Importance of Product Profitability

This is one subject in the financial world that I have yet to figure out. Not how or why profit is important, however why is it that organizations that managed hundreds of thousands or even billions of dollars don't feel the importance of Product Profitability or even worst want to just bury their heads in the sand if they can't come to a conclusion as to if a model is at least directionally correct?

Being in marketing for as many years as I have, and then moved to the finance world four years ago I found that one of the reasons was "If it didn't come from finance, then it can't be trusted."  And the other is if it came from Marketing it is laughed off because that's the place with the colorful pens and paper they don't understand the numbers. Well after four years on the other side I'm here to tell you there is as much if not more voodoo science there than in marketing.


So then why is it that the financial world, where everyone is suppose to be financially savvy 60% to 75% of the products offered lose money?  And if it loses money, how heck can an operation stay in business.  There are a few reasons for it... and a lot has to do with a simple 80/20 rule, where 20% of your clients produce 80% of the profits, however it is more like 20% or less of your clients produce over 150% of the profits.

I always seem to answer a question that leads to more questions; 150% how can that be?  Well it's simple; somebody has to make up for those that are a drain to your institution or those that cost you money just to keep them around.

Here is an example:  Your Senior Management demands your branch increase the number of accounts in non-interest checking accounts, no balance requirements are given so what does marketing do? They run ads, provide give-a-ways, any thing to promote traffic.  At the end of the month your branch, which was producing 30 accounts, produced 60 accounts, twice your normal.  When reporting comes out everyone declares the program a success.

Now the real research begins, you find out the average balance of these accounts are $75 far below the $1,500 average balance your MCIF system says you have.  I will get in to product balance stratification a little later, however let's review a single account.


Here are a few more parameters; Besides being non-interest, the program provides free checks, you give a small gift valued at $5, there are no minimum balances or fees. NSF charges are at $35 each.  There are costs associated with opening an account which conservatively we will set at $25.


We can then get into a debate on whether the costs to maintain the account should be fully allocated or only relevant.  Fully Allocated would be a portion of all expenses related to the operation and salaries.  Relevant would be salaries and brick and mortar are just part of doing business and it will not be counted.  The real costs should be a combination of the two.

For this example we will use a fully allocated profit model which for a non-interest bearing account would cost right around $225 annually.  Also since a non-interest checking account provides the highest spread we will make the return at 5.34%.

Income is figured $75 X .0534 = $4.00 in annual interest  income.  The average NSF fee assessed to each account annually is 2.5 X $35 = $87.50.  Saying the average person will bounce 2.5 checks a year. The income for this account is $91.50 annually.

As for the costs, we use the Fully Allocated costs of $225 + $5 gift + 2 check orders at $8 + and a one time on boarding cost of $25 = an annual cost of $263.

($263.00) Expense
 $91.50     Income
($171.50)


For each account at $75 you lose $171.50 annually.  This is something you just can't make up in volume.


Now going back to a few things said earlier.  The average account balance for the product group was $1,500, you increase the interest income by $80, however your results are still negative.  You really need to look for those clients that will maintain an average balance of $3,300 or more just to break even.


Here are a few suggestions to look at your clients a little closer.  Most MCIF systems will allow you to look at a group of accounts and then stratify the balances of the accounts.  Once you do this you will see that although your average may be higher, you could have 60% or higher of clients that fall far below that average.


Now this piece here is what I've tried for years to get financial institutions to understand.  If you stratify your accounts, it should follow pretty true to what a client will maintain in their accounts.  So look at your break-even point and see what percentage falls below.  Budgets should be built on the majority.


Secondly NSF fees are one of those interesting facts that everyone has to look at now.  My preliminary research indicates if you have a new customer or one new within the first year and you assess an NSF fee on them one of three things will happen.  They pay the fee get ticked off and then close the account and bad mouth your company for the rest of their lives: Two they pay it and move on and most likely it will never happen again.  And three you council the client, wave the fee and hope you did the correct thing.  In all examples the one that happens the most is the client is assessed the fee and then they leave.  Producing a churn that strains budgets and staff.

I look at myself and it has only happened twice in my life.  The first stupid me I got mad at the bank and closed the account and then a few years back when I asked a teller to transfer money from my money market to my checking and for some reason it was moved from my money market back into my money market.


So don't rely on NSF fees in the future.  If financial institution are doing what is fiduciary correct for the customer we would teach them how to be better stewards to their finances.  Now I know there are some that just love to pay NSF fees, however if they don't mind bring them on.   


This brings us to the question, If checking accounts cost the institution for the majority of clients then why are they offered?  The answer is the same as any other retailer.  It is for the most part a lost leader.  At times stores will offer a product at or below cost just to bring in customers.  For the financial industry if you ask a customer were they bank 98% of the time they will tell you the company that holds their checking account.

