Service Guaranteed — Will Profits Follow?

By John R. Engen

Despite a difficult economy, Jerry Grundhofer is pushing U.S. Bancorp to differentiate itself with service quality.

In a largely commoditized industry, it is difficult for any financial institution to set itself apart from the pack. But Jerry Grundhofer, chief executive of U.S. Bancorp, is convinced his troops can make a difference by rallying around the banner of better service quality. Will it pay off for shareholders?

The logic behind his approach is simple: Since products are pretty much alike from one bank to another, the best way to grow revenues is by retaining and deepening established customer relationships. "If we can give our customers better service," Grundhofer says, "we will accomplish all of our financial objectives."

This theme is resonating across the industry. Late last year, for example, executives of FleetBoston Financial Corp. announced that service quality had moved to the top of that institution's priority list, displacing the "old game" of buying companies and cutting costs. Bank of America Corp., another major acquirer during the last decade, has likewise signaled a shift from doing deals to taking better care of customers.

The transition is difficult, however, and the rewards uncertain. Building a service culture is a murky, long-term proposition that requires perseverance and a complex system of incentives, measurement and monitoring. And it's not certain that higher levels of service will yield financial rewards to the institution. Given that the majority of any bank's customers aren't continuously profitable, some question the wisdom of providing excellent service across the board.

The 57 year-old Grundhofer responds that today's unprofitable customers will, in many cases, become tomorrow's profitable ones. His goal is to win customers for life, thereby generating improved returns over time.

Implementing this vision will be difficult in the current environment. The national economy has fallen into a slump, exacerbated by the September 11 terrorist attacks, just as Grundhofer is integrating Minneapolis-based USB's two predecessor banks: the old USB and Firstar Corp. The merger closed in last year's first quarter, and subsequent earnings reports have been marred by merger-related charges and credit quality woes. USB's third quarter earnings fell 95% from year-ago levels, and its shares have been trading near their post-merger lows.

Grundhofer thus faces the need to invest managerial and financial resources into his service quality campaign at a time when those resources are at a premium. Under pressure to show tangible cost savings from the USB/Firstar merger, he's cut 2,200 jobs, or about 4% of the combined workforce. Can he inspire his troops to improve service in that atmosphere of austerity? Will USB's shareholders be patient?

Those questions aren't likely to be answered for at least another year. In the meantime, Wall Street is more focused on USB's credit problems, underscoring the fact that one strategic initiative, no matter how well implemented, can do little for a company if other critical trends are negative.

In one way, however, the service guarantee has already had a positive impact, according to analysts. With the aid of an aggressive new branding and marketing campaign, Grundhofer is beginning to differentiate his company in the public realm. "Improved service creates a good buzz throughout the community," says Ryan, Beck & Co. analyst Nancy Bush. "And banks need buzz."

Five-Star Guarantee

Grundhofer's service theme strikes a chord with both the public and Wall Street because banking has an undeniable service problem. According to the University of Michigan's annual American Consumer Satisfaction Index, overall bank service levels — based on factors such as customer expectations and perceived quality — sank 5.4% between 1994 and 2000. In fact, the bank index has lagged a composite index of 38 U.S. industries since 1997. "Most bankers believe they provide good service. But they're lying to themselves," says Charles Wendel, president of Financial Institutions Consulting in New York.

Bankers were able to gloss over service problems during the previous decade, when earnings and valuations benefited from new fee-income sources, relatively high spreads and merger-related efficiencies. Meanwhile, a strong overall economy spurred loan demand and kept credit problems at bay.

Today, margins are shrinking and credit losses rising. In this tougher environment, banks are revisiting their basic consumer deposit business, a bulwark of industry profitability. The average large bank churns about 15% of its retail account base annually, according to First Manhattan Consulting Group in New York — a number that would almost certainly be lower if customers were satisfied with their banking experience. "This is an industry that understands cost savings, but not the benefit that derives from service," says analyst Bush.

USB's service crusade centers on its "five-star service guarantee," which pays customers a minimum of $5, and up to $500, if they experience any of a variety of specific inconveniences.

These include waiting in a teller line for more than five minutes; a call-center wait of more than three minutes; an automated teller machine that is closed or fails to provide a receipt; and an inaccurate account statement. Restitutions are made in cash whenever possible, and USB employees decide if and when to dole them out.

Grundhofer pioneered this guarantee at Cincinnati-based Star Banc Corp. and Firstar, two of USB's predecessor organizations. This time around, the guarantee is backed by a marketing campaign that includes a new USB logo and advertising that promises "focused and attentive service."

The guarantee touches all business lines and back-office functions within the USB system and is intended to let customers know the company cares about their business. Even more importantly, it's a signal to USB employees that they are expected to go the extra mile on service, even if it causes disruption in their work routines and costs the company money. "It's a public declaration that employees are accountable for the quality of service customers receive and are empowered to make things right," says Richard Davis, vice chairman in charge of retail banking.

