Executive Summary: All banks say that want to serve the small business space, but few succeed. As strong returns on capital become more difficult to achieve, banks need to reevaluate their commitment to this segment and determine whether, where, and how to participate.

Last time, I wrote that, for some players, focusing on the small business market is a poor match, and I highlighted how some lenders we know have decided to pull back from that segment in favor of mid-size and larger companies.

 

However, most banks remain publicly committed to small businesses. In addition, in the past year many regional and larger players seem to have reorganized and changed the internal leadership of this segment. Along these lines, one senior banker commented that most banks “are very focused on small business but once again everyone is looking to remake themselves.” The “once again” phrase underscores that many players, both in the U.S. and around the world, take stutter-steps with this segment, with few successfully demonstrating a meaningful link with small businesses or developing a leadership position.

 

While the small business segment continues to be attractive for many banks, the question remains, how should banks approach this segment to succeed?

 

Go beyond lending.

If you think that small business is all about lending, don’t bother to focus here. As noted last week, a lending-only emphasis will be increasingly difficult to justify from an economic and risk perspective.

 

Further, a successful small business loan-only focus requires a player to be a volume shop with excellent proprietary credit scoring capabilities, if lending to a customer requiring less than $250,000. Most banks lack both the capital, marketing prowess, and skill set required to do this.

 

One problem is that many bankers reading the above paragraphs will respond by saying that their bank does not rely on lending, that they offer a full product suite to the small business. Unfortunately, this view is largely delusional. To this day, most small business bankers are lenders first and foremost. I think that leads directly to the frustration that many banks have experienced and continue to experience with this segment.

 

Of course, there is no denying that lending is important to a significant portion (30-40%) of the customer base. But that leaves 60-70% for whom it is less significant. And, as already discussed, even those who need loans also need to provide more business to the bank to justify the cost and risk of being granted a loan.

 

The best small business players get this. However for most, these words fall on deaf ears.

 

Define it.

What is the right definition of small business for your company? The starting point for determining a bank’s focus probably begins with a consideration of the company size you wish to emphasize. Micros (under $1 million in revenues) and “core” small businesses differ substantially in their profit dynamics, underwriting requirements, and potential per company revenue, among other areas.

 

Beyond determining the upper range of micro, banks also need to determine the lower and upper end of “core.” We have seen banks define core small business to be as low as one million dollars and as high as $10 million. Similarly, depending upon the bank, the upper end of this segment has ranged from $5 million to $30 million. There is no one right answer here (although above $10-15 million, a company may be more a lower end middle market company than a small business). Each bank needs to look at its capabilities, products, and risk appetite to determine where to focus.

 

I am deliberately using company size as the key segment determinant for three reasons: company revenues are easy to obtain (although businesses self-reporting to D&B lie), size rather than industry largely (but not always) determines the products/services companies require, and more sophisticated segmentation is hard, if not impossible, to execute consistently. Other aspects, such as industry, product use, and life cycle serve as a secondary screen for most banks.

 

Be consistent.

Do not find yourself in the situation in which you need to send out the following letter:

 

July 30, 2010
Dear x:

 

We hope you enjoyed the benefits of your Citibank Business card. Your existing account referenced above will be discontinued and will be closed to new transactions effective August 31, 2010. We are closing your account because we have decided to discontinue this product. The decision to end this program was not based on any information regarding your individual account or credit standing.

 

Sincerely,
Citibank

 

This letter says a card is being dropped and offers no easy alternative to which the business customer can switch. What message does the above excerpt send to small businesses? Certainly it is not one that would suggest that the bank is concerned about a small business’s ability to manage its cash flow (the life blood of small businesses). The above is hardly an unusual example. During the recent downturn many banks turned their backs on small businesses just when they needed them most. These actions were done by banks big and small operating in large cities and small communities.

 

If a bank wants to be great in small business, it has to view this segment as a long term and highly attractive investment (which it is) and not an opportunistic one-off.

 

Concluding thought.

Banks that are remaking themselves with this segment need to make decisions beyond definition and consistency. Next time we will focus on some additional areas, including risk management and internal organization.