PRODUCT DIFFERENTIATION AND PERFORMANCE OF...

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PRODUCT DIFFERENTIATION AND PERFORMANCE OF

COMMERCIAL BANKS: A CASE STUDY OF DFCU BANK.

BY

NDUGU MARYANNE WAHITO

07\K\3153\EXT

A DISSERTATION SUBMITTED IN PARTIAL FULFILLMENT OF THE

REQUIREMENTS FOR THE AWARD OF A DEGREE OF BACHELOR OF

COMMERCE OF MAKERERE UNIVERSITY.

JUNE 2011

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DECLARATION

I, NDUGU MARYANNE WAHITO, declare that this is my original work and it has never been

presented to any university for any academic award. Where work of another individual has been

used, acknowledgement has been duly given.

Signature: …………………………. Date: ……………………………….

Ndugu MaryAnne Wahito

07/K/3153/EXT

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APPROVAL

This is to certify that this research ―product differentiation and performance of commercial

banks” has been under my supervision as the university supervisor.

Signature: ……………………………. Date: ………………………………….

Mr.Musiime Grace

(Supervisor)

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DEDICATION

I dedicate this project to my parents, Mr. James Ichamuya, Mrs. Rose Nyambura (RIP) and Mrs.

Agnes Muthoni, my twin brother SimonPeter and my sisters Beatrice, Martha, Maryanne and my

grand Pa Peter Ichamuya (RIP) and my niece Stephanie for their continued support and patience

as I pursued my university education and all those who have made an impact in my life to make

it what I am today.

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ACKNOWLEDGEMENT

I wish to thank the Almighty God for His continued blessings as I pursued my undergraduate

studies at Makerere University.

My sincere gratitude goes to my supervisor, Mr.Musiime Grace for his constant guidance in

writing this project and his patience during my presentation. May God bless him for the

dedication he has shown in the course of finishing this research work. My gratitude is also

extended to all respondents that assisted me in collection of my data for analysis of my project.

I would also like to thank all my friends who have been the source of my inspiration. I would

like to thank in a special way, my cousin David Ndirangu and my friends Patrick, Peris, Mukami

and Sylviah for their continued support in my research.

Lastly, I wish to thank all those whom I have not mentioned above and in one way or another

have contributed to the success of this project. Thank You.

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LIST OF ACCRONYMNS AND ABBREVIATIONS

ADB African Development Bank

ATMs Automated –teller machines

CAMEL Capital adequacy, Asset quality, Management, Earnings quality and Liquidity

DEA Data Envelopment Analysis

DFCU Development Finance Company of Uganda

FIA Financial Institutions Act

FIs Financial Institutions

IASB International Accounting Standards Board

NPLs Non performing Loans

SPSS Statistical Package for Social Scientists

WiB Women in Business

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TABLE OF CONTENTS

DECLARATION .................................................................................................................................... ii

APPROVAL .......................................................................................................................................... iii

DEDICATION ....................................................................................................................................... iv

ACKNOWLEDGEMENT ....................................................................................................................... v

LIST OF ACCRONYMNS AND ABBREVIATIONS ............................................................................ vi

LIST OF TABLES ................................................................................................................................. ix

ABSTRACT ............................................................................................................................................ x

CHAPTER ONE:INTRODUCTION ....................................................................................................... 1

1.0 Introduction ....................................................................................................................................... 1

1.1. Background of the study. .................................................................................................................. 1

1.3. Purpose of the study ........................................................................................................................ 2

1.4. Objectives of the study...................................................................................................................... 3

1.5. Study questions................................................................................................................................. 3

1.6.1. Geographical scope ........................................................................................................................ 3

1.6.2. Content scope ................................................................................................................................ 3

1.6.3. Time scope .................................................................................................................................... 3

1.7. Significance of the study ................................................................................................................... 3

CHAPTER TWO: LITERATURE REVIEW ........................................................................................... 4

2.0 Introduction ....................................................................................................................................... 4

2.1. PRODUCT DIFFERENTIATION .................................................................................................... 4

2.2. Types of product differentiation ........................................................................................................ 4

2.2.1. Vertical differentiation ................................................................................................................... 4

2.2.2. Horizontal differentiation ............................................................................................................... 5

2.2.3. Mixed differentiation ..................................................................................................................... 5

2.3. Product differentiation by banks........................................................................................................ 5

2.4. Determinants of financial innovations. .............................................................................................. 6

2.4.1. Competition. .................................................................................................................................. 6

2.4.2. Size. .............................................................................................................................................. 6

2.4.3. Type of organization. ..................................................................................................................... 6

2.4.4. Diversification. .............................................................................................................................. 6

2.5. Benefits of product differentiation..................................................................................................... 7

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2.6. The Costs of Differentiation .............................................................................................................. 7

2.7. BANK PERFORMANCE ................................................................................................................. 8

2.8. Performance measures ...................................................................................................................... 8

2.8.1 Profitability .................................................................................................................................... 9

2.8.2. Capital adequacy. ........................................................................................................................... 9

2.8.3. Asset quality .................................................................................................................................. 9

2.8.4. Management Quality .................................................................................................................... 10

2.8.5. Earning Performance ................................................................................................................... 10

2.8.7. Sensitivity to Market Risk .......................................................................................................... 11

2.9. Relationship between product differentiation and performance of commercial banks ....................... 11

Conclusion ............................................................................................................................................ 12

CHAPTER THREE: METHODOLOGY ............................................................................................... 14

3.0 Introduction ..................................................................................................................................... 14

3.1 Research design ............................................................................................................................... 14

3.2 Study population .............................................................................................................................. 14

3.3 Sample size...................................................................................................................................... 14

3.3 Sampling methods. .......................................................................................................................... 14

3.4 Data Collection ................................................................................................................................ 14

3.4.1. Primary data source...................................................................................................................... 14

3.4.2. Secondary data source .................................................................................................................. 15

3.5 Data collection instruments .............................................................................................................. 15

3.5.1 Questionnaires .............................................................................................................................. 15

3.6 Data processing, analysis and presentation. ...................................................................................... 15

3.7. Limitation of the study. ................................................................................................................... 15

CHAPTER FOUR: PRESENTATION, ANALYSIS AND INTERPRETATION OF THE FINDINGS. . 16

4.0. Introduction. ................................................................................................................................... 16

4.1. Demographic characteristics of the respondents. ............................................................................. 16

4.2. Product differentiation in DFCU bank ............................................................................................. 17

4.3. Level of performance in DFCU bank. ............................................................................................. 21

4.4: Relationship between product differentiation and performance of commercial banks. ...................... 25

CHAPTER FIVE :SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATIONS. ........ 26

5.0. Introduction .................................................................................................................................... 26

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5.1. Summary of the findings. ................................................................................................................ 26

5.1.1. Summary of findings on product differentiation ........................................................................... 26

5.1.2. Summary of findings on bank performance. ................................................................................. 27

5.1.3. Summary of findings on the relationship between product differentiation and performance of

commercial banks. ................................................................................................................................. 27

5.2. Conclusion...................................................................................................................................... 27

5.3. Recommendations .......................................................................................................................... 27

5.4 Areas of further research ................................................................................................................ 28

REFERENCES...................................................................................................................................... 29

QUESTIONNAIRE.................................................................................................................................... 32

INTRODUCTORY LETTER ........................................................................................................................ 38

LIST OF TABLES

Table 1: Showing gender of the respondents.............................................................................. 16

Table 2: showing age of respondents ......................................................................................... 16

