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The Small Business Customer Is Ready to Switch ?
for Payments Products
BY AJAY NAGARKATTE
BAI RESEARCH
BAI research quantifies the risk of underserving small business customers? payments needs: One out of two small business customers say they?d move providers for the right products and services. Are banks underestimating the interest?
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SYNOPSIS | BAI research finds that small businesses feel they are underserved by banks in payments products and services. At the same time, the study reports that bankers tend to underestimate the opportunities available to them. The study recommends that banks take a targeted, segmented approach to offering payments services and products and identify opportunities in several key areas: remote deposit capture, working capital, credit cards, electronic payments and integrated risk management.
In recent years, banks have begun to focus more closely on their small business banking franchises. After all, small business customers tend to be far more profitable than their retail consumer counterparts. Yet, based on survey questions and interviews with more than 1,000 small and mid-size businesses included in BAI?s Small Business Payment Strategies research study, small businesses feel underserved. This is particularly so in the payments arena, with banks potentially missing an opportunity to capitalize on emerging needs.
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The cost of underserving could be expensive: When asked whether they would switch banks to obtain the right types of payment services, half of small business respondents said they were either likely or very likely to switch.
With client relationships at stake, banks clearly need to do more to address the payments needs of small businesses and should approach their customers in a targeted manner. In general, the study finds that small businesses with revenues of between $5 million and $10 million are most receptive to payments services. Such firms have the scale to use these services. They are also the most inclined to switch banks if offered a better competing product.
Total revenue is just one way to categorize small businesses. Another consideration is to organize by industry, credit need, attitudinal dispositions or a combination of such attributes. Not all segments need advanced payments vehicles and not all segments have the wherewithal to use such products. Picking the right segments can prove effective for bankers, provided the appropriate value-added products and services follow.
Remote deposit capture (RDC), for example, is of high interest to a certain segment of small business owners. Between 10% and 25% of firms (with interest varying according to size) told a recent ESP Consulting Group survey that they use or plan to use check imaging at the point of sale or back office. The management of working capital, credit cards, electronic payments and integrated risk management are other areas of opportunity identified for banks in the BAI research.
Mixing in Payments
What does it take to acquire and develop small business relationships? Bankers have tended to focus on three elements. Convenience, or proximity to the bank branch, is always important to small businesses. The second is service, particularly service provided by the client’s business banker. Individualized and personalized service by a dedicated representative of the bank has often been linked to the durability (or lack thereof) of small business relationships. Finally, there’s localized decision-making. Large banks with distant headquarters have difficulty maintaining this perception, which is why community banks have gained wallet share at their expense.
While these core elements remain critical, banks are trying to differentiate themselves with unique offerings and value-added services. Our study suggests payment products and services should be part of that mix. A substantial number of small business customers surveyed stated that they would switch banks to obtain certain types of payment services and products, such as remote capture or integrated accounts payable products (i.e., wires, corporate-to-corporate ACH, etc.).
To better understand the demand dynamics, we should look at how banks stratify their small business customers. Most banks segment their small business customers by revenue size. In most cases, businesses with revenues under $5 million or $10 million are classified as small businesses, with sub-stratifications within those bands. Typical sub-segments include the micro-segment, with sales under $1 million; a $1 million to $5 million segment; and a $5 million to $10 million segment.
In almost all banks, any enterprise with revenues over $10 million is treated as a mid-market customer and provided with a completely different sales, service and delivery model, because of lower cost-to-serve dynamics. Larger small businesses are serviced by business bankers while smaller businesses are treated more like retail consumers. The BAI study looked at categorizing needs based on revenue size and, broadly, by industry.
The $5 million to $10 million segment is often considered the most attractive to banks. Our research indicates it’s also the most receptive and the most likely to benefit from new payments products and innovations. First, these businesses have the wherewithal to utilize efficiency-driven payments products, and would often pay to have a centralized, integrated payments platform. Second, this segment is also the most vulnerable to competitors’ offers, according to our analysis. Attrition of customers from this segment can significantly impact a bank’s revenues and net income, even if it continues to grow its share of smaller customers. Third, this segment often has a professional financial executive tasked with increasing financial automation and operational efficiency.
