With both economic and competitive pressures coming to bear on financial institutions, bankers are under the gun to wring more profits from all lines of business. That's no easy job in any industry, but it's especially tough for commercial banks, where up to half of the customer base may be unprofitable today.

The venerable 80/20 rule-in which 80% of profits come from 20% of customers-doesn't even apply to the banking world anymore. Instead, according to Newton, MA-based Meridien Research, 20% of customers generate about 150% of revenues in many banks. At the bottom end, about 30% of the customers actually drain 50% of the profitability.

These marginal customers typically consist of "bargain seekers, or customers who are lured in with a great pricing scheme, then leave as soon as the bank tries to make money," says Tom Richards, research director of customer relationship management technologies for Meridien. The remaining customers in the equation "just kind of bump along on the bottom," Richards adds. "They don't make (the bank) much, and they don't drain much."

How do banks identify who's in that golden top 20%? And how can the unprofitable segment be coaxed up into more profitable relationships?

Through detailed analysis-nearly all of it fueled by technology- some banks are finding that profitability lies in unexpected places. For instance, the lucrative high-income segment is growing increasingly diverse, and banks need to rethink their strategies for reaching underserved market segments. For example, the U.S. Census Bureau calculates that the incomes of the top 5% of African-American households have grown by 50% over the past decade, to $107,000. Top Hispanic/Latino household income has also jumped to about $100,000. Overall, African-American purchasing power is approaching $300 billion a year, while the United States' Hispanic/Latino population has about $170 billion in purchasing power.

Meanwhile, the number of households headed by minorities and women with annual incomes of more than $100,000 is expected to double, to 1.6 million, by 2010.

Proper deployment of profitability analysis tools will help banks identify and serve such potentially profitable segments. Still, discovering and catering to these potentially profitable customer groups is not so simple.

"Behavior, not demographics, drives customer profitability," says Meridien's Richards. "Different consumers, even from the same demographic groups, engage in all different kinds of behaviors."

Two customers with the same demographic and income profile are likely to use bank resources differently, Richards says. For example, one person may write a check for a particular item, while the other will use a debit card.

"They are consuming different levels of resources to get the same job done," the analyst continues. "That becomes critical when the institution is trying to determine not only who is profitable but who has the potential for being profitable, and about how they allocate resources to customers who are less profitable than others."

Of course, the results of such an analysis may fly in the face of conventional wisdom, which dictates that it's cheaper to hang on to a customer than replace that customer. A good business, in theory, will pull out all stops to retain every customer it can. However, it's simply not profitable to try to hang on to every customer, says Richards. Some customer segments use more bank resources, while others have high service requirements.


Customer profitability analysis will help distinguish whether customers are part of the high-profit or high-maintenance segment, driving marketing strategies in the process.

"You want to be able to cross-sell and up-sell profitable portfolio products and services to these customers," says Gary Parisi, business development manager for Acxiom MarketWise, headquartered in Bloomington, MN. "Before, bank managers were measured on the number of products and services that the customer had. They found out that the customer could have five unprofitable relationships with the bank, instead of just one. You can't make that up in volume."

For some banks, especially those with formidable IT strength, customer profitability analyses have produced some eye-popping results. Fleet Bank, for instance, discovered half of its customers were essentially unprofitable. First Union Corp. found that what it considered the lower fifth of its customer base in income was its most profitable segment.

Across the board, customers with razor-thin checking balances, including many who come from relatively low-income households, can represent a lucrative segment for banks. "The number one money maker for retail banks is fees for insufficient funds," says Kim Sutherland, director of Market Line Associates, based in Atlanta.

First Bancorp of Naples, FL, which serves real estate and high-end commercial customers, also encountered some eye-opening data when it recently implemented a customer profitability analysis system.

"We had some customers that we thought, on the surface, would be very profitable, with an average of $300,000 in business accounts," says Jerry Williams, chairman and chief executive officer of First Bancorp. "What we didn't pull out of that was the fact that some write more than 275 checks a month. Once you apply those labor costs, it's not a profitable customer. But, branch managers were treating them as better customers. Our industry as a whole has never been able to track those things-understand what the labor piece of that means. We only look at one portion."