Table 3: showing education level of respondents ....................................................................... 17

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Table 4: showing position of respondents .................................................................................. 17

Table 5: showing whether new products have been introduced. ................................................. 18

Table 6: Showing whether the bank has improved the quality of its products ............................. 18

Table 7: finding out whether the bank has other networks country wide .................................... 19

Table 8: finding out whether new branches enhance competition ............................................... 19

Table 9: finding out whether customer satisfaction is achieved through introduction of new

products .................................................................................................................................... 20

Table 10: finding out whether unique products create a competitive edge .................................. 20

Table 11:showing whether with improved quality products the bank can charge higher prices ... 21

Table 12: showing whether increase in core deposits has led to growth of the bank's branches .. 21

Table 13: showing whether the bank has good internal cash controls and accounting processes to

ensure liquidity ......................................................................................................................... 22

Table 14: showing whether the bank has adequate loan and investment policies, procedures and

practices .................................................................................................................................... 22

Table 15:showing whether DFCU's capital level is sufficient in relation to the bank's risk profile

................................................................................................................................................. 22

Table 16: showing whether the bank's liquidity is adequate to cover short term obligations ...... 23

Table 17: showing whether the bank annually pays dividends to shareholders ........................... 23

Table 18: showing whether DFCU bank holds a loan loss reserve to help cover losses arising out

of borrower defaults. ................................................................................................................. 24

Table 19: showing whether the bank transfers part of its net profits to reserves ......................... 24

Table 20: showing whether non performing loans in DFCU bank have been increasing ............. 24

ABSTRACT

The study was carried out to determine the effect of product differentiation on the performance

of commercial banks in Uganda. In particular, the study sought to determine the effects of

introduction of new unique products with improved quality and the effect of opening more bank

branches on the overall performance of DFCU bank.

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The main objectives of this study included;

Establishing the level of product differentiation in DFCU bank.

Establishing the level of performance of DFCU bank.

Establishing the relationship between product differentiation and performance of

commercial.

The researcher used both descriptive and analytical research designs. The research designs were

appropriate because data was easily analyzed using frequency counts and percentages derived

from the responses obtained in the questionnaires.

The findings indicated that the bank has opened several branches in various parts of the country

which has led to increase in its customer base and this has also improved on the convenience due

to customers‘ nearness to the bank. It was also evident that the bank has diversified its operations

by offering other products and services other than just lending and accepting of deposits. It was

also evident that the bank has adequate level of capital, high profitability level, and favorable

liquidity level to help it meet its short term obligations and also it has a good management.

However, the existence of nonperforming loans has posed a threat on the performance of the

bank. From the study undertaken, the researcher found out there is a weak relationship between

product differentiation and performance of commercial banks having a correlation of 0.405.

Based on the findings, the researcher recommended that in order to avoid nonperforming loans ,

bank should improve its credit policy measures, ensure that transactions are immediately

recorded in books of accounts and also ensure that integrity and accountability is highly upheld

by the bank‘s management.

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CHAPTER ONE:INTRODUCTION

1.0 Introduction

1.1. Background of the study.

Product differentiation is defined simply as distinguishing the goods or services of one seller

from those of another on any basis that is important to the buyer and leads to preference;

(Chamberlin 1965). Porter adhered to the traditional operational definition of product

differentiation as the degree of cross-price inelasticity with respect to competing brands. Product

differentiation is achieved by offering a valued variation of the physical product. The ability to

differentiate a product varies greatly along a continuum depending on the specific product.

Authors Gary Armstrong and Philip Kotler noted that differentiation can occur by manipulating

many characteristics, including features, performance, style, design, consistency, durability,

reliability, or reparability. Differentiation allows a company to target specific populations.

Differentiation looks to make a product more attractive by contrasting its unique qualities with

other competing products. Successful product differentiation creates a competitive advantage for

the seller, as customers view these products as unique or superior. Product differentiation highly

depends on competition and market positioning. In relation to the banking industry, product

differentiation can be perceived in two aspects; horizontal product differentiation and vertical

product differentiation.

Performance is defined as a barometer or an index that measures the returns or profits in relation

to costs. According to the IASB Framework, ―performance is the ability of an entity to earn

profit on the resources that have been invested in it. Performance is measured in terms of

profitability as a sign of efficiency. Profitability is the ability to generate revenue in excess of the

costs incurred in producing these revenues. Some of the other useful measures of performance

are coined into what is referred to as CAMEL. The acronym CAMEL refers to the five

components of a bank‘s condition that are assessed; Capital adequacy, asset quality,

management, earnings and liquidity. In the year 1997, another component was added, the bank‘s

sensitivity changing the acronym to CAMELS.

The differentiation of goods along key features and minor details is an important strategy for

firms to defend their price from leveling down to the bottom part of the price spectrum. Within

firms, product differentiation is the way multi-product firms build their own supplied products'

range. The concept of being unique of different is far more important today than it was ten years

ago. The key to successful marketing and competing is differentiation. DFCU bank limited is a

wholly owned subsidiary of DFCU Limited that provides commercial banking services. The

bank‘s core business is accepting of deposits from the public to whom the bank provides a wide

range of financial products and services including the advancing of loans and overdrafts on a

sustainable basis. DFCU bank‘s main products are credit products and deposit products. The

credit products mainly comprise of personal loans, overdrafts, guarantees and letters of credit.

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Deposit products offered by the bank include forex deposits, demand deposits time deposits and

savings plan. Other than the credit and deposit products the bank also provides products such as

transaction services, custodial services, remittances and drafts, treasury services, and financial

advisory services. The bank has also recently introduced pinnacle banking which is aimed at the

high net worth individuals and corporate (DFCU Prospectus 1st July 2004 issue). DFCU bank

has introduced a loan scheme specifically targeting businesswomen who wish to boost their

businesses. According to a press statement, DFCU Bank‘s Women in Business (WiB) Access

Plus Loan will assist women entrepreneurs to borrow up to Shs100 million, which can be repaid

at lower interest rates in a maximum of three years ( Observer Wednesday, 07 April 2010 ) .

The overall performance of banks in Uganda has been unsatisfactory(Oola,2002). Even after

the intervention of the Bank of Uganda through the closure of atleast three commercial banks in

1999, commercial banks in Uganda have continued to register poor financial performance.

DFCU bank limited is one of the best performing banks in Uganda. However, like any other

financial institution, DFCU bank also experiences the problem of non performing loans.in the

financial year ended 31st December,2006 DFCU bank registered a high amount of non

performing loans which amounted to Ugshs. 4,248,857,000. (DFCU annual report 2006). Non

performing loans reduces the liquidity of banks,credit expansion,it slows down the growth of the

real sector with direct consequences on the performance of banks, the firm which is in default

and the economy as a whole.

1.2. Problem statement.

The performance of commercial banks has been bedeviled by a barrage of nonperforming loans

and increasing competition in the banking industry. Non-performing asset means a loan, credit

accommodation or asset whose principal or interest has been due and unpaid for ninety days or

more, or where it‘s principal or interest payments, overdue by ninety days or more have been

capitalized, restructured or renewed (FIA,2004).DFCU bank being one of the leading

commercial banks in Uganda has been doing well by reporting high levels of profitability

amounting to Ugshs. 5,938,000,000 in 2006 and also the bank has maintained a good capital

adequacy level of 26% in 2006 which is higher than the minimum requirement of 8% by Bank of

Uganda.(DFCU annual report 2006). However, DFCU bank‘s performance has also been

affected by the existence of non performing loans. DFCU bank has been experiencing an

increase in the value of its non performing loans. In the year 2006 the value of non performing

loans stood at Ugshs. 4,248,857,000. (DFCU annual report 2006).

