Saturday, September 15, 2012

Customer Profitabilty in Banking: Do you do it?

According to an ABA survey (see table), I doubt it.

I am speaking at the upcoming ABA Marketing Conference next week. Well, maybe not as much speaking as appearing. Mary Beth Sullivan and I are appearing as guests of Susquehanna Bank's Susan Bergen, in an Oprah like talk show format. I suggested Saturday Night Live's Point-Counterpoint format, but it was rejected. To appease my objection to appearing on Oprah, they orchestrated my entrance to a Pitbull song. I did not know who Pitbull was.

Our discussion will revolve around an ABA survey done this summer regarding actions banks have taken, or intend to take, to improve profitability. One question that didn't make the cut in the interest of time, was the one represented in this post's table: Does everyone in management know profitable versus unprofitable customers the bank serves today?

If you were in the corporate headquarters of McDonald's, you would be alarmed at the results. If you are in banking... not so much alarmed as happy that so many others remain as in the dark as you. I think lack of knowledge of profitable customers comes from three things:

1. Getting such a number requires investment in resources your FI currently does not have:
2. The regulators don't require the information; and
3. Even if you had the information, what would you do about it anyway?

All are related. FIs earn money on the spread. In order to create spread, FIs focus on creating a basket of the highest yielding assets within risk parameters, while funding them with a basket of the lowest costing funding. Why do you need some fancy profitability information to tell you that?

Problem: Various assets and liabilities take differing amount of operating expenses to accumulate. Also, based on risk, different assets and liabilities require different equity allocations. If your attitude is that the "incremental" cost of chasing this business or that is minimal, you may very well be mis-allocating your precious resources to low profit customers.

For example, we have a client that served the bar/restaurant business in a college town. These establishments brought decent balances to the bank. The problem: we found employees that spent half their day sorting through the bag-fulls of cash delivered every day. Could the bank allocate that operating expense to a campaign to acquire and serve higher profit customers? Without determining the profitability of those customers, we would never know about the opportunity lost.

I think it's time to change the paradigm from acquiring the highest yielding assets and the lowest costing liabilities based solely on interest earned or cost of funds. We should instead focus on acquiring and serving baskets of the highest profit customers. Doing so will efficiently allocate resources, improve our profitability, and enhance our FIs value.

~ Jeff


  1. Jeff, great post. As a banker, I value customer profitability. It does not have to be complicated like risk based profitability. Simple customer profitability can be just as powerful. How? It is better than nothing.

    The only advice I can give is, just do it. You will never get there if you do not start. If today you have nothing and you do not start you will have nothing. The math is simple. Zero plus zero is always zero. If you start with a simple model you have a beginning. Then iterate over time.

    I was not always a banker. I started my career in the direct marketing industry and customer and household profitability reigned king. I will admit bank profitability is a bit more complicated due transfer pricing but that is one area that most banks excel in. So like I said, just start, iterate and enjoy the rewards.

  2. Jeff and David, excellent thoughts. David's comment about "just do it" is paramount in my opinion.

    I've seen numerous reasons why FIs don't undertake customer profitability analysis and you've identified several of them above.

    One of the concerns I hear is that the profitability calculations aren't likely to be exact. The argument against this, as David says, is that you can get it good enough to be functional. The value isn't in identifying that Joe Smith is worth $100,000 per year to the bank, it's in understanding that Joe is in the top 1% of profitable relationships and we should allocate efforts to notice that and retain that relationship.

    I seem to remember hearing, or reading (it might even have been in your blog Jeff), once about a bank executive saying that he just needed "directional profitability", i.e. it needed to be good enough to point them in the right direction on strategic initiatives and resource allocation. In my opinion, that is the absolute best way to look at it.

    I still find it difficult to believe that such a high percentage of FIs don't consider this to be vital information.

  3. Great post! We should always remember, the head in the sand approach exposes another part of the anatomy. Unfortunately,the banking industry is behind others in its understanding of where profits come from. The future will focus on at least "getting started" and then building on this strategic implementation.

  4. I remember a seasoned bank profitability expert telling me, when I asked how accurate the per transaction cost of a wire transfer was, that "it didn't matter". I was shocked.

    But he went on to explain that what mattered is the wire transfer took 4x the resources of a teller transaction and 10x the resources of an online transaction. In that manner, we can assign the FIs operating cost based on relative resource utilization and get to the customer ranking Mike mentions above.

    From that point, you continuously improve your assumptions, as Dave mentioned.

    Utilizing "directionally correct" (told to me by a banker and repeated in this blog) customer profitability information to tweak your offerings, improve profitability of low-profit customers, and deliver gold-plated service to your top customers, your FI will be more profitable, valuable, and sustainable, in my opinion.

    Thanks for the feedback!

    ~ Jeff