I can feel the heat around me. Everywhere I turn, there is another financial institution chasing the lucrative small business market. There are banners in branches. Free coolers! And bankers hitting the streets with call reports to fill out and sales goals to meet.
How far we’ve come, dear bankers. Ten years ago, small business was considered a “niche” by many banks. These days, a small business strategy has become as generic as retail banking and mortgages – no first mover advantage and few barriers to entry.
The reason for the massive small business rush is clear: this is still one profitable segment of banking. Remember what the experts have told us:
However, just as the laws of microeconomics tell us, the banking industry is now entering a return to pricing/profit equilibrium. Small business banking will simply be more competitive and a lot tougher in the future.
With the neon “Open for Business” signs flickering over every bank, broker and insurance company in the country, bankers had better prepare for the next wave of competition. So GonzoMongers, let me lay out some road rules for the next five years in the small business banking arena:
1. Small business deposits are going “free” and retail.
As our industry starts to peak with an oversupply of “free” retail checking programs, banks are beginning to flood the market with free small business checking programs. Commerce Bank of New Jersey was one of the early adopters of this strategy, but now free business checking is popping up in most major metro markets. Business banking was once considered an area rife with lazy balances and fees, fees, fees. With the “free” coming into small business deposits, banks can expect rabid, price-conscious business customers. Some banks are trying to offset the small business price compression with overdraft privilege schemes similar to those that exploded in the retail market. However, it is unclear if micro business behavior will emulate that of the mass consumer and make this strategy profitable. Stay tuned.
2. Convenience wars will escalate.
Small business is proving to be an integral part of banks’ aggressive branching strategies. Because small businesses are heavy users of the teller line, banks are counting on this segment to make new branches profitable. According to my friend and branching guru Steve Reider (bancograpy.com), banks are now focusing on branch hours and deposit cutoff times to differentiate their small business services. For example, Commerce’s extended evening hours have appealed to the busy business owner. However, as the insightful Mr. Reider points out, ”This will become like an escalating arms race, where every bank’s delivery cost will go up, but, ultimately, there will be no differentiation between competitors.” Banks looking to expand branches and access for the small business market also need to sharpen their ROI analytics on these sizable cost increases.
3. Automated lending will go mainstream.
Large banks have successfully migrated their business loans under $250,000 to more streamlined and scored processes. In the next five years mid-size and smaller community banks will follow suit. Today, there are still way too many commercial loan officers managing portfolios with tiny (e.g. under $100,000) loan relationships. Some of these banks are beginning to dabble with business credit scores, but they are still using an underwriter for 100 percent of their loan decisions. Cornerstone sees this behavior changing significantly by 2009. Stronger small business lending productivity and more technology-based portfolio management capabilities will become high strategic priorities. With scoring technology from folks like APPRO, Baker Hill, and S1 (formerly X/Net), smaller banks will finally position small business as more of a retail lending operation.
4. Business will get more personal.
In the next five years, banks will step up their efforts to capture both the business and personal relationships of their clients. According to Financial Institutions Consulting, the total revenue from a business owner’s personal account almost matches the revenue from the business itself. This “one-two” punch is where profitability really gets interesting. To leverage this opportunity, banks will need to continue integrating the delivery of “business owner” services to include the following:
Banks all tend to talk a good game about serving both the business and personal needs of clients, but few have formalized this strategy into anything meaningful from a product or delivery standpoint. This is fertile ground for creative competitors in the years ahead.
5. The payment migration will play a central role in business services.
Banks have a huge opportunity to cement small business relationships with their payment services. With Check 21 and the rapid movement to imaging, business customers are now expecting to access check images over the Web. Check image capture at the business customer’s office could also grow in popularity for busy corporate controllers. Product innovations like Sterling Bank of New York’s EZ Cert are good examples of how the teller line will come to the small business office. Electronic payments will also get interesting as small businesses increase their credit card, bill pay and debit card transactions. For instance, Charter One bank has been an early mover in serving up a business debit card loyalty program.
In addition to basic checks, services such as lockbox (accounts receivable conversion, image lockbox) and merchant services (image drafts) will also be areas where banks need to upgrade their capabilities to attract profitable small businesses.
6. Banker knowledge will shake out the winners and losers.
On every street in America, banks now have their branch personnel calling on small business customers. The only problem is that most branch staff today are not qualified to be making these calls. At Cornerstone, we’re big fans of the philosophy that bank staff sales people are mindless annoyances unless they have strong product knowledge. Winning banks will become much more serious about training, testing/certification, and tools/systems to support branch-based small business efforts.
7. Niches and innovation may (thankfully) be resurrected.
There’s one thing I really miss about the dot.com boom – the pure energy that was concentrated on innovating financial services for the business market. Anyone remember OneCore? This fledging startup hoped to become an online provider of integrated business services, but it flamed out like most dot coms. Despite the crash and burn, OneCore was onto something that bankers shouldn’t forget: a huge opportunity exists to become the information hub for the business client’s transaction processing, investment, insurance and credit needs. No bank provides all of these services in a truly integrated fashion today. What should this information hub look like? More than 3 million small businesses use Quickbooks software primarily for the ease of use and integration it provides. In the next wave of small business competition, banks will need to think more like Intuit and less like craggy old bankers. Otherwise, we’ll all be hawking free checking, killing each other for Libor-based loans and spending gobs of money on branches open until Jack in the Box closes.
Time to Really Mean Business
Hear’s a big wake up call for 2005 strategic planning: small business is becoming a hyper-competitive, commoditized business, threatening to suck out all our beautiful profit margins. It’s time for banks to get more creative and aggressive in how they attack and grow this market. The easy part is over – we’ll need more than the neon signs flashing “Open for Business”!