Building profitable relationships with multichannel consumers

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Building Profitable Relationships with Multichannel Consumers Consumer Insight Brief October 2010

Paul McAdam, SVP of Research and Thought Leadership, FIS Jim Gamble, Director of Research and Thought Leadership, FIS

Building Profitable Relationships with Multichannel Consumers

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© 2010 Fidelity National Information Services, Inc. and its subsidiaries.

Market Upheaval The challenges facing today’s retail financial services organizations aren’t only constraining near-term profitability, but are also permanently altering the retail banking business model. By now, these challenges are increasingly familiar to industry participants — new regulations, future regulatory ambiguity, increasing expenses associated with regulatory compliance, higher capital requirements, etc. The combination of these structural changes and current business cycle obstacles (low net interest margins, weak loan demand, high credit losses, etc.) is forcing many banking organizations to pursue a new set of options to organically drive earnings to pre-recession levels (see Figure 1). The days of barbell profitability in retail banking, when a small pool of high-end customers and a small group of extreme NSF-paying customers subsidized the rest of the

retail customer base, are coming to a close. A new economic and competitive reality in retail banking has emerged and executives face a range of complex business decisions in the coming year.

1) Delivery system rationalization. There is growing acceptance that banks must reduce branch operating expenses and increase investment in self-service delivery channels. But the pace of rationalizing branch network coverage is complex as branch proximity is still a key factor influencing bank selection for most consumers. Three-quarters of consumers still like the idea of having a branch location convenient to their daily routine, even if they only use the physical branch a few times a year. Consumers have repeatedly proven that there “isn’t a retail channel they don’t like” and the number of customer interactions


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and transactions with retail touch points has continued to increase. It is expensive for banks to simultaneously maintain robust branch-based and self-service delivery systems, and the myth of self-service delivery reducing overall retail channel operating costs in a meaningful way has largely failed to materialize. So, there is a balancing act that must be achieved. In the new retail banking business model, consumers will need to repay their banking providers for all of this channel access through one or a combination of: (1) paying higher fees, (2) bringing the provider greater financial wallet share and (3) substantially shifting transactions to self-service channels.

2) New fee income sources. As many consumers do not have the means to bring substantial financial assets to their primary banking provider, there is growing realization that increasing fees across a large portion of the retail customer base is necessary. Increasing monthly maintenance fees on checking account products is a likely option for most providers, as is charging new fees for delivery channel access that was formerly offered free. Many executives are closely monitoring the pricing and product redesign actions of the U.S. mega banks and plan to be fast followers. But some banks that have not experienced severe credit problems and have remained financially healthy may opt to sit back and maintain customer-friendly, low-fee positioning in an attempt to gain a disproportionate share of new account volume.

3) Consolidate with the primary bank. Executives realize that reversing course on branch network density and scaling back on free and unlimited banking channel access will not go unnoticed by consumers. Many executives are actively working on value propositions and relationship-based product packaging approaches that encourage consumers to consolidate deposit, payment and credit relationships with a primary banking provider in order to avoid fees.

Indeed, many consumers are receptive to this value proposition. However, as pricing is the primary basis of competition for most retail banking services, fee increases will be a highly visible factor that will likely propel customer dissatisfaction and switching behavior. In addition to specialized new entrants to banking, there are still more than 17,000 traditional banks and credit unions operating in the U.S. that will gladly target disgruntled customers. So if the “consolidate to avoid fees” value proposition isn’t right, many consumers may be prompted to move elsewhere.

While delivery system rationalization, finding new fee income sources and encouraging consumers to consolidate relationships are not the only big issues facing retail franchise executives, they are key imperatives FIS hears about repeatedly from clients. In response, FIS has conducted extensive primary research to establish a fact base and generate insights to help clients better understand their options for dealing with these complicated issues. Building Profitable Relationships with Multichannel Consumers represents the first in a series of FIS Consumer Insight Briefs. This particular brief is


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based on a survey completed by more than 4,000 U.S. households in early September 2010. FIS will publish additional briefs based on analysis of this data set in coming months, in addition to briefs addressing retail payments, mobile banking and small business banking.

Multichannel Delivery Dilemma The era of multichannel retail banking was launched approximately 40 years ago with the creation of the ATM, the ACH Network and credit card network expansion. Since then, the range of delivery channels that enable consumers to interact and transact with banking providers has steadily expanded. As the number of delivery channels swelled, consumer adoption steadily followed. Today, consumers use multiple retail banking channels (see Figure 2).

