The Future of Business Banking Dominic Cooper, director at Bluerock Consulting, highlights some of the key themes and conclusions of the recent Institute of Economic Affairs' (IEA) conference on business banking. This event saw the great and the good of the business banking world gather to review how it has moved on in the year since the publication of the Competition Commission report, and to cast a forward look at the trends and drivers set to shape its future. The bottom line - There have been recent developments in the business banking market that have brought benefits for both customers and those banks wishing to challenge the dominance of the big 4 clearing banks. The Competition Commission report was found significant evidence of an anti-competitive situation, but actual progress towards remedying this has been minimal so far. - The role of government in providing the right regulatory framework is crucial. This represents both a spectre and an opportunity. The right result will be sign-posted by less red tape, more competition, more switching and reduced barriers to entry. - From the customer's point of view, the need for more effective communication is a big message from businesses to banks. As well as the expected demands for fairer pricing and more efficient service, SMEs want the frequency and content of communication from banks to be improved. - From the banks viewpoint, relationships are the key to the future of business banking. This has many guises. For some banks it means using better customer relationship management (CRM) systems to collect more information about customer needs so it can be reflected in service offerings. For others it means investing in staff so that customer-driven needs can be quickly identified and fulfilled (including a return to branch-based banking for some). There is also a value based pricing point, around offering close relationships to those businesses who want them (and are prepared to pay for the privilege) and low-relationship (and low-cost) banking to those businesses who don't. The concept of relationships seems set to be developed over the next few years as more and more businesses start to use e-mail and the world wide web as integral parts of their business processes. The theory here is that this will help move SMEs more towards electronic banking for most business banking transactions - potentially swinging the balance away from relationship banking as a matter of course and towards relationship banking only for those aspects of business that need a personal touch. - Not unsurprisingly for a conference on the future of business banking, there were several forward thinking ideas around innovation. These included not only product and service innovation such as offsetting, but also innovative ways of looking at the nature of the relationship between an SME, or actually the individual who owns an SME, and their business bank. For example, the business banking / wealth management cross-over and the extension of the customer-banker relationship to a high-trust, advisory based partnership. This kind of innovative thinking is perhaps best seen as an area to be developed in parallel with addressing the hard realities of business banking. The whole concept of business finance is merely the price of being in business for some customers, perhaps even a necessary evil for some. The need is often for low-price, just-in-time business banking with a low time investment up front and low maintenance going forward. Time poor SMEs need to devote as much time as possible to surviving and thriving, giving them the space to do just this is perhaps one of the most valuable things a business bank can do for its customers. The "three where's" The 2003 Future of Business Banking conference saw the great and the good of the business banking world gather to review how it has moved on in the year since the publication of the Competition Commission report, and to cast a forward look at the trends and drivers set to shape its future. The simple but effective "3 where's" technique (where have we been, where are we now and where are we going) was used in several sessions to explore the following key questions: - What exactly is the SME sector and why is it vital to the UK economy? - What changes have resulted from the Competition Commission report? - What does the customer want, and what is the future for the relationship between SMEs and banks? - How will innovation be driven forward? - How will delivery channels and distribution networks feature? What exactly is the SME sector and why is it vital to the UK economy? Defining the SME sector is something usually left to the statisticians, and because of this there are contradictory definitions from such worthy sources as the DTI, the Small Business Service, The Companies Act 1985, the European Commission, the Bank of England, the British Bankers Association and of course the banks themselves. This is not really a problem provided we avoid comparing apples with pears when bandying about statistics. So if you want to make comparisons then state your definition, otherwise it is probably safe to say that if a company has a turnover of under £25 million per annum and a balance sheet of under £15 million its probably an SME. This definition quite suits the banking industry as its nice and precise and is a metric that is relatively readily available, unlike alternative measures such as number of employees, organisational model and ownership structure. This debate really adds nothing to the key point that SMEs play a vital part in the UK economy (not to mention the global picture). Allowing for some distortion due to the apples and pears effect, there are some telling and probably undisputed facts to back this point up. For instance: - There are over 3.5 million SMEs in the UK. - 55% of employees work for an SME. - 45% of UK business turnover is generated by SMEs. - SMEs account for around 54% of the gross value added in the UK economy. The numbers tell their own story, but behind them there is something else about the way SMEs go about their business. The defining factor of SMEs, perhaps their USP (unique selling point) to use a hackneyed marketing term, is the strength they possess due to their flexibility, innovation and risk-taking. And this is where the banks come in because it is precisely these strengths that produce quite unique and challenging banking needs. Whether or not this point is fully appreciated by bankers is something that may yet take some time to become clear. The biggest problem faced by the banks is keeping up with changes in the individual needs of customers and collective changes in the market place. To make things more difficult, SMEs feel such changes first and react more quickly than large bureaucratic banking organisations, so banks are often find themselves having to play catch-up. What changes have resulted from the Competition Commission report? The Competition Commission report, also known as the Cruickshank report, into the supply of banking services to SMEs was published in March 2002. To recap on the main conclusions it was found that a complex monopoly existed, with the big 4 clearing banks - Barclays, HSBC, Lloyds