Retail Contrarian

By Kenneth Cline

De novo branching, CRM and cross-selling may have the industry abuzz, but U.S. Bancorp's Richard Davis still sees service excellence as the winning formula.

Anyone can take pot shots at conventional wisdom, but the significance of a contrarian stance reaches a whole new level anytime a major banking company heads in a distinctively different direction. Thus, the significance of the maverick views of Richard K. Davis, who built his reputation in the banking industry as one of the architects and chief proselytizer behind U.S. Bancorp's "five-star service guarantee" program, which enshrines service quality as the key element in the Minneapolis-based bank's retail strategy.

This focus on service has placed the 45-year-old vice chairman and head of retail banking at U.S. Bancorp at odds with some of the top growth strategies seen around the industry these days.

Take the current enthusiasm for de novo branching, for example. Many prominent institutions have recently announced major expansions of their branch networks as a way of sparking growth in new markets. But Davis doesn't see such initiatives as a "wise use of investment dollars." He points out that today's environment of rapid deposit growth — spurred by flight from the stock market — can't be expected to continue indefinitely. "I definitely don't subscribe to the 'big blast' theory of opening hundreds of branches at one time," he says.

Davis also doesn't think much of the fad for reconfiguring branches to look more like coffee shops or retail stores: "At the end of the day, if you're a bank, you've got to look like a bank. I'd rather spend time being good at what customers expect." For Davis, that means transactional excellence and a closer relationship with customers based on good service.

He certainly doesn't endorse aggressive sales tactics driven by customer relationship management, or CRM, technology. While Davis sees some value in using computer-generated customer data for marketing purposes, he adamantly opposes deploying this data to customer representatives. "Neither our tellers, nor our call agents, nor our personal bankers are trained to discriminate, based on a customer's income or other factors," he says. "There's no upside to making public the data behind customer segmentation."

Nor does U.S. Bancorp incent its employees to boost their cross-sell ratios, another popular tactic these days, since Davis feels this can actually harm customer relationships. "There should be no disconnect between what's good for employees, what benefits customers and what's good for the company," he says, summing up the common thread linking all his beliefs.

While many financial services executives no doubt disagree with Davis on specific points, many will surely find his views worth pondering. We interviewed him last April at BAI's SmartTactics for Profitable Retail Delivery conference in New Orleans.

Banking Strategies: Consumer-oriented banks have had a good run the last couple of years. What's your outlook for the immediate future, given that consumer loan delinquencies seem to be on the rise?

Davis: There are a couple of things that have changed in recent years. First, banking companies have been very successful in banking more people, both with sub- and near-prime lending and by offering checking accounts to many previously un-banked consumers. We gave more people access to financial services.

So when people talk about delinquencies and bankruptcies, they're looking at the underwriting implications in this lower tier. The good-credit customers have actually become quite prudent in the wake of the dot-com crash. Also, discretionary income is at historical highs. So I'm comfortable that worries about consumer credit overlook the fact that we've been banking more people.

Still, the relative performance of the consumer bank vis-à-vis the rest of the organization will certainly fall in proportion in the coming years. And let's hope it does, since we all want the commercial and capital markets businesses to come back!

The essential question facing retail banks has to do with deposits. When capital markets improve, there is a short-term risk of a deposit outflow from banks. Fortunately, banks have developed hybrid deposits/investments programs to retain that cash. We'll have an opportunity to sell customers our mutual funds or money market accounts.

The longer-term threat stems from payment alternatives. The movement toward check digitization, or electronification, will force retail banks to reevaluate the role they play in the payments system. What's going to happen when the paper-based payments stream migrates to electronic channels? Are banks positioned to recapture those payments?

Banks have two roles in the payments system: authenticate identities and validate parties to a transaction. The danger is that nonbank entities can step into those roles. A large merchant, for example, could decide it knows a certain customer well enough to avoid having to turn to a bank to validate that customer's financial soundness.

At U.S. Bancorp, we have devoted extensive energy to understanding the impact of electronic banking changes in the coming years. Likewise, we have evaluated our capabilities so as to optimize our position in the emerging payment practices.

Banking Strategies: De novo branching is another hot issue in retail banking. A lot of major institutions have announced massive expansions of their branch networks. Do you think such programs will produce the growth these institutions expect?

Davis: The rationale for building new branches is to grow the deposit base so the rest of the bank can turn around and lend that money. Unless you're shrinking your balance sheet, you don't want to shrink your net distribution.