Our interviews with both bankers and small business owners generated some findings that may be somewhat troubling to banks. When asked about their primary financial institution’s ability to provide payment services, businesses with revenues less than $10 million showed a strikingly low comfort level. This is less of an issue with larger and mid-size businesses, as they often have better access to such products. Such institutions have access to highly effective cash management and integrated payment solutions, and more importantly, banks have serviced those products more effectively with those larger customers.
Bankers Underestimate Business’ Interest
This research identifies a disconnection between what small business owners want and what bankers think they want. The survey shows that small business owners’ interest in new technology-based payment solutions is high. In fact, almost 80% of businesses with revenues between $5 and $10 million expressed strong interest in a technology-based electronic payment platform.
Yet bankers believe that small business interest is low. As one banker stated, “I’m not a big proponent of technology for this segment. The small businesses really can’t handle it.” Another bank executive said, “Small businesses often don’t have the time, expertise or the resources to take advantage of technology solutions, even when they are reasonably cost-effective and easy to deploy.”
Such broad generalizations can misfire. While they may be true for certain sub-segments and micro businesses, increasingly, the payment needs of small businesses are growing. Owners are getting more sophisticated about their options for satisfying their needs for payments solutions. The Web, for example, provides a vehicle for them to research and select the right credit cards for their companies.
Furthermore, while many bankers are looking to offer new products to their small business customers, most admit that they do not have all of the technical and analytical tools needed to understand their customers’ changing payment needs. Banks might like to rapidly respond with the right mix of products, such as RDC, credit cards, electronic payments, etc., but they cannot.
At issue is good information about small business customers. External data overlays are not as effective with small business customers as they are with retail consumers. Yet that information is often critical in developing segmented product offerings, whether those segments are defined by business size/demographics, behavioral attributes or attitudinal attributes of the owner.
Retail consumer lead generation and propensity modeling are facilitated by solutions from providers such as Acxiom Corp. and Claritas Inc. While there are some strong providers in the small business arena such as D&B and Experian, many banking executives agree that such overlays are not as accurate and actionable — largely because the data-gathering process itself is much more complex.
Finally, to save expenses, many banks have simply whittled down their mid-market payment product offerings to serve small businesses, particularly in the areas of cash/treasury management, or they’ve enhanced their retail consumer offerings. While this approach might be cost-effective, it does not directly address the specific needs of small businesses, which are very different from those of mid-market and retail.
A direct result of these challenges is a growing sense of discontent among small business customers. When asked whether they would switch banks to avail themselves of the right types of payment services, 50% of the survey’s respondents said they were either somewhat likely or very likely to switch. This represents an opportunity for some of the largest institutions or smaller specialists with a wide array of small business payments solutions.
The most lucrative segment for banks is also where the vulnerability is the highest; 57% of the respondents in the BAI study in the $5 million to $10 million segment said they would switch providers if their payment needs were not met.
Banks must decide quickly which opportunities they want to pursue aggressively. Much as has occurred with credit cards, banks risk losing certain components of the financial value chain to non-traditional alternatives and specialists, posing a long-term threat to the deposit relationship itself. Banks that do not address this issue soon are more likely to experience customer attrition, particularly within the more lucrative small business segments.
Significant Opportunities
In spite of the challenges suggested by the research, banks continue to be well positioned to serve small business customers. Banks, after all, “own” the transaction accounts. This anchor point is important because it is the source from which most payment-oriented transactions are executed and consummated. And while considering their options, banks should pay special attention to larger small businesses, those with $5 million to $10 million in revenue, since they present the greatest opportunity.
The BAI survey identified the following key opportunities for banks:
Cash (Working Capital) Management
Maintaining working capital continues to be a concern for many small businesses — roughly 45% of those surveyed stated this was a problem. Many banks have excellent working capital, cash management and treasury management services for the middle-market. Migrating such services down to the larger small business segments can be beneficial, provided the right sub-segments and industries are targeted — for example, asset-heavy industries such as manufacturing.
Remote Deposit Capture
Similarly, remote deposit capture (RDC) could also be extremely beneficial to small business customers, provided the economics, pricing and appropriate training/onboarding programs accompany the sale of such services. While most bankers say that adoption of RDC remains low among small businesses, they see the product as having great potential with many of their customers. Faster processing time is a factor in bank adoption, but most bankers cite the time savings gained from avoiding branch deposit trips. Bankers are also optimistic about extending their reach to businesses that are not in close proximity to their branches.
