Details Matter, for Branch Effectiveness
BY ANAT BIRD
De novo branches can boost profitability, but only when properly aligned with strategy and local markets.
As bank branches proliferate, de novo offices are finding profitability increasingly elusive. What's needed to stand out from the crowd is a combination of factors, including: a clearly articulated strategy, integrated delivery channels, branch design appropriate for the local market, an effective sales process and changing expectations regarding profitability break-even points.
The banking industry is awash in branches, with grim implications for new offices now coming on-stream.
In the past twenty years, the number of bank branches in the country has almost doubled, to about 80,000. Plans are afoot for building hundreds more. While the mega-banks are behind much of this growth, smaller banks continue to participate in the fray as startups, which numbered almost 200 in 2006. Many major markets are now glutted, as evidenced by the average anemic size of $19 million in deposits for all de novo branches opened in the past five years. The traditional yardstick for a profitable branch is about $30 million in deposits.
Can banks afford such cash drains in an era when net interest spreads are thin, costs are under pressure and earnings-per-share growth is king?
There are also some long-term trends that raise questions about branch viability. These include: robust growth in debit card and credit card payments, a system-wide decline in check presentment, modest growth in cash payments and the impact on-line banking is having on the industry.
Banks such as Wells Fargo & Co. (http://www.wellsfargo.com) and Bank of America Corp. (https://www.bankofamerica.com/index.jsp) enjoy more than 60% customer penetration in their online banking programs; the industry average of online penetration among checking account holders is fast approaching 30%.
So the question remains: Why are we building all these branches? Is the industry failing to recognize a sea of change in the customer environment?
Not necessarily. Study after study has shown that while consumers’ buying behavior varies widely, one phenomenon holds true for all generations and all consumers. The anchor to the relationship is the physical distribution network. And this doesn't just apply to financial services, as evidenced by the enormous retail store success of Apple Inc. (http://www.apple.com/)
One might think that Generation Y (people born after 1996) and younger customers would gravitate to online purchasing, particularly for electronic products. Yet Apple’s 180 stores now contribute close to $1 billion in revenue, with a profit margin exceeding 20%, which is huge by retailing standards.
As banks figure out how to attract these coveted younger customers, they find that branches are still relevant. While online and phone channels are important for customers who choose to transact remotely, most profitable customers still visit their branch at least weekly and they continue to choose their bank the old fashioned way—by locational convenience.
This leaves the financial services industry in a quandary. On one hand, branches appear necessary to achieve growth, which is a key element in most banks' strategy. On the other hand, too few de novo branches are truly successful and many cause a significant drain on the bank’s profitability for years. Since profitable growth is still king from a capital markets perspective, the question becomes: How can we make these new branches profitable?
Successful Precedents
In addressing the question of profitable branch growth, it helps to keep in mind several institutions that appear to have worked out the puzzle, at least in part.
Consider Wayzata, Minn.-based TCF Financial Corp. (http://www.tcfexpress.com/), whose grocery store branches use space and staff efficiently and therefore require lower deposit and loan bases to achieve break-even points. TCF has figured out how to serve its target market with smaller spaces and less expensive fixtures, while generating primarily low-cost deposits. This lowers its break-even points for de novo branches.
Commerce Bancorp (http://www.commerceonline.com/) of Cherry Hill, N.J., meanwhile, has gone in the opposite direction, with huge full-service offices that reach break-even points much faster than many smaller branches, proving that a strong and clear brand message coupled with crisp execution can and will attract profitable customers.
Commerce’s strategy has been to build its brand around a concept of convenience and superb locations. It does not compromise on location or branch size and places its branches in middle- and upper middle-income neighborhoods. Commerce then supports the branches with a consistent look and daily routine of customer-friendly and sales-oriented behaviors. The result has been impressive deposit growth in convenience-sensitive markets.
Another marketing standout is San Antonio-based Cullen/Frost Bankers Inc.(https://www.frostbank.com/cgi-bin/splash/portal/ep/home.do), whose positioning is all about Texas, from the electronic state flag behind the teller line to the boot scrape outside the door. Frost’s current 37% plus ratio of non-interest-bearing deposits to total deposits is a testimonial to the success of the strategy.
And then there's Ft. Pierce, Fla.-based Riverside National Bank, which bears a heart in its logo and gives away bumper stickers that say: “Riverside loves me.” This bank boasts an amazing 39% ratio of interest-free deposits as a percent of total deposits.
As these examples suggest, the solution to the branch growth vs. profitability question lies in the details. Most banks want to grow and most recognize that branching is the way to go. The problem is that strategies, brand promise and sales execution vary so widely that some branches become highly profitable while others languish. The marketplace is not ready to give up on branches yet, but many banks are still missing the boat by adhering to an ineffective branching strategy.