But I definitely don't subscribe to the "big blast" theory of opening hundreds of branches at once. It seems that some bankers are basing their de novo branching decisions on the current situation of rapid deposit growth, as opposed to average conditions. As I said earlier, you can't assume the retail side of banks will continue performing disproportionately, as it has in recent years. When capital markets and commercial banking return to full strength, the retail contribution to earnings will be less as a percentage.

As for U.S. Bancorp, we're currently in a "rightsizing" mode, having consolidated six or seven legacy banks over the last five years. That means we're focused on relocating certain branches, but not necessarily on significant net growth in our network.

Over the last five years, we've opened about ten to 15 free-standing branches and 20 to 30 in-store locations, but we've also closed between 20 and 25 stand-alone offices. So if you add that all up, we're growing our network at a nominal rate. We expect to continue with this approach over the next couple of years.

Banking Strategies: But assuming you were able to expand your network, how would you go about it? For example, would you use de novo branches to enter new markets, as some of your competitors are doing?

Davis: No. I would move into markets where we currently have a presence and then enhance those franchises with clusters of new locations.

I don't think entering new markets de novo is a wise use of investment dollars. If you don't have enough branches in the right places, you're going to fail. To compete effectively with the established players, a new entrant needs enough "critical mass" to offer customers a meaningful franchise alternative. Opening just one or two locations in a new market is insufficient to be competitive.

A bank needs to set specific goals for its individual markets and then dedicate a bank-wide effort to ensuring success in these markets. Entering too many different markets at the same time can strain your resources.

Having said all that, we are building new offices in corporate and in-store locations, albeit in a "right-sizing" context. We have nearly 300 grocery store branches and another 20 to 25 corporate locations. We see a lot of value in those sites because the cost of entry is anywhere from 25% to 40% less than with traditional, free-standing de novo branches.

Banking Strategies: So you prefer to build in-store rather than free-standing branches?

Davis: The ramp-up to a healthy balance sheet and earnings contribution is actually faster at the in-store branches because they're not carrying the load of heavy fixed costs. The risk, of course, has to do with your grocery store partners — the sponsoring banking company has less control over the branch site. We've experienced maybe five to six in-store closures in recent years. So you have to be very prudent and careful in your selection of partners.

In every case where we think there might be a risk of the store closing, we identify an alternative location, such as a strip shopping center, in order to migrate customers there. That's just one of the tactics that goes along with in-store banking.

Banking Strategies: Some of the de novo players are going into new markets with re-designed free-standing branches that look and feel more like retail stores. Do you think these "new style" branches can really help in attracting new customers?

Davis: We should all be looking at innovative approaches. But I don't know of any design strategy I would deploy across the board with any confidence. After all, this idea of styling branches differently isn't really new. It's been tried before, with limited success, because the physical structure isn't the issue — it's how you staff it.

U.S. Bancorp is not in any position to go into Philadelphia, for example, and wow the world with a "new" approach because the physical structure alone won't deliver that difference. Our people there would still be tethered to the main bank. And if the main bank isn't prepared to be fully unique, we would fail in Philadelphia.

I don't believe any institution outside of New Jersey's Commerce Bancorp has managed to make the staffing aspects of its de novo branches as superlative and unique as the physical branch itself.

Now, we could go into Philadelphia right now, hire people at twice the average salary and train them in the Commerce or Disney mode. But eventually, they would still find themselves connected to a bank that manages under a different model. While that model serves us well in 24 states, you couldn't guarantee that the outcome would be unique in any one market.

I do think branches should be attractive; they should be inviting, and they should be sales venues. We're testing some of those concepts, but I'm not talking about it publicly for competitive reasons. When something works, we'll roll it out with customization in each market.

But at the end of the day, if you're a bank, you've got to look like a bank. I'd rather spend time being good at what customers expect.

Banking Strategies: What do customers expect? There's some debate in the industry about whether customers are looking for a "relationship," or simply transactional excellence.

Davis: I definitely agree that customers want transactional excellence. We bankers exaggerate in our minds the propensity of customers to think of us as part of their relationship network.

On the other hand, I believe the paradigm of happy customers includes those who say, "I like my bank because I don't have to go anywhere else." That's another way of saying, "I have a relationship with them." A relationship means I don't have to go a lot of places to get what I need. I can count on my bank or banker to meet my financial needs as those needs change throughout my life.

Maybe customers in Los Angeles, New York and San Francisco are less interested in relationships. But the majority of bankers are in small towns, where they are part of the community. Customers in those areas, which constitute a large percentage of U.S. Bancorp's franchise, do want a relationship.

