Sales Methods: Which Tack to Take?
Measured in terms of consumer demand, the remarkable performance of mutual funds in the last decade challenges commercial banks to sit up and take notice.
The funds have increased dramatically in both market size and growth rates, two standard measures for charting the potential profitability of products and services.
According to published statistical data, only 6% of U.S. households owned mutual funds in 1980. By 1990, one-quarter of all U.S. households maintained some investment in a mutual fund, a fourfold increase. Within that decade, the total of mutual fund deposits grew tenfold, from $94.5 billion to more than $1 trillion.
Those figures paint a rosy profit picture for commercial banks that already offer mutual funds as part of their bank brokerage services. The numbers also strongly suggest that banks failing to explore the financial feasibility of putting mutual funds in their product mix will be missing a good long-term bet.
Survey Promises Growth
Bankers who doubt the significant appeal of mutual funds to bank customers need only consider a recent private survey of 25 of the 31 largest sponsors of long-term mutual funds. The findings indicated that, by 1995, distribution of mutual funds by banks will have increased by more than 50%, while distribution through wire houses and regional firms will have declined by 10%.
If those estimates hold true, investment in nonmoney-market mutual funds through banks would rise to $40 billion in 1995.
While some bankers cling to the fear of deposit disintermediation as a reason for resisting retail sale of mutual funds, hundreds of bankers have learned through experience that the fear is greater than the reality.
It boils down to how soon the reluctant banks will realize that their customers are bying mutual funds - if not from them, then from someone else. Ultimately, offering mutual funds is a decision to remain competitive.
Banks participate in retail sale of mutual funds in three pre-dominant ways:
* Through discount brokerage firms.
* By developing proprietary or private-label funds.
* Through third-party service firms.
From a banker's perspective, each method has advantages and disadvantages to consider.
For purposes of this discussion, discount brokerage is defined as a service offered without involvement of registered sales people located in the bank. The bank simply provides a toll-free telephone number that customers use to place buy and sell orders.
This do-it-yourself approach to brokerage services attracts, by necessity, a particular profile of investor who has both the time and ability to do his own research and to make his own investment decisions. Only about 20% of the investing public uses discount brokerage services, which means that most bank customers who invest in securities do not find the services they need in discount brokerage.
Because the heart and soul of discount brokerage operations is trading activity, 80.5% of securities sales in discount bank brokerage programs are in equity securities. By nature, mutual fund investment does not lend itself to recurrent trading, which explains why mutual funds make up only 3.3% of the product mix in discount bank brokerage programs.
For banks, the advantages of offering discount brokerage include ease of entry, low cost of operations, and expansion of customer service.
Disadvantages include limited revenue potential, little opportunity to cross-sell bank products, and, since the service is generally provided by non-bank employees through a toll-free number, little opportunity for the bank to enhance its image.
About 200 banks nationwide have chosen to develop proprietary or private-label funds. Funds are considered proprietary when the bank acts as adviser and manages fund investments directly or appoints an outside company as subadviser. Private-label funds carry the bank's designated name but are part of an existing fund managed by an outside company.
The development of proprietary funds is largely dependent upon a critical mass of investment dollars. As such, proprietary funds are most often associated with institutional and trust activities. Private-label funds are most often associated with retail sales activities, and their success is chiefly dependent upon a broad retail customer base in well-defined markets.
The advantages of this approach are:
* Greater image enhancement because the funds are directly associated with the bank.
* Opportunity to leverage existing trust and institutional asset-management services.
* Increased earnings potential from advisory and ancillary service fees and, at times, commission income. Service fees are charged for shareholder, transfer agency, and custodial services and for fund accounting.
* Opportunity to enhance client retention by maintaining direct relationships.
The disadvantages are:
* Cost of startup. The bank bears the cost of developing and promoting the fund, which generally has limited this option to larger banks.
* Funds may be hard to sell. Proprietary funds have no track record, which means that, initially, bank customers must have a greater measure of faith in the financial institution than in the fund itself.
* Higher image risk. If a fund performs poorly, there is direct reflection on the bank and some risk of losing customers.
* Requires a sales force, including effective training programs.
* Requires development of marketing approaches and materials. Clearly, proprietary and private-label funds are the purview of larger banks with large trust, institutional, and/or retail operations. If bank assets of $500 million or more are established as a cutoff point, then only 735 banks, or 6% of the total, are candidates.
3d-Party Service Firms
The most prevalent distribution method chosen by banks today is the third-party marketing company or broker-dealer. This lets banks offer brokerage services through a registered sales force in the bank's branch offices.
The sales people give face-to-face investment advice and directly help customers. They may be employees either of the bank or of the third-party firm.
This form of distribution holds the broadest appeal and offers the greatest potential for generating sales for two interrelated reasons. In general, third-party service firms offer many types of fund from several fund sponsors that attract a broad customer base. Only the smallest of banks might find it difficult to generate adequate sales volume.
A bank's product mix with a third-party service firm is significantly different than with a discount brokerage operation. Mutual funds account for about 40% of product sales in bank-based, third-party programs, whereas sales of stocks account for only 28%.
The advantages of this approach are:
* Low-cost entry.
* Broad range of mutual funds available.
* No responsibility for product and vendor due diligence. Third-party firm does all reviews.
* High-commission products favored.
* Substantial profit potential. Third-party service firms pay as much as 90% of gross commissions to the bank.
* Opportunity to cross-sell traditional bank products.
* Product and sales training generally provided.
* Marketing materials and programs generally provided.
* Sales and lead tracking systems often provided.
* Indemnity for claims arising from negligence of registered sales representatives, even if they are bank employees. Third-party service firms assume risk.
* Limited responsibility for compliance with securities law and regulations. Third-party service firms assume obligation.
* Enhanced bank image.
* Availability. Third-party services were first offered in the early 1980s. Today, perhaps 150 third-party service firms offer mutual funds and other products to customers at nearly 2,500 U.S. banks.
The disadvantages are:
* Little control over products offered.
* Customer relationships are shared with the third-party service firm and mutual fund sponsors.
* Higher operating costs if the sales representatives are bank employees.
Mr. Ayotte is a founder and senior partner in American Brokerage Consultants Inc., St. Petersburg, Fla., which offers research and consulting services to the bank brokerage industry.