Growth Formula: Mergers and Retail Strength

By Kenneth Cline

Even as Wachovia's Ken Thompson forges a retail strategy based on service, sales and new customer acquisition, merger integration remains a key concern.

As 2004 draws to a close, retail banking strategy at Wachovia Corp. is dominated by a familiar theme: merger integration.

Never mind that in the last four years, chairman and CEO G. Kennedy "Ken" Thompson has also presided over a complex evolution of Wachovia's retail operations based on improved service quality, sales management and customer acquisition. The Charlotte-based company now has a multiple channel delivery system that is able to provide appropriate products and service levels to a wide array of targeted customer segments. And more refinement of that model is underway.

Yet for now, and for Wachovia's executives as well as for Wall Street, merger integration remains the front-burner issue.

In June, Wachovia announced a $14 billion purchase of Birmingham, Ala.-based SouthTrust Corp., which comes shortly after the completion of the company's landmark deal, the 2001 merger of First Union Corp. and the old Wachovia Corp. Last year, Wachovia also undertook a joint venture with Prudential Financial Corp.'s retail brokerage operation that created the third largest U.S. brokerage.

It's fair to say, then, that merger integration has been a top-of-mind issue at Wachovia since Thompson assumed command of the old First Union in April 2000. This makes it difficult for Thompson, 53, to keep analysts and investors focused on the more fundamental changes and improvements engineered by his retail operation, headed by senior vice president Benjamin Jenkins, 60. Jenkins manages the company's General Bank, which includes 1,637 retail branches and the small business banking and recreational dealer finance units.

Wachovia's "challenge, in the near term, is integrating the most recent deal," i.e., SouthTrust, says Denis Laplante, an analyst with Keefe, Bruyette & Woods Inc. in New York.

The SouthTrust integration occurs in the context of Wall Street's long-held concern that mergers take up too much of management's attention at Wachovia. "Any time you have a focus on a deal, it takes away resources from customer contact and customer marketing," Laplante says. This causes some frustration for Thompson, who likes to point out that deposit growth and service quality metrics improved steadily throughout the First Union/Wachovia integration process. "We ought to be applauded for doing two things at once, not criticized for it," he says.

One problem is that Wall Street still remembers the problems predecessor First Union encountered in its 1998 integration of CoreStates Financial Corp., when a rushed systems conversion caused massive customer defections.

This time, the concern has less to do with systems integration — which is expected to go smoothly, given the fairly straightforward systems architecture at SouthTrust — and more to do with SouthTrust employee morale as the combined bank adopts Wachovia's more robust sales culture. Will employees stay or leave? "Investors should not underestimate the challenges of bringing the SouthTrust retail system up to Wachovia's level," says Gerard Cassidy, managing director of bank equity research at RBC Capital Markets in Portland, Maine.

The merger integration is scheduled to be completed in the first quarter of 2006. In the meantime, Thompson and his team also are contending with the issues of running the bank, which includes managing in a rising rate environment.

Service Matters

The ramifications of rising rates are complex. In certain scenarios, such as when assets re-price faster than deposits, higher rates can help bank profitability. But retail bankers will certainly be challenged to grow deposits, since customers will be looking for higher yields in the broader market. This will at least partially reverse the trend of recent years, when customers had few attractive alternatives to low-rate bank accounts.

"We won't have the rising tide lifting all boats that we've had over the last several years," Thompson says.

The challenge for banks will be to keep this money in-house, whether that means in certificates of deposit, money market accounts or investment accounts, in order to preserve as much share of the customer wallet as possible. In this arena, Thompson argues, Wachovia is fully competitive, since it can offer a wide array of bank deposit and investment products through multiple delivery channels. "We are well balanced in that we can play in the bank deposit market or in the investment market at the same time," he says.

This balanced approach is at the heart of Wachovia's retail strategy, which stresses quick and efficient service in the branches and call centers for transactors and a full product array for investors. The investors can be served by licensed salespeople in the branches, or off-site brokers and financial experts who work closely with the branches.

This delivery system is backed up by a rigorous enforcement of service quality standards based on up-to-date feedback from customers using all the company's branches and call centers. To obtain this feedback data, Wachovia has hired the Gallup Organization to survey each week a sample of 6,500 Wachovia customers who recently visited a bank branch or phoned a call center. The data is compiled into weekly reports, which the managers use to either praise and reward employees who met customer service expectations or coach those who fell short. The scores for individual branches and call center units are also linked to the compensation system, so they become an important factor in how Wachovia employees get paid.

To measure itself against industry standards, Wachovia looks at the University of Michigan's American Customer Satisfaction Index (ACSI), which ranks the four major retail banks in the U.S.: Wachovia, Bank of America Corp., Bank One Corp. and Wells Fargo & Co. Both Gallup and ACSI data show a steady improvement in service quality at Wachovia in recent years. In the most recent ACSI ranking (fourth quarter of 2003), Wachovia beat its three peers.

Jenkins recently added customer loyalty to the mix as a metric to be analyzed and linked to incentives. The weekly Gallup survey of Wachovia customers now includes three questions that seek to determine whether the respondent is likely to stay with the bank, such as "Would you recommend Wachovia to a friend?" An affirmative answer to the question, Wachovia believes, shows the customer is likely to stay loyal.

"We want to go beyond customer service and achieve loyalty," Thompson says. "We think there's a big payoff in revenue."

