Our last newsletter launched a series highlighting some of the key management issues for 2005. We have selected these themes based upon what our clients and contacts in the industry are working on and what they tell us are areas of concern.

 

 

Our first theme centered on cross-sell. While not a new focus, it has become a driving principle at some top commercial banks. As it becomes a “must do” rather than an option, growth in cross-sell and wallet share will become a key performance metric, both internally and for the investment community.

 

Theme Two, “Definitional Disagreements,” refers to internal organizational questions that at least a half-dozen banks we know are evaluating. Their resolution can have a profound effect on both a bank’s revenue growth and its cost structure. Questions center on the role of the branch in selling/servicing small businesses, the optional focus for the small business group, and the need for a more segmented commercial banking focus:

 

• What is the “right” definition for business banking? What is its floor and what is its ceiling? Realistically, what role can/should the branch play?
• Should the bank establish a focused lower-end middle market effort?

 

Business Banking. Managers at several banks we know are reconsidering how to define both the bottom and top ends of business banking, attempting to better align resources with economic potential.

 

For example, at some banks, the revenue floor begins at zero dollars, with virtually all businesses handled by the small business group. However, to generate the highest returns, banks must shift more responsibility for the smallest businesses to the branch level. Unfortunately, even today, branch knowledge of and attention to small business remains spotty. Branch failure with these businesses means either that customers are lost to the bank or that business bankers (who should be serving higher-potential customers) need to step into the breach and, thereby, deleverage themselves.

 

For the upper end of small business, revenue ceilings differ dramatically with ranges varying from $1 million on the low end to $20 million and beyond. Over the next year, we expect ceilings to hit $25 million and above at some major banks. Ideally, banks will increase their small business floors by shifting responsibility to the branch. In turn, this will allow these units to increase their ceilings.  Several factors are driving executive interest in an expanded definition:

 

First, many business banking groups operate more efficiently than middle market areas: products are standardized, underwriting principles are uniform, and business originators’ compensation is often highly variable, rather than salary-oriented. To the extent that a bank transitions this model to larger accounts, it can gain significant efficiencies.

 

Second, the best small business units have become sales and marketing machines, with a fierce focus on sales. Middle market groups are moving in that direction, but many still embrace service and credit activities over sales.

 

Third, industry surveys have shown some bank executivesthat their middle market group is failing to focus on smaller companies (anywhere from $5-50 million depending on the bank). They believe that these companies will receive more attention in the small business unit than they get in middle market

 

As we noted, these organizational changes represent the ideal. However, while a push for efficiency certainly underscores the benefits of enlarging business banking’s world into the lower-end middle market, numerous cautionary signals are slowing down this shift.

 

For example, branch personnel may not be ready, from either a knowledge or cultural perspective, to sell to businesses and take on the business relationships. Similarly, business banker capabilities and experience may not be sufficient for a more sophisticated customer base; underwriting capabilities may need to be sharpened to incorporate more complicated lending to these targets; and increasing the customer revenue ceiling may erode the unit’s focus on the core business customer as business bankers focus on the “elephants.”

 

Theoretically, revising floors and ceilings for the branch, small business, and middle market makes sense. However, practically, the roadblocks to doing so are significant; hence, management’s increased focus on analyzing and addressing the roadblocks and skill gaps before allowing change. Banks operate in a world of high growth goals and an unforgiving investment community. Therefore, bankers want to protect their current revenue streams and are extremely reluctant to make changes that may make sense in the long term but could lead to a short-term earnings gap.

 

Lower-End Middle Market Focus. More banks understand the attractiveness of the lower-end middle market customer. In some instances mentioned above, they are expanding business banking’s world to focus on this segment. In other cases, they are rethinking the core middle market that, today, can include companies from $5 or $10 to $250 million in revenues, a very diverse group.

 

Companies with approximately $10-50 million in revenues represent a hybrid between the small business and middle market. Like small businesses, they have limited alternatives to bank financing; banks are a key financial partner. And as with small businesses, because of limited product and business complexity, RMs can handle higher account loads than can core middle market RMs. However, they also offer significant cross-sell opportunity, in areas like personal banking, cash management, and wealth management.

 

Managers focusing here work to ensure that internal organizational considerations do not clash with building a reputation with this segment. Usually, the middle market group, rather than small business unit, will possess the capabilities required to serve this segment. However, unless a bank highlights this segment with a separate unit, it tends to suffer from under-marketing, resulting in poor penetration and wallet share. Quantifying this segment’s revenue potential and size underscores its attractiveness to the bank and emphasizes the need to build a bank-wide strategy aimed at this segment.

 

Final Comment. Bank management is increasingly willing to rethink market segments in order to generate faster core growth. Business banking and the lower-end middle market are two of the sweet spots for banks. In 2005, they will need to squeeze as much profit as possible out of these high growth areas