Branching into Micro-Markets

For most bankers, determining where to put branches is primarily viewed as an “art” – something qualitative, often based on a “sense” of which markets are growing or the opportunity for available space that comes from a realtor telephone call (“You must see this wonderful new space that’s now on the market!”). While data is often brought into the equation in an assessment of high-level market demographics, more often than not, the bankers end up with a subjective decision.

That’s not to say that branch pro-formas aren’t ultimately put together. These spreadsheets look at the cost of the real estate, the branch operating costs, and then guess at what kinds of revenue might be brought in, typically by examining a few demographics and deposit dollars at competitive branches in the market. These pro-formas end up being very much subjective themselves, as the assumptions are simplistic and broad.

Under these circumstances, it’s no wonder that so many branching decisions turn out wrong. We find that when detailed profitability analyses are conducted, about half of all an institution’s branches are often unprofitable and bankers quickly become frustrated with the results of their branching decisions. “It’s like a coin toss,” so many bemoan. Of course it is, with so little effort and in-depth analysis used for making the branching decisions.

Distance from a Pin

The problem is that most branching analyses consist of three steps. First, a market is defined as x-mile radius around a pin on a map. This approach assumes that natural barriers (rivers, parks, etc.), highways and other issues that define “neighborhoods” are not important. But simply being within a certain distance is not a good definition of a market; markets are far more complex and micro-market analysis is the best approach. A “micro-market” can be defined as a concentrated geographic area that defines a community or a neighborhood with size dependent on population density (small in urban areas, larger in rural).

Second, a market is defined by the deposits in this x-mile radius at financial institution branches. But simply assessing the deposits at a competitor branch does not indicate the viability of a market for additional branching or for profitability. Often, it simply represents how institutions book deposits, not from which markets those deposits emanated. Moreover, loans and off-balance products are often sorely missing from the equation.

Third, a market is defined by how “big” it is in terms of population, households and average income. But we know that size alone is not the critical factor and often does not necessarily correlate with profitability potential.

This three-step approach has changed very little over the past decades. The industry keeps assessing markets in the same way and keeps finding itself frustrated by the poor results these assessments yield.

Micro-market Characteristics

There are, however, new and innovative ways to assess markets and to conduct branching analyses. And these methods do not start with a realtor call, a drive-by or a simplistic assessment; they start with a strategy.

As a foundation, it is essential to appreciate that every micro-market is unique and many factors come into play. A beginning point is to map out the micro-markets and understand their specific geographic boundaries. Successful branching is about understanding micro-markets, not broad geographies.

Then, look at the detailed characteristics of each micro-market, focusing on both retail and business demographics. One needs to understand the differences between micro-markets on a wide variety of variables, such as housing units, rental units, age groups and employment base. Issues such as employment rates and home market values should be included in the assessment so as to understand the degree to which the micro-market is in distress or is vibrant.

Market saturation needs to be an important variable so one must ask whether a particular micro-market is “overbanked” or whether there’s room for another financial institution. A micro-market may have good appeal on the surface but simply offer no more room for another institution to penetrate. And then, look at the purchasing propensities of the population in each micro-market. Understanding those dynamics is core to understanding the value each micro-market presents.

When all of the above factors are taken into account, a detailed assessment of the profitability potential of each market must be undertaken, by including growth patterns, product purchasing behaviors and future predictive values within a micro-market. The profitability potential must be detailed and take into account the specific products purchased and what each market affords relative to a complex list of products (balance sheet and non-balance sheet). Micro-market product purchasing patterns need to then be integrated with the unique profitability dynamics of the specific institution on a product-by-product basis. This provides an assessment of the profitability potential of each micro-market, modeled on the potential net impact to the income statement that the micro-market can bring if a branch were to be established in that market. Ultimately, the profitability potential must drive the branch strategy.

Mr. Weissman is president/CEO of Beaverton, Ore.-based DMA, a provider of profitability integration systems and tools for financial institutions throughout the US and Canada. He can be reached at [email protected].