Rx for Segmentation
By Robert Giltner and Richard Ciolli
Customer needs, not historical profitability, should be the guiding principle for customer relationship management strategies.
One school of banking wisdom holds that relationship profitability is the best tool to manage the approach to the customer, and that banks are disadvantaged because most customers are only marginally profitable at best. Awestruck by segmentation analyses purporting to show that all of a bank's profits stem from an elite client group, many retail bankers preoccupy themselves with efforts to pamper the scarce "A" customer. They reflexively cross-sell to those "B" customers deemed salvageable and pare back the seemingly hopeless "C" accounts.
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But this profit segmentation model is fatally flawed. Why? It is based on the assumption that profitability is strictly a function of the customer's activity -- that banks are not a factor in the equation. Strategies based on this fallacy inevitably focus on techniques for selecting and selling to the "right" customers. Little is done to change the processes by which customers are served, and not enough is done to ascertain their requirements. And through this gap is marching an army of alternative providers who, instead of trying to "reform" customers, devise attractive new business models that profitably serve customers' emerging financial services needs.
For those banks finding themselves at the losing end of this proposition, setting things straight begins with recognizing that customers are not intrinsically profitable or otherwise -- they simply have needs and product usage patterns. Relationship profitability hinges on how a provider chooses to serve those needs. Given all of the emerging service and delivery options, in fact, nearly all bank customers have the potential to meet required targets for profitability.
Realizing this potential, in turn, requires that banks segment customers by their needs -- and commit themselves to the institutional adaptations needed to profitably fulfill those needs. This commitment has four facets: The first is a vision of growing profits by matching bank processes to customer needs. The second is understanding the customer's ability and willingness to pay. The third facet is a proactive focus on creating profitable relationships in all customer segments. Fourth, the institution needs the proper information systems -- ones that can provide insights into customer usage patterns and requirements, as well as measure progress in creating profitable new ways to serve.
This approach is far superior for guiding customer relationship management strategy than the profitability segmentation model. It is easier for bank personnel to understand and adopt, and it shifts the emphasis from measuring historical results to optimizing the potential of each relationship on an ongoing basis. Further, it emphasizes the need for proactive organizational change.
The Profitability Trap
The vision for many CRM initiatives is identifying and serving "profitable" customers. Local managers, commercial loan officers and executives are encouraged to develop plans based on "A," "B" and "C" segments. In turn, product development, delivery channels, marketing budgets, sales efforts, information systems and service levels all are geared around these segments. For example, some banks proudly tout how they can leave "C" customers on hold longer than "A" customers, force "C" customers out of the branch to alternative channels, and target "A" customers for special customer calling efforts.
The trouble with this strategy lies in its execution. For starters, the profitability segments themselves have limited utility because so many different kinds of behaviors can combine to place an individual into a particular segment. For example, "A" customers can range from large borrowers to those who perennially overdraw their accounts and rack up lots of penalty fees. What possible segment-derived treatment would be applicable to both? There is none, obviously, yet bank personnel are urged to pretend the case is otherwise.
In devising retention strategies, for example, institutions often use profitability data to work up lists of clients who should receive personal calls. The reps make the contacts and dutifully tell the customers that they are valuable to the bank. But customers don't care about that -- they want bankers who will listen, anticipate their needs and respond with appropriate products and services. The same thing goes for new "A" prospects, who can't be expected to switch their accounts to a different institution unless their needs will be better met as a result.
Then there's the seduction of the cross-sale. Selling more products to each, it is thought, can increase the profitability of "B" customers. So the bank distributes standardized offers to people in this category in the branch and through the mail. It often doesn't work, however, because usage, not the number of products, drives profitability. Customers may simply spread the same dollar balances over more accounts. A product used by one customer can be highly profitable, but with a different customer, usage patterns and balances actually may make the same product highly unprofitable.
Customer alienation is also a distinct hazard attending sales campaigns based on something other than the client's needs and best interests. Consumer surveys already show that many customers do not believe that bankers understand them. Rather than viewing banks as allies, they tend to view them as mercenaries pushing products.
"C" customers also can be mishandled under the profitability segmentation framework. Some bankers describe them as "not our type." Rather than searching for a way to understand their needs, they allow or encourage "C" customers to leave the bank. This sort of behavior is inflexible and defeatist. It also can be financially naive. Often overlooked in relationship profitability analyses is the important interplay between fixed costs and variable costs. So long as a transaction's incremental revenues exceed its incremental expenses, it has economic value. At the very least, it helps offset a portion of fixed overhead expenses. To dismiss all "C" customers, then, is to forfeit valid incremental revenues.
A further drawback of profitability segmentation is that it traps bankers in a mindset that focuses solely on sales and prospecting techniques. CRM becomes an elitist exercise in acquiring and retaining "A" customers, and maximizing those relationships. Banks shell out substantial training dollars so that representatives can do a better job of listening and advising, but they make little effort to change the processes by which customers are served, defeating the exercise. The hard truth is that even when reps hone in on the right targets, results will not come without a supporting organizational vision and the appropriate sales and service management processes. Most institutions cannot point to any significant financial results from their sales training efforts.
