High Tech or High Touch?

By Bill Stoneman

Wells Fargo & Co. has captured first place among bank lenders to small businesses, up from fourth place in 1994. By exploiting their own delivery channels, meanwhile, nonbanks such as General Electric Capital Corp., Fidelity Investments, Merrill Lynch & Co. and American Express Co. have made major inroads into a market once totally dominated by banks.

But the personalized service model, favored by community banks in particular, is by no means obsolete. Surveys repeatedly show that small business owners feel a need to know a local banker. They like having someone to talk to when issues arise. And rightly or wrongly, they worry that the high-tech credit merchants will leave them in the lurch when times get rough. "There will always be a willingness among small business customers to forego sophisticated products for personalized service," says consultant John Carusone, president of the Bank Analysis Center, Hartford, Conn.

The real challenge for bank managers pursuing the small business market may be blending the two approaches. By using technology to cut service costs, banks can lower prices and boost their customer allure. At the same time, a personalized service component will help firm up valued relationships. The key to maintaining such a balance, experts agree, is to segment the small business customer base, reserving high-touch service for the most profitable clients while encouraging marginally profitable customers to use automated delivery channels.

Such a balancing act can be tricky, of course. Managers will have to vary the mix of high-tech and high-touch contact from one customer to the next, and develop product and pricing blends appropriate for each segment. It may also be necessary to manage the entire business as a profit-and-loss center -- even if it is still an appendage of the retail department -- to make sure it receives requisite attention from top management. And banks need to work harder at the deposit business, which reportedly is not managed nearly as creatively as the lending side of small business banking. True, small business owners still like to make deposits at branches, which increases banks' cost of service. But a blend of enabling technology and price incentives could at least steer those customers into economical self-service channels.

The payoff for meeting these challenges could be great. First Manhattan Consulting Group estimates that small business banking earns a return on allocated equity of between 35% and 50%, not a market to be given up lightly. The risk of ignoring the challenge is that technology-savvy players, who have proved adroit marketers to middle market companies and consumers, will snap up the most profitable small business prospects.

Small Business Priorities

To give you a sense of the market, Dun & Bradstreet has 8.5 million businesses with less than $5 million in annual revenue in its database and estimates that up to 12 million additional businesses fall below its radar. In such a large universe, customer expectations and requirements vary widely: by the size and maturity of businesses; the industry in which they compete; and the preferences of individual owners.

Some observers contend convenience drives small business banking decisions, and it appears that priority increasingly can be met with a pre-approved loan application that arrives in the mail. Indeed, the tide seems to be shifting toward bigger players skilled at database analysis, direct marketing and the use of call centers. Banks with more than $10 billion in assets, for example, more than doubled their share of loans under $100,000 on the books of FDIC-insured institutions between 1994 and 1997 -- from 11.9% to 29.6%. Still, continued profitable growth is not assured for heavyweight players.

One issue: small business owners are wedded to branches, at least for making deposits, which predisposes them towards their local banks. Small business owners also want consistent support and service, and they don't want to be put on hold waiting for a loan decision. The small business lobbying group, the National Federation of Independent Business, recently asked small business owners to rank the importance of 11 bank attributes. "Knows you and your business" easily captured the top slot, picked by 68% of the survey respondents. It was followed by "reliable source of credit," selected by 57%.

Small business owners worry how direct providers -- the out-of-market players operating via mail and phone -- will treat them when the next economic contraction occurs and delinquencies begin to rise. "The profound question is whether the borrower will suddenly receive a call from 1-800 saying: 'Your loan is called because you missed two payments,'" says Gerard Cassidy, an analyst in Portland, Maine, with Tucker, Anthony & Co. "If big banks take a heavy-handed approach, the small business borrower is going to say, 'My God, I'm never going to borrow from these guys again. I'm going back to Charlie at First National, who knows me and will work with me.'"

The attitude of Helen Hodges, president of a $3 million environmental clean-up company in Houston, is typical. Her company, Separation Systems Consultants Inc., does much of its business with government agencies, which are notoriously slow in paying their bills. She says she doesn't want to do battle with a bank that raises a red flag on her line of credit every time a big chunk of receivables exceeds a specified age. And she's not convinced that a big bank, despite all of its powerful information systems, can cope with her company's cash flow idiosyncrasies.

"I need to be important to my bank," Hodges says, explaining why, like many small business owners, she pays little attention to direct marketing offers from other institutions.

But other customers may be up for grabs. "There's an open question as to the price of loyalty," says Benjamin Crabtree, an analyst with Dain Rauscher Inc. in Minneapolis. "The answer we get is: about 50 basis points." He says banks with economies of scale have a big opportunity if they can wring cost savings from technology investments and compete on price.

Applied Technology

Credit scoring, more than any other technology, has revolutionized small business banking by extending consumer underwriting procedures to a commercial market. Fair, Isaac & Co. Inc., the market leader in developing scoring systems, has 270 clients for its small business model, including most of the largest banks in the country.

In theory, scoring provides a superior appraisal of creditworthiness by focusing on the borrower's track record, which is more predictive of repayment behavior than traditional metrics such as cash flow and collateral. It slashes the cost of underwriting by eliminating most of the complicated analysis. And it provides a great marketing tool by expediting decisions and lowering paperwork burdens on borrowers.

