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Growing Fee Revenues in a Challenging Market
by Hank Israel
As early fee revenue tactics reach their limits, banks must start now in developing customer-friendly innovations that will bear fruit over the next few years.
In the challenging era that has unfolded since checking-related fee revenues were slashed by new laws and regulations, retail banks have searched for any immediate possibility to regain revenue altitude. Responses have ranged from bold pricing changes eliciting national attention to suffocating new fee schedules stuffed with dozens of entries. But as this initial round of new fees has run its course, confusion and even fatalism has crept in, with banks trapped in a cycle of hit-and-miss experimentation. Given the estimated industry revenue shortfall of $18 billion to $20 billion annually just from the reduction in debit interchange and checking overdraft fees, the pressure for recovery is tremendous. In setting the agenda for the remainder of 2012 and next year, it is time to recast the quest for transaction revenues in terms of customer-oriented innovation. This is the point where the development teams ideally should be mocking up a variety of potential new initiatives and working with senior management to chart a multi-year course. The continuing goal is to build transaction revenues in a way that rewards customers, encourages efficient channel usage, captures fair returns for valuable services, and sets a sustainable foundation for growth. It is a tall order, to be sure, with many complexities in dealing with customer sentiment and the new regulatory environment. Yet necessity is the mother of invention here. In considering how to get paid for providing transaction accounts, banks need to incorporate the customer’s perspective. by then. These include campaigns to increase debit and credit card transaction volume; financing innovations that will help households to meet spending contingencies; and new service propositions centered on prestige and specialized value. interchange. The Fed’s action on signature debit interchange will have a lasting impact on the card business but shouldn’t be viewed as a closing of the book. There still is an interchange stream of revenues to be nurtured and possibilities to improve adoption and usage patterns among regional banking customers. The bottom line for the debit card is that even at a sharply lowered average of 26 cents of interchange revenue per transaction, it still is a valuable component of the retail DDA account. The traditional constituency of the debit card includes customers who prefer to electronically spend from their deposit accounts and avoid credit card usage, and people who like card convenience but simply do not have access to credit cards. While these categories of transaction growth are slowing as the market becomes saturated, a fresh wave of customer demand is building as the debit card is promoted as a financial planning tool. As championed by mass market financial planners such as Suze Orman and Dave Ramsey, debit appeals to the myriad households that continue to deleverage and tighten monthly spending. Regional banks have historically been kicked out of the credit card business. But given their powerful potential of better credit underwriting based on a relationship play, we believe that regional banks will increasingly re-enter that market. Banks that issue credit cards can jump on the bandwagon of household cash management by promoting the credit card as a dual-purpose vehicle that provides a liquidity
As banks look beyond this year to 2013 and 2014, we see at least three main types of fee-building and -substitution initiatives that need to be started now in order to bear fruit
Growing Fee Revenues in a Challenging Market
buffer when needed and also provides tools to track and control spending (Figure 1). In following through on card transaction opportunities, one challenge that banks will face is coaxing customers into switching their card usage patterns. Historically, wallet position for a credit card has been driven by the size of credit line, rewards and/or brand. Few regional banks can compete with national card brands or the elaborate rewards programs that the mainline issues have in place. What regional banks can do is compete on credit line (with better credit) and the integration of card products into the customer’s overall cash management solution. Overall, it appears that relationship credit and improved household cash management
offerings currently are the strongest banking industry hook to encourage credit and debit card usage. liquidity alternatives. There are gaps in the products offered by banks for managing liquidity, spelling opportunity for innovators. Indeed, there are sound credit line opportunities linked to the payment account that the home equity product can’t support — for credit worthy customers with little to no equity in their homes, for instance, or without homes at all. There is also a big product gap between the de facto lending provided by overdraft coverage and the spending power of the credit card. While only a portion of the total mass market is qualified for a credit card, a large swath of consumers would qualify for a three, five or two week
Figure 1: avenues to Build Fee revenues
Card usage and unsecured lending will play especially important roles in addressing the current fee revenue crisis.
Card Usage & interchange
Drive improved adoption and utilization of credit and debit cards, further eroding cash and charge cards.
Develop propositions on unsecured lines to capture balances outside the bank — e.g., unsecured lending, responsible deposit advance programs, and structured installments for the credit wary.
Develop value-added propositions for customers around prestige and add-on services, including: • • Concierge / Platinum Card Travel, dental, purchase, and ID theft, etc
terms & Conditions
Increase behavioral requirements or relationship requirements on transaction accounts, or raise maintenance fees.
Increase fees for transactions that represent conveniences, for example: ATMs, Wire Transfers, Stop Payments and Returned Items.
Charge for premium service channels that do not provide sales or relationship benefit to the customer, for example — paper statements and Envelop- less ATM/ or mobile check deposit.
