For retailers, format renewal is fast becoming a recognized way to revitalize a flagging business.¹ For most banks, on the other hand, experiments with different branch formats have yet to pay off. Few have hit upon a formula that transforms the distribution network and boosts the bottom line. Even supermarket banking, now commonplace, has in many cases failed to return a profit.

The problem is that the rationale for retail format renewal is essentially about attracting more customers. But banks, however much they try, are hard pressed to persuade consumers to move in any numbers. Bank customers, unlike retail customers, tend to be loyal. Provided they are satisfied with its service, they stick with the same bank for five to seven years on average, and switch only when they move to a new home in an area outside their bank’s network.

This explains why banks’ market shares are so static. Assuming that most banks replace customers moving out of the market with people moving in (and replace most of those who choose to leave with new customers), the only extra customers up for grabs come from net household growth, which seldom rises above 3 percent a year. Even if a bank were to capture a disproportionate share of this growth—40 percent, say—it would be unable to increase its market share by more than one percentage point a year, a situation that the deposit shares of the top ten retail banks in five key US markets confirm. In the absence of acquisitions, the market share of any one institution rarely grows by more than one or two percentage points a year (Exhibit 1).

So retail banks should not expect format renewal to result in dramatic swings in market share. But this does not mean they cannot use format renewal to lift profits. The trick is to focus on areas that can be influenced: customer retention, contribution per customer, and costs. Successful format renewal programs find ways to leverage the physical format to pull at least one of these levers.

Retaining important customers

Approximately 6 percent of a retail bank’s customers are lost every year because of dissatisfaction with some aspect of its value proposition. This "voluntary attrition" compares with "involuntary attrition" of roughly 9 percent a year of customers who move. If a typical bank with annual revenue of $4 billion and a 25 percent market share could bring its voluntary attrition rate down to 2 percent, it could raise market share by one percentage point and increase annual profits by 4 percent, or almost $20 million.²

Retaining the most profitable customers would deliver still greater value. Most banks live by the 80/20 rule: 80 percent of profits come from 20 percent of customers. On average, between 50 and 70 percent of any bank’s customers are unprofitable. If the typical bank described above focused its retention efforts on the top 10 percent of customers (who are each worth about five times the average customer) and kept voluntary attrition down to 2 percent, annual profits would rise by about $10 million.

Examples abound of banks that have changed their retail formats to enable them to serve their most important customers better, and thus hang on to them for longer. One major Canadian universal bank recognized that its top 20 percent of retail and small business customers, who provided almost 90 percent of profits, were poorly served given their value to the bank. To meet their needs, it is piloting smaller sales-oriented branches staffed with skilled salespeople and financial advisors. At the same time, it is encouraging lower-value customers to use less expensive transaction channels such as automatic teller machines (ATMs). Results suggest there is potential for a 20 to 45 percent increase in after-tax profits.

Small business customers are particularly important to banks, being up to 20 times more valuable than ordinary retail customers. But retaining their business can be difficult, since small companies tend to shop around for loans. To improve its targeting of these customers, the Californian thrift (savings and loan institution) Glendale Federal opened six branches in outlets of the print and copy chain Kinko’s in late 1997, and plans 15 more this year. Between 50 and 75 percent of Kinko’s customers are small businesses.

The attraction of these branches for Glendale’s small business customers is the opportunity to conduct banking business while they wait for a copying service. The sites are staffed by up to six employees to ensure swift attention. Glendale says its pilot branches have exceeded expectations in terms of deposit acquisition and transaction volume, although the long-term measure of success will be whether the extra business outweighs the cost of employing so many staff.

Certain format changes can actually damage customer retention: closing branches in favor of supermarket sites, for example, has annoyed some small business customers. Similarly, surveys show that more than 70 percent of older people with assets to manage prefer to go to their bank rather than conduct business by telephone.

Increasing contribution per customer

Focusing on customer account retention is important, but it does not fully deal with the losses caused by customers’ tendency to shift pieces of business to other providers. Account closures represent only a small percentage of total bank deposit erosion. The average US household now holds only 15 percent of its assets in bank deposits, down from 20 percent in 1992, reflecting the appeal of mutual funds and securities. Among household mortgages, 43 percent are currently held by banks and thrifts, down from 65 percent in 1982, while banks’ share of total credit card volume fell sharply from almost 90 percent in 1988 to about 50 percent in 1996.

To counter these trends, format renewal must also consider contribution per customer. The more products a customer has with a bank, the longer he or she is likely to remain a customer.

The Midwestern bank Norwest has discovered that 90 percent of customers stay at least two and a half years if they hold eight of its products, yet only 65 percent do so if they hold no more than two. Norwest is known for having one of the highest cross-selling rates in the industry: roughly four products per customer, compared with two at other banks. It attributes this success to a sales-oriented culture. Branches are referred to as stores, and their managers have goals for revenue growth, customer retention, and cross-selling. Yet these "stores" are laid out just like traditional bank branches; what makes the difference is the skill of the sales staff.

To consolidate its customer relationships and thus improve contribution per customer, Citibank launched the CitiSource account, targeted initially at customers with combined accounts worth at least $6,000. CitiSource bundles banking and investment products held by customers into a single account, and charges lower fees to holders who consolidate more of their business with the bank. Customers receive an integrated statement and can choose from a range of mutual funds that are not all Citibank’s own. Encouraged by the first three months’ results, Citicorp, the bank’s parent company, has announced its intention to roll out CitiSource across the United States during 1998.