TSB and Royal Bank of Scotland Group - restrict and/or distort banking prices resulting in those banks making excessive profits because of restricted and/or distorted banking prices. Specifically, issues were raised around: - 90% of banking services to SMEs were provided by the big 4 in a complex monopoly situation, between them making a profit of at least £725 million per year with an average return on equity of around 36%. - A reluctance on the part of SMEs to switch banks, and the fact that the incumbent banks appear to have a number of levers to pull in order to deter customers from switching. - A number of particular pricing practices, for example, the similarity of pricing structures amongst the big 4 including no payment of interest on current account credit balances. - The significant barriers to entry that exist, preventing other providers from gaining a significant share of the market. The Competition Commission'sCruickshank's main recommendation to remedy the situation concerned the introduction of credit interest on current accounts and/or the provision of some free banking services. A number of further recommendations were made such as the need for the major players to give certain undertakings; including easy switching and the introduction of portable credit histories, as well as a number of other best endeavours and information disclosure measures. That was 14th March 20042002. Reviewing the situation in May 2003 we see some positive signs like the current account credit interest. However, the sense is that the report has had little practical impact; a complex monopoly still exists, switching has not really increased, service levels are not noticeably better and from a customer viewpoint the burden on SMEs with regard to managing their finances has increased rather than decreased. The school report equivalent is 'could do better' - perhaps the problem is, to stretch the analogy, that no-one in the class (or in the staff room, on the governors board, at the LEA or at the Department of Education) thinks the report is about them. A collective sense of could do better does not appear to have been sufficient motivation to bring about changes. This needs to be balanced with the alternative view that if it ain't broke don't fix it; counter-evidence exists to show that most businesses are happy with their banks, few want to switch, they get the finance they need and the cost of banking is low on their priority list! Another, somewhat controversial, view is that the issues around business banking are extremely complex and that the report did not demonstrate a deep enough understanding for it to be able to put forward workable solutions. What does the customer want, and what is the future for the relationship between SMEs and banks? This theme was recurrent through a number of sessions at the conference. From a customer viewpoint we heard a success story from a rapid growth SME producing snack foods. The message was that customers want their banker to believe in them and trust their entrepreneurship, to offer flexibility in products and prices, to communicate regularly and to respond to requests rapidly. All admirable concepts which give the message to the banks that they need to focus on customer intimacy, operational efficiency and product innovation. (Interestingly, these happen to be the three 'core competencies' which, according to the management theory, any organisation can be good at only one). The business bankers tended to put forward their views in more analytic terms, using research and behavioural analysis to back up market insight and apocryphal evidence. Customers want easy access to staff, trusted financial advisors, prompt and efficient follow-up to requests, accuracy, negotiated tariffs and kept promises. Another survey says simplicity, accountability, consistency, speed and efficiency. Banks have expectations of customers too in terms of business expertise, standards of financial acumen, the initiation of communications and integrity. All these views are entirely consistent. The truth is that customer needs do vary, both between customers and within a particular customer depending on any number of factors (i.e. business 'events' like expansion, credit control failure, ownership change, new product / market launch, business restructuring etc. etc. etc.). The problem from the banks' perspective is how to market a compelling response to this wide array of needs. The answer does not appear to lie in sophisticated customer segmentation techniques, rather the sense is that a bank needs to do the basic things well and rely on good relationship management to hook into changing business circumstances and provide financial solutions accordingly. The main message is that an effective relationship is the only way to be close enough to individual customers to understand exactly what they need at any particular moment in time. The term 'dynamic segmentation' comes to mind to describe this concept. This has to involve an investment in both staff and technology to provide continuity, transparency, genuine choice and most of all a high quality customer-driven service. An interesting question is whether a bank can deliver this high level of service on a cost beneficial basis across its customer base. If we believe CruickshankCompetition Commission findings, the answer has to should be yes on the evidence that current profit margins are healthy and there is room for them to be squeezed in favour of the customer. Good news for the big 4, perhaps less good for the second tier playersThe real world experience is that LTSB's attempts to provide different levels of relationship manager service in different price bands is not thought to have been well received because of a mismatch in expectations, customers tend to expect a Rolls Royce service at the price of a Mini. HSBC have tried a different approach, perhaps a factor contributing to its high satisfaction ratings and its low staff turnover figures. On a note of realism, it was pointed out that the main reason why banks lose customers is declined credit requests. The implication is that what customers really want is never to be turned down for credit, and this confronts the very nature of SMEs because flexibility, innovation and risk-taking entail a proven attrition rate in terms of business failures. Because the price of business failure is much greater for the customer than for the bank it would not be socially responsible to meet every customer's needs 100% of the time. This may sounds like a statement of the obvious but sometimes it can be useful to do just that. Actually, the main losers apart from the business owners are unsecured creditors (many of whom are small businesses themselves) and the government through lost tax and NI - it is relatively rare for the banks themselves to lose out significantly. In contrast to the review of the impact of the Competition Commission report, there were also positive views on where business banking is now. Some healthy trends have started to emerge: - There is more choice when it comes to business banking providers and products / pricing. - There is more scrutiny from the media and interest groups. - Business