Commercial Loan Automation
Small Business Banking
non priced-based competition or competing where others are not
tips from other industries
I hope that starting the year with a thought-challenging article calling for a fresh look is a good choice. Let me know if I hit it right. Also, my Recommended Reading List for 2005 has been posted on www.anatbird.com in the "About Anat" section. New entries to the website are reported on New In The Nest section on the front page.
Your comments on my last article were most insightful. Here is an example:
On the regulatory front, Bill Bonds of Marquette pointed out two additional regulatory "hot buttons":
Funding. While the regulators accept wholesale funding sources, they are now also looking for a step-by-step comprehensive liquidity plans that go beyond the primary and secondary liquidity sources we are accustomed to. These plans call for the identification of specific triggers within the liquidity plan that put into action detailed remedial actions
ALM models. Back testing and independent validation of the models are on the regulators' agenda, consistent with my comment regarding their lack of practical application in the last article. The regulators are expected to be more critical of ALM systems that are generated from call report data vs. the bank's application systems, i.e. loan by loan, deposit by deposit.
Wishing you a new year full of excitement, challenges, fun, profits and special moments,
Non Priced-Based Competition Or Competing Where Others Are Not
Tips From Other Industries
Priced-based competition is a strategy that isn't available to most companies. Only few players in any industry have a sustainable cost advantage, due to a patent, economies of scale or other elements. They can parlay the cost edge into a competitive advantage by consistently pricing above the market. They can afford to do so and remain highly profitable by passing some of the cost advantage to the customer. Fifth Third has been known to execute this strategy well in banking without penalizing its profitability. Others became consistently the high rate player in their CD market to fund an extremely profitable asset strategy. Citibank can also muscle other competitors out of a business, leveraging its huge size and economies of scale. Wells Fargo's mortgage servicing business capitalizes on a similar advantage. Like Wal-Mart, they can edge competitors out utilizing size and the associated cost benefit. Surprisingly, however, size isn't a pre-requisite for building a competitive advantage, even when economies of scale are concerned. The edge often lies in redefining the market or the product.
Mid-size and small players in an industry must find levers other than size and price to compete profitably and grow. Several examples from non-banks come to mind:
Trader Joe's. Consider the food distribution industry: razor-thin margins; size means everything in achieving cost concessions from food producers and packagers; one-off players continue to be squeezed out of the business by Wal-Mart, Safeway and other scale players. This isn't a market that attracts newcomers, since barriers to entry appear overwhelming. Yet, in 1958, Trader Joe's was created as a chain of convenience stores called "pronto". In 1967, the founder, Joe Coulombe, made the decision to go beyond convenience stores and enter the food distribution business by expanding the stores' offerings and enhancing their image. He doubled the floor space and offered hard-to-find boutique wines and other gourmet food items as outstanding prices. He could afford to cut the price because so many of his items were sold under Trader Joe's private label, which typically carries 15-20% higher margins than commercially branded items. Joe also decked out the stores with cedar plank walls and nautical décor, and garbed the Captain (the store manager), the First Mate (Assistant Manager) and Crew Members in colorful Hawaiian shirts. The brand identity was born, and, with it, a unique product strategy that could compete effectively against the giants: private labeling rare and hard-to find items that won't find their way into the typical supermarket shelf.
Today, Trader Joe's stores carry more than 2000 privately labeled items, and the company continues to expand its capacity to buy unique things. All private label products have their own "angle", such as organic or minimally processed. The store combines its special merchandize with a fun atmosphere (the Hawaiian shirts are only the beginning) and quality control (using tasting panels). The result: a high growth business in an intensely competitive, scale-driven business. The underlying reason for the success: changing the business paradigm by offering
- Non traditional, non-commoditized products
- Fun shopping atmosphere
- Brand reliability supported by quality control
Trader Joe's did not compete head on with the major players in its industry, nor did it attempt to take the paradigm and improve it. The vision was outside the box, and the execution as crisp as in any military operation.
The lessons learned by Trader Joe's are directly transferable to banking. Breaking the mold for consuming and serving banking products has been a successful strategy for several banks, starting with Commerce of the northeast and continuing with Umpqua of the northwest and other, less "obvious" banks such as Capitol of Michigan. These banks elected to compete on grounds other than cost, but also to be very clear about their competitive niche, strategy and execution. They all developed very regimented and disciplined approaches to their business, from the physical facility look and feel to the activities of the employees within those facilities. Their thinking was not supported by traditional banking models, but their success speaks for itself.
Southwest Airlines. The airline industry has typically carried a cost structure that was too heavy for its income streams. This became especially true as oil prices started rising, but has been the case for the decades following deregulation and the elimination of the monopoly enjoyed by a handful of large carriers. As other players emerged, the large, stodgy, hub-and-spoke airlines could not compete effectively against the nimble newcomers. Southwest Airlines exemplifies all the reasons why an out-of-the-box thinking airline with strong professional and technical expertise could run circles around the experienced big guys:
All employees had a stake in the airline's success. Southwest Airlines brought a new model to the industry: no longer did employees view the airline as the rich employer that deserves milking to the last drop, an invincible big corporation that will never go bankrupt or die. Instead, the airline, owned in part by the employees, became the employees themselves. As the saying goes, "we found the enemy and it is us". Aligning the employees' and the shareholders' interests was a critical breakthrough that changed the attitude and the performance of the airline's employees dramatically.
All airplanes were of the same model. Maintenance and parts and a huge part of any airlines' cost, second only to labor and fuel. Standardizing the equipment allowed Southwest to service and maintain their planes less expensively than the big guys. It also reduced the likelihood of having a mechanical problem disrupt flights, since all planes were the same, and, as such, totally replaceable (as opposed to a Boeing 777 and a CRJ, one designed for very long hauls, the other for short hops). Consequently, both costs and foregone passengers were lowered.