With the introduction of each new channel, industry practitioners hypothesized delivery channel costs would decline, or at least remain flat, as transactions migrated from the expensive branch network. ATMs, ACH, online banking and other self-service channels have certainly reduced overall per unit transaction costs and branch transaction volume, but the number of bank branches has increased by 18 percent over the past decade. The overall number of interactions the typical consumer has with their bank has also increased. This represents a massive strategic dilemma for retail banking executives. Recognizing new business realities, most banking organizations have designated strategic and permanent cost efficiencies as a major goal. To many institutions, this includes rationalizing branch network operating


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expenses as they move past the Great Recession and into banking in the “2010s.” But this transition must be handled delicately as the majority of consumers still use the branch. In our research, 64 percent of consumers reported using their primary checking account provider’s branch lobby for transactions at least once within the past 30 days (see Figure 3). Of those consumers who reported using the branch lobby, 38 percent used the branch once, 39 percent used the branch two or three times and 23 percent used the branch four times or more during the past 30 days. (Note that our survey population was completely comprised of online households). In addition, our research found that Gen Y and Gen X consumers conduct just as many in-person branch lobby transactions as baby boomers and mature consumers.

Self-service channel adoption and utilization is increasing, just as branch transaction volume is certainly declining. But branch transaction volumes are not falling fast enough for many institutions. The New York-based consulting firm Novantas estimates that 50 percent of retail bank operating expenses come from the branch network, while only 6 percent of operating expenses are directly attributable to ATM, online banking and telephone banking channels. The consequences of this are troubling for banks. As transactions continue to shift to self-service channels, the unit costs of in-person transactions within the fixed-cost branch system will steadily increase and eventually become unsustainable. Many banking organizations will rationalize branch network expenses in the coming years by opening smaller footprint facilities, closing underperforming


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branches and exiting slow-growth markets. But given that nearly two-thirds of the retail customer base still uses the branch on a monthly basis, and given the branch’s critical role in new account generation, the sensible management course is to scale down branch network expenses in a measured manner.

Capturing New Fee Income As the transformation of the traditional retail banking economic model takes hold and executives grapple with the fact that branch operating expenses will need to be managed downward over a multiyear period, the race is on to introduce new sources of fee income associated with retail checking accounts and deposit products. The largest banks are leading the way with new pricing approaches and product redesign. They have every intention of gaining back their projected declines in NSF and debit card interchange fee income. Bank of America plans to raise minimum balance requirements over the next 12 months and charge a monthly account fee for customers who can't maintain those balances. At a Barclays Capital conference held in mid-September 2010, Bank of America CEO Brian Moynihan said, "We currently estimate over time through these and other items we are working on that we will have the ability to offset a substantial majority of the revenue lost from the various regulatory changes." 1 At the same conference, JPMorgan Chase & Co. CEO Jamie Dimon commented that regulatory rules limiting overdraft fees and affecting debit interchange fees would ultimately force JPMorgan

and other banks to make up the lost fee revenue on these fronts by charging customers elsewhere. “We’re going to earn it all back, whatever the number is,” he said. 2 Regional and community-based banking organizations are watching the large banks closely and many will be fast followers in the coming months. Copying the large banks is clearly one approach to addressing the fee revenue challenge, but our research reveals other insights that may be helpful. While no customer ever wants their banking fees to increase, banks can take advantage of pockets of pricing insensitivity. Any effort to modify retail checking and deposit fee structures must start with an assessment of the current level and mix of fees paid by existing customers. In this regard, the industry has dug itself into a hole over the past decade. Whereas monthly maintenance fees on retail checking accounts were relatively common in the 1990s, this changed as banks pursued Totally Free Checking strategies to attract low-cost deposits. Much of this strategy was linked to aggressive de novo branch expansion and the need to quickly develop customer bases and NSF revenue to support new branch business plans. These strategies have built a pervasive expectation among consumers that they will pay nothing for checking account services. Eighty-two percent of the consumers we surveyed agreed with the statement, “I do not expect to pay any fees for my checking account.”


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In fact, many consumers pay no fees for their retail checking accounts. Our research found that nearly half (48 percent) of consumers pay no fees whatsoever to their primary checking account provider (see Figure 4). An additional 31 percent of consumers pay $5 per month or less (much of which is drawn from foreign ATM transactions). Only 21 percent pay monthly fees exceeding $5 per month. This is problematic for banks as there will be significant “built in” consumer resistance to fee increases. To better understand pricing sensitivities, we questioned consumers regarding the point at which increased fees on their primary checking account would cause them to consider switching the relationship to another provider. Not surprisingly, most consumers did not react positively to the notion of price increases. Thirty-six percent

indicated they would strongly consider switching their primary checking account to a different provider if their current provider increased monthly fees by $1 or less (see Figure 5). This grows to 63 percent of consumers who would consider switching if their current provider increased checking fees by $4.99 or less. While this is certainly not good news for the industry, there are pockets of opportunity. Thirty-seven percent of consumers stated it would take a fee increase of $5 or more for them to consider switching. Our research uncovered three interesting facts about this group of consumers who indicated somewhat lower levels of pricing sensitivity. A disproportionate portion of them:

Are younger (Gen Y and Gen X) consumers

Conduct a high number of banking


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transactions across all channels

Are at the high end of the spectrum when it comes to the current level of fees paid for checking account services.

