The financial crisis and the regulatory response have created a significant revenue crunch for the banking industry.
There is no doubt that several of the major sources of revenue growth that fueled bank performance over the past two decades (real estate-driven lending, “ancillary” fees on payment and credit products) have shrunk substantially and rapidly. Technology and consumer behavior are shifting sources of advantage and value from “supply side” advantages (i.e., privileged payment system access, proprietary credit information) long enjoyed by the industry to “demand side” advantages built on customer engagement, trust and the ability to convert customer insights into profitable action. Banks face an unusual opportunity – and set of risks – as they formulate their response to the revenue crunch.
Overall, banks’ responses have been relatively straightforward. In an effort to rebalance the profit equation, many are resizing their cost bases, “leaning out” their middle and back offices, and ratcheting up expense controls. On the revenue side, the answer seems to be imposing fees for checking accounts and/or debit card use. This move is essentially an effort to better match revenue and cost drivers, as the crisis ended many of the sources of cross-subsidization masked by the high-growth era.
Do banks really want to follow the example of the airline industry in unbundling services and charging fees wherever possible? Beyond a certain distance, airlines are the only choice for travel. Are banks really in a similar position of strength, especially these days as disruptors look for ways to cherry-pick the richest profit pools?
As we look to the future – defined as both short-term survival and sustainable value creation -- there are three worrisome elements to imposing fees as the dominant industry response:
The first of these is that the traditional response of the industry over the past decade – growing out of a highly transactional view of the business and the customer interaction – probably fails to demonstrate to consumers the value provided by these products, ultimately the source of “fair price” perception.
Imposing fees also risks further alienation of consumers, raising the stakes on the “dare” to consumers to find other ways to meet their financial needs. Note the new account volumes at the larger credit unions since Bank of America announced its (short-lived) plan to impose a $5 monthly debit card fee.
A third problem with fees as the main strategy is that it overlooks existing and emerging ways in which banks can (and, we would argue, will need to) make money in the coming years.
It is around this third point where we are starting to see financial institutions diverge.
The need to respond to the continuing crisis atmosphere has made it very difficult for organizations to focus the time and resources needed to define “what’s next” – in effect, how to avoid the often-mentioned danger of becoming quasi-utilities. Those able to address it are starting to see some clues to a way to diversify their response to the revenue crunch – to develop new capabilities that enable new ways to make money.
These alternative or supplemental responses all revolve around a better understanding of what customers value, how it can be packaged to demonstrate value clearly, and how best to monetize these sources of value. They fall under three broad categories:
1. Defining customer investment strategy explicitly – Know which customers you want to keep and grow and how you want to do it as you impose new fees; make sure you understand these dynamics beyond a product-based view. The typical segmentation of Mass/Mass Affluent/Affluent is not nearly surgical enough to capture the behavioral, current-value and profit-potential distinctions that can be used to drive further penetration and value creation in your existing customer base. Manage it explicitly as a micro-segmented portfolio and act and allocate investments accordingly – including how and under what conditions you impose new fees (focused on low-profit, low potential customers with high-cost behaviors). A handful of financial institutions have developed this discipline over time; it is now a requisite table stake.
2. Evaluate new value-creating revenue streams according to existing and emerging capabilities – Banks have often developed skills and information assets that have been provided to customers, particularly in the commercial and small-business sectors, as bundled add-ons or even as loss leaders. Yet some of these can be “unbundled” to provide very tangible value and can become the bases for businesses.
For example, a bank can package information for its clients – aggregated data for marketing and sales opportunities for middle market and small businesses (with appropriate opt-ins), and guidance and social network insights (for instance, “mirror” investment portfolios that automatically make the same trades as the account of a friend or stranger) for consumers. American Express has been active in parts of this business for several years, providing merchant clients with actionable information. On the consumer side, consider tiered pricing structures (basic/silver/gold) that engage and demonstrate an escalating value exchange. Multi-channel providers of investment information and education, such as TD Ameritrade, often provide free public access for basics and then offer richer data, insights and customization to registered clients (who may pay fees for the most personalized service) – explicitly linking the value consumers see to the price they pay.
Banks can also provide expertise and advice, particularly to middle market and small business clients. Banks have developed substantial industry knowledge in their relationship management forces but have struggled to institutionalize it, and there little effort has been made to codify and package it. Just as FedEx and UPS provide counsel and software support on logistics management, banks have substantial financial and operational risk management insight to share – and get paid for.
Another opportunity is white-labeling analytics for other financial institutions and consumer-facing companies. A handful of banks are developing the analytics capabilities that smaller institutions, retailers and others are beginning to see as critical to business success; as the analytics space explodes banks should participate. Multiple providers in this space are spinoffs from financial institutions. Perhaps banks should seek to retain some of this value.
Finally, there’s white labeling and outsourcing transaction processing – an existing segment that is likely to grow further. Companies from First Data to ADP to Yodlee provide transaction and information processing and reporting back office capabilities. The largest financial institutions have infrastructure and expertise that should enable them to compete in this space.
There are significant lessons bankers can learn from the evolutionary path that Amazon followed as it parlayed multiple parts of its value chain into distinct businesses. It purposefully looked for ways to monetize the capabilities it needed for its core business around site commerce applications, warehousing, and logistics, to establish its Amazon Marketplace and site outsourcing businesses. On one level, these endeavors are very different from selling books online but they highly related from the perspective of building and leveraging capabilities.
3. Craft the next way to play – Our hypothesis is that the next wave of competition for retail banks will be the battle for customer engagement and customer information. Winning banks will create a portfolio of interlocking revenue strategies, combining the traditional with the emergent. These strategies will be grounded in a core set of value-creation capabilities that will collect and translate insight into profitable products, services, and experiences. Building these capabilities will be expensive and resource-intensive – banks will need to make explicit choices about their Ways to Play. In the short term, understanding possible Ways to Play under different scenarios allows you to start identifying “no regrets” moves.
Turning emerging opportunities into powerful revenue engines will require banks to undertake challenging investment and acquisition and partnering decisions to build capabilities most are still developing. But banks that do so will find ways to rebuild revenue in a demand-driven world and will learn how to demonstrate value to consumers, providing those banks multiple ways to ensure they don’t find themselves confined to a quasi-utility fate or worse, to the commoditization of becoming a checkbox on someone else’s dropdown menu.
As banks consider their fee imposition strategies, they should be “war gaming” where they think these fees will take them over the next two to three years.
Corey Yulinsky is a partner with Booz & Co.’s Financial Services practice in New York. He was formerly a senior executive for a major bank and a national retailer.