1.3. Purpose of the study

The purpose of the study was to establish the relationship between product differentiation and

performance of commercial banks in relation to DFCU Bank Limited.

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1.4. Objectives of the study

i. To establish the level of product differentiation in DFCU Bank Limited.

ii. To establish the level of performance of DFCU Bank Limited.

iii. To establish the relationship between product differentiation and performance of DFCU

Bank Limited.

1.5. Study questions

i. What is the level of product differentiation in DFCU Bank Limited?

ii. What is the level of performance of DFCU Bank Limited?

iii. What is the relationship between product differentiation and performance of DFCU Bank

Limited?

1.6. Scope of the study

1.6.1. Geographical scope

The geographical area to be covered in this study was DFCU Jinja road branch which is the

bank‘s headquarters.

1.6.2. Content scope

This study was confined to product differentiation and performance of commercial banks using

DFCU bank as the case study.

1.6.3. Time scope

The data collected had a range of five years from the year 2004 to the year 2009.

1.7. Significance of the study

The study was to help identify the relationship between product differentiation and the

performance of commercial banks. The resultant relationship was to be used to enlighten

commercial banks executive managers on the importance of differentiating products so as

to attain a competitive edge and sustain a high performance.

This study was to help create awareness to the public of the various products that are

being offered by DFCU Bank.

The study was also to act as a future point of reference to the continuing academicians.

The study would also help the researcher in attaining her Bachelor‘s degree in

Commerce.

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CHAPTER TWO: LITERATURE REVIEW

2.0 Introduction

This chapter represents the existing literature about product differentiation and performance of

commercial banks that have been explored and studied both theoretically by a number of

scholars. The secondary data will be obtained from journals, books and pamphlets.

2.1. PRODUCT DIFFERENTIATION

The concept of product differentiation was formally introduced by Edward Chamberlin in 1933.

According to Chamberlin: A general class of product is differentiated if any significant basis

exists for distinguishing the goods (or services) of one seller from those of another. Such a basis

may be real or fancied, as long as it is of any importance whatever to buyers, and leads to a

preference for one variety of the product over another.

Smith and Samuelson maintained that product differentiation results from the firm's promotion

and advertising efforts. This group had also associated product differentiation with recognition of

only one, rather than several, demand functions.

Shaw, Chamberlin, and Porter, viewed product differentiation as depending on both physical and

nonphysical product characteristics.

Grossman and Shapiro (1984) consider a differentiated products, duopoly framework in which

ex ante consumers are unaware of the existence of either product but through firms' advertising

consumers are informed of their existence. Product differentiation refers to such variations

within a product class that (some) consumers view as imperfect substitutes.

The concept of differentiation is described as a process of adding distinct characteristics that are

not only meaningful but also valued, to the offerings of a company in order to distinguish the

goods or services from the ones of competitors (Kotler, 2003).

2.2. Types of product differentiation

Product differentiation takes on various forms which include vertical differentiation, horizontal

differentiation and mixed differentiation.

2.2.1. Vertical differentiation

Vertical differentiation refers to differences in the actual quality of two brands. Vertical

differentiation occurs in a market where the several goods that are present can be ordered

according to their objective quality from the highest to the lowest,( Hotelling (1929). It's possible

to say in this case that one good is "better" than another. Vertical differentiation can be obtained:

along one decisive feature; along a few features, each of which has a wide possible range of

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(continuous or discrete) values; across a large number of features. When products are vertically

differentiated (for example, by quality), truthful advertising may solve problem by signaling

quality. If all customers are informed about product quality, a high- quality good should

command a higher price than a low-quality good. If advertising is truthful and credible, higher

price means higher quality ;( Valentino Piana (2003).

2.2.2. Horizontal differentiation

Horizontal differentiation refers to differences between brands based on different product

characteristics but not on different overall quality. When products are different according to

features that can't be ordered in an objective way, a horizontal differentiation emerges in the

market. Horizontal differentiation can be linked to differentiation in colours (different colour

version for the same good), in styles (e.g. modern / antique), in tastes. It is quite common that, in

horizontal differentiation, the supplier of many versions decide a unique price for all of them.

For horizontally differentiated products, informative advertising enables a consumer to find a

product that best matches his or her preference. A consumer's preferences can be graphed as

locations in a spatial market or city, (Hotelling (1929). The distance between the locations of a

firm and a consumer represents the difference between a product and the consumer's preference.

Therefore, an advertisement about a product's location helps the consumer find out which

product is closer to one's location ;( Valentino Piana, 2003).

2.2.3. Mixed differentiation

Certain complex markets are characterized both by horizontal and vertical differentiation. For

instance, apparel, garments and shoes have an amazingly rich combination of shapes, colours,

materials, complementarities, seasonal and territorial specificities, and appropriateness to social

events, relative distance to ideals promoted by media, stylists and the show business. The quality

of the materials can often be seen as a vertical differentiation but some other elements are clearly

horizontal, like shapes. In such an environment, consumers can develop fairly different styles of

comparison, with some spending large amount of time getting exposed and evaluating versions,

talking with others and sharing judgments, while others drastically reducing the difficulty of the

comparison through repurchase of very classical items ;( Valentino Piana (2003))

2.3. Product differentiation by banks

Vertical differentiation is considered to cope with the heterogeneity of bank types. It is

introduced by allowing consumers‘ preferences to depend on the type of the banking institution

they are dealing with by considering that the relevant interest rate for customers‘ decisions is the

sum of the explicit interest rate and the implicit interest rate. (Banks and Bank Systems, Volume

4, Issue 4, 2009). Vertical product differentiation results into less competition, derived from a

bank's ability to differentiate its services from those of its rivals through quality, is positive

because it helps to provide a more stable banking system. Moreover, the banking market power

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generated by investing in quality does not prevent banks from operating efficiently from a

production point of view. Horizontal differentiation in relation to banks is done by considering

that banks compete spatially through the opening of branches in several geographical markets

(Banks and Bank Systems, Volume 4, Issue 4, 2009). Product differentiation in banks involves

the various financial innovations undertaken by banks. The financial innovations include the

introduction of new products offered by a bank and also increasing on the bank‘s branch

network.

2.4. Determinants of financial innovations.

There are various factors in the banking industry that push banks towards the introduction of new

range of products and also that lead to the expansion of the bank‘s network.

2.4.1. Competition.

The standard theory argues that there is a positive relationship between competition and

innovation. Allen and Santomero (2001) suggest that the launch of financial innovation process

undertaken by banks prove to be a response to the intensifying competition within the financial

markets.

2.4.2. Size.

Size is an important factor in adopting financial innovation among financial institutions. Large

FIs are usually in a better position to pay fixed costs of developing new technologies. Large

firms are assumed to direct the innovations and spread the process thanks to economies of scale

and scope in research and design activities (Buzzachi et al.1995)

2.4.3. Type of organization.

This refers to whether an organization is privately owned or publicly owned. Private

organizations are considered to be more innovative than public organizations. In the banking

context, public banks are sometimes led to financing high risk or to emphasize more traditional

banking operations such as collecting deposits or granting credit.[ International Research Journal

of Finance and Economics - Issue 51 (2010)]. Mohieldin and Nasr (2007) and Megyery and

Sader (1996) cite promotion of innovation through better access to technologies as one of the

objectives planned by government in the privatization process.

