NEW YORK -- James M. McCormick contends the U.S. banking industry is enmeshed in a retail crisis that may well determine which companies survive the next round of consolidation.
President of First Manhattan Consulting Group, Mr. McCormick has been a driving force in developing a line of business management techniques for the banking industry. By melding technology and modern financial and statistical tools, Mr. McCormick maintains, banks can gain precise feedback on each distinct operation, enhancing capital allocation, competitiveness, decision-making, and performance.
But that's no longer enough, Mr. McCormick says, especially when it comes to retail banking.
Unless information systems and strategies penetrate to the customer level, banks will face a protracted era of revenue stagnation, he warns.
The huge diversity of client profitability profiles makes it imperative that banks find ways of recognizing and retaining the most valuable clients, while overhauling or even shedding neutral or unprofitable relationships.
"The guys who don't reinvigorate revenues, and really make it happen, are going to be sold," he says.
In an interview with American Banker, Mr. McCormick says the banking industry ultimately needs to cut product delivery costs by up to 40% if retail banking is to achieve sustainable growth and profitability, and that bank stock trading multiples already reflect this sobering reality.
Q.: You seem to be suggesting that rationalizing the customer base is the key to rationalizing the banking infrastructure. Is there a broad-based realization of this in the industry?
MCCORMICK: For some banks, the near-term lift from repricing the most unprofitable customer relationships will lull them into varying levels of complacency, because it will pump up income.
The better banks will be taking out clean sheets of paper and doing two things: rationalizing even further their infrastructures, lowering costs so they can serve even price-sensitive customers; and differentiating service, so they truly are giving better value.
The challenge that's going to catch people flat-footed -- and, I think, drive stock prices and consolidation -- will be finding the keys to profitable revenue generation.
That's a higher pursuit, involving technology, and data bases, and creative approaches to segmentation, and precisely guided cross-sell programs, and mail programs, and phone programs.
The day a bank can walk into an investor conference and show how it is using these tools to gain a share of profitable accounts is the day the bank will start to enjoy a trading multiple on par with the credit card players.
That sophistication is not easy to develop, however. There's a multiyear lead time, and a temptation to fall asleep on the issue. Some banks will gain revenue momentum, and some won't.
Q.: You have said banks don't realize the extent to which they are carrying break-even and unprofitable relationships. How serious is the situation? By the year 2000, for example, what must be done to turn around profit dynamics in the weaker segments?
MCCORMICK: If the number of institutions which can calculate per-household profitability at a reasonably accurate level is one tenth of the top 50 banks, I'd be kind of surprised.
I would say if the industry wanted to serve most customers at capital-supporting levels of profitability, it would have to reduce delivery costs -- predominantly distribution, but back office as well -- by 40%.
Now, will it get all the way there by 2000? Probably not. But will we be seeing a 30% reduction in branch costs by better-run banks over that period? Absolutely.
Q.: Will this be accomplished largely by branch closings, or perhaps by some broader reconfiguration of capacity?
MCCORMICK: This will be strongly spurred by direct banking initiatives, such as telephone banking, and PC banking, and automated teller machines.
Now, one of the big hurdles, I think, is that most people still feel they have to go into the branch to get a problem solved. I, the customer, have to look you in the eye and impress upon you the importance of my problem in order to believe that you, the banker, will follow up.
To provide the same comfort level, alternative delivery will have to divide into many forms, with orientations and capabilities tailored to distinct customer segments.
If you are serving seniors, for example, you arrange things so they can call and talk to someone who resonates with a senior, and who doesn't try to sell them inapplicable products.
A second challenge is with the deposit.
How do we get customers comfortable with making deposits without having the presence of a teller?
Boosting direct deposit payroll will address some of the problem. But we need a real breakthrough. And when we get it, it will go a long way in liberating banks from traditional, costly, labor-intensive branches.
Q.: What about the economics of information? You are talking about extensive customer analysis, accompanied by sophisticated electronic delivery mechanisms. Is this another case where large institutions will have the advantage?
MCCORMICK: The most expensive part of it, interestingly, is precisely specifying the data fields you want, and getting all the transaction systems to give you the information according to that exactly specified format.