Source: Novantas, LLC
“Convenience sells itself in many instances. With the right marketing and a bit of orientation, people often willingly adapt self-service technologies, as in the successful rollout of self-service booking and ticketing in the airline industry.”
advance based on household cash flows. Banks need to provide a continuum of credit products that match customer cash flow patterns. The goal for the bank is to build substitute revenues by meeting household liquidity needs in innovative ways. Novantas research reveals that short-term credit offers can be tailored across three dimensions to meet the broadest customer sets: access. From automatic coverage (traditional overdraft protection) to manual request (deposit advance-like programs), each customer group has its own preferences for accessing credit, both when and how. Banks that offer only one option won’t reach the full market, whereas those that study various segment preferences and respond accordingly will have the best result. Also the total pool of potential customers can be expanded as providers move from traditional revolving credit programs to per-incident arrangements that are tied to various kinds of transactions, such as bill pay. Payoff. Our research has detected a broad range of situational pay-off preferences for short term liquidity. For “Oops I missed” transactions, for example, automatically paying off balances is preferred for many. By contrast, the preference for “I’m away, cover it” transactions is a manual payment or a transfer at the customer’s direction. Interestingly, a third liquidity needs group prefers installment credit. Here the customer orientation includes “I’m behind and need to make an emergency purchase,” and “I want structure when I incur debt.” Developing liquidity programs that address the customer’s pay-off intent maximizes consumer acceptance and trust; doing it simply and elegantly maximizes utilization. Pricing. Most institutions focus on prevailing rates and transfer fees in setting credit prices, but they ignore the customer perception of value in the particular circumstances when credit is extended. Consumers generally expect to pay less for pre-arranged longer-term programs, for example, and more for contingency liquidity. By developing liquidity solutions around customer preferences, banks can reach a wider range of credit users and grow revenues. Challenges to this type of progress include developing a mechanism for low-cost underwriting; developing self-service mechanisms; communicating a simple message to creditwary customers who don’t want to get in over their heads; and balancing the requirements of the new regulatory environment with the need for revenue replacement. Prestige/value. A final source of transaction revenues is to charge premiums for functional value and/or prestige. Here the opportunity revolves around propositions that solve particular needs and/or provide an aura of prestige or recognition. While the market potential is smaller in scale, we have seen successful firms reach as much as 10% of their transaction base with the right combinations of offers, including: Concierge/platinum services. In this scenario, the bank develops (or brands) a service center that provides prestige services to customers. Examples include special event ticket purchases; special lines of personal service; and insurance resolution services for auto and health claims, etc. (e.g. American Express Platinum Card). Situational insurance programs. Examples in this category include travel (health and trip protection); dental packages; purchase protection for debit and credit cards; account/ID theft insurance; and referrals to lower cost providers of health care. enhanced information and linking services. Possibilities include programs to market small business services to customers in the micro-market; mobile apps that help customers track warranties and proof of purchase; and financial coaching services that remind customers to take insurance photos, shop auto insurance, track investments, etc. Taken alone, each possibility will appeal only to a segment of customers, and that is why effective banks will build a broad shelf of programs and utilize all customer communication channels to appropriately position offers. One plus is that the inexpensive Internet and mobile channels provide many opportunities for interactivity, as well as geo-location functionality that facilitates customer-relevant offers (The challenge is ensuring that the bank matches the cost of marketing to the value of the programs. It is also important to avoid overwhelming the customer with either irrelevant or repetitious offers that impede the customer experience).
While no banker relishes the prospect of raising fees in the current environment, the current financial realities may require that they do so. There are a few options that will help while a bank waits on longer term cost and revenue growth strategies come to fruition. We see three classes (in descending preference) of opportunities.
Growing Fee Revenues in a Challenging Market
1) Behaviors/relationship. Many banks have experimented with various types of account usage terms for free checking. Examples include monthly minimums for debit transaction minimums and checking balances. In another vein, fuller relationships can be encouraged by adding successive features as deposit and loan balances grow. In exploring the possibilities, one consideration is that higher deposit and transaction requirements may discourage households that are shopping for new deposit products, impacting the rate of new customer acquisition. Finally, there is a risk that raising deposit balance minimums may actually reduce profitability in the current environment, given that few banks are growing their loan portfolios. However, effective banks may be able to leverage the strategy to substitute rate-sensitive balances with lower cost balances from transaction relationships. 2) Convenience charges. Possibilities include higher fees for established conveniences such as automated teller machine usage, and for infrequently used “situational products” including wire transfers, stop payments and returned deposit item fees. While not strategic, such tactics can generate incremental returns if not overdone.
In considering the options, one important factor is anticipating public perceptions. In the current environment, consumer groups and media are focusing on these types of fees. Also, convenience fees have less overall revenue potential compared with other options, even with extreme pricing. Along with other factors, the bank needs to examine whether a potential fee initiative offers a material return. 3) Channel pricing. Here the bank begins to differentiate pricing for deposits and withdrawals based on the cost of transactions. Banks have been fundamentally backwards on this topic, in that many provide free check-clearing and ATM services, while charging for person-to-person (P2P) transfers or electronic payments, and mobile deposits. Bankers should examine the long-term picture, and understand the value of converting paper statements, check writing and ATM services while incenting basic electronic services that support cost reduction. Interestingly, there is also inelasticity in certain segments around manual transactions – they are willing to pay for it. One challenge is that the opportunity to cleanly reduce or eliminate a certain type of channel delivery cost is limited so long as even basic levels of transaction volume persist.
