Key message: We all use the term “small business” as if it were a homogeneous market. In fact, it is extremely diverse. Success with this segment requires that each financial company define what small business is for itself with its own capabilities, aspirations, and market potential in mind.
Small Business is Not a Homogeneous Segment
In recent weeks we have worked with clients in which the phrase “small business” has been used to mean very different types of companies with very different needs.
In one case, the client views “small business” as a company with a specific type of secured financing need that this client believes it is well-positioned to serve. For another client, small business means a company for which the bank can meet both the business banking and owner banking requirements. This client emphasizes a more holistic approach in which its perceived competitive differentiation rests on its ability to anticipate and meet multiple needs. Yet another client defines “small business” primarily as a rich deposit source while a fourth client believes it can generate strong returns from an unsecured loan business.
As the above examples indicate, the four small business segments that these players are aiming at have distinctly different needs. However, each can offer strong returns to the company that properly aligns products and delivery approaches versus them.
The secured lender needs to operate with a targeted origination approach that allows the lender to plug into potential borrowers efficiently. The relationship player not only must have a more developed product set but must also be able to assess the economic potential of targets so that the returns justify the time spent with clients. The deposit specialist needs a streamlined product set and efficient operations while the unsecured lender needs to operate with a high tech, low touch factory. All different but also potentially very effective economic models.
Virtually every successful small business player we know has set its own parameters for where it wishes to focus and, conversely, what it wishes to avoid. Attacking multiple small business segments may be possible but brings with it many strategic and tactical issues.
All Things to All People
Too often, banks generate small business portfolios that more resemble a smorgasbord rather than a targeted strategy like the ones outlined above. In one case, our client had focused on share growth as it established itself in its market. We were hired to determine the type of companies that were in its portfolio and analyze its best growth opportunities. We found that the portfolio featured overweighting in industries that had more volatile performance (e.g., retailers) and was underweighted in more attractive segments such as professional services. At the same time, the bank aspired to be a professional services leader, hoping to reap the benefit of strong deposit levels and high-quality credit.
Its fundamental mistake was its failure to determine the direction it wanted to pursue at the beginning of its small business venture rather than several years later. By direction we mean some very straightforward but, nonetheless, complex decisions:
* Size. Do you wish to focus on microbusinesses, “core” small businesses, or larger small businesses that are on the road to becoming middle market companies? If your answer is “all three and more, please,” your likelihood of success is low. The size of a company is a decent (although by no means perfect) indicator of the degree of complexity required in product, delivery channels, and reporting. For example, those banks that define the size of their small business focus broadly as $0-10 million need to consider how to subsegment beyond that criteria. Otherwise, cost-to-serve will be misaligned with revenue potential.
* Customer Positioning. Banks can be either relationship- or transaction-oriented in how they deal with customers. Most banks see significant value in a relationship approach because it can result in increased cross-sell and, ultimately, higher returns. However, in actuality many banks emphasize product pushing while misleading themselves into believing they are pursuing relationships. The successful banks will frankly assess where they are today and objectively judge what they need to do to transition to the position with their customer that they wish to attain.
* Product. Stealing from the old joke about real estate and location: Banks make most of their small businesses profits from deposits. Banks make most of their small businesses profits from deposits. Banks make most of their small businesses profits from deposits.
Still, most banks highlight loan products. Or they pursue products like free checking that ultimately are profitability dead ends unless the bank achieves significant cross-selling to tie down the customer. (Of course, that assumes the customer whom you attract to your bank by free checking is one you wish to tie down.) Increasingly, we see banks creating more and more products, hoping that something sticks with the customer.
Product design based upon a clear market strategy and its related products may in fact result in fewer products, not more.
Where to Start
Begin by understanding where you are today. Who are your customers now? Why are they your customers? In too many cases, low rates and “flexible” offer may dominate as the reason versus the value of your brand or your unique selling proposition.
The very good news is that the small business segment is so large and attractive that room exists for a large number of players to generate significant profits from it. However, you need to select your market and, ultimately, your competitors in order to achieve the extraordinary returns available to you.