But the fixed costs are not enormous. I think any bank ranging from $5 billion of assets on up would get a high return from doing what I'm talking about. In fact, we're running some data bases now on large-scale personal computer networks.
Q.: Of course, at some point you have to turn these systems over to their owners. Does the industry generally possess the sophistication needed to take advantage of these systems?
MCCORMICK: These approaches are fairly straightforward.
For example, data bases can identify groups of customers where almost every type of product you cross-sell is profitable, and groups where almost every type of product you cross-sell is unprofitable.
Well, how do you predict that? There are clues in the interactions these customers already have with your bank. You go in with desktop computer technology, and start to calculate the propensity to buy, and the likely profitability.
There are some customers who inevitably are going to be unprofitable on deposits, but who indeed may be profitable in lending. And there are some customers who are price sensitive, and pop off to the next teaser rate the moment yours goes away. These things can be gleaned using PC-based systems.
Q.: What about transition costs, and risks?
MCCORMICK: For the executives who click on this, who understand, transition costs are trivial compared with the benefits coming out the other side. But the disruption still is high.
You have to take the discretionary time of the retail banking group and say "Look, you are going to have to reconstitute the way you think." You can get into serious turf battles about who owns the customer.
We are saying let the data base own the customer. We throw product propositions against the data base, and distribution propositions against it, and segment propositions.
That's progressive, and efficient, but it involves very provocative and politically wrenching redefinitions of roles and responsibilities.
As for risk, it is the same as in any management information system investment, and that is that people don't spend enough time defining how they will use the technology. We give clients a list of 15 or so totally pragmatic things they will do differently once they have customer knowledge databases.
But even if you have a pragmatic chief executive, he delegates to the technologist, and this guy says "I'm in love, my career is going to be reinvigorated, I am going to have lots of fun. So let me take six months and do a vendor parade. Then we'll take a year to load the system." But it will actually take two years.
Q.: If these techniques are as powerful as you say, why aren't they catching on faster?
MCCORMICK: There are myths which tend to dominate behavior. The mind set is that I, the banker, touch X percent of the households in my franchise, and I've got less than X percent of their business. So all I have to do is get the rest of that business.
It seems simple. And it doesn't threaten the status quo.
But we're saying that can destroy value. The average bank motivates branch people to cross-sell, but it relies on aggregate profitability data in designing incentives.
The result is that people sell, but not to a uniform advantage. This is because the bank fails to take into account the significantly diverse profitability profiles of various customer segments. So the bank winds up boosting the cross-sell ratio, but revenues stagnate or even decline.
Q.: How do you see these issues playing out in the market?
MCCORMICK: What you will see is that the industry for the most part is not going to get wise enough to avoid some discomfort.
Bankers have gone to their boards and said, "I will squeak out earnings-per-share growth of at least 12%, and I will do it by growing revenues at 6%, and limiting expense growth to 3%, and buying back some stock."
But what's likely going to happen -- and I don't wish this on the industry -- is that we are going to see continuing erosion in pricing spreads. Many banks are going to be disappointed, and the boards will actually see 5% growth, versus the 12% that was promised.
Next year at this time, some boards will be saying, "Hey, we haven't emerged as a marketing company; we have no revenue momentum; we are dead in the water."
They will have to consider more radical solutions.
But other, wiser banks are investing heavily in these new approaches.
The results aren't readily perceivable to the investment community today. But in a year, the market will start seeing the fruits of these efforts nd giving progressive practitioners the benefit of the doubt. Their stock valuations will rise.
Meanwhile, there will be a rising propensity to sell among the banks that are stagnant. So you will have the makings of the next consolidation period.
A Wake-up Call For Retail Banking
The customer base is diverse, so aggregate data and blanket strategies won't do...
Margin Analysis on Deposit ProductsCustomer segment Expenses(*) Revenues(*) MarginSuburban affluent $310 $920 $610Urban singles $230 $510 280Exurban $100 $380 280Urban middle $230 $430 200Suburban elders $280 $480 200Small town $140 $320 180Rural $150 $320 170Urban lower $250 $340 90Suburban middle $350 $360 10
(*)Average per household per year
(**)Projected