In summary, the less fee-sensitive tend to be younger consumers who actively use a wide-range of banking channels and are already accustomed to paying fees. However, banking organizations must be careful and deploy a sound analytic approach when determining how to leverage this type of information to increase fee pricing. One option often considered by bank executives is to increase

fees among Gen Y customers who conduct a high number of channel interactions, as many of them consume extensive channel resources and generate little, if any, profit for the banking provider. But re-pricing customers based primarily on characteristics such as age and channel usage may be a mistake as banks typically don’t have a complete understanding of consumers’ entire financial wallet and wealth potential. For example, we specifically analyzed Gen Y consumers who met thresholds of high household income and high deposit balances held with the primary checking account provider and all other financial institutions. The research found that 50


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percent of these wealthier Gen Y consumers were active users of the vast majority of the banking channels tracked. Retaining and deepening wallet share with these Gen Y consumers is vital to the long-term health of any retail banking franchise. Re-pricing them in an untargeted manner could damage the primary bank’s ability to capture wallet share from other providers. In the worst case scenario, it could cause these consumers to switch their existing checking and deposit relationships to the competition.

Consolidation with the Primary Bank The data above clearly supports the stance that adjustments to fee pricing should be pursued through a robust analytic process that includes estimates of consumers’ current and potential relationship value. It also supports the position that fee pricing should be a key element of relationship product packages that encourage consumers to

consolidate their deposit, payment and credit relationships with the primary checking account provider. Current industry challenges have led many retail banking executives to pursue a renewed emphasis on deepening relationships with existing customers. Dick Kovacevich, former chairman and CEO of Wells Fargo, has been quoted as saying, “The cost of us selling a product to an existing customer is only about 10 percent of selling the same product to a new customer.”3 This is a timeless truth in retail banking. It was true at the zenith of the free checking era and it’s still true today. Fortunately for banks, many consumers are also receptive to deepening relationships with their primary banking provider. As demonstrated in Figure 6, approximately half of consumers trust their bank and are receptive to the concept of


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bringing additional business to their bank in exchange for a combination of benefits that include product selection, lower fees and rewards programs. Consistent with these findings, approximately half (53 percent) of consumers stated they are likely to consider bringing additional account balances and/or products to their primary checking account provider in order to avoid fees (see Figure 7). But many of them are younger consumers with lower balances and lower household incomes. This point is demonstrated further in Figure 7 with the finding that among those who are likely to bring more business to their primary checking account provider in order to avoid fees, only 33 percent stated they could consolidate deposit balances of $5,000 or more. Only 19 percent could consolidate deposit balances of $10,000 or more. So while many

consumers are receptive to consolidating with their banking provider to avoid fees, a far smaller portion has the resources that make the exercise strongly worthwhile for the provider. This creates a dilemma for banks. Most are chasing the top 10 - 20 percent of consumer households who maintain high deposit balances and multiple financial product holdings. Obviously, this small pool of consumers who have the means to consolidate large balances should be vigorously pursued. But to maintain the long-term health of the franchise, banks need to create compelling products that profitably attract and retain the remaining 80 percent of the retail consumer base. This situation is analogous to several major U.S. industries outside banking, including air transportation, retail and telecommunications.


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Companies in these industries have recognized the benefits of preserving relationships with mass-market consumers. Productively filling capacity (be it retail store traffic, available seat miles in air transportation or network utilization in telecommunications) supports profitability when it is leveraged, but drains profitability when it is not. Just as coach-seat customers are essential to airlines, mass-market customers are essential to retail banks. 4 The new economic realities of retail banking require a mass-market approach to: (1) attract the deposit, payment and credit services these consumers have available and (2) service this base through low-cost, primarily self-service channels. While many of these consumers will be less fee sensitive than the high-end consumer base, they will not be oblivious to them. Thus, fee policies should be structured

around encouraging self-service behaviors, including:

Adopting payroll direct deposit

Using ATMs and the mobile phone to make deposits rather than in-person branch visits

Using computer and mobile phone-based online banking for inquiries and balance transfers rather than live contact center representatives

Receiving electronic statements rather than paper statements

Using online bill payment and person-to-person (P2P) payments rather than paper checks

Using the debit card for point-of-sale (POS) and online purchases.

Mass-market consumers may not have large deposits, and many of them are tied to their


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banking provider only by a checking account, but many of them actively utilize credit. Thus credit cards, automobile and student loans can be packaged into the product offering. Loyalty program benefits can be coupled with bringing additional short-term deposit or credit products to the banking provider and utilizing fee-generating payment services.

