First Manhattan Consulting Group, a company that helped wake bankers up to the fact that most of their retail customers were unprofitable, is still sounding the alarm.

For all their newfound analytical sophistication and lower-cost, self- service delivery channels, major banks still suffer unbalanced profit distribution.

The top 10% of accounts yield most of the profits, the bottom 20% cause most of the losses, and reported expense improvements have been deceiving, First Manhattan executives said at the Bank Administration Institute's Retail Delivery '97 conference last week.

"Half of your customers are destroying your capital," said James M. McCormick, president of the New York firm, which has promoted the concept of "customer knowledge-based management" to its big-bank clients.

Even as the industry racks up record aggregate profits, customer incentives remain out of whack and cost structures out of line, First Manhattan research indicates.

The least profitable 40% of households are generating two-thirds of transactions, whether at branches, automated teller machines, telephone call centers, or personal computers.

Most of the phone calls come from 7% of customers, who are unprofitable.

At one large bank, the least profitable 20% of households accounted for more than 40% of what First Manhattan calls "branch and ATM events" and 60% of telephone interactions.

In other words, as fast as banks could reduce unit costs, the number of units went up faster. Because customers tended not to be charged for these convenient means of access, the volumes put upward pressure on total costs.

Banks are coping with "runaway transaction growth:" Phone calls rose 39%, ATM usage 32%, and branch transactions 6% in 1996, according to PSI Global and the Council on Financial Competition.

First Manhattan said the picture is far bleaker than indicated by efficiency ratios, which measure costs as a percentage of revenue.

The reported ratio of the 20 largest banks improved to 59.6% in 1996, from 62.7% in 1993, the company said. But when nonrecurring items are factored out-what First Manhattan calls "nonrepeatables"-the ratio improved by only 60 basis points, to 63.2%.

"You need to have precision pricing, to put fees on households that are unprofitable and leave the profitable households alone," said Mr. McCormick. "You need to be prepared to ... become a truly low-cost producer with self-service. It's a very powerful, albeit tactical, thing to do."

He added that it would not be enough just to reduce overall cost levels. Profitability must be analyzed at the account level, and tactical and strategic steps taken to maximize the bottom line.

Other observers agreed that the problems are widespread and tough to solve.

Thomas K. Brown, vice president of Donaldson, Lufkin & Jenrette, sees information-based marketing as one of the essential needs for future survival.

But the analyst said he can highly recommend only five institutions on this score: the monoline credit card lenders Capital One Financial Corp. and First USA Inc., along with Chase Manhattan Corp., Royal Bank of Canada, and Wachovia Corp.

"We have good execution of old skills like risk, expense, and capital management," Mr. Brown said. New requirements like lifetime customer value calculations and interactive marketing are lacking.

"The industry and its information have gotten better, but that has not gotten down to the point of execution," said Robert E. Hall, chief executive officer of Action Systems Inc., Dallas, which specializes in helping banks improve their "market competence" at the "front lines" of branches.

"The issue is not how fast you buy and install a system, but how fast you apply it," Mr. Hall said. "Getting it to the point of customer contact has been much slower than the rate of acquiring it."

"Banks that are losing money need to focus on the 20% of customers who account for 70% of the losses-and give special treatment to the top 20%," said First Manhattan head of retail banking Seamus McMahon.

"Our analysis of banks indicates an attrition of deposit balances running at 1% to 5% a year," he added.

"To put it bluntly, some consumer segments feel they are getting ripped off in terms of rates on their money and so they are shopping around for better rates or are taking their money outside the banking industry."

Mr. McMahon said bankers must strike a new deal with customers, adjust service levels, and eliminate waste.

They could learn, he said, from companies in other industries that rooted out losing business segments and reinvested in growth areas: Toyota, Heinz, Marriott, Virgin Atlantic, and American Express.

Mr. McMahon said it will take nothing less than rethinking the bank.

"This is what your nonbank competitors do every day," he said, "and they're unburdened by history."

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