Retail Banking Business Models PDF

MODULE 3: RETAIL BANKING BUSINESS MODELS 3.1: Introduction to Retail Banking Business Models On completion of the Business Models module, candidates will be able to: Understand the relationship between a retail bank's strategy and business model...

MODULE 3: RETAIL BANKING BUSINESS MODELS 3.1: Introduction to Retail Banking Business Models On completion of the Business Models module, candidates will be able to: Understand the relationship between a retail bank's strategy and business model and how it influences the bank's operating model, which is discussed in the Customer Management Module; Understand the key features, advantages, and disadvantages of the business models that most banks use; Identify the drivers of change in retail banking that are making banks examine their current business model to improve their relevance to customers and their survival and growth in a competitive environment; Understand the importance of customers' trust in financial services and how some business models can erode trust and how some can rebuild trust between the bank and its customers; Understand the challenges of banks who believe that they are customer-centric but operate a different model; Explain the case for a bank adopting a customer-centric business model. This module will develop your understanding of the different business models that retail banks can use to create, deliver, and capture value for their stakeholders, who include shareholders and investors, customers, employees, and the community. During the past 20 years, banks have become 'financial supermarkets', where the customer can buy all the products and services they need. This has contributed to them adopting a product-centric approach. However, as we discuss, new players such as Revolut have emerged and are threatening to unbundle the bank's most lucrative revenue streams by providing very good niche products that they can then expand into a wider retail banking offering. 3.2: Business Models You will understand the key features of different business models used by banks, together with the relative advantages and disadvantages, and why a customer-centric business model is relevant for the future of retail banking. This Module will identify the drivers of change that are forcing banks to re-evaluate their existing business model to react to changes in the retail banking environment. We will examine the reality facing many organisations where senior managers believe that their marketing department should operate a customer-centric model yet operate in a product-centric way. We will explain what that reality or paradox means for organisations trying to achieve key customer objectives, such as acquiring, growing, and keeping valuable customers, as summarised in this research by The Future Marketing Organisation/MiQ 2018. How well is your company structured to achieve these customer objectives? Score out of 5 Optimising customer experience 3.1 Being led by customer insight 3.1 Capturing a single customer view 2.8 Customer acquisition 3.2 Customer retention 3.2 This module will also explain the case for banks adopting a customer-centric business model. You will also understand how to operationalise a customer-centric business model and what it means for the bank, its customers, and its employees. 3.3 Business Strategy and Business Models Having the right business strategy and business model is essential for businesses, including banks, to succeed. Too many times, we hear of businesses failing because they chose the wrong strategy or business model, or they couldn't implement the model. "The most basic idea of strategy is the application of strength against weakness. Or, if you prefer, strength applied to the most promising opportunity." Richard Rumelt Good Strategy Bad Strategy, (Deckle Edge, 2011). "A business model describes how an organisation creates, delivers and captures value." (© Smarter Way Mentors Limited 2021) To achieve the retail bank's strategic objectives, it must align its business model, and its ability to capture value, with those objectives. In pursuit of their strategy, a retail bank can choose one of three different models. These are: Product-centric; Channel-centric, also called delivery-centric; Customer-centric. In the past, most retail banks chose a product-centric business model that defined them by the products and services that they offered, not by the problems they solve for their customers. This is because it is easier for companies (and their management) to focus on things they can control, such as product features or channel design, than to open up to listen to customer needs. However, because of the ease with which customers can compare how banks treat their customers, and market and other pressures, many banks are attempting to transform into a customer-centric business model. Comparison between the three models Each strategy and business model has its own defining characteristics. This table outlines some of the key characteristics of each of the strategy and business model. Characteristic Product-centric Channel-centric Customer-centric Design the best Offer the most Orientation product on the channels on the Find solutions to customer problems market market Push via direct Push via channel Event & life-cycle trigger and a hierarchy Marketing marketing banners of products within segments Defined by Balance between customisation and Defined product- Processes channel complexity through a matrix of actions by-product capability and options based on the customer Rigid team silos, Rigid team silos, Organisational Cross-organisational teaming, low friction between friction between structure friction teams teams Profit & market Cost & channel Metrics Mutual value measures share efficiency © Smarter Way Mentors Limited 2020 These are all characteristics often observable in the bank's language in its information provided to the public. We can observe it in how they treat people as a customer or as an employee. In the next section we explore the models in greater detail. Exercise: Which of these models best represents your organisation? Look at the table above. Think about how your bank compares against each characteristic and give it a 'mental tick'. But you can only tick one column! Are your results spread across over one or all three columns? The column with the most ticks is the model your bank is following. 