2.4.4. Diversification.

Many authors have shown that there is a negative relationship between diversification and

financial innovation. In a system of full-service banks, financial innovation is usually lower than

the innovation in a financial system where commercial banks are separated (Boot and Thakor,

1997). Diversification leads to creation of agency costs related to investments in innovations

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which discourages managers from getting involved in innovation (Denis et al. 1997, Francis and

Smith, 1995).

2.5. Benefits of product differentiation

For the consumer, product differentiation can increase the satisfaction from her/his consumption,

as the product better fit her/his needs, conditions of use and special purposes. Product

differentiation can lead to the exploration of the product space by un-loyal customers, who use

the repurchase occasions to try new versions.

Product differentiation gives the product or service an edge over rival products. It highlights

unique aspects of the products and also generates value for the product in the eyes of the buyer,

which should be any manufacturer's ultimate goal. When the buyer perceives, a difference is

when he will remember the product and buy it, thereby resulting in higher sales for the company,

Kotler, P. (2003).

In neoclassical theory, product differentiation provides consumers with a variety of different

products within a particular industry, rather than a homogeneous product that characterizes

purely competitive markets.

Financial innovations are used by banks as formidable strategic variables to outstrip the

competition and have become an essential means for the bank to improve its performance and to

maintain its effectiveness on the market (Batiz-Lazo and Woldesenbet, 2006).[ International

Research Journal of Finance and Economics - Issue 51 (2010) ]

Product differentiation allows banks to gain higher prices for their services.

Successful differentiation increases competitiveness by creating an irreplaceable product

(Armstrong & Kotler, 2005), allowing companies to extend product life cycles.

In a highly turbulent environment, a successful innovation creating a unique competitive position

can give the company a competitive advantage and lead to a superior performance (Roberts and

Amit, 2003).

2.6. The Costs of Differentiation

Differentiation adds cost. The direct costs of differentiation include higher-quality inputs, better-

trained employees, higher advertising, and better after-sales service. The indirect costs of

differentiation arise through the interaction of differentiation variables with cost variables. If

differentiation narrows a firm‘s segment scope, it also limits the potential for exploiting scale

economies. If differentiation requires continual product upgrading, it hampers the exploitation of

experience curve economies.

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2.7. BANK PERFORMANCE

Performance can be considered as the degree of accomplishment of the objectives and goals

which an organization‘s resources have been provided (Dittenhoffer, 2001).It is best to measure

performance because it serves as a basis of motivation for an individual or an organization.

Performance measurement is an aspect of management control which indicates the extent to

which corporate strategies and objectives may have been met (Nyabirambi, 2004). Performance

is normally measured to check whether there is need to reinforce action or to diverse alternative

course of action. Traditionally financial performance has been based on the income statement

and balance sheet.

2.8. Performance measures

Pattern and Rosengard (1991) identified six determinants to evaluate the performance of any

financial institution. These include; efficiency, effectiveness, adaptability, personnel, autonomy

and accountability.

Boray and Sierra (1998) were of the view that the key performance indicators of banks include

capital adequacy, credit quality, nominal and real return and profitability, efficiency and spreads

and operating margins and net operating income.

Financial analysts view institutional strength in terms of level of capitalization, quality of assets,

earnings capability as well as ability to meet short term liabilities with minimal constraints or

liquidity. In addition to these quantitative indicators are the equally important qualitative

measures in form of management and internal control practices.

Bar and Siens (1993) use the CAMEL model to measure bank performance. CAMEL measures

performance in regard to capital adequacy, asset quality, management quality, earnings and

liquidity. It should be appreciated that when using the CAMEL model to assess bank‘s

performance the examiners can find ample information from the balance sheet and financial

statement to assess capital adequacy, asset quality, earnings and liquidity. It is however difficult

to determine management quality since no clear-cut measures of management quality emerge

from the financial statement.

The Basle Committee on Banking Supervision of the Bank of International Settlements

(BIS) has recommended using capital adequacy, assets quality, management quality,

Earnings and liquidity (CAMEL) as criteria for assessing a Financial Institution in 1988 (ADB

2002). The sixth component, market risk (S) was added to CAMEL in 1997 (Gilbert, Meyer and

Vaughan 2000). However, most of the developing countries are using CAMEL instead of

CAMELS in the performance evaluation of the FIs. CAMELS‘ framework system looks at six

major aspects of an FI: capital adequacy, asset quality, management soundness, earnings,

liquidity, and sensitivity to market risk In this study the researcher will measure the performance

of commercial banks basing on profitability and also using the CAMEL model.

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2.8.1 Profitability

It is the ability of the bank to earn a profit on the level of income made. Traditionally the

financial performance of banks and other financial institutions has been measured using a

combination of convectional accounting measures of risk and return (Duncan et al 2004).

Dermirguc and Detrigiache (1998) argued that bank performance can be measured using

profitability which is the percentage of net profit before tax to the total income of the bank.

Sadakkadula and Subbaiah (2002), contend that profitability indices are widely accepted and

used by bankers, financial institutions, management, owners and other creditors as they are

interested in knowing whether or not the firm earns a profit on its activities.

2.8.2. Capital adequacy.

Capital adequacy ultimately determines how well FIs can manage with shocks to their balance

sheets. Thus, it tracks capital adequacy ratios that take into account the most important financial

risks—foreign exchange, credit, and interest rate risks—by assigning risk weightings to the

institution's assets. Leverage ratio can be used to measure the capital adequacy of a bank. This is

the ratio of bank's book value of core capital to the book value of its assets. The higher ratio

shows the higher level of capital adequacy. Capital adequacy is a percentage ratio of capital to

risk weighted assets, used to protect depositors and to measure the financial strength and stability

of a bank. This ratio indicates the ability for a bank to absorb any losses by accounting for risky

asset, making the Capital Adequacy Ratio (CAR) advantageous (Uniform Bank Performance

Report Fall 2009). The 1993 Basel Accord enforced the capital ratio to risk adjusted assets of

commercial banks (According to this accord, core capital must equal to or exceed 4 percent of

the risk weighted assets of the commercial banks. Similarly, the amount of the supplementary

capital should not exceed the amount of the core capital and the total capital must equal or

exceed 8 percent of risk weighted assets (Saunders and Cornett 2004).

2.8.3. Asset quality

Asset Quality mainly looks at how good are the bank's loans and advances - this is because credit

risk is one of the key issues that affect the success of a bank. Credit risk is influenced by many

factors including: Loan concentration by industry, borrower, portfolio quality, etc. (ii) Non-

performing advances, (iii) Bad debts, (iv) Loans to related parties, (v) Loan loss provision ratio,

among others[Source: www.bis.org, bou.or.ug accessed on 15 Jan 2009) Credit risk is one of the

factors that affect the health of an individual financial institution. The extent of the credit risk

depends on the quality of assets held by an individual financial institution . The quality of assets

held by a financial institution depends on exposure to specific risks, trends in non-performing

loans, and the health and profitability of bank borrowers—especially the corporate sector. We

can use a number of measures to indicate the quality of assets held by FIs. ADB suggests these

measures—loan concentration by industry, region, borrower and portfolio quality; related party

policies and exposure on outstanding loan, approval process of loan, check and balance of loans;

10

loan loss provision ratio; portfolio in arrear; loan loss ratio; and reserve ratio—of checking the

quality of assets of a financial institution (ADB 2002). Commercial banks have to make 1

percent provision for pass loan/performing loan, 25 percent for substandard loan, 50 percent for

doubtful loan and 100 percent for bad loan (NRB 2005).