people are becoming more confident in their dealings with banks, perhaps as a result of the huge changes that have taken place in personal banking over the last ten years. - Advisors are becoming better informed of the range of options available to SMEs when it comes to financial services. - There is (a little) more competition, and this will gradually drive innovation in business banking products and services. How will innovation be driven forward? Much of the above refers to where we have been and where we are now. The conference was much more up-beat when moving on to consider where we are going, that is, what the future will hold. There was much talk of customer-driven innovation, and how it is a key driver for long-term competitive advantage because it is recognisable sign of a 'customer first' approach to business banking. After a while such innovation becomes part of the bank's brand, the obvious example of this effect is Egg's position in retail banking. And innovation can be sustained by focusing on particular areas of strength, such as expertise in one particular product or experience in a particular market sector or dominance in a particular delivery channel. Products signposted as likely to feature more prominently in the future of business banking included invoice discounting and commercial mortgages, as these are believed to be high in the minds of customers at the moment. Similarly, concepts like offsetting, product commoditisation, mass customisation (choices around a traditional core product) are potential areas where innovation could occur from a bank-driven perspective. Innovation, though, is not just about new products and services; innovative approaches are envisaged too. For example, addressing the needs of 'people in business' rather than 'businesses' is a subtle but significant step forward. The implication is a bridging of the gap between wealth management and business banking, something that has been happening from the wealth managers' end for some time and now looks set to happen from the business banking end too. Private bankers already address the business concerns of their clients as a matter of routine. Could it be that business bankers will soon address the retirement planning and taxation concerns of their customers too. This would be real innovation in business banking relationship management. Another innovative approach would be to take a look at what business bankers are really selling to their customers. Is it invoice discounting and leasing, or is it actually reassurance about their financial decisions and a sense of confidence in their banking partner? This is somewhat of an open question because there was no time to explore the implications of this in any detail, but clearly this is an area that may be developed by the banks in the next few years. A very practical angle on innovation lies in potential opportunities opened up by spin-off. For example, the Basel II initiative may well mean that banks put in place systems to measure risk. This will by definition mean gathering and processing customer information. The spin-off benefits of using this information and infrastructure creatively could be significant in the hands of forward thinking business bankers. As counterpoint to the discussions on innovation, there is statistical evidence that product innovation is less important to customers than service, price, advice and local presence. And inherent barriers to innovation exist, such as: - Complacency - because new product development has in the past been seen as neither threat nor opportunity. - Conservatism - because business banking is full of... bankers. - Maturity - because the industry is established and has in-built inertia, as pointed out by Cruickshank. - Monopoly - because protectionism is the natural reaction. An interesting corollary to this is that in an industry typified by incremental product development, the opportunity to stand out is enormous. The concept of branding has already been mentioned in connection with innovation, and the conference looked at some aspects of branding that may play an increasing part in the future of business banking. It is recognised that there is more to brand than a logo and the corporate colour scheme. Brand is reflected in the service offering which means brand is encapsulated within, or is actually defined by, all the bank's customer facing business processes. So the message is that a bank needs to review / re-design its business processes if it want to reposition its brand. Whether this concept will really be a significant factor in the future for business banking is perhaps an open question bearing in mind the strength of brand of the big 4 banks and the traditional reactions to profit pressure - either focus on the sales force to win more business, or focus on the operations to cut costs. How will delivery channels and distribution networks feature? Delivery channels are being enhanced by new technologies. The effect of this is to open up more possibilities for business banks to influence their customer mix and behaviours, and to offer different value propositions on the basis of such segmentation. While branch based banking remains the favoured channel for SMEs at present, the use of telephone and internet / PC banking is growing. It seems likely that this trend will continue if one particular survey is to be believed because it shows that 50% of businesses routinely using a branch do so because they did not know there was an alternative. It is unclear whether there really was no alternative, or whether the alternatives had simply not been communicated effectively to them. Either way, the trend away from branches seems set to continue because either new technologies will provide the alternatives or better communication will inform customers of preferable servicing choices for some kinds of transaction. There is a latent demand for electronic banking in the SME sector that is currently blocked because relatively few SMEs routinely use e-mail and the world wide web as part of their day-to-day operations. It is believed that when this penetration crosses the 30% threshold there will be a significant move to electronic banking, although it is worth noting there is some dispute as to how this threshold should measured (the apples and pears effect again). The critical issue affecting the use technology as far as SMEs are concerned tends to be fears around security and access control. From the banks' perspective addressing this point effectively can mean significant investment, especially if the existing platform is based upon a personal banking system rather than a specialist business banking system. The power behind channel management is said to lie in offering the customer increased choice and increased convenience in return for a decreased servicing cost. The ideal win-win scenario. The reality at present is that cost of true multi-channel infrastructures is still relatively high and the implementation effort is significant. However, experience has shown that as technologies mature the cost decreases and the manageability of implementation rises. This may be a factor that helps to lever open the doors of competition.