Getting It Right
Branch growth and profitability should not be at odds; they should reinforce each other. Profitable branch growth is possible but it requires several key elements.
The first is a clearly articulated strategy. Crisp clarity of the bank’s value proposition, desired positioning in the consumer marketplace and its target customers is essential to success. Without knowing who you are and what your differentiation strategy is, how can you effectively execute? This sounds obvious, but too few banks have taken the time to spell out their retail strategy in a way that is actionable, specific, differentiated and clear to all members of the retail team.
There also needs to be an integration of all retail distribution points, otherwise known as the “network effect.” All too often, the branching strategy is divorced from other distribution channels for retail products such as ATMs, in-store branches and mobile branches, etc.
Understanding the “network effect” of all retail outposts and taking care to optimize their synergy is critical to success. This is not necessarily about a “seamless” customer contact among the various channels; it’s more about a cohesive approach to all forms of physical distribution and their anticipated role in the customer experience, as well as the role that other channels are expected to play. For example, bankers need to understand which channels are expected to sell more, which are conducive to more transactions and which channels help create loyalty and repeat visits.
Aligning branch design with strategy is important. Branch design appears to follow the “herd principal” that is all too common in our industry. Instead of ensuring that branch layout, technology and furnishings are supportive of the strategy, too many banks go for the “branch of the moment” in terms of layout and design.
At the most basic level, branch design needs to achieve at least two goals. First, customers should feel comfortable, i.e. the office shouldn’t be so fancy that they feel out of place or too plain that they find it unprofessional. Second, design needs to facilitate execution of the strategy. For example, if your target market is “Joe Lunch Bucket,” count on more teller lines than if your target market seeks more of an advisory and less of a transaction-oriented environment.
Branch design also has to be aligned with the shift in payments from paper-based to electronic transactions. As customers reduce branch transaction usage, branch physical design needs to reflect that change. For example, most branches today have more tellers than bankers. That will need to change as customers shift their primary branch activity from transaction processing to sales and service. Instead of those numerous teller stations, more banker desks might be needed.
The role of the branch in the sales and fulfillment process is still critical today, even to Generation Y customers. In fact, over 70% of all profitable customers still visit the branch at least weekly. An integral part of successfully morphing the branch from a transaction mortuary into a thriving sales outlet is the effective implementation of a sales process. Banks have repeatedly fallen short on this front.
And this might be one of the last opportunities banks have to get it right since the marketplace is getting saturated with branches and many markets cannot support the branch expansion programs now on the drawing boards. Strong sales execution is a necessary element to achieving organic growth since it takes the bank’s resources—customers, employees and facilities—and fully leverages them to create value for all constituencies through strong cross-selling and fully meeting the customers’ needs.
Straddling Functionalities
Given all the technological changes taking place in the retail banking business, it’s advisable to build flexibility into your design and location. Certain markets and customers move faster than others. Banks should not abdicate their transactional responsibility before the customers are ready to move into a self-service mode. While it’s difficult to straddle both functionalities without causing inefficiencies, flexibility in branch design and staffing will help banks transition with the market as it evolves.
It’s also essential not to forget your existing customers. Wells Fargo reports that 80% of all its new sales are to existing customers. Yet, most banks’ incentives are aimed at customer acquisition, not mining and cementing those relationships. Consequently, customer attrition rates have not experienced much change system-wide and what comes in the front door often leaves by the back door, with many banks experiencing a one-to-one or even greater ratio between opened and closed accounts. Shifting attention to existing customers and building their product ownership contributes directly to growth and profitability.
Finally, change your expectations for de novo branches. The traditional rule of thumb that new branches reach run-rate break-even profitability (i.e., breaking even without taking into account the initial capital expenditures) in three years and all-in break-even profitability in five no longer applies. Banks such as Commerce or TCF have proven that even traditional facilities can achieve break-even profitability in half that time and some have moved even faster. In addition, bringing a tenth branch into a market is very different from breaking into a market with the first branch. Expectations for these different branches should differ greatly. When a new branch has a network to support it, it should achieve break-even profitability much faster than a first branch in a new market.
Whether the de novo branch is first in line or tenth, though, expectations do need to change and break-even points shortened. If your people tell you that such expectations are unrealistic, perhaps the branch should not be built.
In summary, branches can be an engine for growth or a holding pond for ebbing transaction volumes. The difference between the winners and losers will be the banks’ ability to fully capitalize upon their investments in bricks, mortar, human capital and Web capabilities.
Ms. Bird is president and CEO of Granite Bay, Calif.-based SCB Forums Ltd., which facilitates peer group meetings of banking professionals.