While growth may be significant in the next few years, adoption will top out at a small percentage of small businesses. Many of these firms simply do not have significant check volumes for RDC to be cost-effective. Cost is often cited as a factor that will limit the scope of adoption. Banks can get around this issue by offering innovative programs, such as offering the device for free, provided certain other criteria are met, or leasing such equipment to small business clients for a more palatable monthly fee.
Another factor appears to be the awareness of RDC by small businesses. For example, in a recent survey by Salisbury, Md.-based ESP Consulting survey, only 55% of businesses in the $5 million to $10 million range said they were aware of RDC and image capture/scanning capabilities that banks offered.
However, in that same survey by ESP Consulting, 10% to 25% of businesses (depending on size) stated that they use or plan to use check imaging at the point of sale or back office — a percentage that cannot be ignored despite the slower than expected adoption rates. Says Leon Majors, President of ESP Consulting, “The base of awareness is building with businesses of all sizes, and tens of thousands of remote capture terminals will be deployed within the next 12 months. Across industries, companies are hearing the promise of the technology, although the message is unclear regarding functionality, pricing and benefits to the merchants.”
It is up to the banks to assure that the benefits of this technology are communicated effectively, and that the accompanying pricing structure is palatable to the small businesses they serve.
Credit Cards
Small businesses continue to use credit cards for short-term financing. With borrowing rates on credit card debt relatively low in recent years, credit cards have gained in attractiveness as a vehicle for providing short-term financing for small businesses. Credit cards have the added advantage over loans and credits of lower entry requirements, more immediate access to funds and less paperwork. Nearly one-half of businesses that use credit cards and did some borrowing for their businesses in the past few years report that they increased their use of credit cards for short-term business financing.
One of the most interesting findings from our study, however, is that less than half of small businesses surveyed use credit cards issued by their primary deposit service provider — a huge opportunity lost for banks. Also, 29% of businesses in the $5 million to $10 million revenue segment use their primary card issuer for other services.
How can banks overcome this? Many banks are creating innovative rewards-based programs coupled with their credit card offerings to drive both sales and usage. Such cards are best sold when the initial deposit account is opened by a small business.
Rewards-based programs targeted at certain segments have also shown promise. For example, American Express Co.’s Gold business credit cards come with built-in rewards programs. Users earn a point for every dollar spent, and points can be used to redeem travel and other rewards. In addition, American Express offers discounts to small business owners with certain vendors when their cards are used.
Such programs, while expensive to issuers, have been shown to generate loyalty or commitment — key components of lifetime value. In fact, over 55% of respondents with sales of under $10 million agreed when asked whether gaining rewards and points is important to their company when selecting a method of payment.
Electronic Payments
Integrated electronic payment products also represent a significant opportunity. While the need for such electronic transfers is tepid in the smaller segments (less than $5 million in revenue), the opportunity with large small businesses is tremendous. When asked about current or planned usage of different electronic payment protocols, businesses in the $5 million to $10 million range expressed deep interest. For example, 82% of respondents in this segment said they use or plan to use ACH direct deposit and 79% currently use or plan to use wire transfers. Any integrated payments solution would need to accommodate such functionality so that business-to-business or business-to-consumer transactions are seamless and easy to use.
Integrated Risk Management
With fraud and identity theft emerging as serious concerns in banking today, small business owners are seeking financial institutions that go the extra mile to ensure the security of accounts and payments. In our survey, 69% of respondents were concerned with identity fraud, 59% were concerned with check fraud and 52% were concerned with the potential for employee fraud. In addition, over 70% of the respondents stated that an identity management platform that safeguarded their business’ identity and access to financial and other key accounts when conducting business electronically would be valuable. In fact, 77% of respondents with revenues between $5 and $10 million thought it was very important.
Many bankers recognize this trend and are integrating risk management tools and analytics into their payment offerings. As many as 83% of the executives interviewed reported a need to have such integration, and many have begun the process. Such risk management systems need to keep up with not only the needs of the business owners, but also the variety of mechanisms by which funds are transferred from or received by a small business.
As Harvard professor and business strategist Michael Porter stated in a recent Banking Strategies interview see “Refresher on Strategy,” the essence of corporate strategy is ultimately about helping develop some unique value that provides long-term competitive advantage. Delivering such unique value to small business customers can be achieved only if there is a comprehensive understanding of those customers, bridging the gap between perception and reality.
Questions or comments about this article? Post them at the Banking Strategies blog.
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