3.4: Product-centric, Channel-centric, or Customer-centric? Product-centric Because of a lack of information about customers and the technology to analyse individual customer behaviour, most banks are product-centric. Others have developed from a focus on branch networks, creating a more channel-centric model. A product- centric bank characterises itself by the products and services that it makes and sells, not by the problems it solves for its customers. It has a centralised 'inside out' management approach that concerns itself with the superiority of its products, how many they sell, and maximising their profitability and market share. 'Inside out' means that the bank thinks 'make the best product in the market' rather than being 'outside in', which is when it thinks 'how can we solve a customer problem?' Many banks have positioned themselves as 'financial supermarkets' where the customer can get all the products that they need. As a result, they focus on trying to sell as many products as possible to as many people who will buy them, and like a grocery supermarket, on their market share. This has contributed to them adopting a product- centric approach. They want to offer the best product in the market. That's not a bad ambition, but it leads to products that are loaded with 'bells and whistles' that add complexity and cost to operations, but don't get a customer job done or solve their problem. Because they are driven by product profitability and market share metrics product-centric banks want to sell as many products as possible to anyone that will buy them. Marketing's response is to push product offers at customers any way they can. The outcome of a product-centric strategy is products with every perceived feature to meet ever smaller niches of customers to squeeze out every cent of profit. The result is that each sub-product has a unique on-boarding and service process. In a product-centric organisation, the product manager handles his product profit-and- loss account. This drives organisational behaviour to treat every interaction, no matter the reason, as a sales opportunity, where the bank pushes its sales agenda. Product-centric organisations can suffer from friction between departments who define targets (that are often unachievable) and those who must deal with customers, such as marketing and product management defining targets for sales, operations, and customer service to achieve. Channel-centric A channel-centric, or sometimes called delivery-centric retail bank focuses on how it delivers its products and services via its channels, with the emphasis being on the cost of delivery. This is a traditional model born out of branch networks of branch networks with branches as profit centres. This is also an 'inside out' approach that concerns itself with lowering the cost of delivery by driving customers to the lowest cost channels it can, regardless of the value and preference of the customer. It often results in customer buying and servicing journeys that suit the bank, not the customer, some channels which the average customer can't or isn't willing to use. Banks driven by cost mitigation can end up servicing all customers in the most cost- effective channel or reducing the time employees spend helping customers, irrespective of the customer's value to the bank. They rarely consider what job the customer is trying to do or the problem the customer is trying to solve. A channel-centric organisation only thinks about what is happening when the customer is in the channel, not what led them there. They manage through strong measurement and controls that focus on transaction efficiency and not how the customer uses the channel. Customer-centric A customer-centric bank focuses on the diagnosis of its customers' problems, dreams, and needs and finds products and services that provide valuable solutions. It is an 'outside in' approach driven by constant interaction with the customer, that leads to development of innovative service delivery experiences to fulfil their customers' emotional as well as financial needs. The primary goal is a long-term valuable relationship with the customer, and aims for mind share, rather than market share alone. In terms of strategy, a customer-centric bank will adopt a buyer-driven pull approach rather than the sales-driven push approach of a product-centric bank. This approach, through interactions that are relevant to the customer, also helps the bank improve its understanding of its customers, and that improves its ability to find the right solution next time. A customer-centric bank recognises it exists to help its customers get a job done and to help them solve their problems, not be the market leader, make the most profit from a product or deliver another low-cost channel, but to be the customer's most relevant and preferred supplier. Through sophisticated data collection, synthesis, and analysis, banks learn something about their customers from every interaction, even if it doesn't result in a sale, by gathering information from customers concerning their dreams, their needs, and the problems they are trying to solve. They use their intelligence to find solutions to customer's problems or get a job done more effectively from the customer's point of view. To do this, customer-centric banks collaborate across departments and teams to create innovative solutions that customers want to buy and use, that are also profitable to the bank. It's natural for most people who work for banks to want to help customers and a customer-centric organisation harnesses it through a shared culture. They also balance the customer's perception of customisation and complexity, building on channel strengths and eliminating weaknesses. Because they focus on the customer, they measure success by how they create customer satisfaction and mutual value. 