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Solving the small business dilemma


For years banks have recognized that the small business market represents significant opportunity to drive both balance sheet and earnings growth. The reasons are straightforward.

First, the small business market is large and growing. Currently there are over 5.1 million businesses categorized as “small,” representing 90% of the total number of businesses in the U.S. Moreover, 500,000 small businesses are created every year. Second, small business relationships can be more profitable on average than most consumer relationships. Deposits can be significant and are concentrated in non-interest bearing accounts while loans tend to carry higher interest rates than larger commercial credits, contributing to attractive margins. Small businesses also are strong prospects for a broad range of value-added fee services. Finally, small business owners and their employees tend to be attractive consumer customers, offering further growth opportunities.

However, despite these compelling reasons to focus on small business as a strategic imperative, success continues to elude many banks that try to achieve meaningful market positions and results with traditional business models and approaches. This is not surprising given the challenges of targeting, capturing and serving this market. These challenges include defining the market, creating and managing an efficient sales and service model, developing a full range of value-added products and capabilities, establishing appropriate risk practices and parameters and building a differentiated brand and value proposition within a highly fragmented competitive environment.

Success in serving this market requires a fresh understanding of what truly motivates and drives small business behavior and a commitment to create comprehensive business practices, organizational constructs, and value propositions that differentiate your institution. While some of the challenges are significant, they are not insurmountable and the rewards can be large. Banks that move quickly can capture dominant shares of this highly fragmented market and realize a significant return on their investment.

Definitional Issue

The first, and most important, challenge is to define what small business means in your market and to your bank. All other decisions should flow from this definition.

Some banks will define the market by sales size, others by loan size and a few by demographic characteristics (industry type, number of employees, the presence of a full time chief financial officer, etc.). Regardless of which characteristic (or combination of characteristics) is used, bank size usually has a bearing on what the actual cutoff will be. For many large institutions, a million dollar credit may fit within their small business model while the same credit would be considered large commercial in most community banks. However, while specific definitions are helpful in developing strategy, they can create challenges in day-to-day execution.

The key is to agree on a small business definition that helps scope the size of the market, provide insight into critical customer needs, build appropriate product and distribution capabilities and the like, while maintaining enough flexibility in implementation to accommodate individual customer situations. If definitions are too rigid, there is a significant risk that customers could be forced into a system of doing business that fits the bank’s internal structure but is inappropriate for their specific needs.

For most banks, the components of their sales and service model are dependent on the definition of small business. For a long time there has been considerable debate on whether small business is a retail or commercial business. Unfortunately, the answer to this debate is “yes;” most small businesses are both, which makes it difficult for them to fit within a traditional bank’s organizational structures and constructs. Too often that means that organizational structure and operating models drive market strategy rather than the other way around.

One key to success is recognizing the hybrid nature of this market and building sales and service models that leverage retail capabilities such as multi-channel distribution and scalable and standardized operating processes while providing elements that are most often associated with commercial business, such as more sophisticated money movement products, advice and empowered relationship management. In a real sense, this means managing the sales and service model in a way that cuts horizontally across business lines rather than within a vertical organizational silo.

For most small businesses two critical financial needs are access to capital and cash flow management. While these are important components of a small business product set, the true short resource for many small business owners is time. Most small business owners wear many hats: CEO, chief financial officer, marketing director, operations manager and more. They focus all their energy on their businesses and just don’t have the time to deal with complex banking products, unwieldy and unreliable online systems, or organizational red tape that makes it difficult to find a decision maker.

Successful banks understand this core customer need and build their product set and distribution capabilities accordingly. That means focusing on convenience, simplicity and ease of doing business as essential components of the small business value proposition. These elements need to drive decisions around product features, branch and online capabilities, loan underwriting and approval practices and operating procedures.

Cumbersome Credit  

The issues of time and convenience surface most often with the credit process. While less than 40% of true small businesses borrow, even fewer subject themselves to most banks’ small business credit processes. Many will use other forms of credit such as home equity loans or even credit cards to provide initial or working capital.

The use of non-bank, alternative lenders is also growing rapidly. The reason that many, if not most, small business owners do not use traditional bank small business loans is pretty straightforward – the process is often time-consuming, cumbersome, and downright painful. In fact, many banks use some elements of their commercial credit practices to underwrite even relatively small business loans, requiring detailed business plans, three years of financial statements and tax returns, quarterly audited financial results and the like. On top of this, many even require personal guarantees or other forms of security from the business owner(s).

Clearly, many banks have developed costly and complex small business credit policies and practices that are not commensurate with the risks of lending to a customer segment that borrows, on average, less than $100,000. One of the most important elements of winning in this market is understanding the true nature and scope of the risks involved in small business lending and creating highly streamlined application, decisioning and funding processes that enable targeted customers to access credit easily and quickly.

Mr. Johannsen is a senior consulting associate and Ms. Sullivan managing partner at Washington, D.C.-based Capital Performance Group, LLC. They can be reached at [email protected] and [email protected] respectively.