Grundhofer and Davis are confident this program can work at USB as it did at Star Banc and Firstar. But they face a stiff challenge in spreading the gospel across a $168 billion-asset franchise that spans 2,200 branches, 24 states, and numerous different banking cultures absorbed over the past decade.

The differences between Firstar and the old USB were particularly stark. The latter institution, run by Grundhofer's brother Jack (now USB's chairman), was known for an aggressive combination of cost-cutting and cross-selling that ultimately alienated many retail customers.

Prior to the merger, the old USB's revenue growth had stalled. "They had almost become too efficient, and were suffering attrition in core deposits," says Jon Arfstrom, an analyst with RBC Capital Markets in Minneapolis. "The merger was predicated on the fact that U.S. Bank needed help on the service level."

Profitability Debate

Grundhofer believes that overlaying Firstar's service approach onto the old USB franchise will help restore growth. The merger itself may hinder that task, however.

Like any acquirer, the new USB needs to cut costs. Such consolidation can depress employee morale, which in turn impacts customer service. Based on a 2001 survey by Accenture, more than two-thirds of U.S. banking customers believe the service quality they received deteriorated following a merger. That's a pocketbook issue for merging institutions and their shareholders, because customer dissatisfaction tends to show up in falling deposit levels and higher defection rates.

Davis asserts that merger integration is not an issue at USB, and that the service guarantee initiative was conceived, in part, as a way to capitalize on the service shortcomings at other banks. "It becomes something to rally around," he says.

USB will, in any case, have difficulty showing direct financial benefits from the service guarantee. Unlike a cost-cutting program, the benefits of which can affect the bottom line directly, emphasizing service doesn't necessarily produce tangible results. "I don't think there's much shareholder value created by service," says John McHugh, a New York-based financial services partner with Accenture.

McHugh points out that most large banks already spend between 15% and 20% of their net revenues on service-related expenses — a level he views as "unsustainable" in today's increasingly pinched earnings environment. Instead of offering blanket guarantees to all customers, most of whom are unprofitable, he says it's better to target those segments that actually merit the expenditures.

USB does use its customer database for some forms of segmented marketing and service. Higher-value customers who contact the call center, for example, are often steered to specialized reps. But Davis argues that customers in general have different needs at different times and that discriminating on the basis of current profitability fails to recognize the potential value of these hard-won relationships. This is especially important to an organization that aims to grow its insurance and investment services businesses aggressively, as does USB.

Nor, he adds, does USB's service model cost as much as outsiders might think. In total, the guarantee itself is expected to cost the company about $5 million, or 4% of its 2002 marketing budget, with some smaller, additional expenses in training and technology. As for tangible benefits, Davis points to improved results on customer satisfaction surveys and complaint tracking. He says the former Firstar's customer retention levels were more than 6% higher than at the old USB.

Service Before Sales

The service guarantee, first introduced at predecessor Star Banc in 1996, has evolved into a comprehensive template that includes customer satisfaction measurement, employee incentives and accountability, monitoring systems, and lots of managerial cheerleading. The system rests on a foundation of local accountability. Branch managers are rewarded on how well they grow their balance sheets and income statements, and on the quality of service their unit provides, rather than sales volume.

This last aspect may be surprising, considering Grundhofer's reputation as one of the industry's leading cross-selling practitioners. The American Banker named him "Banker of the Year" in 1999 for successfully ingraining "the product cross-selling culture of which many other bankers are still only dreaming."

Grundhofer actually believes pure cross-selling is counterproductive, because it inspires bankers to sell products that customers don't need. That can alienate those customers, and saddle the institution with the cost of opening and closing inactive accounts. Emphasizing service, on the other hand, gets employees to think about customers' needs first, which helps build long-term relationships, trust and eventually more sales. "Service is part of the selling cycle," Grundhofer says.

Selling Firstar's ethos of service-over-sales to bankers trained in the old USB's high-octane sales environment is crucial to the strategy's success. Ideally, Davis would like to incorporate the superior sales acumen of the old USB into the new organization, while de-emphasizing its priority. But that will be tricky. The old USB's sales force received large bonuses for sales, even if that meant merely re-writing existing loans at lower rates. Shifting to a system that emphasizes net asset growth — and cuts those sales commissions — has sparked debate between managers of the two predecessor organizations.

Davis' strategy is to migrate employees incrementally from one incentive plan to another, while continuing to preach the long-term value of service-based growth. Almost immediately after Firstar announced its acquisition of USB in October 2000, Firstar executives began touring the new franchise, talking with employee and management groups about the service culture and asking them to sign off (literally) on their commitment to the new way of doing things. Branch managers were schooled in the philosophies and tactics required of the new system.

Those efforts were followed in October 2001 by a series of kick-off rallies in old USB markets for all employees, featuring pep talks from top executives and an unveiling of the new marketing campaign. All employees received lapel pins with the new USB logo, while branch managers were given clipboards and stopwatches — tools to help better "manage" teller lines.

