Retail bankers consistently pursue two strategies to improve branch profitability -- cost reduction and price increases. While these strategies can build short-term profits, Bain & Co. has found that they may actually undermine long-term profits. The reason is that sustainable profits depend on the growth in balances. And neither direct cost-cutting nor price increases facilitate balance growth. In fact, both may detract from it.
Reducing costs often leads to closed branches and lower service levels, which may cause some customers to deposit their money elsewhere. Raising fees and balance requirements generates income, but it can also cause depositors to seek lower-cost alternatives.
If traditional strategies are somewhat wanting, how can a retail bank build the kind of deposit levels that guarantee sustainable profits? A few banks have found the key to rapid growth without the need to inflate advertising budgets, expand branch networks, or engage in loss-leader pricing.
One leading regional bank grew its branch deposit base over twice as fast as its local competitors from 1986 to 1989. Yet it opened few new branches, and its deposit rates never exceeded the market average. In another region, a similar-sized bank also grew deposits substantially faster than the local market. Yet it maintained a rate schedule that was actually below the competition. In the end, both banks outperformed their competitors by focusing on a single measure -- the retention of their branch deposit customers.
While the average retail bank retains 80% to 85% of its depositors, these banks had increased their retention to nearly 90%. This seemingly modest improvement in customer retention yielded higher margins and faster growth. Moreover, improved retention gave these banks a strong hidden advantage. It shifted the competitive battlefield from the open market, over which they had limited control, to inside their own branches, where they had much greater control.
The hidden advantage of customer retention is not limited to these two banks. Bain & Co. has quantified the potential impact of improving customer retention for several banks, and the results are inevitably impressive. In fact, we have measured the impact of customer retention on over two dozen service businesses, and concluded that a five-point improvement in customer retention can lead to profit swings of 25% to 80%.
For simplicity, we have limited most of our discussion to retail deposit businesses; however, most of the general themes could be applied to any financial service business. This article illustrates how customer retention drives margins and growth, and explains why the retention advantage is both hidden and sustainable. Finally, we offer some suggestions regarding the key pre-requisites for improving customer retention in a retail deposit environment.
How Longevity Boosts Profits
The value of customer retention is simple. A five-year-old customer relationship is worth more to a bank than a new relationship, and a 10-year-old relationship is worth more than a five-year relationship. The effect of longevity on profits comes from several sources.
First, balances grow over time as interest accrues, multiple accounts are consolidated, and customer economic positions improve....
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