So if this is the case checking is the core account.  Now if you can break even from it all the better, however if not, additional products and services need to be cross-sold to obtain a profit.  That is the very reason we look at households for profitability instead of a single account.


Keep in mind the more account types you make profitable the more profitable the organization becomes and this is the Importance of knowing and understanding Product Profitability.

If you have additional questions please feel free to contact me. 
 

How to identify the real issues within a branch attrition rate.

If you have already built a strong retention/attrition program and have started to identify issues within your organization, it is now time to put in place a data collection tool that will allow you to understand what makes up your attrition rate.

It is one thing to reprimand associates for bad behavior, however another if you are doing it without any knowledge of how the issues occurred.  With any project I research it is not to call out anyone, but a way to look at a process, improve on it, then coach or redefine a new behavior to obtain the needed results.

Here is how to look at breaking down attrition: Accounts close all of the time for many many reasons, however of all of the reasons, can we determine if they are life cycle, process issues, relocation, death, divorce, a closing of a location, personnel, ingress, egress issues, NSF or anything that force the client or the institution to close an account.   

What you will find is that of the 10% to 25% of those clients that attrited, most are issues beyond ones control, however what this exercise will accomplish is of those that can be controlled if fixed can it change the retention rates.

I must add a simple note here.  At times depending on your clientele, attriting is not a bad idea.  I'll leave the deeper aspect of identifying profitable clients to a separate blog, however sometimes retaining clients just to retain them is not always a good thing.  That is why it is so important to research all aspects of attrition before coming to conclusions.  This information is to identify issues then to fix them...not a way to hang and burn people.

You are first going to have to find a way to collect data from the front line.  If your core system has the ability to collect reason codes that will be your best bet.  It may be as simple as an open field that you can use, however contact your IT group to find out.

Our sales group implemented the first go around and boy was that a failure.  The attempt was knowable, but the results were a mess.  In their defense they gathered the troupes and implemented the data collection process, however that is about a far as it went.  It got better, however keeping 1,500 associates capable of entering data informed as to the process, and the churn factor of employees just didn't help.

Keep this in mind when working with data and lots of it there has to be commonalities so one can work with and review the results quickly.  Problem #1 the sales staff chose a alpha numeric field to enter information in.  This is fine if you truely want to read about the issues, however disastrous if you have 4,000 closed accounts in a month and they all have different verbiage.  The only way to review the data is to look at it and try to match it in silos.  It is just not going to happen.

I quickly made a change to the input of data.  With the help of the sales staff I asked for as many common issues we could think of then I assigned a numeric code to each.

They were as follows:
1 - Rate
2 - Facility Closure
3 - Moving out of the market
4 - Account funds used for purpose intended
5 - Deceased
6 - Removal of name
7 - Dissatisfied with service
8 - Dissatisfied with product
9 - Competitors promotion
10 - Convenience - moving within the market
11 - Transfer funds to another account within the institution
12 - Divorced
13 - Other
14 - NSF/Overdraft
15 - Married
16 - Fraud
17 - Dormant
18- No longer needs accounts
19 - Lost job


If you are looking to implement such a program use these only as guidelines.  You may need to begin with a few then add as needed.  I provided a simple sheet that could be posted close so they could refer to it as often as needed.       

After implementing these new standards it became easier for both sides.  It was less work for the associates and for me I could now do something with the data.  We still struggled with even this part for some associates who felt they were being helpful would instead of just entering the number they would enter "#12" or "number 12" instead of just "12."  If I had the capabilities to change the field to just numeric I would have.  If you can, do it.

I was able to identify those associate issues and then passed that information on to their branch manager.  After some time it got better.

The results in graph form allowed myself and associates to quickly see where the issues were.

Once a month in the core system I had a query run in periodic options that would collect the information I needed to build the report.  I was able to through Excel build a path through an ODBC function with iSeries that after building macros would shake hands with the query grab the data then bring it back and configure the report they way I wanted to see it and deliver it in graphic form for the company and by branch.  This report could be built in seconds each month.

The report provided results in three multiple ways:  1. Numerically providing numbers associated with a graph.  2. The same results, however in graph form.  3. The numeric data was broken down by branch. 4. Each code was given a factor as to if an associate could have changed the behavior of the client which became "issues."  A percentage was provided as to of all the closed accounts what percent was the branch in control of. 5. Where and who the data came from.  


I must bring back once again how important it is for you to learn Excel.  This report on its own could take several hours to build, however once set up it takes longer to open the report than it does to run it.  Learn your core or find someone in IT to work with you.  Have them look into iSeries or ODBC in Excel to connect with your core system.  Learn how to build macros in both your core and Excel.  And also learn how and understand pivot tables. 


It will be hard at first, however once you get the hang of it you will be able to understand the data, build it quickly and start spending more time analyzing it. 


If you need additional help please feel free to contact me through e-mail