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I see you are Head of Customer Intelligence why don’t you tell me if their strategy is intelligent! † Philippa had 48 hours to figure out what she thought of the strategy proposed by the retail division, formulated with the help of a major consulting firm. That meant finding out what the new branch strategy involved and whether it made sense – fast. She hoped a recent study of customer profitability would help provide the answers. History Infinity Bank, one of the 10 largest banks in the United Kingdom, was a major force in banking. The bank had over 1,800 retail branches – one of the largest branch networks in the UK. Infinity’s management viewed the branches as essential to its retail banking strategy: branches drove the majority of costs and recruited over 70% of clients. Vice-President of Retail Operations, Andrew Shebbeare, summarised the significance of the branch network: â€Å"The branches are where we first meet new customers. They are where we help existing customers to solve their problems. They are our frontline. We have over 50,000 customer interactions per day. Twenty thousand full- and part-time staff work in our branches, well over two-thirds of our workforce. The branches are the heart and soul of this organisation. However, its vast branch network had not helped Infinity achieve a high level of profitability. (Exhibit 1 shows the bank’s performance compared with some of its peers in 1998-2003). Industry analysts felt that Infinity had not successfully coped with the major changes that had affected the UK banking industry – particularly retail branch banking – over the previous 20 years. Numerous structural changes had altered the ways banks interacted with customers through retail branches. (Exhibit 2 describes the key changes that affected UK banks, beginning in the 1980s). Deregulation, new technology and branch alternatives had all had a major impact, transforming retail banking to such an extent that it had become practically unrecognisable in less than 20 years. Deregulation had been a major shock to the industry. Competition from new entrants, particularly the building societies and American banks, put severe pressure on profits. Many UK banks had responded effectively, tightening operations and becoming more competitive. With a record boom in consumer lending in the 1990s, many banks’ profitability and value- added metrics had improved despite increased pressure on margins. Retail banks had become expert users of technology to automate processes and make them more efficient. Technology investments had enabled a significant reduction in headcount Copyright  © 2006 INSEAD2 06/2009-5348 106-016-1 [pic] from the late 1980s. For example, Barclays Bank reduced its headcount from 118,000 in 1988 to 97,800 in 1993. 1 Banks had also closed many branches during this period. The number of branches roughly halved in the UK between 1981 and 2003, and by 2004 the UK population had far fewer branches per head than other European Union countries. 2 Less visible, but no less significant, was the reduction in activities carried out in branches. Up until the early 90s, branch managers were in charge of most customer relationships. The branch manager made decisions on who could take out a mortgage, be covered by insurance, or go into overdraft. At Infinity, as at most UK banks, these powers had been vastly curtailed, and by the late 90s most decisions were made in a centralised fashion. Call centres and information technology enabled the move to centralised decision making. Banks increasingly used call centres for all kinds of customer queries. By 2003 over 80,000 people were working for banks in call centres. 3Although the centres brought a new level of convenience for customers, they were also a target of customer frustration. Call centre operatives worked within strict guidelines on how to answer customer queries. For example, â€Å"discretionary† overdraft extensions, if allowed at all, were only granted if the operative’s computer system gave the authorisation. With the emergence of alternatives to branch banking, banks began to call into question the need to have branches at all. Successful new banks were created using only telephone and mail-based channels. First Direct, a telephone-service bank, was launched in 1989. The mid- 1990s saw the emergence of several major direct-mail-based firms. The launch of Egg in 1998 heralded the arrival of internet banking. New technology, regulatory changes and branch alternatives had created a completely different landscape in retail banking. Infinity Bank had followed the trends but its results continued to worsen. Under the new CEO, the retail banking division had launched a strategic review with a top consulting firm to revive its fortunes. Bank Branches as Supermarkets The radical changes in branch management were summarised by Alex Gawley, a consultant whose company specialised in improving the efficiency of bank branches: â€Å"Bank branches ceased to be what the previous generation considered to be a bank. There are still branch managers and tellers and back-office staff, but to a large extent the service that used to be provided by the branch is now done in huge call centres in Milton Keynes. The branch workforce is still there as a face to the customer, but in terms of power to help customers they are only a facade. Branches are now nothing more than financial service shops. Barclays Bank Annual Report 1993 2Datamonitor report, Branch Banking in Western Europe, 2004 3Datamonitor report, Call Centres in the United Kingdom, 2004 Copyright  © 2006 INSEAD3 06/2009-5348 106-016-1 [pic] The new strategy of Infinity Bank’s retail