as efficiently as teller transactions -- because they are specifically and unusually "tuned in" to their own needs for flexibility and efficient time management.

The discriminating adapters want to be shown. They want the buses always to run on time. They want the deal to be fair.

My biggest fear is that the nonbanks will reach out and satisfy the discriminating adapters before the banks do. And 1 estimate that they are about 50% of our customer base.

I do not believe that the customer is the change resister. I think we are! We mislabel customer dissatisfaction as resistance to change.

The reality is this: If the banks give customers a fair deal, tell the what they are trying to do, protect their physical security, support transactions with reliable systems, use intelligent, well-trained people to transact with them, and do not waste their time -- they will help the banks move away from the branch.

There are other important developments that have reduced the risks associated with the introduction of systematic change in our delivery system:

* Process thinking. This enables us to unlock many old mysteries. We can fix and upgrade our nonbranch sales and service support channels through a straightforward application of process re-engineering, and it does not have to be a big deal.

* Technology. We do not need to invent anything. We just need to use the tools more effectively.

* The telephone. Our service experiences with the telephone over the past five to seven years may be the most important factor that gives hope for a reconfigured future.

So where do we need to go from here?

Retail banking's most crucial need is to discover a new reference point to replace the branch system as its cornerstone image. It is essential for long-term customer satisfaction. It is essential to productivity improvement.

Other industries and companies have changed their central reference points. Arco did it when it abolished its credit card and started to build fast-food markets at gas stations.

It was also Arco -- and ironically, not the California banks -- that spoke to the consumer by radio during the early days of Interlink and explained what point of sale debit was all about, namely, that you could get cash at their stores if you were afraid to use an ATM at night.

The industry cannot cost-control itself into the next era. If banks are to continue as the dominant financial service industry, if they are to lead the world's payment system, they must define a new value proposition for the customer base with respect to how products are sold and serviced.

This proposition is built around "process" as much as "product." It merchandises the intrinsic value in how the relationship works, not simply the products exchanged in that relationship. And the key word here is "merchandise," which means listening and talking to the customer.

Process, now at the center of the relationship and the reality of how things actually work, must be benchmarked against explicit customer satisfaction criteria.

Banks take enormous risks every day when lending money, but seem fearful of taking risks when trying to improve process. What we need is an underwriting mentality in the redesign of process.

The potential financial rewards are enormous, possibly a 30% reduction in operating expenses.

In the new value proposition, the telephone occupies the center of the relationship, replacing brick and mortar in this role. But flowing from the telephone is a cybernetic integration of all forms of delivery, a seamlessness that does not exist today.

The branch is moved to the periphery; fewer are necessary, and they are used as sales channels and production channels for small-business deposits. They are no longer the reference point.

The "virtual bank" is now the high point of promotion and advertising. The branch is no longer the focal point of compensation strategy. Performance measurement must, therefore, become more sophisticated and more exact.

In this new value proposition, the management and creation of information is the cornerstone of the relationship. The telephone can provide almost infinite time and place convenience.

The ATM in the retail mall offers improved physical security where the customer obtains cash. PIN-secured POS debit offers almost unlimited locations for obtaining cash. Very significant numbers of deposits are now coming into the system through the ACH.

But all of these channels, and the potential integration of them, are not empowered with enough information, and we do not reconfigure how they operate as a function of the information we solicit from our customers.

As a consequence of our failure to transform the huge amounts of behavioral and demographic data into valued information, our delivery channels are less potent. Out-of-industry competitors do not make the same mistake. Microsoft's Windows 95 is all about empowerment.

In addition we do not monitor our customers' usage patterns or ask about their behavioral needs.

This is the second category of information that lies at the heart of the new value proposition.

We do not ask aobut process -- "Do you understand our systems of support and delivery?" "Do they work for you?" "How might we change our processes to work better for you?" We do not collect this kind of information. We ignore a hugely potent competitive weapon -- the explicit knowledge of how our customers want to be served.

I suspect this is part of what Microsoft chairman Bill Gates is talking about when he accuses banks of being dinosaurs.

Their most valuable competitive advantage is the store of data, but it just sits there, uncollected and unanalyzed.

So my message is simple: Our processes are outdated. Branches are symbols of an aging paradigm. We are in danger because top management is clinging to this system.

If we do not change the fundamental paradigm of our distribution system, we will lose our best customers to those who do.

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