Executive Summary: Customer segmentation serves as one of the main foundations of strategy development and its successful execution. Too often, however, segmentation analysis fails to uncover the key issues that management needs to address both to maintain current customers and to grow in new directions.
Worldwide, more banks are announcing their commitment to the small business segment. Factors driving this focus include: revenue and profit potential, barriers to growth in other business areas, and, in some cases, a push from the national government.
The recent downturn saw many banks suffer from their small business exposures while others continued to thrive. Many of the most successful players did so because they had implemented and stayed with a well-developed segmentation strategy. In other words, one bank’s definition of “small business” differed sharply from another’s.
One of the challenges involved in segmentation is that a bank’s analytical ability often outpaces its ability to execute on that analysis. Recently, I was reviewing a segmentation strategy conducted by another consulting firm for a major bank. Their analysis resulted in 38 (!) segments for its retail bank client to focus on, including some that were small business related. It was beautiful work from an analytic perspective but largely useless because, practically, it could not be implemented.
Start with the current status.
Segmentation is one of the basic tools of success in the small business space; simplicity in segments chosen will usually win out. Agreeing on a segmentation strategy begins with a detailed understanding of the current customer, an analysis that can be conducted largely in-house. When we work with clients on segmenting their current customer base, we look at multiple segmentation cuts. Three areas often become our central focus:
* Profitability. We want to know which clients drive the bottom line. (The Pareto Principle or 80/20 rule always applies.) What do these high profit customers look like in terms of demographics, industry, product use, geography, etc? Similarly, what are the characteristics of the worst customers? This analysis helps us to determine the steps required to improve and likelihood of improving these customers’ profitability.
* Product use. Many banks tend to focus on loan products, an area of limited growth and, likely, diminishing profitability. To succeed with the small business segment, banks need to become less loan-reliant and, oftentimes, refocus on the 60 percent or more of businesses that are non-borrowers. We want to know how concentrated is the customers’ product use? What percentage of the customer base is loan only? Deposit only? What percentage of customers use both business and personal products?
* Channel focus. A well-respected industry analyst recently predicted than about five percent of bank branches will close in the next year. Given the reduced activity at many branches and the high cost of operating them, banks need to reassess the value of individual branches. As with the consumer, small businesses are also moving away from the branch, although this is more true for certain industries (professional services) versus others (retailing). Some banks are maintaining branches to support the requirements of low profit businesses, obviously a losing tactic.
As branch use changes, alternative channels are increasing in importance, in particular telephone, online banking, and remote deposit capture (RDC). We think RDC can be a game changer, but are a bit skeptical about how critically important mobile banking is to most businesses, at least in the near term.
In this area we look at trends in channel change and want to understand which types of customers are the quickest adopters, laggards, etc. Ideally, we would also evaluate customer profitability by channel.
Compare with competitors and aspirations.
As part of the initial segmentation process, banks should also compare their performance versus competitors. We found that one client, by chance, had a much higher percentage of small clients in unattractive industries than its peers. This called for some immediate remedial action.
Another client had chosen a future strategy aimed at the high end professional. As a target this makes sense based upon that group’s attractive balances, good lending track record, and multiple cross sell opportunities. In that case, however, the goals of the bank were very far apart from its actual client base. In fact, given its starting point, trying to reposition it as a bank for higher end small businesses had little chance of success.
Internal and external analysis.
Analysis based upon internal data can provide significant direction related to future segmentation. Above, we mentioned segmentation by internal profitability data, householding, geography, products, and channels. In determining future segmentation, external analysis, including the competitive environment, needs to be evaluated. In addition, primary market research may also be appropriate.
Primary research has limits, and it is usually best used to test hypotheses and possible approaches. The customer often does not know what he or she wants or cannot imagine the impact of an ATM or RDC until it is up and running. Nevertheless, this type of research may be critical in determining the optimal approach for and likely success of a segmentation scheme.
Segmentation is messy.
Basically, at least six segmentation options exist: demographics (largely size or geography based), profitability/contribution, lifecycle, need-based, product, and/or behavioral.
Management will often learn that its best overall segmentation strategy may involve elements from more than one of these groups. For example, one of our clients focused on a niche area within commercial real estate and deposit-only customers. Another concentrated on older small businesses, assisting in selling the business and investing its proceeds; it also had a strong retail franchise it levered to sell to microbusinesses.
Concluding thought.
The best small business banks know what they are good at and know what they do not know. Segmentation should provide management with insights about its current customer base and direction about its future growth path. Banks need to define their small business and then build a plan aimed at that subsegment(s).