At the same time as it launched CitiSource, Citibank opened a pilot financial center designed as a showcase for its investment products. The center features electronic services aimed at investors, including Internet access, real-time stock quotations, and a large-screen television showing financial news. While the bundled product appears to be successful, it is unclear whether the pilot financial center has contributed to its success.

Just as some retail formats can harm customer retention, some may hamper cross-selling. Many customers would prefer not to discuss their mortgage requirements in the middle of their local supermarket, for instance, while ATMs and remote banking limit the face-to-face contact that can be crucial to cross-selling more complicated products. Moreover, it is important to recognize that most bank’s deposit erosion is due not to failings of the physical format, but to rates, fees, or level of advice. Overcoming these difficulties will require more than format renewal.

The magnitude of the improvements needed to justify investing in format renewal is also worth bearing in mind. A $500,000 investment in a single branch remodeling with a three-year payback horizon requires an increase of about 11 percent in contribution per customer from all customers, or 17 percent each from the top 10 percent of high-value customers (Exhibit 2).

Given these figures, it easy to see why untargeted format renewal so often fails to pay off. It is probably more effective to target high-value customers, even though it demands a bigger increase in contribution per individual, because initiatives can be focused on meeting a particular set of needs.

Lowering the cost of delivery

All banks will have to manage costs strenuously to keep up with the industry’s leaders. Efficiency ratios³ are constantly improving, and it is estimated that most banks will need annual productivity gains of 5 percent over the next decade to keep abreast of the industry average. The best will achieve more than double this figure.⁴ US Bancorp has already set the goal of a 35 percent efficiency ratio by 2002, against a current average of 62 percent for all US bank holding companies. Cost reduction—particularly in distribution, where the bulk of any bank’s expenses lie—will therefore be vital to any format renewal.

Distribution costs can be cut in various ways: by encouraging unprofitable customers to use ATMs, designing smaller branches, and reducing the number of outlets. All these measures enable banks to tackle the two biggest costs: staff and real estate.

Wells Fargo has closed many traditional branches in favor of supermarket outlets. In Sacramento, where restructuring is almost complete, the bank’s expenses have fallen by about 20 percent. Sales have risen by almost as much. Meanwhile, National City Corporation, based in Cleveland, is closing or reconfiguring 200 of its 750 branches over the next three years; 110 of these will become smaller "bank express" offices, staffed by one-quarter fewer employees than before. The new offices’ operating expenses are expected to be 10 to 15 percent lower as a result.

Consumers’ increasing familiarity with ATMs, coupled with falling technology costs, means virtual branches are on the horizon. Citibank already runs a handful of electronic banking centers that use interactive technology to deliver all the services provided by a traditional fully staffed branch. A real-time two-way video system enables customers to speak "face to face" with multilingual staff at a central customer service center. These staff can open accounts, assist with transactions, help customers apply for credit, and advise on specific products and services such as mortgages and investments.

For now, these branches are chiefly a showcase for Citibank; the estimated investment of $1 million per branch is unlikely to pay off over the next three years. But more modest, less expensive video kiosks could be feasible for a bank if reasonable sales targets were achieved and if technology could replace tellers. As technology costs continue to fall, these formats are likely to make more and more economic sense (Exhibit 3).

To reduce real estate costs, smaller formats, often co-located with other retailers, can be a solution. Given the uncertainty over how much extra business this approach might generate, a bank should ensure that the income it receives from leasing some of its excess space at least covers the cost of remodeling branches.

Despite their potential, new formats sometimes make serving customers more rather than less expensive. There are two reasons for this. First, banks often deploy new formats without eliminating or reducing older ones. They may be afraid of losing precious customers; they may lack the skills to encourage customers to switch to the new format; or they may have neglected to consider the whole network and whether some customers might now be overserved by new sites.

Second, new formats such as ATMs or telephone banking can encourage customers to carry out more transactions. This increased usage can increase banks’ costs per customer even if the cost per individual transaction is lower. Banks therefore need to consider how these formats might change customers’ behavior, and how they might manage that behavior (for example, raising the minimum amount that can be withdrawn from an ATM so that customers use the service less often).

What kind of format renewal will work for an individual bank will depend on a number of factors: its core capabilities and assets, its competitive strengths and weaknesses, its brand equity, and the preferences of its target customers. Innovations that work for one bank will not necessarily work for another.

If a bank already has a reputation for technical innovation, its customers are likely to feel comfortable with more technology. But if a large share of its profits or growth comes from older customers who prefer personal service, it could be unwise to push ATMs too hard. Similarly, if it is already good at cross-selling, format renewals that might jeopardize this would be pointless.

Success will also depend on running disciplined pilot studies that test and refine the innovation. The best pilots test specific elements of an offer so that it is clear precisely what is making customers increase their balances or helping the bank reduce costs. They should be subjected to qualitative and quantitative evaluation, and be viewed not as the first wave of a rollout, but as an opportunity to learn. This way, results can be evaluated before large investments are made and without the risk of upsetting customers with radical change.

Done well, format renewal can be a means of differentiation that boosts a bank’s performance—but only when an enhanced physical environment directly affects customer behavior and results in improved customer retention, increased contribution per customer, and lowered costs. Other shifts in the value proposition, such as product innovation and pricing, are likely to have as much or more impact on customer behavior. The danger is that banks will concentrate on the format, rather than the content.