All routes were short. You can take Southwest from one side of the country to the other, but the hob-and-spokes model does not apply. Instead, all routes are short, which supports the single aircraft model concept. It also builds in further flexibility in the network for both airline and passengers.
Most airports were secondary in their markets. Southwest didn't have to pay a King's ransom for the gates it secured in the airports it served. Instead, it brought secondary airports onto the map, such as Baltimore and Manchester, NH. It offered a less expensive, more convenient alternative points on the map that both lowered its own costs as well as the passengers' costs (of parking, accessibility, aggravation etc.).
No seat assignments, no food. The airline eliminated two cornerstones (perhaps sacred cows?) of air transportation in its business model. In return, it offered greater reliability of flights, faster on and off boarding, much less expensive airfares and a good atmosphere. It expended the market by lowering the airfare threshold, thereby making it more affordable to more people. And, it attracted the most cost-conscious segment by appealing to a combination of elements, not cost alone.
Southwest sells FUN in addition to transportation. The value proposition is simple and clear: get from point A to point B, no frills and a good atmosphere. It appeals to a huge segment of the population, since it is coupled with meaningful cost advantages, as Southwest passes some of its cost savings in labor, gates and plane acquisition and maintenance to the consumers. The result has been a resounding success.
Standardization. Southwest flies about 400 planes, all of them Boeing 7473. This standardization creates flexibility because both planes and crews can be swapped. Southwest planes spend less time on the ground between flights than other airlines (20-30 minutes) and are expected to make 7 flights a day. Efficiency increases through standardization at all levels, including cockpits (Southwest does not accept modernized cockpits for the 737s, even though Boeing has updated the look of the cockpit). If a lane has a maintenance issue or a pilot gets delayed, Southwest need not disrupt its schedule; any pilot can fly any plane on any Southwest route.
The Southwest story is well known, but its business underpinnings have not been transferred to many other industries, and certainly not to banking. The airline offers the same basic service as other competitors, but it has changed major elements in the cost equation, as well as the entire value proposition to the customers. Can banks translate this approach to financial services? They certainly can, by breaking down the production and delivery of banking services and offering a different solution than the traditional model. ING Direct is an example of a successful deposit gathering machine that replaced branches with a high rate deposit value proposition. Convenience has been moved from the physical to the web world, and the package appeals to a broader and broader segment of the population. ING didn't compete with other depositors on their own grounds, even though their product was undifferentiated. They differentiated the convenience element instead, and traded off physical convenience with higher deposit rates. The segment that likes this equation is broad enough to make ING Direct an extremely successful bank.
Blockbuster. Blockbuster was merely one of many movie rental businesses, a player among many in a highly fragmented industry. Until 1998, it bought videos from the major studios like all other movie rental outfits: they paid $66 and charged $3 per rental, for a 22 rentals breakeven point. This cost structure did not coincide with consumer interests, which peaked and waned shortly after the movie release.
This was true until it cut a deal with Paramount Pictures to buy their videos for only $9 per film in exchange for 50% of the rental revenues. Even though Blockbuster gave away 50% of the revenues, it now took only 6 rentals to break even. This agreement gave Blockbuster the leading edge on both product (it could not afford to buy many more copies of each "hot" film) and cost (at a lower cost than other competitors). Blockbuster's inventory increased to 124 tapes per title, vs. its competitors' 12 copies.
That initial agreement redefined how the industry configured, eliminated many smaller players that could not get enough product, and established a highly concentrated industry where Blockbuster dominated (market share grew from 24% in 1999 to 42% in 2002) until NetFlix came along and changed the paradigm yet one more time (Blockbuster's late fees, a huge source of income for them and annoyance for its customers, has been eliminated thanks to NetFlix).
The parallels in banking are many. Among them are:
The elimination of online banking fees, debit card fees and other such fees when a couple of the mega banks decided to do without them (much like the move by NetFlix to eliminate late fees, which forced Blockbuster's hand).
The difficulty many banks with small insurance agencies have experienced when they entered the insurance business and realized that they need to show a larger distribution network to get product and rate concessions from the largest insurance underwriters. Like Blockbuster, the bigger the agency, the greater its profitability not due to economies of scale but due to accessibility of product (insurance coverage) to a wider range of risks with a better rate structure.
The economic viability of collaboration, such as loan participations up- and down-stream, insurance joint venture (such as Bankers Insurance by the Virginia Bankers Association) or leveraging banks' distribution networks and customer bases to sell annuities, investment products and trust services by third party marketers (much like Blockbuster reached an accord with paramount Pictures that changed the face of the industry).
The sustainable competitive advantage created by taking a different take of the market or the product can become the cornerstone of a high growth, high profit strategy if effectively executed. Ceding lines of business to large players due to the cost implications of existing delivery and production models isn't necessarily the right thing to do. Thinking out of the box and redefining the competitive landscapeis a viable option.
This article is meant to cause you, the reader, to ask "why?" or "what can I do different?". Traditional banking and "sticking to one's knitting" are both alive and well, and highly profitable in many institutions. At the same time, what worked in the past is no guarantee for future success, especially given today's pace of change. Considering breakthrough thinking like the examples outlined above and so many others we come across every day is a useful strategic effort for any company, no matter how successful it is. In fact, the greater your success, the better your opportunity to question and get even better. The more successful a company is, the more difficult it is to question, but the future depends on building upon strong foundations with new ideas.