2.8.4. Management Quality

Sound management is key to bank performance but is difficult to measure. It is primarily a

qualitative factor applicable to individual institutions. Several indicators, however, can jointly

serve as an indicator of management soundness. Expenses ratio, earning per employee,

cost per loan, average loan size and cost per unit of money lent can be used as a proxy of the

management quality. ADB recommends cost per unit of money lent as a proxy of management

quality. Banks evaluate management quality through Data Envelopment Analysis (DEA)

developed by Charnes et al (1978) to measure the comparative performance of homogeneous

organizations. Wei-Shong and Kuo-Chung contend that banks adopted DEA in the 1990‘s as

the principle method of assessing bank efficiency. Since then DEA has been extensively used by

Bar and Siems (1993) and Siems et al (1993) in measuring management quality in

commercial banks. Bar and Siems (1996) contend that assessing management quality requires

professional judgment of banks compliance to policies and procedures, aptitude of risk taking,

development of strategic plans and the degree of involvement by the bank officers and directors

in making decisions. Management quality is evaluated by assessing the board of directors across

all functions of the bank. Management should identify and control risks through monitoring

procedures and enforcing policies in the bank. The performance of the bank directly reflects the

quality of the management.

2.8.5. Earning Performance

A variety of earnings-quality definitions exist. Teets (2002) states that ―some consider quality of

earnings to encompass the underlying economic performance of a firm, as well as the accounting

standards that report on that underlying phenomenon; others consider quality of earnings to refer

only to how well accounting earnings convey information about the underlying phenomenon.‖

Pratt (2003) defines earnings quality as ―the extent to which net income reported on the income

statement differs from true earnings‖. Penman (2003) indicates that quality of earnings is based

on the quality of forward earnings as well as current reported earnings. Schipper and Vincent

(2003) define earnings quality as ―the extent to which reported earnings faithfully represent

Hicksian income,‖ which includes ―the change in net economic assets other than from

transactions with owners.‖ Earning capacity or profitability keeps up the sound health of an FI.

Chronically unprofitable FI risks insolvency on one hand and on the others, unusually high

profitability can reflect excessive risk taking of an FI. There are different indicators of

profitability. Return on assets, return on equity, interest-spread ratio, earning-spread ratio, gross

margin, operating profit margin and net profit margin are commonly used profitability indicators.

11

2.8.6. Liquidity

It is the ability of an organization to pay its short term debts as they fall due. Liquidity ratio is the

result of dividing liquid assets by current liabilities. On the other hand, liquidity risk is the risk of

the financial institution being unable to meet financial commitments or payments at the right

time, place and in the required currency (Kaufman, 1995). Kasekende and Atingi-Ego (2003)

argue that Ugandan commercial banks keep excess reserves on hand that is sufficient to cover

adverse interbank clearing. This means that commercial banks have to divert a greater proportion

of their loan able funds to accumulated reserves with Bank of Uganda and cash at hand which in

effect earn zero interest rate. Liquidity is essential for a bank because it determines whether the

bank will be able to provide funds for growth. Liquidity analysis determines how easily the bank

can acquire immediate funds through either assets or liabilities. This would involve selling assets

as a first option or increasing the bank‘s liabilities. Although both of these scenarios come with a

cost attached. By selling assets the asset quality will decrease, and by adding liabilities the bank

may add costs depending on the market situation. (Uniform Bank Performance Report Fall 2009)

2.8.7. Sensitivity to Market Risk

Commercial banks are increasingly involved in diversified operations such as lending and

borrowing, transaction in foreign exchange, selling off assets pledged for securities and so on.

All these are subject to market risk like interest rate risk, foreign exchange rate risk, and financial

asset and commodity price risk (Saunders and Cornett 2004). The health of an FI more sensitive

to market risk is more hazardous than that of less sensitive. Foreign exchange risk, interest rate

risk, equity price risk, and commodity price risk are the indicators of sensitivity to market risk.

Sensitivity to market risk is a way to measure how risk changes in the market can affect earnings

or capital. The primary risk most banks are concerned with is the interest rate risk (IRR).

Fluctuations in market interest rates determine how the net interest income varies. The simplest

model to use is the Gap ratio, which measures assets and liabilities reprising within a given

period. (Uniform Bank Performance Report Fall 2009)

2.9. Relationship between product differentiation and performance of commercial banks

The study of bank branching efficiency by Berger, Leusner and Mingo (1997) supports the

notion that the primary roles of branches is to provide high quality service. Bank branching

leads to profit maximization since additional offices provide convenience for the bank customers

that may be recaptured by the bank on the revenue side. Larger branch networks may also serve

as an advertising function. In particular branches are thought to represent the face of the banks to

customers. A large branch network may indeed increase the value of a firm‘s brand separately

from any associated gains in convenience.

Berger (2003) argues that the relevant aspects of technological change include innovations that

reduce costs related to the collection, storage, processing, and transmission of information, as

well as innovations that transform the means by which customers access bank services.

12

Humphery et al. (2006) cite ATMs (automated teller machines), telephone banking, internet

banking, and e-money as being among the significant innovations affecting the banking

distribution system that influence banking performance significantly. Goddard et al. (2007) add

that client relation management systems, bank management technologies, and various other

technologies are among the major changes in internal banking systems that also have exercised a

positive influence on banking performance and profitability. If the process of innovation

continues and new technologies are introduced over time, innovative banks can continue to earn

high profits on the various new or improved products.

A successful innovation generates a proprietary competitive position that bestows on the firm a

competitive advantage and superior performance. Vertical product differentiation results into less

competition, derived from a bank's ability to differentiate its services from those of its rivals

through quality because it helps to provide a more stable banking system. Moreover, the banking

market power generated by investing in quality does not prevent banks from operating efficiently

from a production point of view (Banks and Bank Systems, volume 4, Issue 4, 2009).

The desire by banking organizations to provide convenience to customers may lead to bank

inefficiency. Banks with large branch networks may be inefficient from the perspective of

minimizing costs, they may be effective at generating revenue, Berger et al. (1997) implying that

horizontal product differentiation through the opening of branches leads to an increase in the

bank‘s earning capacity.

By differentiating banking products and services, a bank gains competitive strength over other

banks and also attracts many customers. Through the attraction of many customers a bank is able

to increase its customers‘ deposits which in turn will positively influence its performance.

Conclusion

Grossman and Shapiro (1984) consider differentiated products, a duopoly framework in which

consumers are unaware of the existence of either product but through firms' advertising

consumers are informed of their existence. By differentiating banking products and services, a

bank gains competitive strength over other banks and also attracts many customers. Through the

attraction of many customers a bank is able to increase its customers‘ deposits which in turn will

positively influence its performance. However, product differentiation as a strategy to improve

performance of commercial banks in Uganda has not been fully undertaken by banks and this has

in a big way contributed to the poor financial performance of the commercial banks.

However most authors have shown the existence of a negative relationship. Boot and Thakor

(1997) find that in a system of full service banks, financial innovation is lower than the

innovation in a financial system where commercial banks and investment banks are functionally

separated. They conclude that the natural tendency of a full-service bank is to innovate less. The

model of Kanatas and Qi (2003) is based on the fact that it is the size of savings (low

informational cost and economy of scale and scope) which prompts a bank to integrate credit and

issue and which reduces innovation in the industry where financial services are integrated.

13

Furthermore, the literature has suggested that diversified businesses suffer from serious agency

costs related to investments in innovations which discourage managers from getting involved in

innovation. It is therefore because of the stated reasons that the researcher has found it profound

to investigate further the level of product differentiation and performance of commercial banks

in Uganda.

