The middle market has always represented a critical client base for US banks, though over the last decade some have focused their cash-management services more on large companies. With these customers proving increasingly difficult to serve profitably, it’s time to pay renewed attention to the middle market—companies with $40 million to $500 million in annual revenues—where growth is stronger and margins look more attractive.

Historically, middle-market bank customers have been unwilling to incur the administrative cost of switching to a new institution, even when they were dissatisfied with their present service. McKinsey, however, has identified critical moments when banks can establish a new cash-management relationship with them. To take advantage of these evergreen opportunities, banks must overcome a number of internal sales and service challenges. Doing so will require better low-cost service, segmented product and service offerings, world-class account planning, and revamped sales organizations.

Our experience shows that these moves can increase a bank’s revenues from middle-market cash management by 10 to 12 percent in just 18 months.

An attractive market

We estimate that cash-management revenues from the middle market, amounting to some $16 billion a year, are growing by 3 to 5 percent annually. By contrast, revenues from the large corporate sector are growing by about 1 percent. Banks active in the middle market tell us that its margins are higher partly because smaller companies have less negotiating leverage and partly because they are less likely to sweep their relatively small balances from noninterest-bearing accounts into interest-bearing products. These small numbers add up to a profitable business.

Furthermore, active cash-management usage has its own momentum. One bank found that the balances of middle-market customers that had started to use more of its cash-management services in 2004 had nearly doubled by 2007. During those years, the inactive customers’ balances actually shrank by about 30 percent.

Middle-market companies are interesting not only because of their growth and margin potential but also because they increasingly desire sophisticated solutions to their cash-management needs. We see this in the segment’s growing demand for services such as remote capture and payables automation (Exhibit 1). Moreover, middle-market CFOs, unlike their counterparts at large companies, usually can’t draw on in-house capabilities to meet all their needs internally.

Banks thus have new opportunities to sell more value-added products, whose attractiveness they can often enhance by taking advantage of the investments they have made to serve large customers. Yet they must also understand that competitive advantage lies not in developing a single “killer product” but in designing portfolios of standardized products and services that give different middle-market customers appropriate tools.

Meeting the middle

To take advantage of the opportunity to serve middle-market customers, a bank must overcome their reluctance to switch cash-management providers. A survey of 200 such companies confirms that challenge: almost 80 percent already had a primary relationship that, on average, spanned 14 years. Our interviews indicate that middle-market companies do not view a bank’s product capabilities as a reason to switch. These customers are also willing to endure less-than-satisfactory service. “Administrative hassle” is the most common reason customers cite for not changing banks. Overcoming this inertia will require financial institutions to grapple with two issues: the timing and substance of an offer.

Timing is easier to address. The opportunity is especially ripe at three key moments. The first comes when a customer’s bank merges: many middle-market customers seem prepared to contemplate change if they think that the integration process will be painful. The second opening occurs when a company expands rapidly, whether by acquisition or organic growth. Companies that move beyond the small-business stage may quickly find themselves facing cash-management needs their existing banks can’t provide or struggling to gain the attention of banks that still think of them as small fry. The third opportunity comes when a customer’s leadership team (especially the CFO) changes, and the new regime wishes to make its mark. One way of doing so is to initiate a new financial-services relationship.

Devising a compelling and well-targeted offer is more daunting than offering it at the right time. In our experience, four factors can make it harder for a bank to meet the demands of middle-market customers. The first concerns their expectations of service and value: while in general they expressed high satisfaction with the cash-management services they received, customer service issues were the number-one reason cited for overcoming inertia and finally ending a banking relationship. Second, banks too often overlook the nuances of the middle market, whose demands vary markedly by behavior, size, and sector.

Another shortcoming bedevils account planning: many banks still lack the infrastructure to identify the customers most likely to need cash-management products. The final weakness is organizational, arising mainly from the traditional split between commercial-lending and cash-management operations. Although some institutions have made progress on this front, the lead relationship manager at many banks still focuses on lending products at the expense of cash-management ones.

Four best practices

To overcome these limitations, banks need to implement four best practices that can help them increase their revenues from the middle market.

Enhanced service at low cost

Much of a bank’s value proposition for middle-market customers centers on the quality of its service. Our work with banks offering cash management to this sector suggests that three considerations are important. First, middle-market companies need extra support when they create new banking relationships—for example, when a bank makes a first sale to such a customer or cross-sells products to an existing customer. The second requirement is a single contact point to resolve problems. Third, that person must either solve problems on his or her own or refer the customer to someone else in a clear hierarchy of problem solvers, not a chain of intermediaries. The customer must always have the sense of dealing with a single institution rather than a collection of disparate businesses that fail to communicate.

The three requirements appear to be simple, but many banks fail to provide them consistently and thus leave the door open for competitors. One especially persuasive support technique is to provide creative tools that make it easier for new customers to change banks or to add new services as part of an existing relationship. Several players, for example, have developed a software package that automatically converts a new customer’s data from the old file format to the new one. Others have tailored file conversion software to help new clients transcribe their payments instructions, with dedicated “on boarding” teams to help migrate all payments information. Guaranteed service levels, fortified by an option to let customers withhold payment for subpar support, can be a particularly effective inducement to switch.

