The Segmentation Conundrum
In the wake of recent regulatory restrictions on fee income and the continuing sluggish economy, financial institutions are increasingly targeting certain high-profitability affluent and mass affluent customer segments. However, this customer targeting creates challenges, which might be described as the “segmentation conundrum,” highlighted in slide 4 of JPMorgan Chase & Co.’s 2012 Investor Day presentation. The chart shows that 70% of the bank’s households in the bottom three quintiles (i.e., 60%) ranked by deposit balances are unprofitable on a fully loaded basis. Further, up to 15% of those households are unprofitable on an incremental basis.
What is most startling about these statistics are the dimensions of the quintiles: the bottom tier includes households with as much as $5,000 in combined deposit and investment balances, well above the portfolio mean of many institutions. The bottom line: focusing solely on high margin households can’t deliver the desired financial results.
Mass Market Challenge
Chase’s articulated strategy for addressing this profitability issue is twofold: first, extract more value from affluent and mass affluent relationships and second, enhance the contribution of lower-value relationships by reducing sales and service delivery costs via enhanced self-service channels. While this approach is both logical and practical, it certainly doesn’t lack for challenges.
Consider, for example, the relatively small share of customers in a typical bank’s portfolio that actually meet the affluent/mass affluent criteria. Generally, only 15% to 25% of a bank’s customers fall into one of the affluent segments and competition for these highly profitable clients among banks, brokerages, and credit card issuers is fierce. No matter how successful an affluent customer strategy, it definitionally fails to address the attributes and needs of the mass market.
And herein lies the segmentation conundrum: retailers can and should have a target market, but they can’t dictate which consumers come through their doors. They can employ advertising, branding, branch configuration and other tools to subtly communicate to their preferred customers, but those same messages are often received by consumers that don’t meet the preferred customer profile. Consequently, banks require a solution for the remaining 75% to 85% of their customers that provides value and earns a reasonable profit for the bank (and does so without charging high fees or redlining). Turning them away is not an option.
Hence, the second strategy comes into play – enhancing the profitability of lower value relationships. Yet, the challenges of this strategy are more imposing. First, this strategy suggests maintaining a two-tier business model: traditional sales and service channels for affluent/mass affluent customers and alternative models for mass market customers. Second, this strategy requires transitioning a large percentage of the existing client base from the current model to the new model.
Driving such change in customer behavior is both hard and risky, and speaking as a frequent traveller, won’t succeed if it means simply putting down a piece of red carpet for your “preferred” customers. Further, the law of large numbers comes into play. Given the “sunk” costs of legacy branch networks, a significant number of high-cost customers need to shift to a self-service model to move the needle. This is a long-term investment in most cases.
With these challenges duly noted, retail bankers can redefine the customer value proposition, the customer experience, and importantly, the sales and servicing cost model, with technology in the here and now. Proven and popular technology, properly integrated, can fundamentally alter how consumers think about their financial institution relationships. Some examples include:
Mobile. In a recent First Annapolis study, 73% of surveyed institutions offer some mobile banking functionality, although only 6% to 20% offer more advanced functions (e.g., remote deposit capture, person-to-person and support for business accounts) and only 4% provide real payments capabilities. While bank mobile capabilities have a long way to go to replicate physical capabilities, financial institutions should explore using mobile technology to expand their servicing capabilities, such as deploying tablets in smaller, more flexible branch environments, or offering mobile point-of-sale solutions for new and emerging merchant categories.
Online has become the second-biggest channel for new credit card and deposit accounts for many banks. While these sales may ultimately be closed and/or fulfilled in a branch, the importance of online (eCommerce and mCommerce) in the shopping experience cannot be overstated.
Personal Financial Management, which has evolved from robust tools (e.g., Quicken) targeted at true finance geeks, into simple and elegant interfaces for mass market customers to look at how they spend, save, and invest money.
Self Service. We have recently observed a renaissance of interest in the ATM channel among financial institutions. This interest ranges from increasing the functionality of on-premise machines to reduce branch service costs to using remote or third-party owned and branded ATMs to enhance geographic coverage in a “thin branch” or “hub-and-spoke” model. Current self-service terminals can cost effectively replicate almost all transactions performed by branch staff, such as check cashing, image deposits and loan applications. And, when equipped or paired with video chat, they can also address many routine customer inquiries. Similarly, in-branch self-service devices are being tested by several institutions as a means to enhance the service experience in a cost-effective manner, and as discussed above, attempt to differentiate that service.
Product. A small subset of banks are addressing the segmentation conundrum with expanded product sets specifically targeted at traditionally underserved customer segments, such as prepaid cards, short term, small dollar unsecured loans and money transfers. These product extensions are generally priced more attractively than those offered outside traditional banking channels and profitably address the most commonly cited financial needs of underserved consumers. The challenge for banks is to deliver these products effectively and efficiently through distribution channels designed with other customers and products in mind. Importantly, the rise of mobile, online, and self-serve solutions facilitate this delivery to the targeted customers.
If banks are to successfully employ these alternative models as a means to enhance the profitability of a larger segment of client relationships, elegant integration of these tools and channels will be critical. Much like the retail banking model, customer acquisition and servicing will not be easily defined by a specific channel (e.g., branch, online, call center.) Rather, those sales and servicing interactions will increasingly cross channel boundaries: shopping online and opening an account in a branch; opening a branch account and accepting a cross-sold credit card via email; receiving a bill online and paying it with a mobile device; or, depositing a check at the ATM, and having a video call with a service representative about funds availability. As these channels become better integrated, banks can more easily rationalize their largely fixed, legacy infrastructure and drive long-term value.