Relationship Product Packages Dramatically reconfiguring retail delivery channels is expensive and consumer migration to lower-cost delivery channels occurs steadily, but slowly, over many years. Conveniently for banks, relationship product packages are a viable means to meet the objectives of reducing delivery channel expenses, generating new fee revenue sources and capturing greater consumer wallet share. It is not necessary for banks to make wholesale, expensive changes to their retail distribution systems or product portfolios in order to achieve these objectives. Selective changes to products,

prices and marketing communications can help an institution move toward a relationship packaging approach and allow it to get more mileage from existing delivery systems and frontline resources. Pursuing a relationship package approach means going beyond commodity prices and commodity product features. A differentiated approach consists of creating packages that are sold on the basis of customer need by ascertaining the requirements of major customer groups. There are a variety of different variables that can impact package design (see Figure 8). As we’ve demonstrated in this analysis, consumer channel behavior should be a key element impacting package configuration. At a minimum, banks should create a packaged offer for their high-end relationship customers, as well as a packaged offer for mass-market customers and configure the value proposition elements appropriately. In the coming years, we expect many institutions to create families of packaged offers based on customer segment knowledge (see Figure 9). This transition will most likely revolve around


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consumer life-stage segments, with unique features based on in-depth analysis of consumers’ demographics, behaviors and attitudes. The benefits to a bank of successfully implementing a relationship packaging approach are numerous. Well-constructed product packages tend to be more stable and profitable for a provider. While it does take more time to sell a relationship package solution, selling multiple products within a single package at one point in time is more cost-effective than cross-selling the same product mix over time. They can also help an institution create a distinct position in the marketplace and fend off price competition, as packaged product solutions are more difficult for competitors to copy than standalone products. Finally, relationship product packages generally increase customer stickiness and thereby improve longevity, as it is more difficult for customers to unbundle a package and comparison shop the component parts.

Conclusion Banks face many challenges in the coming years, but challenges always bring new opportunity. A prime opportunity is to determine ways to configure products and delivery channel access so an institution can move beyond commodity status. After all, retail banking products aren’t that different from institution to institution; they all basically do the same things. But the way institutions enable customers to access those products and the experiences wrapped around that access can be differentiated. Analyzing what customers are trying to accomplish then using financial products and the sacrifices they often have to make to access their financial products and information can be a helpful exercise. In many cases, products and channel access can be bundled together and priced within a relationship

context to make it easier for consumers to complete these jobs. Consumers will reward a financial institution that gets this formula right. The institution will be rewarded with loyal customers who bring greater wallet share and utilize the institution’s services more efficiently (lower cost to serve). As the industry evolves to a business model that is based on more-equitable and transparent revenue generation from the mass-market base, this will be the path to develop profitable relationships with today’s multichannel banking consumers.


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Citations: 1 CNN Money, “New Bank Fees Hit Consumers,” Sept. 24, 2010. 2 SNL Financial, “Dimon Says FinReg Needed, but too Complicated,” Sept. 14, 2010. 3 USA Today, “Wells Fargo’s Kovacevich Banks on Success as a One-Stop Shop,” March 26, 2007. 4 BAI, “Specialization and the Deposit Business: Implications for Growth and Market Share,” 2005.

About the Research Building Profitable Relationships with Multichannel Consumers is the first in a series of Consumer Insight Briefs based on primary research conducted by FIS Enterprise Strategy. The research findings are based on a 42-question, online survey completed by over 4,000 U.S. consumers in early September 2010. The survey was fielded by FIS Enterprise Strategy to a consumer panel maintained by Survey Sampling International. The estimated margin of error rate for this sample is +/-1.6% to 2.3%.

About FIS FIS delivers banking and payments technologies to more than 14,000 financial institutions and businesses in over 100 countries worldwide. FIS provides financial institution core processing, and card issuer and transaction processing services, including the NYCE® Network. FIS maintains processing and technology relationships with 40 of the top 50 global banks, including 9 of the top 10. FIS is a member of Standard and Poor's (S&P) 500® Index and consistently holds a leading ranking in the annual FinTech 100 rankings. Headquartered in Jacksonville, Florida, FIS employs more than 30,000 on a global basis. FIS is listed on the New York Stock Exchange under the “FIS” ticker symbol. For more information about FIS see www.fisglobal.com.

Building Profitable Relationships with Multichannel Consumers was authored by Paul McAdam, SVP of Research and Thought Leadership at FIS and Jim Gamble, Director of Research and Thought Leadership at FIS. Please contact the authors if you have questions about the research or how the results apply to your financial institution. Paul McAdam Ph: 708.449.7743 [email protected] Jim Gamble Ph: 614.414.4213 [email protected]

Building profitable relationships with multichannel consumers

Economy & Finance

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