3.5: Defining Customer-centricity "Customer-centric (also known as client-centric) is a business strategy that's based on putting your customer first and at the core of your business in order to provide a positive experience and build long-term relationships." (Superoffice.com How to create a customer-centric strategy for your business,4 May2021.) It is important to note:  Customers judge a company on their performance, and it informs whether they will buy from them again and whether they would recommend this company to their friends and family; Positive customer experiences drive repeat business, enhance loyalty, and improve business growth. Most bank products are the same, sometimes only differentiated by the colour of their debit card. Competitors can replicate product features and delivery channels. But customer experience, loyalty, and satisfaction are hard to copy (quickly at least), and it is very hard to break the relationship with a preferred solution provider. 3.6: Drivers of Change and Un-bundling the Bank In a saturated retail banking market, brimming with new challenger banks, multiple products and services, the challenge is to create unique differentiators in competing for profits, and vying for volume and value share. Those banks that have a higher understanding of their customer, their needs, their value, and their problems will hold the competitive advantage. Enlightened banks listen to their customers, responding to them, and ensure their engagement and interactions build trust, especially in the early stages of the relationship. Like other retail businesses, banks cannot bucket all customers into one catch-all segment and have the same broad-based communication, engagement, customer management and sales strategy for all of them. Customer centricity isn't a new concept. It's been around for many years. In fact, many companies or brands started being very customer-centric, but as they grew, with the pressure for ever-growing sales and profits, and the focus short-term results, they developed a product-centric mentality and business model. Most companies or brands are product-centric. They focus on how they can sell as many of their products to as many customers as possible, for the greatest amount of profit. Their internal metrics focus on product profitability and market share. Customer engagement means developing from broadcasting to the customer to collaborating with the customer. The customer shifts from being an asset to be exploited to being the purpose for which it exists. Customers Customers' expectations are changing. Many are no longer content to be the target of banks' marketing and sales activities: they want respect and to be valued by them. There are four drivers of change: Customers are understanding the value of their data, which many organisations have taken for granted as being theirs, to do with as they please. Customers expect their bank to be more ethical and transparent about how they use their data; The rapid and continued adoption of digital technologies, such as mobile phones, is creating broader and deeper sources of data at an exponential rate; Consumers are getting more control over who they share their personal data with through new regulations, such as data privacy laws, such as the European Union's General Data Protection Regulation 2016/679 (GDPR), and the similar California Consumer Privacy Act of 2018 in the United States. Other regulations are resulting in commercial applications, such as Open Banking; Banks are suffering a loss of trust. According to Accenture's Purpose-Driven Banking Consumer Survey, 2020, 53% of consumers across 12 markets trust their bank to protect their data and accurately process their transactions, but only 43% trust their bank to look after their long-term financial well-being. In seeking financial advice for life events like getting married, starting a family, or buying their home, twice as many consumers asked family and friends than asked their bank. Competition Technology and more flexible legislation have reduced the cost of establishing a bank, allowing for new business models to emerge. Banks are now under threat both from traditional competitors and a host of new digital banks that all want a share of the customers' wallet or value. Sometimes customers defect without the bank ever knowing. They reduce how they use their product and then close it, or worse, they stop using it and don't close it. With hundreds of thousands or millions of customers, it's impossible to defend each customer against tempting offers from competitors who spend millions of dollars on advertising and promotions. Retail banks spend millions of dollars trying to keep customers or gain new customers from their competitors. Unbundling Threat to Banks The first challenger banks and fintechs weren't interested in following the route of traditional banks and 'unbundled' their products, by building new businesses around selected ones such as foreign exchange and payments. Unbundling is the fragmentation of a traditional bank's revenue streams to access the underlying revenue. A fintech, neobank or tech giant doesn't need to invent new products, it just needs to offer the bank service customers pay for – but for free! To understand the threat, we must look at the six principal things that a