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BirdsEye View

A recent article in the Financial Times drew three lessons from the credit squeeze (which I still think is a misnomer, since liquidity and credit were squeezed only of very specific and narrow, albeit deep, markets). The lessons were enlightening:

1. "A conference call to announce bad news is like a visit to the dentist or a school exam: the experience is painful but it is preferable to worrying beforehand about everything that could go wrong."

   Time and time again, the market welcomes "kitchen sink" quarters where banks take huge losses, since it mostly looks forward, and such quarters mean better future earnings. (AB Note: we've seen banks from National City to Citibank take advantage of this already, and more to come)

2. The trader's option changed hands.

   One age-old problem faced by banks is that traders are incentivised to take undue risks with their employers' capital because of the way they are rewarded. They gain bonuses based on revenues they generate during the year, while banks are stuck with credit and trading losses that emerge later. Banks have mitigated this risk by paying the bulk of bonuses in restricted stock and options: it is common for half of the annual bonus only to vest three years later... Financial innovation means traders still have the incentive to make risky trades or sell bad securities; the difference is that most of the pain now ends up outside the bank".

3. Liquidity is priceless.

   All banks, SuperCommunity banks included, can heed these lessons, since they apply directly to them despite the fact that they don't play in the megabanks' trading space. Biting the bullet and 'fessing up to analysts while compounding current losses to yield future earnings is an age-old tactic that works, under the right circumstances, for all banks. Figuring out how to pay lenders (a.k.a relationship managers) in a way that will both retain them and reduce their incentives to make bad loans is another eternal bank quandary. The new compensation systems for traders described above are certainly applicable to that population, as well as others, among bank employees. Last, we indeed forgot how beautiful liquidity is during the days of 1% Fed funds, and took our eye off the ball of building core deposits. Many banks are paying the piper now with off-maturity high rate CDs, high rate money market accounts and the like. One should never forget that liquidity - especially core DDAs -- is beautiful, not even when rates are low and alternative sources of liquidity are cheaper than branch-driven funding.

Can Non-Mega-banks afford to invest in their brand? It's a questions that has been haunting us for decades. The question has resurfaced again, this time slightly modified: Can we afford NOT to invest in our brand? The purpose of the article below is to help you answer the question, and to evaluate whether your brand does have intrinsic value that can be grown over time. The real question that needs to be answered is: Will brand investments yield improved short and long term shareholder value, i.e. more current income and/or more franchise value? Read the article below to take the first step toward answering this difficult yet important question.

Branding has been a dirty word among bankers for years. Marketing Directors were repeatedly rebuffed in their attempts to win allocations for brand building and image advertising. Against this backdrop, it is surprising to find more CEO's interested in discussing branding initiatives, and even willing to fund them.

A brand is a set of expectations and associations evoked from any experience with a company or a product. It is an emotional reaction to the company or merchandise. A brand has several components:

• Image - how the customer perceives the brand
• Positioning - carving out a distinct space for the brand in the customer's mind
• Promise - the pledge of what customers can expect from your brand
• Equity - the monetized value of the brand

We all know that a strong brand has many benefits, from higher customer loyalty to reduced risk of new product failure and, ultimately, to a sustainable competitive advantage. At the same time, it is extremely expensive to build, and most banks can't compete with the mega-banks on pouring advertising dollars into the brand to achieve a strong identity in their customers' minds.

Customers, on the other hand, like brand identity because it helps them know what to expect from the company or product, and thereby reduces their risk of buying a disappointing product or service. This value works, however, only when the product or company consistently delivers on their promise and indeed provides superior goods and service levels.

Brands fail because consistent execution is extremely difficult. At some point the drive for profits causes a trade-off in execution that compromises the brand promise, and, in other situations, strong brands simply take their customers for granted and become over-confident. As Howard Schultz, the Chairman of Starbucks, said, "We desperately need to look into the mirror and realize it's time to get back to the core and make the changes necessary to evoke the heritage, the tradition and the passion that we all have for the true Starbucks experience."

A brand can become just as much of an asset to a company as its people and products. Its value is expected to grow if properly nurtured and executed. Banks are beginning to realize that as Gen X and Gen Y customers have become more brand loyal and brand sensitive, and as purchasing and research on the internet have increased the importance of the brand in the purchasing decision and company selection. Yet, in almost all cases, when a bank gets acquired its brand is erased, as is the entire investment in its building. This tells me that many banks have failed to increase their brand value over time enough to make it a variable in the buyer's decision to both purchase the bank and later to integrate it. I know this isn't always the case. When Norwest and Wells Fargo merged, an in-depth brand study showed that the Wells Fargo brand is far more valuable in terms of both financial and economic value than the Norwest brand, and the name of the company was changed to reflect that. Achieving such distinction can be an important goal to bank managements going forward, since their brands can become valuable to both shareholders and customers.

There are clear and sophisticated methodologies to value brands. Coca Cola is the #1 brand in the world in value at $67 billion and Microsoft close behind at $50 billion. Some brands are growing in equity value, like Google and Starbucks, and others are declining, like Intel. Among banks, the most valuable brand is Citi, valued at $35 billion, or about 14% of its market cap in 2005. Wells Fargo's brand is valued at $14 billion, and American Express at $31 billion or 28%+ of its market cap in 2005.

These are all gargantuan brands, and they span the globe. A community bank can achieve similar results in its own market with far less investment and execution risk. It can get there by answering four main questions:

• How different is my brand in my market from other competitors?
• Does my brand have personal relevance to the customer?
• Is my brand held in high regard and considered best in its class?
• Do prospects understand what my brand stands for?

The first two questions address differentiation and relevance, two indicators of the brand strength. The second two elements—knowledge and esteem— relate to the brand stature.

Research shows that brands that grow their differentiation have 50% higher operating margin on an average than those who are not well differentiated. This statistic comes from manufacturing; I believe the number can be even higher in service industries such as financial services, where product differentiation is murky at best. The same research indicates that brands that grow both their differentiation AND relevance report the greatest increase in operating earnings.*

Community bank executives have come to realize the power of the brand, which is why their interest and willingness to invest have increased. The task remains daunting in face of the magnitude of competitor investment and sophistication, yet, I believe that the main impediment to strong brand building is management's inability to clearly articulate a differentiated strategy and market position. In our quest to be all things to almost all people, differentiation eludes us.

Strong brand identity starts from a crisply differentiated strategy emanating from the executive suite, and not from the marketing department.

*Methodologies of brand valuation are discussed in the book Brands and Branding, An Economist Book, in the chapter titled "Brand Valuation". The book is published by Interbrands at www.interbrands.com.