14

CHAPTER THREE: METHODOLOGY

3.0 Introduction

In this chapter an attempt was made to present descriptive information on research design,

population and sample selection techniques, source and data collection, instruments, data

processing and analysis and anticipated limitation of the study.

3.1 Research design

Descriptive research design and analytical research design were used to help the researcher

analyze the data obtained into frequency counts and percentages.

3.2 Study population

The study population consisted of the clients and the staff of DFCU bank. The study will target

about 100 respondents who included the clients, managers, auditors and the other general staff at

DFCU bank.

3.3 Sample size.

Within the population, a sample of 30 respondents was selected as a representative of the whole

population. The sample was composed of 5 managers, 2 auditors, 3 accountants, 6 tellers, 4

consumer consultants and 10 clients of the bank

3.3 Sampling methods.

In undertaking the research purposive sampling method was used for selecting a sample for the

study.

3.4 Data Collection

Both primary and secondary data were be used.

3.4.1. Primary data source.

This refers to the raw facts collected or generated for a given research. It is gathered originally

for the first time for a specific research problem. Primary data is obtained using different

methods such as use of interviews, questionnaires, observation, experimentation and

participation. In this study, primary data will be gathered through use of interviews and

questionnaires.

15

3.4.2. Secondary data source

Secondary data refers to that data which already exists prepared or developed for some purpose

other than to solve the problem at hand. It is data that has already been assembled. The

researcher will make use of information obtained from journals, internet and text books.

3.5 Data collection instruments

3.5.1 Questionnaires

The questionnaire was the main instrument used in the study. The questionnaire was used to

collect primary data from the respondents. It was designed as set of formalized close ended

questions which were later be analyzed to provide results necessary for solving the research

problem.

3.6 Data processing, analysis and presentation.

Data processing involved a series of activities ranging from editing, coding and tabulation.

Editing was undertaken by the researcher at the end of data collection so as to detect and

eliminate errors. This was to ensure data accuracy and consistence to facilitate proper coding and

tabulation. Coding involved classifying the answers obtained from the questionnaires and

interviews into meaningful categories. Tabulation involved the processing, summarizing of the

raw data and displaying the same data in compact form by the use of tables, pie charts and

graphs to bring out relevant conclusions. After data had been processed, it was analyzed using

tables and frequency tables. Excel computer program was used for analysis and in order to

simplify the analysis, percentage values were used. Data was presented using frequency tables.

These presentations helped in the interpretation of the obtained data based on the diagrams. In

the analysis of the relationship between product differentiation and performance of commercial

banks, the statistical package for social scientists (SPSS) was used.

3.7. Limitation of the study.

The researcher faced non-responses on some of the questionnaires as some of the

respondents were reluctant to give relevant information.

Time also posed a challenge to the researcher while carrying out this study. Time on the

side of the researcher was limited bearing in mind that exams were underway. However,

a well scheduled timetable was used to make use of the available time.

The researcher incurred a lot of expenses while undertaking the research in terms of

transport costs and report production costs.

16

CHAPTER FOUR: PRESENTATION, ANALYSIS AND INTERPRETATION OF THE

FINDINGS.

4.0. Introduction.

The major objective of the study was to evaluate the impact of product differentiation on the

performance of commercial banks. This chapter deals with the presentation, analysis and

interpretation of the findings in line with the research objectives which are; to establish level of

product differentiation in DFCU Bank, establish the level of performance of DFCU Bank and to

determine the relationship between product differentiation and performance of commercial

banks. The researcher had a target of 30 respondents but only 25 0f the questionnaires

admistered were returned. This represented 83% of the respondents hence the analysis was done

using the 25 questionnaires received from the respondents.

4.1. Demographic characteristics of the respondents.

Demographic characteristics of the respondents is addressed in this section and it contains

information on gender, age, education level, level of qualification and number of years the

respondent has been in the organization.

Table 1: Showing gender of the respondents

Gender Frequency Percentage

Male 11 44%

Female 14 56%

Total 25 100%

Source; primary data

As shown in the table above the female respondents constituted 56% of the total number of

respondents who responded while the male respondents stood at 44% of the total.

Table 2: showing age of respondents

Age bracket Frequency Percentage

20-30 years 10 40%

31-40 years 7 28%

41-50years 5 20%

Above 50 years 3 12%

Total 25 100%


17

From the table above, it is evident that most of the respondents lie in the age bracket of 20-30

years represented by 40% of the total ,28% are in the age bracket of 31-40 years, 20% in the age

bracket of 41-50 years and 12% lie in the age bracket of above 50 years.

Table 3: showing education level of respondents

Education level Frequency Percentage

A –levels‘ - -

Certificate 1 4%

Diploma 4 16%

Bachelors‘ degree 14 56%

Masters‘ degree 6 24%

Total 25 100%

Source: primary data

The findings revealed that most of the respondents (56%) had achieved a Bachelors‘ degree, with

24% having masters‘ degree and 4%, 16% with certificates and diplomas respectively. This

therefore indicates that the respondents are highly knowledgeable.

Table 4: showing position of respondents

Position Frequency Percentage

Managers 4 16%

Auditors 2 8%

Accountants 3 12%

Tellers 6 24%

Customer consultants 4 16%

Clients 6 24%

Total 25 100%


The above table indicates that of the positions held by the respondents consisted of managers-

16%, auditors-8%, accountants-12%, tellers-24%, consumer consultants-16% and clients made

up the remaining 24% of the total. This therefore indicated that the respondents were well

distributed to ensure proper generation of information.

4.2. Product differentiation in DFCU bank

This section is in line with the fist objective aimed at establishing the level of product

differentiation in DFCU bank. The researcher wanted to determine whether the bank has

introduced new products and improved the quality of the existing products and also to find out if

the bank has opened other branches across the country.

18

Table 5: showing whether new products have been introduced.

Response Frequency Percentage

Strongly agree 15 60%

Agree 9 36%

Not certain 1 4%

Disagree - -

Strongly disagree - -

Total 25 100%


As indicated in the table above 60% of the respondents strongly agreed to the view that DFCU

bank has introduced new products and improved the existing ones.36% of the respondents agreed

while 4% were not certain most likely because they were not well informed about the products

being offered at present by the bank. However in the view of the majority 60%,the bank has put a

lot of effort to introduce other products.

Table 6: Showing whether the bank has improved the quality of its products



Agree 14 56%

Not certain 3 12%

Disagree - -


Total 25 100%


In the table above, the researcher wanted to find out whether DFCU bank has improved on the

quality of the products that it had been offering over the years. The findings indicated that out of

the total number of respondents, 32% strongly agreed, 56% agreed, and 12% were not certain. It

is therefore evident from the responses obtained that the bank has improved on the quality of its

existing products enabling the bank to satisfy the needs of its customers.

19

Table 7: finding out whether the bank has other networks country wide



Agree 4 16%

Not certain 3 12%

Disagree 1 4%


Total 25 100%


Table above shows the responses obtained while the researcher was trying to find out if the bank

has opened other branches country wide.68% strongly agreed,16% agreed, 12% were not sure

while the remaining 4% of the respondents disagreed. It is therefore evident that DFCU bank has

opened other branches in other parts of the country based on majority of the respondents. Also

given that 4% of the respondents disagreed, this can indicate that though the bank has opened

several branches in various parts of the country it has not yet fully covered the entire country.