First Bancorp implemented a customer profitability system from Milwaukee-based Metavante Corp. that pulls data from every general ledger account across the company.

"Our CRM strategy is beginning to have a very positive impact on our organization," Williams reports. First Bancorp has increased its business by 32% as a result of its new profitability analysis capabilities, he says. By repackaging products to better suit customer behaviors, First Bancorp expects to capture close to $1.5 million in additional revenue over the next year.

"When we first put in Relationship Profitability and did the first reports for the commercial loan officers, I had them write down who they thought their top five customers were," says Larry Hutt, a vice president with Metavante, which is a wholly owned subsidiary of Marshall & Ilsley Corp. "What they learned was, two out of those five, on average, were actually profitable at the bank."

New IT on the market-often working in conjunction with CRM systems- provides bank managers the capability to analyze and decipher the profitability of various customer segments. A number of systems on the market are capable of providing such analytic functionality. (CRM is not a technology in itself, of course, but a process of gathering and retaining information about customers and their interactions with your institution.)

"It's fair to say, on balance, the industry still has a way to go," says Richards. "But, it's not a systems issue; it's a management issue. I've sat in meetings where activity-based costing groups have stood up in front of management teams to explain their findings, and the results have been catastrophic. Typically, these guys have been managing profitability based on the general ledger or some accounting finance- based system. They're suddenly confronted with the customer profitability through allocated costing, which divides costs by total transactions and therefore assigns a "cost per transaction." Richards says activity-based costing, which measures individual transactions, paints a more accurate picture.

For example, if an ATM machine costs $10,000 a month to maintain and only one customer uses it during a given month, allocated costing would look at that one customer as costing the bank the entire $10,000. "Allocated costing cannot account for excess resources; it cannot account for resources that the bank is carrying that aren't utilized because it doesn't know the difference."

Activity-based costing would only factor in the cost of the single transaction and writes off the entire ATM infrastructure cost separately, as excess capacity.

Other lines of thinking also emphasize the value of products customers are buying. If a customer can be persuaded to buy another bank product, their profitability to the bank increases. Some banks are seeing success with the concept of "next best product," says Arthur M. Hughes, vice president for strategic planning of M/S Database Marketing in Los Angeles and author of The Complete Database Marketer.

"Typically, a bank has about 17 products, such as home equity loans, credit cards, savings accounts or CDs," he explains. The key is discovering what the next level of appropriate product should be introduced in an up-sell. Plus, certain products have higher retention rates than others."

Banks have to learn to sell the right products to a particular customer. Customers that already hold $300,000 policies would laugh off a $2,000 life insurance offer, Hughes says. Likewise, a home equity loan offer would not work for renters.

"You use the profitability analysis to figure out first, how profitable are these people to start with," he says. "Then, for each person, you look for the products they don't have. What is the possible profitability for each person with each one of those products? You can figure it out by looking at the person, income, value of his home, amount of money in the bank. The second step is to rank all the next- best products in terms of probability: What is the probability the person will snap at this new thing?"

This scoring can be added to teller, loan officer and customer- service screens to drive new sales.

To build an effective customer analysis system, a bank needs to integrate all channels and databases with customer information.

Says Acxiom's Parisi: "You have to create a single view of the customer. If they bring this customer information together and 10% to 20% of this consolidation is wrong, then they miss customer relationships."

Two separate IT silos could handle the same customer as two separate relationships for years, he warns. "The question is: How do I get a single customer view so I can do truly accurate customer profitability analysis based on the total relationship with the customer? I need an accurate, 360-degree view of the customer."

It's also important that all bank representatives, such as branch managers and loan officers, have access to the same customer profitability analysis information, says Kim Sutherland, director of Market Line Associates, based in Atlanta.

"Right now, that's not the norm in the banking industry, where everybody has access to the same information at the same time." This creates confusion among customers that are accessing differing bank services through different channels, she adds.

"If you're going to pass information back to a touchpoint," she says, "the number one piece of information you should be able to pass back is customer profitability."

Joseph McKendrick is a freelance writer based in Doylestown, PA.

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