Revolutionary changes are occurring in retail banking. Mellon Bank's recent acquisition of Dreyfus is just one visible indication. Interstate banking and increased product powers will accelerate the revolution's pace.

Banks are making fundamental changes in the ways they serve retail customers. As risk-adjusted margins in traditional commercial lending erode, the retail business is emerging as a highly profitable, risk-adjusted, return-on-equity engine. Individual customers, once viewed merely as low-cost providers of funds, are now being courted with a wide array of investment, credit, and insurance products.

Also, banks are investing in a number of distribution channels beyond the traditional brick-and-mortar branch network, and are supporting personnel who interact with customers with information technologies.

Changing perspectives and approaches to market segmentation, distribution, information design, and organization will have ripple effects throughout the retail banks. For example, business processes (e.g., new account openings, or responses to customer service requests that undergo major modifications) will require new human resources strategies.

Banks are changing the way they view their marketplace. Newfound attention to customer needs is a key element. Driven by increased competition from nonbanks, an evolution in marketing techniques, and other factors, banks are devoting more resources to understanding their customer bases and developing sophisticated segimentation approaches. Further, the new marketing analytics are linked with enhanced models that help banks understand customer and segment profitability.

At the core of the changes is a fundamental shift from an "internally oriented" focus toward a "customer-centric" one. Banks are adopting an outlook that emphasizes the retail market and the customer's needs, rather than those of the bank. Customers are now defined in terms of their need for payments/transactions, wealth management, credit, income security, asset protection, and so on.

This can be contrasted with an approach that sought to sell all products to each customer, or to cross-sell products to demand deposit customers without differentiation. While this change may seem obvious, and perhaps even trivial, to marketers from other industries, it represents a major shift in banking philosophy.

Because consumer needs vary, banks are seeking more refined ways to segment their customer bases. Traditional demographic and psychographic approaches are being complemented by behavioral segmentation that goes beyond attitudinal analysis. Because broadly defined segments may insufficiently explain customer behavior, banks are realizing the importance of subsegments. In this regard they are following the lead of other retailers who "micro-market" their products to individual consumers and households.

In addition to focusing on customer needs, banks are increasingly considering their customer relationships as assets, rather than just transactions. The customer asset has a financial value, namely the present value of the discounted net cash flows (or profits) generated over the life of the relationship. This lifetime value can be affected, positively or negatively, by actions the bank takes with respect to acquisition, retention, penetration, or attrition. As assets with varying degrees of value, customers take on another dimension until now overlooked.

Banks are investing in models and management information systems that provide them with more insights into segment, subsegment, household, and customer profitability. These are evolving from static "snapshots" into more dynamic systems that can model lifetime values based on profitability drivers. Also, many banks are employing relational data base technology and sophisticated allocation methods to provide consistent information on segment, product, and organizational profitability. They are finding wide variations in the profitability of customers within and among segments. They are developing strategies to improve profitability of customers.

As a result, banks will become matches for their nonbank competitors, at least regarding marketing techniques.

In the not-too-distant past, retail banking meant "the branches." Today, other distribution and delivery channels, such as ATMs, telephone banking, supermarkets or convenience stores, and direct mail, are increasingly emphasized. For certain transactions, such as mortgage origination, sending salespeople to customers' premises is the preferred method. In the future, other delivery technologies, such as "smart cards," debit cards, and personal computers, may emerge as equally important banking services.

We are entering an age of "virtual" banking, having financial transactions conducted wherever the customer is: in a branch, at an ATM, on the telephone (via land line or radio signal), or on a personal computer via modem. The age of virtuality, however, poses some important challenges.

How much should banks invest in each channel? Maintaining extensive ATM, telephone, direct mail, and home banking networks is beyond the financial reach of most banks. Modern delivery channels. such as home banking and smart cards, have not been eagerly adopted by customers. Despite potentially lower costs available through non-branch networks, if transaction volume is low investments in electronic distribution may be unwarranted.

The way to meet these challenges is through mapping customer preferences and behaviors, and determining the products, transactions, and delivery channels desired. By understanding how and why segments or subsegments use various channels, banks can tailor their distribution strategies to the types of customers they seek to acquire, retain, and grow. Combined with an understanding of the cost dynamics of each channel, a more complete picture emerges.