Table 8: finding out whether new branches enhance competition



Agree 12 48%

Not certain 4 16%

Disagree 1 4%


Total 25 100%


Findings in the table above revealed that 32% strongly agreed, 48% agreed, 16% were not

certain and that 4% disagreed on the idea of banks opening new branches with the aim to

enhance competition .From the above responses it is evident that through the opening of

numerous branches in various location DFCU Bank has been able to compete with other banks..

20

Table 9: finding out whether customer satisfaction is achieved through introduction of new

products



Agree 9 36%

Not certain 3 12%

Disagree 2 8%


Total 25 100%


From the table above, 44% strongly agreed, 36% agreed, 12% were not certain and the other 8%

disagreed. The findings above indicate that through introduction of new products by the bank,

customer satisfaction has been achieved.

Table 10: finding out whether unique products create a competitive edge



Agree 10 40%

Not certain 5 20%

Disagree 1 4%


Total 25 100%


From the table above, the responses from the various respondents (36% who strongly agreed and

40% who agreed) indicate that the existence of unique products in DFCU Bank in comparison to

other banks has enabled the bank to gain a competitive edge in the banking industry. However,

4% of the respondents disagreed and the other respondents represented by a proportion of 20%

of the total respondents were not certain about the effect of unique products on the bank's

competitive edge.

21

Table 11: showing whether with improved quality products the bank can charge higher

prices



Agree 5 20%

Not certain 3 12%

Disagree 2 8%

Strongly disagree 1 4%

Total 25 100%


From the table above it is evident that most of the respondents were of the view that

improvement in product quality encourages a bank to charge higher prices for its products

because with improved quality products clients will demand more of those products so as to meet

their financial needs.

Table 12: showing whether increase in core deposits has led to growth of the bank's

branches



Agree 8 32%

Not certain 5 20%

Disagree 1 4%


Total 25 100%


From the table above, it is evident that DFCU bank owes the growth of its branches in various

parts of the country to the increase in the core deposits as indicated by the findings where 44% of

the respondents strongly agreed, 32% agreed, 20% were not certain and another 4% disagreed.

The findings therefore reveal that increase in core deposits encourages a bank to open other

branches so as to be able to manage the growing number of customers.

4.3. Level of performance in DFCU bank.

This section is in line with objective two aimed at establishing the level of performance of DFCU

bank. The researcher conducted the survey with the aim of finding out the level of performance

based on the bank‘s profitability level, capital adequacy, asset quality, management, earnings

quality and liquidity.

22

Table 13: showing whether the bank has good internal cash controls and accounting

processes to ensure liquidity



Agree 10 40%

Not certain 6 24%

Disagree 2 8%


Total 25 100%


The table above indicates the responses obtained by the researcher while trying to find out

whether the bank has good internal cash controls to ensure good liquidity level of the bank. From

the findings, 28% strongly agreed, 40% agreed, 24% were not certain while 8% of the

respondents disagreed. It is therefore evident that the bank to a high extent maintained a high

level of liquidity given the existence of good cash controls and accounting policies.

Table 14: showing whether the bank has adequate loan and investment policies, procedures and

practices



Agree 7 28%

Not certain 5 20%

Disagree 1 4%


Total 25 100%


The findings in the table above indicate that among the respondents, 48% strongly agreed, 28%

agreed, 20% were not certain and that 4%disagreed. From the findings it is correct to say that

the bank has put in place adequate loan and investment policies thus being in a position to

control the occurrence of nonperforming loans leading to a favorable level of asset quality

Table 15: showing whether DFCU's capital level is sufficient in relation to the bank's risk profile



Agree 9 36%

Not certain 4 16%

Disagree 2 8%


Total 25 100%


23

In the above table, 40% strongly agreed, 36% agreed, 16 % of the respondents were not certain

while 8% disagreed. From the findings in the table above, it is evident that the DFCU bank has a

sufficient level of capital thus the bank can account for any risky assets.

Table 16: showing whether the bank's liquidity is adequate to cover short term obligations



Agree 11 44%

Not certain 4 16%

Disagree 1 4%


Total 25 100%


From the above table, 28% strongly agreed, 44% agreed, 16% were not certain, 4% disagreed

while the other remaining 8% strongly disagreed. The findings above are an indication that the

bank has a high level of liquidity which enables it to meet its short term obligations as they fall

due.

Table 17: showing whether the bank annually pays dividends to shareholders



Agree 15 60%

Not certain 2 8%

Disagree 1 4%


Total 25 100%


Findings shown in the table above indicate that the bank usually pay annual dividends to its

shareholders. This has been determined from the responses obtained showing that 28% strongly

agreed, 60% agreed, 8% were not certain and 4%disagreed.from the findings it is evident that

DFCU bank has high level of earnings that facilitate the payment of dividends annually.

24

Table 18: showing whether DFCU bank holds a loan loss reserve to help cover losses

arising out of borrower defaults.



Agree 8 32%

Not certain 6 24%

Disagree 4 16%


Total 25 100%


The findings in the table above indicate that 20% of the respondents strongly agreed, 32%

agreed, 24% were not certain, 16% disagreed and the remaining 8% strongly disagreed. It is

evident that the bank‘s loan loss reserve is not very efficient thus it does not fully cover the

losses arising from borrower defaults thus leading to increase in nonperforming loans.

Table 19: showing whether the bank transfers part of its net profits to reserves



Agree 10 40%

Not certain 5 20%

Disagree 3 12%


Total 25 100%


In the table shown above, 28% of the respondents strongly agreed, 40% agreed, 20% were not

sure and other 12% disagreed. From the findings, given the majority of the respondents who

agreed it is evident that the bank usually transfers part of its net profits to its reserves which are a

good reflection of high earnings and high level of profitability.

Table 20: showing whether non performing loans in DFCU bank have been increasing


Strongly agree - -

Agree 5 20%

Not certain 2 8%

Disagree 11 44%


Total 25 100%

25


In the table above, 20% of the respondents agreed, 8% were not certain, 44% disagreed and the

remaining 28% strongly disagreed. The findings therefore indicate that DFCU bank has been

trying to reduce the occurrence of non performing loans though a number of the respondents still

were of the view that the bank‘s nonperforming loans were still increasing.

4.4: Relationship between product differentiation and performance of commercial banks.

This part is in line with objective three of the study which is to establish the relationship between

product differentiation and performance of commercial banks. The researcher sought to find out

how improvement in quality of the bank‘s products and introduction of new products by the bank

affected the performance of the bank.

Correlation

Product

differentiation

Performance of

commercial banks

Product differentiation Pearson Correlation 1 .405(*)

Sig. (2-tailed) . .045

N 25 25

Performance of

commercial bank

Pearson Correlation .405(*) 1

Sig. (2-tailed) .045 .

N 25 25

* Correlation is significant at the 0.05 level (2-tailed). Source: statistical package for social

scientist (SPSS) output.

The correlation table above indicates the Pearson‘s correlation of product differentiation and

performance of commercial banks which is r=0.405

The result revealed a weak positive relationship between product differentiation and performance

of commercial banks that is 0.405. This indicates a moderate relationship between product

differentiation and performance of commercial banks.

The above results reveal that through introduction of unique products and opening of several

branches can lead to improvement in the performance of banks.

26

CHAPTER FIVE :SUMMARY OF FINDINGS, CONCLUSION AND

RECOMMENDATIONS.

5.0. Introduction

The purpose of this study was to examine the effect of product differentiation (opening of new

branches and introduction of new products distinct from those of other banks) on the

performance of DFCU bank. This part addresses itself to presenting a summary of the findings,

conclusion and recommendations for the study.