Book of Business

As important as service quality and customer loyalty are, retail profitability also depends on sales — moving more product through existing delivery channels — as well as customer acquisition. Wachovia measures and incents all of these through a management system known as "book of business."

As Jenkins explains it, each branch maintains separate books of business — essentially names of its existing and potential customers — categorized by three strategic initiatives. The first is the retention book, which comprises a list of customers identified by Wachovia's customer integration group as highly valuable. The branch employees are asked to provide these customers with special attention and service so they remain loyal.

The second book contains names of people who are good customers, but who have purchased only a few products from the bank. Branch employees are asked to cross-sell to these customers and try to tie them more closely to the bank.

Finally, there's the third book, which is focused on new customer prospects. Employees are asked to contact these people and try to sell them a checking account or other product.

This approach by Wachovia differs from other banks that manage their branches through individual profit and loss statements. From Jenkins' perspective, separate P&Ls incorporate many elements outside the control of branch employees. By tying employee compensation to 1) service quality as measured by Gallup, 2), sales productivity as measured internally, and 3), what's happening with the balance sheet as measured by each branch's book of business, Wachovia is able to "measure totally what we can control," Jenkins says.

Since Wachovia has already made good progress on customer service and sales productivity in recent years, Jenkins says he and his team are working hardest right now on customer acquisition, an effort that includes advertising, new products and de novo branch openings, particularly in Texas and New York City.

Jenkins is specifically focusing on customer acquisition in the small business and affluent markets. Unlike many banks, which serve small business out of their wholesale or commercial units, Wachovia houses small business customers with up to $3 million in annual sales in the retail bank, with the branches functioning as the service nexus. Small business customers can take care of their basic needs, such as deposits, in the branches while small business bankers are available at nearby locations to handle more complicated issues.

For the affluent market, Wachovia recently introduced its private advisory banking program, which focuses on customers with investable assets in the $250,000 to $2 million range. Like the small business specialist, a private advisory banker typically services several branches from a central location to take care of retail customers with complex financial needs at a level below the wealth management group, which handles customers with $2 million and up in investable assets.

Below the level served by private advisory bankers, customers can receive help from branch platform employees licensed to sell mutual funds and annuities, known as "financial specialists." These financial specialists, in turn, work with and are coached by licensed brokers who work outside the branch and can handle more complex investments, like stocks and bonds.

Wachovia's system is designed to provide investment and insurance products for customers at all levels. One missing element is financial planning for the mass market, which is currently available only to wealth management clients. But Jenkins says plans are underway to introduce a simpler version of financial planning to the mass market by next year.

"For a company with a broad retail product line and a broad investment product line, the retirement market is very attractive," Jenkins says. "And as people think about retirement, they think about financial planning."

Network Optimization

This question of how to serve the mass market efficiently is a perennial issue in banking. Most institutions are generally aware that affluent customers are the most efficient to serve simply because they provide more business to the bank per employee time devoted to serving them. A Wachovia study has found that the typical affluent customer costs $554 per household to serve, but represents $1,837 in revenue per year, compared to a cost of $515 and revenue of $801 for the mass market customer. The "network efficiency" of serving affluent customers, then, is nearly double that of the mass market.

"That told us we need to be really attuned to acquiring affluent customers, and we're all over that," Jenkins says. "On the mass market side, there may be a way to do things more efficiently."

Jenkins intends to proceed gingerly on the latter front. Both he and Thompson are adamant about the need to retain current headcount and service quality levels in the branches. Earlier this year, Wachovia hired a former McKinsey & Co. consultant, Jonathan W. Witter, as its new head of distribution to look into the issues involved in network optimization. This means making sure the appropriate level of resources are allocated to each customer segment and delivery channel. "Like a grocery store, we have to make sure that shelf space in our distribution system is allocated properly between products," Thompson says.

Also like a grocery store, Wachovia needs to keep adding outlets to increase market share. One big plus to the SouthTrust acquisition, Thompson says, is that it jumpstarts Wachovia's entry into Texas by about two years. Prior to striking the deal, Wachovia had planned to open about 40 de novo branches in Texas this year. The addition of SouthTrust gives Wachovia an in-place network of 60 branches in Texas, to which the planned branches can be added. Jenkins says he then expects to build 150 to 175 more branches over the next four years in a state that's growing faster than the national average. Wachovia also believes its four targeted markets — Dallas, Houston, San Antonio and Austin — are on the cusp of a robust job recovery.

And Thompson sees another opportunity. Since SouthTrust's branch sales productivity is less than Wachovia's in several key areas such as core deposits and investments, he estimates that bringing SouthTrust's 665 branches up to Wachovia's standards will generate "a couple of hundred million dollars" in revenue opportunities not included in the financial estimates Wachovia presented when the deal was announced.

Wall Street will be watching this integration process closely, in part because bad memories from the CoreStates debacle of 1998 still linger. First Union had focused so much on headcount reduction during the integration in order to meet financial projections that the CoreStates branches were ill-equipped to handle service complaints generated by a rushed integration effort.

No problem of this magnitude showed up in the subsequent First Union/Wachovia merger, which helped the company regain credibility on the merger integration front. But Thompson concedes that a definitive judgment on the SouthTrust integration awaits the completion of the merger in first quarter of 2006.

As for whether the new Wachovia has once again become the "merger machine" First Union was in the '90s, Thompson says, "We spend very little time focused on the next company we're going to buy. We're focused on execution, organic growth and customers."

Mr. Cline is senior editor of Banking Strategies.

Copyright © 2004 by Banking Strategies, published by BAI.

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