retail bank does for customers: Keep their money safe, whether it is in a physical or digital format; Handle payments (incoming and outgoing)securely and efficiently; Keep track of what they receive and spend to help them budget and save money; Pay interest on savings deposited with them in return for being able to lend the money out to businesses or other consumers; Lend customers money to bridge the gap between income and expenditure or buy an asset like a car or a home; Offer other products help them maintain their wealth or income, such as insurance to protect themselves, their family, home and possessions or pensions and investments that they'll draw down in the future. From the 1990s onwards, banks set themselves up as 'one-stop shops', a sort of 'financial services supermarket', where the customer could buy all their financial products from them. As a result, this made banks very product-centric, as each bank competed for market share in its core products. The 'financial service supermarket' model is dominant for banks where the bank pays the cost of acquiring the customer once, usually through a 'free' current account and then has a lifetime to cross-sell multiple products that cover the cost of the 'free' product. It used to make sense. Customers spend a lot of time engaging with their bank because their current account is central to their finances, meaning that when they need something else, the bank is the natural starting point. Until the Internet became more widely accessible in the early 2000s, it was also difficult to compare product features, price and rates. Vast amounts of product comparison information only a few clicks away eroded the model by encouraging customers to find the best deals for savings, insurance, loans and mortgages, as well as utilities such as gas, electricity, telephone and broadband services. Only the perceived hassle of switching their current account (for example, swapping payment cards and amending regular payments) kept defections in check. While the Internet started this challenge to the traditional model, Open Banking would finish it. We discuss Open Banking in greater detail later in this course. This model and its lucrative revenue streams did not go unnoticed. The new digital banks, often called fintechs or neobanks (and the tech giants such as Amazon)were set up to 'unbundle' the financial services market, offering consumers with more choice, and allowing them to access the revenue stream of a particular product. It usually starts with the current account. Although 'free banking' is widespread, there are current account services that banks charge customers for using, such as using their debit cards abroad or sending money to another country. The charges are less transparent than the headline 'free banking' that banks promote, often causing dissatisfaction when customers pay a fee they didn't expect. For example, it spawned Revolut, the UK fintech, that has 16 million customers worldwide after six years of trading (as of late 2021). Nikolay Storonsky, co-founder of Revolut, targeted banks' lucrative foreign currency exchange revenue arising from overseas payments after the fees levied frustrated him when sending money to friends in his native Russia. Revolut offers the service for free. The downside for the customer is that they can now have fifteen apps on their mobile phone that do the job of a traditional bank. 3.7: Re-bundling the Bank If the financial services supermarket model is now broken, Open Banking promises to let customers to reconfigure their individual financial services, in the way and with whom they want. Banking doesn't have to be done through traditional banking products. Fintechs, neobanks, tech giants and some traditional banks are building models that will improve other areas of the consumer's life. For example, as they have a 360-degree view of your finances through Open Banking, they might help you find better energy deals, like grocery supermarkets do, or help you budget more effectively, taking on countless new roles in your life. New banks, or technology giants, such as Amazon, can re-bundle in three ways: Own products model - where start-ups build product manufacturing capabilities – a bit like a traditional bank, but digitally enabled. They only generate revenue from the products that they build and own. Branded marketplace model - where they don't build all, or any, of the products themselves but integrate other product providers through Application Programming Interface (API) technology. They will make money by take a commission whenever someone wants to borrow, invest, or buy a product, such as insurance, from an integrated third-party; This is a niche market model - a product for an identifiable segment, rather than the whole of the market that solves a particular problem. One example in Europe is Monese, (as outlined by Louise Brett, Partner at Deloitte UK in a blog titled 'Re- bundling the bank') which offers a current account to workers from other European countries that is designed to help overcome barriers that normally make it difficult to get a bank account, such as not having a local credit history or essential 'know your customer' utility documents when moving to a work in a new country. There is no winning model. Only banks, fintechs, neobanks and technology giants who execute their chosen model well will win. Other players, such as retailers and ecommerce providers, are moving towards embedding finance products such as Buy Now, Pay Later instalment financing and product insurance into their websites at the point of sale. We discuss elsewhere this trend in this course. 