5.1. Summary of the findings.

5.1.1. Summary of findings on product differentiation

It was also noted that from the introduction of new products, DFCU bank has been able to meet

the needs of its customers since through vertical product differentiation the bank has introduced

high quality products and services distinct from those offered by other banks. The bank has also

advanced technologically and this has been realized through the opening up of ATMs which has

increased the convenience of withdrawal of money to its customers. Also with the introduction

of the Women in Business (WiB) loan, DFCU bank has in a great way assisted the women

entrepreneurs to boost their businesses. From the findings, it was evident that DFCU bank

charges a lower rate of interest on loans. This has attracted many of its customers in acquiring

loans with the bank since it is not expensive

Also with the improvement in the quality of its products an introduction of other new products,

the bank has increased the number of its clients and given the high quality of its products the

bank has had the advantage of increasing the prices of its products thus increasing its level of

earnings and still maintaining its customers who are driven by quality

The findings also indicated that DFCU bank has opened a number of branches country wide.

This has enabled the bank to increase on its customer base thus making the bank be in a position

to compete effectively with other banks. Also with the opening of new branches, the bank has

been able to reach to its customers thus ensuring banking convenience.

.

.

27

5.1.2. Summary of findings on bank performance.

The study indicates that the bank has high level of liquidity and therefore it is usually in a

position to meet its short term obligations as they fall due. The high liquidity level of the bank

has been achieved as a result of the bank having good internal cash controls and accounting

processes.

The findings also indicated that DFCU bank has favorable asset quality given that the bank has

put in place adequate loan and investments policies, procedures and practices. The bank is

therefore in a position to control the occurrence of nonperforming loans through reviewing of

loan agreements.

In relation to capital adequacy maintained by the bank, the findings indicated that DFCU bank

has a sufficient level of capital and thus the bank is able to account for its risky assets.

The findings also indicated that DFCU bank ‗s earning quality is high given that the bank is

usually in a position to annually pay dividends to its shareholders.

5.1.3. Summary of findings on the relationship between product differentiation and

performance of commercial banks.

The researcher used Pearson‘s correlation coefficient to find the relationship between product

differentiation and performance of commercial banks and the finding revealed a positive

relationship of 0.405 between the two variables. This shows a weak positive relationship

between product differentiation and performance of commercial banks.

5.2. Conclusion.

From the responses obtained from the respondents, found out that the bank has taken up product

differentiation as a strategy to help the bank improve on its performance. This has been achieved

through the opening of other branches in other locations and also through the introduction of

unique, new products and also through the improvement in quality of the existing products.

Majority of the respondents indicated that the bank‘s performance was high through gauging the

bank‘s performance in terms of profitability, capital adequacy, asset quality, management

quality, earnings and the level of liquidity. However, the existence of non performing loans was

indicates as a great hindrance the bank‘s performance.

The findings indicated a positive relationship between product differentiation and the

performance of commercial banks with a positive correlation of the two variables at 0.405.

5.3. Recommendations

Basing on the findings and conclusions obtained during study the following recommendations

were proposed:

28

i. The marketing department at DFCU bank should carry out more survey to ensure that its

products are designed in such a way that they meet the needs of its customers.

ii. In a bid to gain even a higher market share the bank should open other branches in other

countries.

iii. The bank should also add on the number of ATMs available so as to ensure convenience

of withdrawal to its customers.

iv. Recording of transactions in books of accounts should be immediate after any transaction

takes place. This will avoid a scenario where other transactions are unrecorded, leading to

occurrence of nonperforming loans.

v. The bank should also improve on its credit policy measures to ensure that it gives loans to

credit worth customers thus avoiding incidences of loan defaults by customers.

vi. The bank should uphold and maintain proper accounting standards.

vii. The accountants and the auditors and other members of staff should uphold high levels of

integrity and accountability.

5.4 Areas of further research

Product differentiation and customer satisfaction..

Credit policy management and performance of commercial banks.

Corporate governance and performance of commercial banks.

29

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32

QUESTIONNAIRE

Dear Respondents,

The researcher a Makerere University undertaking a research on ―Product differentiation and

performance of commercial banks‖ using DFCU Bank as the case study. Being knowledgeable

in this field, I humbly request you to fill in this questionnaire. This study is for academic

purposes and is being carried out as a partial requirement for the award of the degree of

Bachelor of Commerce. Your responses will be treated with utmost confidentiality and your

cooperation will be highly appreciated.

(Please fill in where appropriate and tick where applicable)

PART 1. GENERAL INFORMATION

A) Personal information

1. Gender

Male Female

2. Age of respondents

20-30 years 40-50 years

30-40 years Over 50 years

Any other

3. Level of education

A‘ Levels Certificate

Diploma Degree

Masters degree

4. How long have you have been in this organization?

Under 5 years

5-10 years

Over 10 years

5. position of respondents

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Manager Teller

Auditor Consumer consultant

Accountant Client

PART 2.PRODUCT DIFFERENTIATION

Tick the appropriate alternative option

1. DFCU bank has introduced new products and improved on its existing products.

Strongly Agree Agree Not Sure Disagree Strongly Disagree

2. Women in Business loan offered at DFCU bank has benefited many women entrepreneurs.


3. DFCU bank has opened a number of branches across the country.


4. By opening more branches the bank has been able to compete more effectively with other

banks.


5. Customer satisfaction has been achieved with the introduction of new unique products.


6. Introduction of unique products by DFCU Bank has enabled it to compete effectively in the

banking industry.

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7. With improved product quality a bank can charge higher prices for the services and products it

offers.


8. Increase in the core deposits has led to the increased growth of the bank's branches.


9. DFCU bank charges lower interest rates on loans extended to its customers.


PART 3. BANK PERFORMANCE.

1. DFCU bank annually pays dividends to shareholders


2. DFCU bank's capital level is sufficient in relation to the bank‘s risk profile


3. DFCU bank's high market power has contributed to increased returns.


4. Loan loss reserve held by DFCU bank helps it cover losses arising out of borrowers defaults.

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5. Non performing loans have greatly hindered the performance of DFCU bank.


6. Book keeping inconveniencies in bank leads to the existence of non performing loans.


7. Customer defaults on loans have increased the level of non performing loans.


8. Adequate level of capital at DFCU bank has ensured the bank's financial strength and stability.


9. DFCU bank has been in a position to keep its credit risk in check.


10. Earning capacity is a performance measure used by DFCU bank to define its financial health.


11. DFCU bank has a adequate loan and investment policies, procedures and practices


12. DFCU bank's reported earnings reflect the company's true earnings.

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13. The liquidity level of DFCU bank is good enough to enable the bank to pay its short term

obligations as they fall due.


14. DFCU bank has good internal cash controls and accounting processes.


15. The bank always transfers part of the net profits to reserves


PART 4. Relationship between product differentiation and performance of commercial banks.

Provision of high quality products influences the performance of commercial banks.


Product differentiation is a source of competitive advantage to banks thus improving its

performance.


Opening of new branches improves the performance of commercial banks.


4. New bank branches encourage provision of high quality services by commercial bank.

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5. DFCU bank‘s profitability has been maximized through the opening of many branches across

the country since it is convenient to customers.


6. Setting up of new branches across the country, has resulted to a higher market share for DFCU

bank.


7. DFCU bank offers favorable interest rates thus attracting many customers which results into

high performance.


8. Through adoption of new technological advances like the introduction of ATMs by DFCU

bank has led reduction in costs thus improved performance by the bank.


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INTRODUCTORY LETTER

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