The financial services industry is caught in the de novo branching trap, and the walls may be quickly closing in.
According to Tom Brown, a banking analyst at bankstocks.com, the estimated population growth in the United States between 2003 and 2004 was 5.6 million people. At an average of 3,500 people per branch, the country would need 1,600 new branches to keep up with the growth. However, the top 10 U.S. banks planned to open more than 2,242 branches, about 40 percent more than required. So why are today's banks implementing de novo strategies that produce more branches than customer demographics can support?
Banks historically have expanded operations by opening branches in anticipation of shifts in demographics. When determining de novo branch expansion, market research typically considers population growth and the potential income from that growth. After all, if a new housing development emerges in an affluent neighborhood, the bank should plan to open a new branch to accommodate the evidently wealthy new population, right? If this logic holds true, then successful retailers would also open new stores to benefit from the potentially profitable demographic shift.
In fact, today's banks routinely identify themselves with the retail industry and often aspire to operate as a typical retail venue would. For example, in retail locations, selling takes place on the store floor. In banks, selling takes place on the sales platform. Retail transactions are completed at the check-out counter, and bank transactions are completed at the teller window. Transactions and the time needed to complete them are also similar between banks and retailers. The sales-platform transaction types and times are similar to those of specialty retail stores, while teller-transaction types and times are similar to those of a fast-food service store. Therefore, a look at the retail industry's successful players, such as Starbucks, provides evidence as to why de novo branching will fail most banks.
Starbucks is the epitome of today's successfully expanding retail operation. Nearly every freeway exit, every shopping mall, and every street corner hosts a Starbucks. In fact, the coffee shop has 8,300 stores worldwide today, up from 3,500 locations in 2000. Today's highest density of Starbucks locations can be found in London, with a whopping 162 stores in a five-mile radius. How can companies such as Starbucks successfully accommodate such immense expansion? Do they add new stores based on demographic information, as banks are currently doing? No. The key factor to support such tremendous and profitable growth is service capacity.
Every bank branch, just like every Starbucks store, is limited by the service capacity it can support. Each Starbucks location can make a given number of drinks using its available machines and scheduled staff. Depending on square footage, the number of cash registers and the number of available staff, there is a maximum number of total transactions that the store can accommodate at a particular time. Furthermore, the random nature of customer arrival rates adds an additional limitation to the store's service capacity. Many of us have walked into a Starbucks store during a peak time, and witnessed the store operating at near-service capacity. When a Starbucks location exceeds its service capacity, customers experience long waits, even though the store is fully staffed and all coffee makers are used. At this point, Starbucks customers can rest assured that a new location will open nearby.
Does this mean that the population is increasing in these Starbucks-congested locations? Absolutely not. If Starbucks only considered changing demographics in its expansion plan, most of its new locations would probably operate under capacity, while its other stores could not support customer demand.
The same logic holds true for today's bank-branch expansion strategies. Branches that reach capacity and can no longer provide acceptable service levels to customers should open a new branch in a strategic location. However, de novo branching strategies fail to consider service capacity-the most important aspect of expansion.
Although today's banks aspire to succeed as a typical retail venue would, they adopt expansion policies that contradict those of successful retailers. De novo branching based only on market demographics is a flawed strategy. Service capacity must become a critical factor in a bank's expansion-planning process. After all, wouldn't your bank like to become the Starbucks of the financial services industry?
