Strengthening the Core

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1 Strengthening the Core A Practical Approach to Increasing Checking Account and Debit Card Profitability in a Rebounding Economy By Ben Colvin Profit from Our Perspective

2 Strengthening the Core As the world slowly emerges from the recent downturn in the economy, banks and credit unions should take proactive steps to keep their customers satisfied and loyal. Regardless of the economic times, attracting a new customer is more expensive than getting increased revenues from an existing one, 1 and the cost return ratio is even more exorbitant at the moment. The best way, then, to drive net account growth and gain wallet share is to focus on those current customers with potential to contribute strongly to your institution s bottom line. The fact is that consumers are spending less and shopping smarter in response to a new era of thrift. As customers move to obtain work, or the housing market begins to rebound, customers seeking mortgages may move their business creating a potential attrition risk. So, managing business the same old way won t be successful in the new world. It is critical that financial institutions understand how consumer spending behaviors and attitudes have changed and determine the value of their customer relationships so that they can increase both customer satisfaction and, in turn, profitability.

3 Who is the new customer? Not surprisingly, consumers are spending less on discretionary items like furniture while continuing to spend on nondiscretionary items like groceries and auto repairs. 1 And there is a significant shift towards online purchasing. Accompanying these behavioral shifts is a migration of customer sentiment toward frugality, as evidenced by the four observations below. Consumers are: 1. Finding creative and less costly way to entertain themselves, like playing games, and renting movies. 2. Demanding greater control over their lives, especially their finances, e.g. by using online budgeting tools and even seeking financial counseling. 3. Focusing more on quality and value. Being a smart shopper is the new status symbol. 4. Demonstrating a new resourcefulness in spending increasing their use of coupons, asking for discounts, etc. What is the value of your customers relationship? Accurately understanding each customer s lifetime value requires a holistic perspective: 1. Looking at the full range of products that a customer uses. 2. Measuring the level of customer engagement. 3. Forecasting the lifespan of each relationship. This article is aimed at showing financial institutions a practical approach to achieving a symbiotic state in which customer satisfaction is increased and net Figure 1: How Payments Optimization Can Impact Multiple Retail Revenue Streams Retail Financial Institution Revenue CROSS-SALES REVENUE Credit Cards Mortgages Consumer Loans Long-term Savings DDA Accounts: Checking and Saving % of Total Retail Bank Revenue account growth is generated through improved account retention and deepened customers relationships. It all begins at the core The demand deposit account (DDA) is at the core of the relationship between financial institutions and their customers, driving cross-sell opportunities for other financial products. Figure 1 demonstrates the sizable portion of financial institution revenue in the U.S. that is derived from the DDA. In addition, if a financial institution can persuade customers to shift their behavior to use their debit cards at the point-of-sale instead of using cash, they may see a direct boost in revenues as a result of increased fees from transactions and incremental net interest income % of DDA Accounts Revenue Debit Card Revenues Net Interest Income 5% Fees and Other Income Sources: U.S. Retail Bank Revenue Federal Reserve Bulletin, profits and balance sheet developments at U.S. commercial banks in 2007, June Customers who stop withdrawing large amounts of cash at the beginning of each week, and instead increase their debit card usage may increase the average daily balance in their DDAs, which generates higher net interest income for the institution. When this pattern of more profitable behavior is spread across the whole customer base, the bottom-line impact can be multiplied by the thousands, and the financial institution can acquire an additional source of low-cost funds for its lending business. 1 Emmett C. Murphy and Mark A. Murphy, Leading on the Edge of Chaos, STRENGTHENING THE CORE 3

