Banking on customers: banks are becoming painfully aware that most customers cost more than they are worth

American Demographics, Feb, 1997 by Bill Stoneman

Banks are becoming painfully aware that most customers cost more than they are worth. The first in correcting the situation is to separate the free-riders from the truly profitable. The second step is to make them pay their way and/or encourage them to bank cheaper.

Comstock Bank in Reno, Nevada, charges some customers $25 an hour for help in balancing their checkbook and $1 a page for faxed statements. First National Bank of Chicago makes customers who hold no-minimum-balance checking accounts pay $3 for many teller transactions. And banks around the country are taking a hard line when customers complain about fees for bounced checks. Notwithstanding research that suggests the public may balk, bank fees appear likely to become ever more prevalent as the industry begins to differentiate between profitable and unprofitable customers in its marketing, pricing, and services.

Behind the new fees at Comstock, First Chicago, and elsewhere is an emerging understanding among bankers that a small group of profitable customers has been subsidizing everyone else for years. First Manhattan Consulting Group in New York calculates that 20 percent of households in a banks customer base typically account for 200 percent or more of its profits in what the industry calls its retail business. Another 20 percent are marginally profitable, and 60 percent actually cost banks money. First Manhattan calculates that the most profitable 10 percent of households provide the bank with average pre-tax earnings of $1,100 year, while the bottom 10 percent cost an average of $580.

Driven by these kind of numbers, bankers are developing strategies they hope will nurture their most profitable relationships and reconfigure the money losers. Some of the new strategies -- in many cases, fees -- are aimed at getting the most expensive customers to change their costly habits or to pay their own way. Bankers are also pushing customers to consolidate their business at a single bank. Even the most unprofitable customers, they reason, may be profitable in other ways.

Generally, bankers say there is no need to chase away customers. Instead, they want the public to understand that banks are businesses with costs to cover, not public utilities. Banks earn most of their profits by collecting more in interest on loans than they pay out in interest to depositors. But increased competition from mutual-fund and insurance companies has narrowed margins, taken substantial market share away from banks, and forced banks to rethink how they measure their fortunes.

"In the past, banks, view of the world has been product profitability," says Christopher B. Kuenne, a senior engagement manager with First Manhattan Consulting Group. But traditional measurements, he says, mask the tremendous range in profitability for different customers using the same type of account. The crucial differences stem from factors like how often the customer visits a teller, how frequently he makes transactions, and how willingly he antes up penalty fees.

As a result, First Manhattan and others are urging banks to look beyond product profitability as the sole measure of success and instead determine profitability by individuals and households. This, in turn, has spawned marketing programs that make sharper distinctions between customers.

WHO PAYS AND WHO DOESN'T

Knowing just how lucrative each customer's business is is neither intuitive nor easy to measure, say bankers and industry observers. When Comstock Bank executives asked branch personnel in 1995 to identify their most valuable customers, front-line staff typically thought they were the ones they saw most often, says Robert Barone, the bank's chairman and chief executive officer. Yet the bank's accounting shows these customers, whom Barone terms "squeaky wheels," consume lots of services at great expense.

Comstock's staff members aren't alone in misjudging whose business should be coveted. A study of 25 highly profitable community banks by international accounting firm KPMG Peat Marwick LLP found that while many banks carefully measured market share, credit risk, and other performance indicators, few had any useful measurement of where they made their money, says Thomas Grottke, a senior manager with the firm in Hartford, Connecticut.

"It takes at least twice as much raw information to measure customer profitability as it does to measure product profitability," writes Guenther Hartfeil, vice president and director of customer information and analysis at Banc One Corporation of Columbus, Ohio, in the Journal of Retail Banking Services. "At minimum, banks must track teller, ATM, telephone, and check-writing activities per customer per account." More than that, they have to install effective database hardware and software.

Three issues determine whether a customer is profitable, says Colleen Jamison, senior vice president with Delta Consulting Group in Austin, Texas: balance in loan or deposit accounts, how the customer uses the bank, and whether a bank collects its stated fees. As First Manhattans Kuenne says, "It's the intersection between high balance and low-to-moderate usage or moderate balance, moderate usage, and high fees."