division was indeed to emphasise that branches should be thought of as shops. A branch efficiency review carried out towards the end of 2003 concluded that there was still significant waste and underperformance in the branches; branch managers had no idea which customers or products were most profitable and made no attempt to optimise selling. The proposed solution was to make each branch more focused on its own profitability. The mechanism to achieve this was to make branch managers responsible for their own PL. Branches would make money by selling products and be rewarded for the products they sold based on product profitability. This became known as the â€Å"supermarket† strategy as it positioned branches as financial services supermarkets selling all manner of financial services in a one-stop shop. To implement the supermarket strategy, Infinity’s retail division conducted its first-ever attempt to understand product profitability. This required a major activity-based costing study. Karine Cheneviere, Senior Operations Manager in charge of the study, described some of the challenges: â€Å"We found that a high proportion of our costs were difficult to attribute to activities. The fixed costs in technology, brand management, capital tied up in 1,800 branches and management overhead were huge; we felt that many of these costs were not related to any individual product. But many of our costs are controllable and variable over a three-to-five year timeframe. Most of these can be associated with individual products. † After minor revisions, Infinity’s managers agreed that the final estimates were an accurate reflection of the relevant costs of providing the products. In particular, the Product Profitability Study addressed the over-costing of current accounts common at retail banks. (Exhibit 3 gives a summary of the product-level data developed by the profitability study for three of the bank’s main products: current accounts, credit cards and mortgages. )4 The results were surprising and insightful. Current accounts, a core banking product, were unprofitable. Mortgages, on the other hand, were wildly profitable. Some managers argued that focusing only on product sales was too simplistic. A customer might be profitable overall even while buying some unprofitable products. It might make sense to sell an unprofitable product in the hope of creating a relationship that would form the basis for cross-selling in the future. (Exhibit 4 shows cross-holding statistics for the three core products). In the end, establishing management incentives based on customer profitability was rejected as too complicated. How could they be certain that a specific product sale would lead to a better relationship or a later sale of a profitable product? Instead, branch managers’ incentives would be tied to product profits. After all, the proponents of the supermarket strategyreasoned,sellinghigh-marginproductswouldnaturallyimprovecustomer profitability across the board. 4All the data and analysis in this case have been simplified to cover only these three main bank products (with the exception of Exhibit 1). Copyright  © 2006 INSEAD4 06/2009-5348 106-016-1 [pic] The Customer Profitability Study Philippa Smith had joined the bank in 2003 as the new Head of Customer Intelligence, expecting something exciting. The headhunter described the position enthusiastically: Customer intelligence is the centre of analytical excellence for this bank. You will need to understand customer behaviour and profitability and convert that into strategic recommendations. And it won’t just be analysis; you will have responsibility and be expected to deliver! † For the first six months nothing could have been further from the truth. It seemed to Philippa that most of the other people in the bank had simply not heard of her department. All the interesting work was done either by external consultants or by the powerful marketing and risk departments. She had difficulty understanding why she had been hired at all. Granted access to the Product Profitability Study that supported the supermarket strategy, Philippa conducted her own analysis of retail profitability – by customer instead of by product. She was convinced that the product-profitability study hid important variations in customer profitability, within each product and also at the customer relationship level. To conduct her analysis, Philippa sampled 1,000 customers for each category of product cross-holdings shown in Exhibit 4. An example of the database structure is shown in Exhibit 5 for customers with current accounts and mortgages. The complete database is in the Excel file). Each customer’s net revenue by product was available from the bank’s databases, but cost analysis was more difficult. Philippa used the activity-based costing component of the Product Profitability Study to associate service activities and their costs with individual customers. The major customer support activities associated with individual customers included branch teller interactions, telephone support, cheque processing, account transaction costs and collection costs. Philippa decided not to allocate corporate-level overhead. The analysis showed major variations in profitability. Not surprisingly, customers holding multiple products and maintaining large balances were generally more profitable. But there was also significant variation in profitability within a single product, even for customers holding similar balances. For Philippa, the analysis raised many questions. Should Infinity try to get rid of its most unprofitable customers? Would it be more effective to focus more effort on the small percentage of customers that generated major profits?