4 Changes in banking behavior People are more anxious about the security of their financial assets, and in some cases where they have their money deposited. Their financial concerns, coupled with the government s temporary boost in FDIC and NCUA deposit insurance to $250,000 per account from the previous $100,000, have attributed to the significant rise in financial institution assets. Credit unions and the smaller independent banks have an advantage to continue to attract these deposits (and new customers) because of the perception by consumers that these institutions are more financially secure institutions. Changing attitudes and needs create ample opportunity for FIs to implement strategies that engage current customers and address their new spending behaviors and attitudes with the right products and offers to generate incremental revenues from the most promising segments. Understanding your customers level of engagement with your institution By analyzing customer transaction activity and payment preferences, financial institutions can segment customers according to the number and combination of products and services they use as well as identify the behavioral paths most likely to lead to either a deeper relationship through cross-sell on one hand or attrition on the other. We recommend a twopronged segmentation approach: 1. Look at how customers use their checking accounts; 2. Then, look at how they currently spend their funds. The first type of analysis measures basic account usage, such as checking account debits, credits, and average balances to track the level of customer engagement discerning those who are utilizing their checking account as their primary account from those who are not. Primary customers are those with longestablished relations with the financial institution, more liquid assets, and more frequent transactions compared to the average customer. Primary customers may also use direct deposit; bank at a branch in close proximity to home or office; have a mortgage or other loans; and hold investments with the financial institution. Non-primary customers are all those customers who don t regard the financial institution as their primary financial institution of choice. They usually fall into one of the following categories: Savers are those who use their accounts primarily to keep funds, not to transact. Convenience users are those with accounts held for pensions or salary deposits, characterized by large withdrawal amounts either one time or regular. Secondary users are those using their accounts for specific, limited purposes, such as bill payments, or those who have downgraded from a primary account because of dissatisfaction stemming from such factors as bad service or increased costs. None of these segments is unprofitable by nature, but Savers who park considerable funds in their accounts for long periods may be more profitable than Primary customers who require high levels of service. The old 80/20 rule usually applies: An accurate assessment of customer engagement helps financial institutions make more informed investments in customer segments. Segmenting for retention and growth Once financial institutions understand their customer relationships, they can identify important customer payment behaviors such as spending at pointof-sale, check-writing, direct debits, ACH transactions, ATM withdrawals, and so on and use the data to track deposit and payment preferences. These preferences Figure 2: Why Debit Cardholders Become Dissatisfied 26% 18% 28% 28% Non-existent rewards program Overdraft fees ATM surcharge fees Poor rewards program Reasons for dissatisfaction with their debit issuer. Source: MasterCard Advisors, Comparative Cardholders Dynamics, Debit and Payment Choices Study, inform further sub-segments such as cash dependents, branch lovers, ATM users, transactors, and low or high debit card users. These sub-segments inform the development of and marketing of more tailored products and services. Once a financial institution has gained in-depth knowledge of its customers attitudes, behaviors, and preferences, it can turn that knowledge into actionable marketing strategies. By determining which changes in behavior are most desirable and worth the investment of time and capital, institutions can be more certain to achieve the greatest return on their marketing efforts. Here are three coordinated strategies we recommend to deepen debit cardholders relationships and motivate more profitable behaviors: 4 MASTERCARD ADVISORS