3.8: The Reality Within Business: Marketing's Customer-centricity Paradox You might expect that an organisation's marketing department would be customer- centric. But this is often not the case and has consequences for the ability to achieve customer objectives. In 2018, The Future Marketing Organisation and MiQ, a marketing intelligence company, conducted a survey among senior Marketing managers of retail companies about the best way to organise marketing department. Best way to structure and organise How it is structured in Organisation method a Marketing Department respondent's organisation Customer-centric 42.2% 5.8% Agile 18.8% 6.4% Segment-centric 15.8% 9.3% Individual products or 12.8% 37.3% brand-centric Channel-centric 3.3% 7.5% Function-centric 3.6% 19.4% Geographic-centric 2.8% 5.8% None of the above 0.8% 8.7% The Future Marketing Organisation/MiQ 2018 (note: does not add up to 100% due to rounding of figures) It's clear from the above data that there's a mismatch in how senior Marketing managers believe that their department should organise and work, and the reality. We could expect that Marketing would be the one department to be customer-centric. What's more concerning is that most of these companies will state that they are customer- centric in their statutory and investor publications, such as their Annual Report and investor communications. 3.9: It Matters if You Are Not Customer- centric The researchers asked the same respondents how well their company could achieve some basic customer objectives. Capturing a single customer view is important to understanding who your customer is and their value to you. Being led by customer insight is important for designing profitable propositions and products that customers want to buy and use. Optimising customer experience is important in building trust, satisfaction, retention, and cross-sales. How well is your company structured to achieve these customer objectives? Score out of 5 Optimising customer experience 3.1 Being led by customer insight 3.1 Capturing a single customer view 2.8 Customer acquisition 3.2 Customer retention 3.2 The Future Marketing Organisation/MiQ 2018 If a score of '5' is doing it well, then a score of around '3' is not doing it very well. The implication is that customers are receiving customer experiences that dissatisfy them, erode trust and loyalty, and result in reduced cross-sales, more leaving for competitors and lower value growth. We will put these differences into perspective in our next section, where we discuss what is driving businesses to become customer-centric. Exercise: How well does your bank perform these customer objectives? Rate how well your bank achieves these five customer objectives. 3.10: Trust We discussed trust in 'Drivers of Change'. It is worth considering in detail the importance of consumers trusting their banks. Banks have lost trust According to Accenture'sPurpose-Driven Banking Consumer Survey, 2020, whilst 53% of consumers trust their bank to protect their data and accurately process their transactions, they are much less confident about banks looking after their best interests. Only 43 % trust their bank to look after their long-term financial well-being. In seeking financial advice for life events like getting married, starting a family, or buying their home, twice as many consumers asked family and friends than asked their bank. With life events like marriage, starting a family, getting divorced, losing their job, or buying their home, 51% sought financial advice help. Of the 51% that sought help, 56% sought advice from family and friends, only 28% from their bank. Compare that with the 25% of consumers who sought advice from strangers on online forums, blogs, and social media or the 21% who asked a colleague. It isn't good news for professional financial advisors, either. Accenture Consumer Survey 2020 Product-centric and channel-centric business models can erode trust Much of this distrust stems from the product-centric sales culture that dominates many banks' thinking and practices where products are structured only with short-term profitability in mind and customers are 'assets to be sweated'. Also, banks' employees were rewarded based on sales, with customer service relegated to a side task. Customer-centricity can rebuild trust Banks can only build trust if they have a deep understanding of their customers, their needs and behaviour, and focus on delivering a customer experience that satisfies customers and develops a relationship of trust and loyalty. Customer-centric retail banks set out to understand each customer's individual life-cycle, no matter how unpredictable it may be. 3.11: Making the Case for a Customer- centric Business Many companies who say that they are customer-centric are not and don't achieve the benefits. To preserve their competitive advantage, successful companies don't reveal their benefits; it's difficult to find hard evidence. If the key measure of customer-centricity is the customer's experience, then there is some evidence backed by research. According to Jawad Khan: Brands with superior customer experience bring in 5.7 times more revenue than competitors that lag in customer experience; Companies that lead in customer experience outperform laggards by 80%; 66% of consumers consider customer service to be a deal-breaker when buying something. Jawad Khan, How to Build a Customer Centric Culture in your Organization. Executives will be Sceptical As it is likely that the bank will have a product-centric business model, there must be a strong case for changing to a customer-centric model. Banks' Boards of Directors, Chief Executive Officers (CEOs), Chief Operating Officers (COOs) and Chief Finance Officers (CFOs) care about two things: increasing revenue and decreasing costs. Things that increase revenue include: Gaining valuable new customers;  Keeping valuable existing customers; Growing the revenue and long-term value from customers through cross-selling and upselling products and services; Being able to increase the price of a product or service or