Banking Strategies: One way large banks particularly have tried to improve customer relationships is through CRM, or customer relationship management. Where do you stand on the idea of using detailed customer information to improve relationships?

Davis: First, I don't think the data should ever be used at the point of transaction. Neither our tellers, nor our call agents, nor our personal bankers are trained to discriminate, based on a customer's income or other factors, and I don't want them to — ever. I don't want customers walking through first class, like on airplanes, seeing all the happy people with their drinks. That doesn't feel good. There's no upside to making public the data behind customer segmentation.

Secondly, if you believe in the transfer of wealth that's going to occur in the next ten years, it's a mistake to teach somebody to give average service to C-level customers because some of those customers may reach the A level within two years when both parents die unexpectedly and leave them new wealth. So, information to differentiate service at the point of sale — never.

Unfortunately, CRM was designed to be point-of-transaction-driven. It was tied to a higher likelihood of products being sold, which is supposed to translate into higher customer satisfaction and retention. Those last two pieces haven't been proven yet.

Now, CRM can be very valuable for improving relationships if used in a back-office marketing context. For example, we send a list of leads to the branches every morning. A typical listing might say: here are 11 customers who are paying too much. You say, "gosh, that means they're going to leave," so you call those customers and offer a better product. And by the way, is there ever a better time to make such suggestions than when you've just saved a customer some money?

If you believe in relationship banking, then, you have to believe in life-cycle banking. A customer may have 2.7 products with us today. While that doesn't sound like a lot, it's the 2.7 they want. But they might not know there are three other products that would help them. We've got to find a way to suggest those products to them. You can have that conversation if you have a good relationship with the customer.

Banking Strategies: U.S. Bancorp, however, does not enshrine cross-selling as a major goal for employees, like some other institutions. Why not?

Davis: I don't think cross-selling is bad. I just don't think you should lead with it or try to measure it at the point of transaction. We do track cross-sell ratios at U.S. Bancorp as a measure of the customer relationship depth. However, we don't incent employees based on this result.

If the cross-sell is tied to relationship pricing, and if it's tied to a value proposition package, then it makes all the sense in the world. But if you're cross-selling just pieces and parts, it fails, period.

We do cross-sell products to commercial customers. For example, we'll call a business customer and say, "You've been a cash management customer for 12 years and I'd like to introduce you to someone in corporate payments. And I've already authorized that person to provide you with special pricing because of the 12-year relationship. So if you like the product, you're definitely going to get the best rate." That's cross-sell. But it's also a way of giving customers value for what they already have.

However, we don't do the kind of cross-sell where you say, "You have the following three items with us and I have two more items I really want you to have." The customer needs to desire these additional services. Cross-selling without the customer request seems unnatural. It commoditizes the relationship.

Banking Strategies: How do you measure and incent employees?

Davis: We measure growth. Each of our branches has its own balance sheet. Everything that's sold to customers goes on that balance sheet, even if other people in the bank sell it; it comes back to the branch as part of the relationship.

Branch managers are rated every 90 days on whether their balance sheet and income statement grows. We also look at spread income, which is a measurement of the balance sheet multiplied by the rates you paid, plus adding the fee income. That motivates managers to break rate only when the retention of valuable relationships is at risk.

The goal is to incentivize managers to waive fees and refund only when it makes sense, to possess more customers than when they started the 90-day period, and earn more service charge income. Managers and their teams will be successful when they enlarge the size of the branch customer base, while deepening the relationships of their clientele.

These results can be tracked directly to the company's bottom line. We don't do any revenue point calculations, cross-sell metrics or other qualifiers.

Banking Strategies: So you rate the branches on their performance and then employees gain proportionally?

Davis: Correct. There's a branch manager who's in charge of everything. The sales and service people below that manager have 60% of their compensation tied to the branch's performance, and 40% linked to their discretionary activities. We want everyone to help the team. There should be no disconnect between what's good for employees, what benefits customers and what's good for the company.

A lot of banks confuse that picture with other metrics. All of the banks we've acquired had some kind of contrived point system, or cross-sell system, that either left employees unsure about what was important to the company or challenged what is best for the customers. Nobody could translate the incentives to the bottom line. And the targets were moving all the time so people weren't setting real goals.

So again, we measure growth rather than cross-sell. The reason I like growth is that growth encompasses everything. It's simple, but it does work. At the end of the day, you can't expect people not to do what's in their best interest. So you have to make sure their best interest is completely aligned with that of the shareholders or there's going to be a disconnect.

Mr. Cline is senior editor of Banking Strategies.

Copyright © 2003 by Banking Strategies, published by BAI.

back to top