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78 T H E N E W W O R L D O F P F S

A future for
bricks and mortar
Matthias M. Bekier, Dorlisa K. Flur, and Seelan J. Singham

Physical banks are not an anachronism, but less is sometimes more.

A s more and more customers of financial-services companies turn to

low-cost virtual-distribution channels, the higher-cost physical chan-
nels—traditional bank branches, in particular—will no doubt have a harder
time earning their keep. Yet rumors of the death of bank outlets are exagger-
ated (Exhibit 1, on the next spread). Indeed, banks should find them a
source of substantial value for years to come if they are carefully contoured
to fit the rest of the distribution system and local market opportunities.1
1
See Lenny Mendonca and Patricia Nakache, “Branch banking is not a dinosaur,” The McKinsey Quarterly,
1996 Number 1, pp.136–46.
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For bank outlets offer customers something that the Internet can never
match: a secure physical location for transacting complex financial business
with real people. In fact, their use has recently been increasing—from
54 transactions per US household in 1993 to 62 in 1998. More than 80 per-
cent of consumers visit a physical outlet at least once a month, and bank
outlets still generate 80 to 90 percent of new deposit, investment, and loan
accounts.

Thus it should hardly be surprising that consumers prefer financial institu-

tions offering services both on the Internet and in physical outlets to institu-
tions that offer them only on-line. Although 40 percent of on-line customers
say they would consider opening an account with an on-line-only banking
institution, some 70 percent say they would open an account with a bank
that had physical outlets as well. Similarly, only 28 percent of brokerage cus-
tomers say they would open a pure on-line brokerage account; 42 percent
say that they would open an on-line account if the broker also had physical
locations.

Matt Bekier is a principal in McKinsey’s Washington, DC, office; and Dorlisa Flur and Seelan
Singham are principals in the Atlanta office. Copyright © 2000 McKinsey & Company. All rights
reserved.
This article can be found on our Web site at www.mckinseyquarterly.com/electron/fubr00.asp.

CHRISTOPHER ZACHAROW
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80 T H E M c K I N S E Y Q U A R T E R LY 2 0 0 0 N U M B E R 3

EXHIBIT 1
Bank executives too favor physical
Bank outlets: Endangered, not extinct outlets. In a series of recent inter-
Compound annual growth rate, 1990–98,1 percent views, several top executives of
leading US banks identified physical
Canada 1.3
channels as the most defensible
Australia2 1.2
source of competitive advantage over
United States 0.9
attackers. Executives confirm that
Germany 0.4
while the Internet and phone chan-
Japan 0.4 nels are good for meeting the service
France 0.2 needs of existing customers (by, for
Spain <0.1 example, providing their account
1
1990–97 for France, Germany, and Spain. balances), physical outlets are better
2
Includes post office outlets.
at bringing in new business. Charles
Schwab, the pioneer on-line broker,
reports that 70 percent of its new accounts are opened in its branches. It
plans to increase its branch network, now approximately 350 units strong,
by 15 to 25 percent a year over the next several years. Many conventional
banks find that when they shut down a physical outlet, a new-economy com-
petitor like Schwab moves into the space.

But physical networks definitely need careful tending to flourish. Overall,

they account for 50 percent of the cost base of a typical retail bank. During
the past few years, banks have been busy developing lower-cost channels:
automatic-teller machines (ATMs), telephone centers, and the Internet.
Paradoxically, these often increase total distribution costs. If banks want to
raise the productivity of their total distribution systems, they must cultivate
their branch networks too—pruning in some places, planting in others.

It isn’t hard to find and close the worst-performing 10 to 20 percent of a

bank’s outlets. Although getting the rest of the network into shape without
losing customers can prove much harder, it is worth the effort. Our experi-
ence suggests that optimizing the physical network can improve a retail
bank’s cost-to-income ratio by 5 to 8 percent.

Principles of distribution
Many bank executives would agree that optimizing a retail distribution
system involves providing customers, at a minimum, with comparable conve-
nience at a lower cost. Distribution systems today comprise not only physical
channels but also remote, or virtual, ones. Banks need to understand how
their physical outlets fit with these other channels. Before making ground-
level decisions about specific outlets and customers, banks must develop
broad guiding principles for serving their target segments.
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A F U T U R E F O R B R I C K S A N D M O R TA R 81

Banks often start work on their distribution strategies by developing value

propositions for many microsegments. But since the challenge of developing
channel variations to serve all of them would be paralyzing, most banks
should stick to confirming value propositions for only four or so segments—
say, small-business, mass-market, affluent, and rural customers. That would
give banks plenty of traction in designing their networks, and they could
save microsegmentation for tactical marketing programs (such as targeted
cross-selling), since programs of this sort can tailor value propositions for
microsegments more economically than a dedicated channel can.