reduce any discounts, without losing valuable customers; Things that decrease costs include: Sales costs, because customers are buying products digitally, such as via their website and straight through processing, rather than via physical channels; Customer servicing costs because they are using self-service, such as using their banking app, in preference to physical channels; The cost of manufacturing their products, such as insurance products, by understanding what problem their product solves; Marketing costs because customers help gain new customers through advocacy, such as their friends, relatives, and colleagues in their social circle. These levers are unquestionable. They apply to whether the bank has a product-centric, channel-centric, or customer-centric business model. Making the Case The case for adopting a customer-centric business model can be challenging, as there is a cost involved, and the potential for less revenue from lower product push in the short- term. Many executives won't want to increase costs through investment without a good reason. Smart executives will maintain revenues whilst making gradual and consistent changes to cultures, processes, and employees' rewards. Doing Nothing is Not an Option As discussed earlier, banks are under increasing pressure from fintechs, neobanks, and tech giants who are all trying to seize their profits (or 'eat their lunch' as it's often described). Many lucrative product margins are being eroded by these new entrants, and both traditional banks and new entrants face falling profits, or never being profitable. The question is: "How can a bank give customers something that anchors them to the bank for products and services that create value?" The answer is: understand their pain, dreams or aspirations and give customers a relevant and personalised experience of using the bank's products and services superior to their competitors. It Starts with Understanding the Customer It starts with gaining a deep understanding of the bank's customers, their behaviour, their dreams, problems and needs, only achieved through a customer-centric business model. 3.12: A Customer-centric Business Model Offers a Solution One common factor cuts across revenue and costs: customer behaviour. Most of the revenue and cost levers mentioned above depend on changing customer behaviour. For example: If customers adopt and use self-service channels more, then the bank will reduce costs, and if they don't, costs may stay the same or rise; When customers become advocates and 'sell' the bank's products and services to their friends and family, marketing costs will reduce; if they don't, costs will increase. If new customers join the bank, revenue will increase; If customers continue to be happy with the bank's service, they won't defect to a competitor, even if their product is cheaper. This keeps revenue and reduces the marketing costs of replacing them; Customers who trust their banks more will remain loyal and will not defect to a competitor. This keeps revenue and reduces the marketing costs of replacing them. Therefore, influencing the behaviour of customers and prospects is the single most impactful way to move business levers in the right direction. It would be appropriate to ask how a bank can influence the behaviour of customers and prospects. People behave one way or another because of their thoughts and feelings when they interact with a brand first-hand or hear about the experience of one of their social circle of family and friends. When we talk about a 'customer experience', we are talking about the 'moments of truth' for the bank that the customer or prospect experiences first-hand or hears from others in their social circle. It is how they feel about these 'moments of truth' that create an experience and influence their behaviour. These will include: Interacting with the bank's website when they are making enquiries about the brand and what they offer;  Interacting with the bank's channels such as branches, telephone banking, Internet banking, Mobile banking, and their sales force; How the bank communicates with them and develops the relationship; The bank's responsiveness to interactions, whether they are enquiries, transactions, or complaints; How they feel the bank treats, respects, and helps them as an individual, and values them; How easy or difficult it is to interact with you, which is often called the 'customer journey'. A 'customer journey' is a series of interactions or experiences. When it results in far more positive feelings or emotions than negative ones, then the customer thinks and feels that the bank is meeting their needs and even giving them a pleasant surprise when their bank exceeds their expectations. When the bank aligns the customer's experience with the customer's values, then the bank has the right ingredients to inspire trust, loyalty, and advocacy. We discuss how a bank operationalises this and other capabilities in more detail in the Customer Management Module. This module has outlined the commercial imperatives that drive a bank's Board and leadership team to adopt a customer-centric strategy and business model. That decision leads management to change how they generate revenue from customers and how they operate to achieve that aim. We discuss what core capabilities they need, and how they operate in a customer-centric way in the Customer Management Level I and Level II modules. Conclusion This module has outlined the commercial imperatives that drive a bank's Board and leadership team to adopt a customer-centric strategy and business model. That decision leads management to change how they generate revenue from customers and how they operate to achieve that aim. We discuss what core capabilities they need, and how they operate in a customer-centric way in the Customer Management Level I and Level II modules.