The small-business market has long held strong appeal for the banking industry because of its profitability. Today, however, small businesses are being offered more products and services through more channels by more and more competitors.

As a result, banks in particular are likely to experience declining profitability in this market.

Mounting competition will push down rates and fees; and as banks strive to acquire and retain desirable customers, their marketing and sales costs are likely to increase.

In this environment, banks have a largely untapped option: to link the potential profitability of a given relationship with the way it is acquired, developed, served, and retained.

We recommend two operating models, intended to work in tandem:

  • A transaction model that represents a high-tech, low-touch approach geared to relationships with low profit potential.
  • A relationship model that targets relationships with high profit potential.

In the transaction model, standardization of products and processes is a key element.The model is also characterized by personnel programs that encourage participation from a wide range of retail banking staff members. With this model, virtual relationship officers based in call centers manage large numbers of relationships.
The transaction model offers two important benefits: a consistent, predictable customer experience, and minimal involvement from relationship officers targeting larger, more complex, and more profitable relationships.

The relationship model uses a high-tech/high-touch strategy that targets high-profitability relationships. The overriding objectives are to doggedly pursue small-business relationships that offer the greatest potential value, to capture the full potential of these relationships, and to retain them for a lifetime.

Although these two models are intended to work in concert, this is not the way banks tend to approach the small-business market.

Most banks house their small-business divisions within retail lines of business, where they generally operate as independents that target larger companies and offer relationship banking services.

Smaller companies are frequently served by branch locations, which also often employ the relationship model in serving this market.

Although a relationship-based approach may be appropriate for serving larger companies, it is not generally a cost-effective means to serve smaller companies that offer less profit potential.

Developing an operating model starts with a segmentation strategy designed to maximize the difference between a customer's lifetime value and the cost of acquiring that customer. Banks must determine which segments to navigate to either the transaction or the relationship models - and also determine which segments to disregard.

Relationships that are sufficiently profitable to pursue yet do not warrant the investment of highly skilled staff are navigated to the transaction model. The model provides customers with multichannel access for opening accounts and makes centralized loan centers the primary point of customer contact for loan requests.

Using the relationship model, banks employ similarly standardized processes and technology. However, the emphasis is on personalized relationship management. Knowledge management tools, however, enable these officers to demonstrate an in-depth understanding of each customer's business.

Obviously, providing differentiated levels of service based on projected account profitability can be tricky.

Since low-profitability relationships do not justify the cost of relationship-management support, which can run $1,000 a day in fully allocated costs, banks employing the transaction model can provide a relationship and develop the profitability of their lower-tier relationships through effective use of call centers.

Unfortunately, banks and nonbanks alike often view call centers as cost centers. Too often, their role is largely reactive and informational; they address customer dissatisfaction rather than deepen customer relationships. One way to transform call centers into profit centers is through implementation of the transaction model, making the call center home to a team of virtual relationship managers who play dual roles. They act as relationship managers for low-profit-potential relationships and take the lead in customer development. Secondly, they are the primary providers of customer service.

When using the relationship model, you need a methodology that optimizes the link between financial investments in particular relationships and the returns on investment stemming from how customers respond to bank offerings. This involves tailoring investments to specific segments, which will result in relationships that are profitable both for customers and shareholders.

Complementary operating models can also help improve customer service, a key factor in account retention and, therefore, in maximizing relationship profitability. In an American Banker survey of small businesses, for instance, 42% of the businesses that had recently switched banks said they did so because of poor customer service.

Banks have long been aware that customer service plays an important role in retaining relationships, but many banks have not fully exploited service delivery as a driver of customer profitability - either by promoting electronic channels or through managing service levels. With the transaction model, banks target low-profitability customers for promotional activities and education intended to stimulate use of electronic channels. They also provide incentives to use electronic channels, such as reduced account maintenance fees or lower loan rates if payments are made through automatic debits.

In addition, banks take steps to have voice-response units handle service requests electronically before routing calls to live agents.

Using the relationship model, a bank scores its customer base by potential value. It then delivers those scores to all customer "touch points" and guides service personnel on how to handle typical situations. With such management, service representatives are well positioned to extend extra courtesies to high-profitability customers using clearly defined business rules linked to relationship profitability. Similarly, a bank can establish priority queues within its call center to give high-profit-potential customers easier access to live agents.

In both the transaction and relationship models, customer retention is paramount.

Proactive and reactive strategies are put in place to help customer service staff pinpoint troubled relationships and take corrective measures. These strategies recognize full well, however, that in some instances a bank is better off letting a customer go. Mr. Wassel is a senior manager in Ernst & Young LLP's financial services industry practice. He is based in Chicago.

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