Hibernia Corp. lets its scoring model drive decisions on loans up to $50,000, and it combines scoring with manual underwriting for loans between $50,000 and $250,000, says Robert M. Kottler, senior vice president for small business banking. Using credit scoring to pre-qualify its direct mail solicitations has enabled New Orleans-based Hibernia to boost its small business loan volume 13-fold since 1992, from $100 million to $1.4 billion. While Hibernia is focusing most of its efforts on Louisiana, Wells Fargo uses similar techniques to mail loan offers nationwide, seeking in effect to be a category killer at the small end of standardized credit products.

Credit scoring and direct marketing are just the beginning of new thinking about how small business banking needs can be served. A host of other tools and techniques are emerging, lowering the cost of serving small business customers and boosting bank profitability. Generally, these tools seek to blend features from consumer and corporate banking products.

First Union Corp., which has opened 300,000 combined brokerage/banking accounts for consumers since 1985, this spring rolled out a new account package for the small business market. The account allows up to 100 withdrawals and 250 deposit transactions per month, and it offers an expense tracking feature to monitor spending and tax deductible purchases.

Cleveland-based KeyCorp offers leasing for small-ticket equipment, such as telephones, faxes and copiers, in efficient packages having fewer options and complications than big-ticket leases for corporations. With brief applications handled by phone, most decisions handled by scoring, and no financial statements required unless the deal exceeds $50,000, KeyCorp can lower costs enough to service very small accounts profitably. The average lease on its books is $17,000.

Fleet Financial Group Inc. is adding both high-touch and high-tech services for small businesses. Even as other banks try to steer customers away from branches, Fleet created small business centers within 350 of its 1,200 branches. The centers are staffed by platform officers specially trained in small business products, and they feature designated business teller lines. The company also introduced a Web site development service to allow small merchants to handle electronic commerce.

The deposit business, which First Manhattan reckons is far more profitable than lending, remains especially dependent on high-cost, traditional branches. So far, banks have had little luck convincing business owners to make their deposits at automated teller machines because those owners want to see someone count their money correctly. These clients also want receipts and quick access to their funds, says Maria Erickson, a vice president with PSI Global in Tampa, Fla.

Still, pricing incentives would at least help move cash-intensive customers into self-service channels. Consultant Les Dinkin, a director of Oliver, Wyman & Co. in New York, suggests banks place coin counting machines at their customers' disposal inside branches. This could ease the burden on tellers. Check-only depositors, he adds, would be happy to use the mail if the deposit could be credited when a call is made to the bank, rather than when the mail is received.

Customer Segmentation

For players large and small, one key to succeeding with new products is segmenting the market on the basis of customer profitability. The principle, says Hibernia's Kottler, is that customers are offered relationship manager service where revenues justify the expense. Low-balance, high-transaction clients are coaxed into automated delivery channels, primarily through price incentives.

Banks cannot afford to provide high-touch service to customers who keep only a few thousand dollars in checking accounts and borrow sparingly. Banks can, however, make vital connections with small business customers in other ways. Wells Fargo, for example, has committed itself to lending $10 billion to women business owners, partnering with the National Association of Women Business Owners to get the word out. As a sponsor of the NAWBO and its sister organization, the National Foundation for Women Business Owners, Wells is positioning itself as a women-friendly institution, says Sharon Hadary, executive director of the foundation. That's important when a loan prospect opens an envelope from Wells.

"There's cold-call direct mail and then there's mail from a friend," Hadary says, adding that large banks can make as big of a splash in target markets as smaller banks by participating in trade and service organizations, both at the national and local level. Even the call center can foster a relationship if operators are equipped with sufficiently detailed information about customers and can retrieve it quickly.

Success in the small business market ultimately requires good execution as much as picking the right strategy, observers say. That means improving everything from accounting systems to understanding how small business owners think.

Although bankers increasingly say they're getting a handle on customer and product profitability, consultants report that banks still are basing business decisions on faulty information. For example, many banks book revenue from small business accounts directly to the small business department, rather than to branches. That makes branches appear much more costly than they probably are. And when banks don't separate small business profits from the rest of their retail business, the small business sector tends to get less attention from senior executives than it deserves.

There are also a host of issues stemming from proprietors' tendencies to intermingle personal and business accounts. It is difficult, for example, to apportion expenses and revenues accurately between the consumer and small business lines. Therefore, it may be useful to market business and personal accounts to business owners simultaneously, or to tie accounts together.

But database marketing and alternative delivery channels will win market share in the long run, says Michael Marcus, a banking consultant with Boston Consulting Group. Technology can greatly extend a bank's reach with simple, standardized products such as a small, unsecured loan or perhaps an office equipment lease.

Efficiencies that are passed along to customers in the form of better rates and lower prices will prove a powerful counterweight to personal service, giving banks that employ technology effectively substantial opportunity in serving small businesses.

Mr. Stoneman is a freelance writer based in Albany, N.Y.

Copyright © 2003 by Banking Strategies, published by BAI.

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