PDF SMALL BUSINESS BANKING

[Pages:12]Financial Services

SMALL BUSINESS BANKING

CHALLENGING CONVENTIONAL WISDOM TO ACHIEVE OUTSIZE GROWTH AND PROFITABILITY

Boasting a base of more than 20 million potential customers1 with a broad range of financial services needs, the Small Business segment has long presented a significant opportunity for US banks. Recent OliverWyman research and analysis2 suggest that the SB sector produces $14 BN of after-tax profit and $10 BN of after-tax economic profit3, annually ? nearly 15% of the total US financial services economic profit pool.

The sector is also resilient: in the face of recent economic turmoil and uncertainty, 73% of business owners told us that their firms were either "very" or "reasonably" profitable, while 75% described them as being in "established" or "growth" mode.

Exhibit 1: SMALL BUSINESSES ARE HEAVY USERS OF FINANCIAL SERVICES

PRODUCT USAGE RATE EMPLOYER SMALL BUSINESSES

100%

Deposits

Cards*

Loans

Payments & Treasury Services

80%

60%

40%

20%

0%

Any deposit Checking Savings

Money market HY Sav/CD Any card Credit card Charge card Store card Any loan Mortgage

Equipment loan Operational loan Auto loan/lease

Other loan Any payments Merchant svcs Remote deposit

Payroll ACH Wire

* Card consists of cards used solely for the business; 44% of SBs are also merchants (accept cards) Source: 2011 Oliver Wyman Small Business banking survey

However, strategies that meet small business needs, create differentiation and maximize potential economic returns have proven elusive. Following the financial crisis disruption, the market has largely settled back into competitive equilibrium, with many banks ? and their advisors ? allowing a set of conventional wisdoms to constrain their thinking as they craft their strategies. A bank willing to challenge these conventional wisdoms, OliverWyman believes, can define a break-out strategy that gains material share from competitors and delivers higher growth and higher profits.

1 ~20% of small businesses in the US have at least one employee in addition to the owner. Source: 2007 Census 2 A 2011 survey of 5,000 small business owners, from which we estimated the profit to banks from these businesses' product and

service usage. 3 `Economic profit' is the profit after tax earned by the bank over-and-above the required rate of return on capital held against the risks of

the business; it is worth noting that today, most of this profit comes from high-balance checking accounts and high-volume merchant services accounts ? and not from small business loans.

Copyright ? 2013 Oliver Wyman

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What are the conventional wisdoms restricting banks' strategic thinking? We see five:

1. SEGMENTATION: "The size of the business is the best indicator of needs, profit potential, and sales and service approach"

2. RELATIONSHIP COVERAGE: "Assigning relationship managers is an effective means to attract new businesses, deepen relationships and decrease attrition"

3. CHECKING: "Offering `free checking' is a table-stakes competitive requirement" 4. SMALL BUSINESS LENDING: "Credit process streamlining is the key to improving

profitability and expanding SB lending" 5. NEW REVENUES: "Expanding into new service areas is the best path to increasing

fee revenue"

OliverWyman research and analysis suggest that some of these conventional wisdoms are wrong, and others only half-right. Worse, they disguise powerful new insights that banks can leverage to upgrade performance substantially. Let us examine them one-by-one.

1. SEGMENTATION: IS REVENUE SIZE ALL WE NEED?

Conventional wisdom places a great deal of weight on business size. For example, most banks use it to dictate how they organize, what prospects they target, and what products and delivery models they employ. Businesses that are larger, the rationale follows, will carry higher deposit balances, have greater credit appetites, and need more complex payments solutions, thus making them more profitable relationships.

Exhibit 2: PROFIT CONTRIBUTION OF SMALL BUSINESS CUSTOMERS RANKED BY RELATIONSHIP PROFIT

CONTRIBUTION TO TOTAL SB PROFIT 80% 73%

60%

40%

20%

21%

11%

0%

6%

3%

1%

-2% -13%

-20%

Top 10% 80th percentile 70th percentile 60th percentile 50th percentile 40th percentile 30th percentile 20th percentile 10th percentile

Bottom 10%

Source: 2011 Oliver Wyman Small Business banking survey

Copyright ? 2013 Oliver Wyman

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OliverWyman research validates the notion that larger businesses are more likely to be profitable. However, it also reveals two interesting findings that averages disguise. Firstly, 20% of businesses (the high value group) generate 95% of total segment profit. More surprisingly, more than half of the high value group have annual revenues less than $1 MM.

Exhibit 3: ANNUAL REVENUES OF THE MOST PROFITABLE SMALL BUSINESS RELATIONSHIPS

TOP 20% OF ALL SMALL BUSINESSES, BY PROFIT CONTRIBUTION

$5 MM?$10 MM 14%

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