Banks must recognize, above all, that middle-market treasury officers have less time and fewer resources for cash management than their peers in larger organizations. The latter have specialized finance staffs with different needs and work styles, whereas the financial controller of a middle-market company typically has to do everything him- or herself. The starting point is a well-designed, intuitive, and well-integrated online portal, similar to the offering of a good personal bank but with more features and flexibility. The quality of bank portals varies enormously. The best, such as Wells Fargo’s, combine rich, deep functionality; access to all services; and an intuitive interface that helps customers find what they want quickly and easily.

Other electronic products that transfer at least part of the burden of cash management from customers to banks include remote check capture, electronic data interchange, the outsourcing of payables, and payroll cards.

Segmented product and service offerings

The second imperative is to tailor solutions suitable for customers who typically may not have the time to grapple with the full range of a bank’s products and services. In doing so, the bank must keep strict control over its costs. In our experience, it can balance these pressures by packaging standard products into combinations that match interlocking customer characteristics: behavior, size, and sector.

Understanding the way customers behave is difficult but worthwhile. Two kinds of customers offer especially attractive opportunities, each built around different lead products. The first comprises customers that depend heavily on credit. The lending relationship is thus central to capturing them; banks that provide the right loan at the right time will tend to win their cash-management business. The second category consists of businesses with limited borrowing needs but significant cash-management activity; typical examples include companies in IT and certain health care segments, as well as professionals in architecture, engineering, and law. For these cash-heavy customers, the primary product is cash management itself, and the challenge is to determine which services will be most appealing. A customer’s size and sector will guide banks in making this determination.

Our market research shows that the middle market’s lower and upper tiers, dividing at about $100 million in annual revenues, demand different products. Not surprisingly, the upper tier is more interested in sophisticated ones, such as automated payables, while the lower tier focuses on products to manage payables.

As for the customer’s sector, manufacturers especially desire support for incoming wire transfers, while automated clearinghouse tax payments can attract many service sector companies (Exhibit 2). Middle-market customers rank industry knowledge as especially important, and an efficient way for banks to meet that expectation is to assess and exploit their natural advantages to strengthen their credibility in certain fields. Institutions with large branch networks are especially well placed to serve highly distributed businesses, such as retailers. Midwestern banks tend to have expertise in light manufacturing, West Coast banks in trade finance.

World-class account planning

Without adequate account-planning tools, sales and relationship managers can’t understand even basic customer characteristics. In our experience, a few judicious changes have enabled sales forces at leading institutions to combine their knowledge of a customer’s behavior, size, and sector with location and share-of-wallet data to guide their sales efforts. The most important tool, either to explore new cross-selling opportunities or to identify possible new relationships, is a robust, centralized lead-generation database keyed to the most important customer metrics. The best customer-relationship-management (CRM) systems, with this tool at their core, can be used for such purposes as combing through existing account-analysis data to identify gaps in the customers’ use of products—for instance, a law firm that makes many wire transfers but has no car service charges (suggesting that it uses a competitor’s product).

At many institutions, the barrier to world-class account planning is underinvestment in the underlying IT systems, which spread data across platforms that communicate poorly, if at all. Sales managers need a good understanding of profitability at both the customer and the product level—something these legacy IT structures can’t provide. A further complication is the large number of cash-management products. Achieving the necessary integration often involves an initial round of simplification to eliminate redundant platforms, followed by targeted investments to allow the remaining ones to communicate. Banks should not, however, overestimate their need for tailor-made IT solutions: one leading regional US bank was remarkably successful using standardized tools typically designed for smaller businesses (for example, simple CRM software from salesforce.com). Another major bank significantly increased the reach of its sales force, also without major cost, by strengthening and customizing its sales materials for each target segment.

A revamped sales organization

The final step is to overhaul the sales organization so that it embraces relationship managers from both commercial lending and cash management, matching their expertise with the behavioral segmentation described above. Many banks still fall short here, so they must be especially vigilant to ensure that the alignment is not only real but also enduring. We have found three tactics to be particularly effective.

First, relationship managers should be rewarded for cross-selling cash-management products. A rule of thumb might be to base 10 to 20 percent of their bonuses on such sales. Equally important, their work must be judged by not only the initial purchase but also the actual use of the product, so that sales teams are more likely to sell customers the right one. Second, banks should adjust their compensation systems in order to credit cash-management sales personnel with the full value they create. Currently, too many banks base sales compensation primarily on fees generated, with little recognition of the increased balances gained from cash-management services: the revenues from these balances can be significant. Third, banks must respond to the frustration of midlevel customers that can’t gain access to product experts. While the size of an individual middle-market account may not justify continuing high-level product support, banks should leverage their experts more effectively. One leading bank, for example, assigns its product experts to whole geographical regions, so they can support customers and relationship managers as needed. Indeed, when cash management is a customer’s primary need, banks should consider assigning the entire responsibility for the relationship to a cash-management expert rather than a relationship manager who specializes in lending.

The investments required to compete in the middle market can not only be large but also require sustained commitment, given the sector’s rapid evolution. Nevertheless, banks willing to make a significant effort are achieving equally significant rewards.