Needs-Based Segmentation
Customer relationship management must start with customer needs rather than current customer profitability. As an example of the conceptual framework needed to support this, one bank crafted a vision statement as follows: "We understand the unique individual needs and potential of each customer or prospect, and match service and pricing with their ability and willingness to pay. Creating this matched value exchange requires that we: develop customer-matched relationship and delivery channels; implement new sales and support systems; track results in terms of customer performance and profitability; and train employees on new performance measures."
With this approach, the bank takes the responsibility for understanding customer needs. Segmentation is structured around those needs and customers' ability and willingness to pay. Then the bank develops the processes required to serve the various needs segments in a profitable manner. Customer relationship profitability -- still a key measure -- now can be appropriately analyzed for each needs segment and used to fine-tune the processes for serving that segment. The question, "Which customers are most profitable?" can't be permitted to stand alone. Its companion must be, "Where can I improve a process to increase profit performance?"
This vision and related segmentation approach is far superior for guiding CRM strategy than the profitability segmentation model. It is more easily adopted, and it focuses on where performance can be improved in the future. Further, it targets bank processes for improvement, as opposed to just attempting to shift the mix of customers willing to interact with the institution as it stands.
All employees easily understand targeting customers by volume and number of accounts. A problem with the profit segmentation model,by contrast, is that it rubs employees wrong when management says some customers are simply more important than others based solely on their respective profitability. Customer representatives often express considerable angst following the internal publication of calculations used to define the most profitable clients and how they will be treated. They may even refuse to accept the results or abide by the new rules.
Segmentation by usage helps bankers achieve the objective of serving all customers with a process matched to their needs and ability to pay. Everyone understands that the bank needs to cover all of the costs of doing business, including the cost of capital, but reps want to pursue this objective in a manner that is comfortable, clear and fair. The product and balance segmentation approach is not stymied by employee hesitancy and concerns about the accuracy and relevance of profit calculations. Customer needs first should be categorized according to potential balances and product usage. Relationship profitability analyses within these segments then becomes highly useful in strategizing how to grow profitably.
Needs-Based Strategies
The first step in implementing a new CRM vision is defining the new integrated sales and service processes that will be used across the organization. These processes must link all of the relevant components, including customer usage characteristics, sales and delivery methods, relationship processes and customer service methods, operations and information systems. Defining a set of processes to match the needs of customers in a profitable way creates a culture of success for the organization. Clearly, this is far more than sales training, which by itself simply adds a short-term veneer to a bank without addressing the underlying processes.
We see three fundamental strategies arising from needs-based segmentation:
Relationship. This strategy targets the roughly 25% of customers having complex needs and a high profitability potential that warrants relationship management. One component of this strategy is a consultative selling approach. Another is a clear relationship offering tailored to this segment, such as financial planning with an asset allocation report. A third component consists of customer management blueprints, which show relationship plans by customer and targeted results. An additional requirement is technology that can automate sales processes and track interactions with targeted households.
Cross-sell. This strategy focuses on the roughly 35% to 55% of customers whose present and potential relationship value does not justify full relationship management. Here, the emphasis is on maximizing each interaction, for example in the branch or via alternative delivery systems, but in a manner that emphasizes the profitable fulfillment of additional customer needs.
A key component of this strategy is product packaging that rewards the customer for maintaining multiple relationships and higher balances. For example, First Merit Corp., Akron, Ohio, gives credit for loan and deposit balances in assessing checking fees. The cross-sell strategy also requires a disciplined process that includes daily evaluations of branch staff performance and appropriate management and measurement systems that help assure consistency and productivity.
Transaction. This strategy targets the 25% to 40% of customers whose potential to increase balances or product usage is limited, at least in the short term. It seeks to maximize the convenience of delivery while minimizing the cost to the bank, and to generate additional transaction revenue. Priorities include lowering costs by re-directing transactions to alternative delivery channels and increasing fee income with segment-specific products such as fee-based overdraft services.
A key factor in these three strategies is aligning technology and systems with the CRM vision. Among the vital tools are integrated profitability systems, data mining and sales automation. Further, the CRM information system must be based on a state-of-the-art database architecture. This requirement is essential because, to be effective, the CRM information structure must integrate diverse sources of customer data and depict the total customer relationship -- activities, balances, and potential -- in a seamless fashion.
CRM represents the key strategy to grow revenue and compete for customers. It defines the processes used to profitably serve the customer and thereby is instrumental in creating more of the customers that a bank wants. To accomplish this vision, banks will need to change sales and service processes to match customer needs.
In this light, needs-based segmentation ultimately is a call for organizational adaptation. Translating customer needs and usage patterns into bottom-line results is the responsibility of the bank. It's not a question of the customer's intrinsic worth; it's a question of how well the bank can align its capabilities with the customer's needs and ability to pay.
Mr. Giltner is chairman of Sales Performance Group and managing partner at Bank Strategy Group, both based in Louisville, Ky. Mr. Ciolli is managing consultant at HNC Financial Solutions, Chicago.