Within the distribution network as a whole, a channel that fulfills an impor-

tant function for one segment may be less useful to another. Moreover,
different channels may play different strategic roles, so a bank must also
determine the functional and strategic roles that each channel should play
(Exhibit 2). If branches are greatly esteemed by high-value small-business
customers and play a critical role in distinguishing a bank from its competi-
tors, for example, those branches have a strategic role and thus warrant
attention and investment. An ATM network, by contrast, might play a
“parity” role: that of keeping a bank even with its competitors rather than
distinguishing it from them. In parity channels, a bank should aim to deliver
services that match those of its competitors at the lowest possible cost.

With an understanding of each channel’s role, banks can identify the ideal
location, format, and staffing pattern of an outlet serving a particular seg-
ment—and thus what to aim for. But in most neighborhoods or micromar-
kets, banks have a “one size fits all” legacy. Usually, it isn’t worth revamping

EXHIBIT 2

Functional and strategic roles

Mass-market value proposition:

Be the first bank people encounter when they move to town

Differentiating: Mini-branch
Overinvest to achieve
advantage relative Supermarket
to competitors outlet
Strategic roles

Automatic-teller
Parity: machine Outbound
Match competitors telephone sales
at minimal cost Teller at
mini-branch

Ancillary:
Inbound telephone Telephone sales to
Lag behind Direct mail
inquiries dormant accounts
competitors’ offerings

Acquisition Transaction Cross-selling Retention

Functional roles
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82 T H E M c K I N S E Y Q U A R T E R LY 2 0 0 0 N U M B E R 3

their outlets, since major format changes rarely overcome the target cus-
tomers’ reluctance to switch.2

A new geographic market or “virtual” channel such as the Internet, how-

ever, does permit banks to target discrete segments. In a new suburb, for
example, one bank has designed branches with the feel of an
upscale café to attract the affluent young.

A single channel may serve two or more target segments

successfully. But doing so mustn’t compromise the channel’s
strategic role in a particular segment; service levels must be
consistent across segments, and banks must be able to cut
costs or boost revenue by combining them. Channels used mainly for trans-
actions—ATMs, mini-branches, and teleservice channels—are more likely
to surmount all these hurdles.

Applying the theory to micromarkets

A few banks still try to optimize physical outlets one by one, but most
understand that it is the convenience of the network to the places where cus-
tomers live and work that matters to them when they choose a bank. The
bank with the most convenient network within a particular micromarket
typically wins market share greater than the sheer number of physical outlets
would explain. But even banks that manage their networks as micromarkets
rather than individual outlets often make the mistake of managing each
micromarket as a simple, closed system of physical resources that supply all
the needs of local customers. Many banks also treat all segments and types
of interaction as equally valuable, which has the effect of making networks
fairly uniform across micromarkets.

Yet today, an increasing number of customers use remote or mobile channels

for transactions. As a result, physical channels are adding value less by
effecting transactions than by generating new accounts. Moreover, customers
from some segments create more value than customers from others. To guide
network investment and cost reduction priorities, banks need a strategy that
takes such factors into account for each micromarket.

A strategic-direction matrix is a powerful tool for developing micromarket

strategies (Exhibit 3). It works by comparing a forecast of the bank’s perfor-
mance in a micromarket under a business-as-usual strategy with the micro-
market’s growth prospects. If, say, the bank’s business-as-usual performance
were only average in a micromarket that had a dim future, the right strategy
would be, “milk hard.” But if the micromarket were set to grow, “invest to
2
Tweaks to formats or staffing, such as the addition of a business teller queue, can approximate the spirit
of a new format at a lower cost.
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A F U T U R E F O R B R I C K S A N D M O R TA R 83

EXHIBIT 3
get better” would be
more appropriate. Developing a micromarket strategy? Ask the matrix
Banks that apply these
differentiated strategies
across their micromar- Move to Defend and invest Maintain relative
Strong
dominate opportunistically position
kets have realized
Forecast performance under a
business-as-usual strategy1

improvements of 200
Invest to
basis points or more in Average
get better
Milk Milk hard

their overall cost-to-

income ratios. Major change
Weak Major change in required, consider Exit or
approach required exit opportunities scale back
Each micromarket’s
place on the matrix Invest if bank Remain
No presence Avoid
determines how the can be strong opportunistic

capacity of the physical

High Medium Low
network serving the
Growth prospects of a particular micromarket
micromarket should be
1
Current performance adjusted for multiyear ramp-up period necessary for new outlets.
adjusted. In a market
that must shrink, deci-
sions about which branches to close depend on how customers use the net-
work, the value of different outlets, and the alternative outlets available.
Banks may wish they could exit some micromarkets. But the results of recent
experiments with alternative forms of outlet ownership suggest that banks
could keep a profitable presence even in some of the most unpromising
places (see sidebar, “Letting go,” on the next spread).