This latter detail is one of the seemingly small, but critical, tactical components of the guarantee. Rather than opening another teller window when long lines start to form in a branch, managers are instructed to begin helping customers with their paperwork at about the sixth or seventh person in line.

If service is slow, branch managers have instructions to say, according to Davis, "By the way, I've been timing this since you walked in, and if you're not served in five minutes, I've got $5 cash in my hand that I'll give to you." Davis says this tactic gets the line moving faster, and also demonstrates the bank's desire to be helpful.

Even with all of the initial groundwork, Davis says it's difficult to get new employees to follow through on the $5-guarantee, because it goes against their instincts. For that reason, old USB branches have been paired with a "buddy bank" that was part of the Firstar system, whose employees are used to the practice. Those counterparts reinforce the notion that it's acceptable — even desirable — to make the payment.

Tracking Systems

While much of its effort is devoted to the consumer bank, from which USB derives 37% of its income, the service guarantee encompasses all business lines — from corporate payment systems to brokerage and insurance operations.

There's a special emphasis on ensuring that USB's frontline personnel get support from the back-office, which Grundhofer calls "the critical cog in the wheel." If back office workers don't do their jobs, he says, "all the front-line people will be out there making excuses for the bad service they're delivering."

To elicit cooperation, there are literally hundreds of "service-level agreements" between various business lines and operating units, and even between the company and some of its vendors and corporate clients. "The layering of internal and external guarantees can be mind-boggling," says Jenny Powell, a Cincinnati-based director of corporate marketing.

Some of the internal promises are simple. Transaction services workers, for example, have pledged to return phone calls to fellow employees on the same day, and to show up for meetings on time, even though such efforts can force some employees to re-order their days.

While individual units don't actually pay each other for missing a guarantee, a strong element of peer pressure makes compliance a high priority. "The internal guarantees help people understand that no one is in this alone," says Jan Estop, a Minneapolis-based executive vice president in charge of the transaction services unit, which deploys ATMs and processes payments for both USB and smaller client banks.

Davis downplays specific performance measurements tied to service. "If you get too wrapped up in technical tracking, it can become more about the numbers than the service itself." Still, metrics that reinforce the overriding philosophy abound throughout the organization. Many of these are subjective. For example, customers in both the branches and call centers are randomly polled on the quality of service they've received. Complaints are tracked and addressed. "Mystery shoppers" tour the branches to rate interactions with tellers and platform bankers. And managers often listen in on call-center exchanges, rating factors such as courtesy and the accuracy of information provided.

Objective metrics include analyzing excessive payments on the guarantee, customer attrition rates and statement delivery times.

Most business units conduct market research with their own client bases to gauge the effectiveness of their service efforts, and many have their own quality assurance units. A corporate-wide quality group, overseen by Powell, acts as an "independent third party" that looks across business lines to monitor service levels, referee high-level grievances and suggest areas for improvement.

These measures, along with success at attaining core growth and profit objectives, are factored into individual incentive calculations. They're also combined with broader, company-wide measurements, including statistical measures of ATM and Web site up-time, statement turnaround times and accuracy. The objective is to create a private "barometer" that alerts senior management to impending problems.

But will any of this help USB achieve higher earnings and improved stock valuations? Since retail operations generate 48% of USB's overall revenues, Wall Street is looking for some long-term improvement in the bottom line, most likely manifested in deposit growth and better customer retention. Fred Cummings, an analyst with McDonald Investments in Cleveland, says he expects USB's deposit growth to reach an "above-average" level "over time."

But for the short term, at least, analysts are more concerned with credit quality trends at USB and the macro-economic environment, both of which have been negative. USB had to take $313 million in chargeoffs and increase its loan-loss reserves by $712 million in the third quarter to cover deteriorating commercial credits, particularly in the transportation and manufacturing industries. The nation's eighth-largest bank is also struggling with weakness in its credit card portfolio and depressed investment banking/brokerage earnings.

With the stock trading near a post-merger low at year-end, USB's top 12 managers (including Grundhofer) forfeited their bonuses for 2001. And Wall Street is waiting to see if credit problems worsen this year. Of the 32 analysts that followed USB as of mid-December, 13 had a "hold" rating on the stock and one had posted an outright "sell;" only seven rated USB a "strong buy."

USB's predicament underscores the fact that strategies aimed at differentiation can't single-handedly overcome deteriorating performance fundamentals. On the other hand, every company needs a vision to carry it through the tough times and make the most of the good ones, and by that criterion, Grundhofer is going full-speed ahead. "In the long-run," he says, "there's only one difference between us and our competitors: the quality of treatment we provide to customers."

Mr. Engen is a freelance writer based in Minneapolis.

Copyright © 2003 by Banking Strategies, published by BAI.

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