Mar 11, 2013

Turning Small Business into Big Business

When it comes to utilizing technology, small business banking customers are definitely traditional in their preferences: branch visits and personal service still rate highly with them, online and mobile banking less so, and they’re highly fee-sensitive, all of which makes them more costly to serve than retail customers overall. But when it comes to institutional loyalty and share-of-wallet value, small businesses rank among the best customers a bank can have, making them well worth the extra effort to serve.

These are some of the highlights of the just-completed BAI Research study entitled Small Business Demand for Banking Services: Growth and Profitability Considerations. The research, sponsored by Argo and Deloitte Consulting, was designed to provide insights into how banks and other financial institutions can develop strategies to attract, retain and grow small business relationships. It’s based on responses from owners and high-level employees from more than 1,500 small businesses nationwide, focused on three categories of annual revenues: $100,000 to $ 1 million, $1 million to $5 million and $ 5 million to $10 million.

The time was right for BAI Research to undertake such a study because our ongoing industry surveys have found that financial institutions are striving to overcome the current revenue crunch in banking in large part by growing quality assets. The best way to do that is by bringing in new high quality customers from specific customer segments and small business owners are among the most-targeted segments.

Unfortunately for bankers, however, this is not an easy hill to climb.

Still Branch-centric

In comparison to consumer banking, where branch transaction volume is gradually dropping, small business banking remains centered on the branch, which accounts for two-thirds of all business transactions. That percentage increases to almost 80% for the smaller businesses with annual revenues in the $100,000 to $1 million arena. Small businesses also show a strong preference for in-person or live agent phone conversations with their financial institutions, which drives them to greater branch usage. In addition, most small business owners (SBOs) in our survey selected their primary financial institution due to proximity of their business to the bank, which essentially means their local branch.

SBOs are also traditional in their check usage – half of small businesses indicated this is their preferred payment method. It’s not hard to see why. Paper checks create an easy-to-follow paper trail and the process is entrenched in the customers’ accounting systems and payables systems. In order to replace this traditional approach, banks must create a compelling reason for small businesses to experiment with electronic payments technologies.

Our study uncovered perception gaps suggesting that bankers are actually over-delivering in some areas. For example, our data finds SBOs who use online and mobile banking tools are more than satisfied with what is currently available, which supports other data we saw in this research demonstrating that small businesses prefer the more traditional channels and relationship patterns with financial institutions.

For example, only about two-thirds of small businesses use online banking at their primary financial institution (FI) while only about one-third use online bill pay, the same percentage that expresses comfort with conducting business banking transactions on a mobile device. Clearly, when compared with consumers overall – 89% of whom use online banking at their primary FI and 69% online bill pay – small businesses are not early adopters.

Bill Gates once said, “We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten.” If Gates is correct, small businesses will likely gravitate to the newer technologies in the future. In the short term, however, bankers must continue to educate these customers on the benefits to be derived from adopting more efficient processes.

The Loyalty Factor

Even though small businesses will require more of an investment by banks from a servicing aspect, due to their high branch usage, there’s another side to the coin: the potential for retention, products usage and share of wallet with their primary financial institution is also much higher than with consumers overall.

For both deposits and loans, small businesses work with, on average, less than two financial institutions. Those responding to our survey have typically been in business for two decades or more, and with the same primary financial institution for 15 years or more. Share-of-wallet at one’s primary financial institution is significantly higher for small businesses than it is for consumers and also increases as you look at small businesses with higher annual sales. Overall, deposit share-of-wallet is around 65% for small businesses, although this drops to 50% for loans and 12% for investment products.

In keeping with their loyalty to their bank, less than one-third of these businesses say they would switch to a new bank that provided innovative products and services. However, nearly one-half would consolidate all of their balances with one financial institution that provided everything they needed. The challenge for banks, then, is to develop a better understanding of this segment’s banking needs and preferences and to meet those needs through more customized product offerings and assistance around other challenges these SBOs may be facing.

Financial institutions do face some risk in retaining their small business customer base as 25% of small businesses say they are not satisfied with their existing bank, suggesting some switching opportunities for those who can provide better services. In addition, of SBOs who use their primary financial institution for business, only a little more than half also use them for their personal accounts, suggesting additional opportunity for competing banks.

Segmentation reveals that large network banks serve more of the smallest businesses ($100,000 to $1 million in sales) while community banks have more of the larger small businesses ($1 million to $10 million). Based on this finding, it is important for an individual bank to know the typical size of the small businesses that it is serving and then determine whether to extend beyond that market or expand within it.

Watch those Fees

Although rewards and innovative products per se are not big drivers for SBOs considering switching banks, giving them a break on or lowering fees could be an attractive selling point. Many small businesses try to avoid fees entirely unless it is a necessity or they can justify the fee on the basis of the value obtained. Just under half of small businesses indicate fees are a main consideration when choosing a financial institution, meaning that higher fees are a turnoff.

Most small business survey respondents provided us, in great detail, the size of the fees they paid and for what services. Larger size businesses were more willing to pay for value-added services such as merchant services and payroll processing while smaller firms tended to be more fee-adverse.

Merchant credit card processing and payroll processing are used by about 15% to 20% of the small businesses surveyed at their primary financial institution. These potentially big-return services are used about as much at non-primary financial institutions and non-banks, meaning that primary financial institutions are only capturing about one-third of the business these products provide.

As non-bank competitors in the small business space are building market share, banks should play the efficiency card by deploying more products and services under one roof. Showing the value of these products and services to the small businesses and the role they could play in streamlining their finances is the key to unlocking the full potential of the relationship between small business and financial institution.

SBOs also require loan products that meet their needs and most are open to education from bankers about the funding choices available. Many SBOs suggested that bankers facilitate meetings with venture capitalists that could highlight unmet lending opportunities. Others had been frustrated by past experiences with bank loans and are now inclined to borrow money from friends or family. Additionally, most banks fall short in proactively recommending products and services and helping small businesses manage cash flow.

All of these service gaps suggest that small businesses are looking for their primary financial institution to partner with them on their journey as opposed to just being a place to conduct financial transactions.

Mr. Riddle is a director at BAI and can be reached at mriddle@bai.org. Mr. Agostinelli is a senior analyst at BAI and can be reached at jagostinelli@bai.org.

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