5 strategy one Cultivating Customer Relationships Strengthening and cultivating customer relationships requires ongoing effort at each point of interaction. Such efforts must become habitual part of business as usual and not a random, last-resort strategy in response to customer complaints. Retain existing customers. The first step is to review the existing customer experience as well as your anti-attrition and retention strategies, processes, and performance metrics. Among the common solutions to improving retention: Employ models to monitor changes in spending behavior, a drop in POS transactions or an increase in outflow balances to detect early indicators of attrition and take preventative measures. Put a Quality Assurance team in place to identify issues and anomalies in customer relationship management procedures and policies, and empower this team to make recommendations to senior management and stakeholders across the organization. Make use of a specialized retention unit that is trained to manage disputes and service problems. Consider developing a rewards program if one is not in place. With consumers more focused on necessities than luxuries, drive spending on debit with restructured rewards programs that enable consumers to earn smaller rewards sooner like movie tickets. A down economy is the perfect time to use rewards to help consumers stretch their budgets further. Proactively score and offer an overdraft line of credit to customers who experience frequent overdraft fees, or include an application for an overdraft line of credit in overdraft notices. Customers using another financial institution s ATMs should be provided easy ways to locate your own ATMs; MasterCard s online ATM Locator, now available on Apple iphones and BlackBerries, lets financial institution embed offers in the location information to prompt customers to in-store promotions at merchant partners. Addressing attrition risk through these strategies does not have to be complex and all of these strategies do not have to be executed to meet with success. Even if you can only put into effect one of these strategies, such as a specialized retention unit trained to manage disputes, you may see a 25% improvement in retaining those customers at risk of closing their account where the closure was within the financial institution s control. Typically, the primary reason customers close their deposit relationship (other than moving outside the branch footprint) is due to a customer service issue or pricing. Encourage Convenience customers to increase usage. Salary mandates or direct deposits typically produce one large monthly deposit to the checking account and an equally large monthly withdrawal or transfer. Financial institutions can employ a variety of tactics to further engage such customers. For example, an estimated 1.5 million customers opened new savings accounts when Bank of America (BoA) launched its Keep the Change program. 2 Consumers embraced this simple savings program, which transferred the change from a debit purchase to a customers savings account. With every debit card purchase, the customer was also making small, incremental transfers to their savings account, which might easily add up to $500 or more in savings in a year. 3 Programs that help consumers save in this economy could be very popular and demonstrates that their bank or credit union is trying to help them. As mentioned earlier, the smart shopper is the new status symbol, so making programs available that deliver value through savings is the right move now. Make a compelling offer to Secondary users. Customers who use their checking accounts for only limited purposes need some compelling reason to increase their business. Using the segmentation model described in this article can help a financial institution gain better understanding of Secondary users payments needs, attitudes, and behaviors. Based on these insights, you can design relevant offers from savings accounts for parents of children bound for university to small business accounts rewarding business owners for their debit card spending through promotions. Each customer is unique, and segmentation is the key to finding the right value proposition for each. 2 Bank of America, Press Release August 28, TowerGroup, Brian Riley, Just Rewards: Adapting Credit Card Loyalty Feature to a Debit Card World, June STRENGTHENING THE CORE 5

6 strategy two Up-Selling and Cross-Selling Leverage the current account by migrating valuable customers to the products and services that are most relevant to them. Customer needs and desires change over time as customers experience different life stage events. Financial institutions that respond to these changing needs with relevant product offerings increase the potential for customer satisfaction and engagement at each stop along the engagement continuum. For example, you should periodically evaluate customers who consistently maintain higher balances in entry-level checking accounts. If your financial institution offers a higher-tiered relationship product with better services, proactively offer to upgrade them. For customers who accept such an upgrade, quickly follow-up with a cross-sell offer to ensure that they continue to maintain and grow their checking accounts balances as required for that higher-level product. Savers may have limited migration potential. While a more effective savings product may attract increased deposits, the financial institution may find that optimization of this segment is more likely to come from growth in net interest income or through increased or retained balances than from any new product offerings. Depending on the customer s age and estimated wealth, a Saver may turn out to be an affluent customer trying to diversify his or her portfolio. One common tip-off: the customer in question does not have or use a debit card because they don t Figure 3: Cross-Sales to Customer Segments Moves Them Up the Value Chain feel the need to. Alternatively, a customer may simply regard the account in question as a piggy bank. Such customers often welcome financial planning and retirement advice from an in-branch advisor. Offering them liquidity solutions to help manage their affairs can often lead to increased deposits and growth in net interest income. Find the sweet spot for Primary users. The secret to cross-selling customers who already are frequent users of their current accounts is determining what drives their engagement with your financial institution. For budget-minded consumers who spend primarily on essentials, merchant discounts on everyday products may be compelling. For the more affluent household, rewards offering unique experiences may be the strongest motivator. Configuring the right offer and the right marketing message for each customer segment will help expand your customer relationships and stimulate profitable payments behaviors without adding unnecessary expense or complication to your communications efforts. CUSTOMER SEGMENTS Primary Convenience Secondary Savers MIGRATION PATH TO INCREASED VALUE AND ACCOUNT ENGAGEMENT, Debit Cards Credit Cards Potential For Customer Adoption Personal Loans Auto Loans Mortgage Investment Account Stimulate recurring payments. Online bill pay and recurring payments have been shown to increase spend and loyalty. A bank may reward the debit cardholder who signs up for recurring payments in such categories as telecommunications, insurance, utilities, and satellite/cable/tv, by offering a credit on their next statement. MasterCard has seen a lift in overall card spend whenever cardholders use debit cards for recurring payments or set up recurring payments through a merchant. Debit cardholders who use their debit card to make recurring payments also spend 36% more with their debit cards than those who don t, and they also are much less likely to stop using their cards in the future (6% vs. 11%). 4 Best Worst Source: TowerGroup, MasterCard Advisors 4 MasterCard Advisors, Comparative Cardholder Dynamics: Debit and Payment Choices, MASTERCARD ADVISORS