Banks are harnessing advances in information technology to improve the development and execution of retail strategies -- metaphorically, the customer is now in the bull's-eye of the information technology target. In the past, information technology was driven by efficiency considerations (e.g., expense reduction, control, and production). Today, however, it reflects a commitment to integrated information management and delivery. Like other retailoriented companies, banks are using technology to shift spending from the back office to the "front end" of customer sales and service.

Frontline personnel are being equipped with information that helps them serve customers. Provided with information and automated tools, they transact business, resolve problems, make decisions, and sell more effectively than before. Telephone service representatives can now answer questions during one customer "session" -- versus prior practice when lengthy information searches and supervisor assistance were often necessary.

Banks are not alone in pursuing a "one4ouch" vision of customer contact. Insurance companies, catalogue retailers, utilities, and even wholesale building product suppliers are building single, point-of-contact, customer service capabilities. However, the complex, multi-product, multichannel, and multi-entity environment at banks and multiple, large-scale, nonintegrated legacy systems make technical and cultural challenges much greater.

Hallmarks of integrated information management and delivery capabilities are: the ability to access and portray all of a customer's (or household's) relationships with the bank. the ability to call up all transaction records and correspondence, and the distribution of nearly identical information through all delivery channels.

The technology also implies a Windows-type environment with rapid point-and-click features.

The integrated information management and delivery mechanism also enhances the ability to market to customers and segments.

Because large amounts of customer-specific data are captured, they can be analyzed almost on a real-time basis. Marketers can assess the results of their programs in terms of customer behavior information. They can also tailor messages or programs to individual subsegments.

Furthermore, because the marketers can be linked directly with the frontline customer serving personnel, they can send to. each "end point" electronic information and advice about issues or events likely to arise during the course of the day's business with customers.

As a result of the deployment of such information management and delivery capabilities, banks will be much more in tune with their customer bases. They will also be much more responsive and effective in dealing with service requests and sales opportunities.

Fundamentally changing the way banks interact with customers will have a profound impact on business processes. Processes -- such as new account opening, credit sales and underwriting, service inquiries, error resolution, cross-selling -- will be redesigned to improve quality and take less time. Steps or activities in such processes that do not add value from the customers' perspective will be eliminated.

Process design will also affect the flow of work between personnel with customer contact and operational back offices. For economy-of-scale purposes, local and regional customer service centers and transaction processing centers will give way to much larger centralized locations.

Because of advances in network, image storage, and retrieval capabilities, paper transit will be minimized, and many traditional back-office activities will be performed at the point of customer contact.

Will advances in market annlytics and segmentation, delivery mechanisms, integrated information capabilities, and an expanding product suite springboard banks into competitive preeminence? Or will they prove to be distractions that will overwhelm banks and plunge them into chaos? The manner in which banks organize themselves to manage their retail initiatives could provide the answers.

Today, the organization of the retail side of most banks reflects distribution channel, product, and functional dimensions. Yet bankers increasingly believe that micromarketing -- essentially, reaching out to individual customers or well-defined, narrow target subsegments -- is critical to retail success. Unfortunately, no one speaks for, or is responsible for managing, the customer.

If-mass-marketing is the bank's basic retail strategy, then the lack of a customer-focused organization is of little consequence.

However, banks are discovering that great differences in profitability exist among customer groups.

Undifferentiated marketing and distribution mechanisms impede banks' ability to obtain and service high-value customers. This is particularly true when it comes to handling their wealth management needs, where substantial differences among subsegments exist. As a result, banks will increasingly organize themselves along segment management lines.

The retail organization may well lag, rather than lead, the adoption of a customer orientation.

Deep cultural forces will make the transition to a market, segment-focused structure difficult to achieve. Retail branch network managers, product managers, and functional managers might be unwilling to give up control to a new segment management organization. Determining roles, responsibilities, authorities, and accountabilities among the competing factions may delay the emergence of segment managers with real decision-making power.

While strategies may differ, bankers will have to make their processes, delivery channels, information systems, and organizations more responsive to target customers' needs, or risk losing a profitable business.

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