Prune the branch, not the customers

Say that Trustbank must close one of its five outlets in Middletown. The
bank measures its target segments’ use of these outlets and weights the

EXHIBIT 4

Close the branch, keep the customers

Step 1: Set priorities Step 2: Design migration plan Step 3: Implement

Design migration levers to

encourage move, for instance:
Prepare alternate
• “Greeter” to demonstrate ATM channel for customers
(automatic-teller machine) convenience
• Deposit products with higher interest
Identify rates but no branch access
transactor, • Remote, after-hours deposit collection Migrate
not transactions points for business customers customers

Realign pricing of alternate channels

to discourage overuse,1 for instance: Shut down
• Charge for excessive calls to outlet capacity
phone center
• Cap number of free ATM transactions
1
That is, ensure that migrated transactions do not multiply.
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84 T H E M c K I N S E Y Q U A R T E R LY 2 0 0 0 N U M B E R 3

Letting go
Several banks around the world are challenging
the assumption that a bank must own, or at least
control, its branches. These banks are experi-
menting with different forms of ownership in
both urban and rural markets. A typical retail
bank could improve its cost-to-income ratio by
a total of 200 to 300 basis points by adopting
some of these alternative ownership structures.
But banks should choose among the options with
care, for the complexity of negotiating and man-
aging them can wipe out profits, and they risk
turning the partner into a competitor.
Urban markets
High real-estate costs and sleepy sales cultures
typically characterize urban branches. Fran-
chising and leasing out excess branch space and
partnering with a retailer tackle both of these
problems.
Franchising: Colonial State Bank of Australia has
used franchising to revive front-line sales and to
make branches more accountable for costs.
Revenues from franchised branches have
increased by up to 30 percent. The franchisees
cover their own premise and labor costs; the
bank has to pay only their sales commissions.
Dexia Belgium has been using a similar system
for some time.
Leasing excess space: Some banks—for
instance, Wells Fargo—have leased their excess
branch space to businesses such as Starbucks,
Thrifty PayLess drugstores, Briazz delicatessens,
and post offices, thus in effect forming mini-
malls within those banks’ branches. Doing so
has helped offset real-estate costs, but there is
little evidence that increased retail traffic equals
increased bank sales, since few bank purchases
are made on impulse.
Partnering with retailers: Some banks seek to
boost traffic by setting up branches in retail
stores—usually, supermarkets. But some

results by the value at risk should any one of them close—that is, the value
rather than the absolute number of customers. By this reckoning, the outlet
with the smallest number of customers at risk isn’t necessarily the one to go.

After deciding which branch to close, Trustbank has to migrate its valued
customers to alternatives. Many banks find it hard to shut a branch and keep
its customers. But banks that adopt a comprehensive program for migrating
them and shutting down capacity within micromarkets (Exhibit 4, on the
previous page) can realize an improvement of 100 to 300 basis points in
overall cost-to-income ratios. The trick is to find and move the heavy trans-
actors rather than to cut out a class of transaction. If all of Trustbank’s cus-
tomers at the branch slated for closure switch to ATMs to withdraw cash but
still make deposits there, Trustbank can’t close it. Banks must also take extra
care to migrate change-resistant customers—elderly people, for instance—
perhaps by moving a staff member popular with that group to the alternative
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A F U T U R E F O R B R I C K S A N D M O R TA R 85

choose venues patronized by more valuable seg- feel poorly served by large financial institutions.
ments; Keycorp, for example, is targeting the Local ownership can also establish trust within
lucrative small-business segment with experi- urban ethnic communities, which banks ordi-
mental branches in Office Depot stores. narily find hard to serve.

Rural markets Outsourcing branches: Banks can obtain a con-

A full branch requires a certain minimum number
of customers, and many rural markets simply
can’t provide it. Two alternative forms of branch
ownership—joint ventures with the community
and outsourced branches—mitigate the
problem.
Creating community joint ventures: Bendigo
Bank, a small regional institution in Australia, has
established new branches through joint ventures
with small rural communities. After opening 12
such branches in one year, Bendigo Bank can
boast impressive results: at the first two
branches, 33 percent of the communities’ resi-
dents became customers within three weeks,
and 75 percent did so within the first year. Such
branches create goodwill among customers who
venient, low-cost branch capacity by outsourcing
their branch functions to nonbanking institutions
such as post offices. Under typical outsourcing
arrangements, the post office will, for a nominal
fee, allow bank customers to undertake basic
transactions such as cashing checks and making
deposits. The UK post office gives Lloyds TSB
Bank and two other banks access to the 95 per-
cent of the rural population that lives within a
mile of a post office. In Australia, 24 banks,
including foreign ones such as Citibank, have a
similar arrangement with Australia Post.
Although outsourcing is only half as expensive as
the fully loaded cost of operating a bank-owned
branch, outsourcing is a defensive strategy: the
goal is to retain customers rather than to build
the business.

outlet. With thoughtful migration levers like this, banks can actually retain
99 percent of their valuable customers from a closed branch.

The pricing of alternative channels is, however, crucial because costs can
increase if customers start using them much more than the old branch, even
if the cost per use is much lower. But while price structures in alternative
channels must reflect their anticipated use and the cost to the bank of pro-
viding them, the price shouldn’t discourage migration.

Taking these principles into account, a bank can begin to adjust its network
to reflect its changing business environment. Rolling out such a program
across an entire physical network might take one or two years. But banks
can’t afford to stop there: retail banking changes so much that perfecting the
physical network is a never-ending task. Banks that continually cultivate
their networks will encourage the greatest growth in profits.