Avoiding the Pitfalls
While many new programs will provide positive customer experiences, fee increases generally have consequences. Out of fear of these consequences, bankers often make compromises that either undermine the impact of the initiative, or force the bank to make more fee increases than necessary. In other cases, bankers do not objectively evaluate their ability to levy the fee in the first place, often resulting in failure. Competitive positioning — “Hanging back is better.” We have found that unless a bank is going to be materially the lowest (by a long shot), being the highest, or nearly the highest, or in the middle, makes little difference. If the bank is using third-party market data to choose a “position,” it should consider pricing near or at the top of market, unless it appears the fee-based activity in question is actively shopped by customers, in which case choose the bottom position and market the difference. Anticipating behavior change — “If I make a smaller fee change than what is seen in the market, my customers will not decrease their usage.” We have observed bank fee revisions that did not cover the subsequent reduction in utilization — meaning that because of a compromise in the amount of the price change the bank actually lost money. Before acting, the bank should understand the minimum fee increase that will cover the expected behavior change — compromises can do damage. Cumulative impact — “It will only impact 2% of the customers 5% annually.” Banks generally make fee changes by line of business and rarely look at the cumulative impact on any one customer. It is important to consider the customer point of view, manage fee changes across the entire retail portfolio and understand the combined impact of all fee changes on any one customer or group. This is the only reliable way to avoid unanticipated compound impacts on profitable customer segments. Fee Schedule — “Small items won’t matter.” Some banks tend to add numerous little “tolls” to their fee schedules over time. Based feedback from focus groups, however, lengthy and complicated fee schedules send the wrong message to customers, who think the bank is trying to “nickel and dime” them. We have observed fee schedules for consumer accounts in excess of three pages. If the bank ranks the revenue generated from each fee, how much comes from the bottom 80% of fees? Could the same revenue be generated by making a slightly larger fee increase on a material line item? Course corrections — “We should quickly pull back if the market reacts.” Many fee changes initially result in attrition or
Meanwhile, the fixed cost of operations is spread over diminishing volumes of manual transactions, meaning that pertransaction economics actually degrade. Also, banks are not uniformly moving towards the reduction of paper, as there are ancillary activities, such as providing paper checks, which are beneficial. Overall, these opportunities do not represent large short-term income and likely turn on the reduction of cost over time.
Driving revenue growth from current products is possibly the most dreaded aspect of retail product management. Planning ahead and working on longer term revenue growth strategies will minimize the bank’s reliance on fee increases. As senior management considers the possibilities, key questions include: • “How do my customers prefer to compensate me for products and services?” • “How much time do I have? Do I need the revenue in 2012, 2013, or beyond?” • “How will this affect my products, services and future growth potential?”
• “What is the potential cumulative impact of all of nearterm revenue initiatives on the customer base, and what do these initiatives represent in terms of revenue contribution, both now and in the future?” Unfortunately in the current environment, fee increases may be necessary in order for many firms to survive and continue to serve customers independently. Yet there are many ways to amplify the value of offerings and mitigate the market impact of changes in prices, terms and conditions. Ultimately, customers who value the bank’s distinctive service most often will accept rate and fee increases when explained transparently.
Hank Israel is a Partner in the New York office of Novantas LLC, a management consultancy.
customer service calls, but later succeed. We have observed banks that have reversed fee change decisions based on anecdotal impacts in the contact center, which initially may receive “a flood of calls.” Upon closer inspection, however, it is typically found that among the small percentage of customers impacted by the fee, less than 1% actually called. But as a percentage of call center volume this represented a bulk of the calls after the fee change. Secondly, most fee changes take 60 to 90 days to season, during which time behavior change and attrition stabilizes and the vocal minority focuses on a new issue. We have observed institutions removing the fee in the second or third month following an increase. This makes no sense — they experience the early downside of the fee change but do not reap the longer term benefit, and actually reduce their income to a lower level than before the change. While there are reputational and regulatory reasons to reverse course, most market over-reactions reflect either poor preparation for fee changes or a management gamble on market acceptance. A better approach is to develop metrics for incremental revenues versus usage potential diminishment and customer defection, and “budget” the impact to the organization. Only when the impact
grossly exceeds expectations or the market trend shifts radically should the bank consider reversing course. Market maker vs. lightening rod — “We move at our own pace.” Various banks have both over- and under-estimated how their market position would support a fee change. In 2009, for example, one small regional bank replaced its free checking product with a flat fee checking product. None of the competitors followed suite and the bank lost share. This bank lacked the market scale to be a first mover in raising a fee. Elsewhere, a nationally recognized bank attempted to introduce a monthly transaction fee, which had been successfully adopted elsewhere by two regional banks. But in this case, the size and brand of the bank attracted public scrutiny to the fee change, and negative publicity led to its removal. The upshot is that when a bank is evaluating potential fee income adjustments, it should consider how market position will impact the ability to realize the revenue. —Hank Israel