7 strategy three Driving Desired Changes in Payments Behavior Because debit cards can be a key contributor to the financial institution overall performance as discussed earlier, it is important to ensure that customers continue to utilize and value the convenience it provides. Increase customer debit card usage. Another way to deepen engagement is to understand customer preferences for POS, cash, and branch transactions and then use that understanding to help increase debit card usage. In building the business case, it s important to consider the broader benefits of debit cards, such as increased balances, improved retention, and cost reductions from switching from more costly ATM, cash, check, and branch transactions. Position the debit card as the smart way to pay. Those accustomed to spending cash or who make few debit card purchases may respond to well-crafted educational messages and incentives that encourage debit card usage. During this time of economic uncertainty, financial institutions may want to capture as much non-discretionary spend as possible by promoting debit cards as a better way to control spending and stay within budget and emphasizing their convenience over making multiple trips to the ATM for cash. Encourage debit usage through loyalty or rewards programs. Customers averaging just a few transactions per month might be offered promotions or rewards with specific merchants in exchange for increasing their card usage to five times per month, for example propensity models can help identify which offers may appeal to certain debit-inactive cardholders. Cardholders can then be invited to use their debit cards for eligible purchases in order to qualify for a reward. By making a $15 debit card purchase in a participating department or hardware store, for example, the cardholder might qualify for a $10 gift card, with further purchases qualifying for additional gifts. MasterCard has seen such programs resulting in 1.5 to 5 percent opt-in rates, with spending lift of up to 60 percent (over control) and a spending increase of 15.5 percent (over control) for customers who received the offer but did not opt in. Seeing the big picture leads to lifetime customer value Over the past two years, economic uncertainty and growing solvency concerns may have presented an opportunity for independent banks and credit unions as consumers have changed what they want from their financial institution. And the historical drivers of account switching a new job or new home although less relevant today, will at some point along the path of economic recovery, present both an opportunity (new account acquisition) and a risk (account attrition). For a financial institution to generate net account growth they must nurture commitment and engagement among key customer segments. Savvy financial institutions that want to build long-term relationships will use tools to understand their customer s migration likelihood the probability of that customer moving up the value chain and welcoming a wider variety of bank products. Only with such customer insights can the financial institution pursue the cross-sell and up-sell strategies that are most meaningful to each customer segment, and deliver the value proposition that the customer desires and the revenue the financial institution needs to survive and thrive in this challenging economic landscape. Ben Colvin is a Global Practice Leader at MasterCard Advisors Retail Banking and Debit Practice. He and his team help global client banks leverage their payments platform to drive the profitable growth of their retail banking value proposition. Based in Purchase, N.Y., Mr. Colvin can be reached at ben_colvin@mastercard.com. STRENGTHENING THE CORE 7

8 2010 MasterCard. All Rights Reserved.

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