Small business, big profits.

In the small business sector, banks have recently discovered a rich vein of desirable customers.

But while many institutions are trying to attract more small business accounts,

You might try to do more with the ones you already have.

A potentially profitable tale of cross-selling

The small business market is anything but small. There are 15 million non-home-based businesses with less than 100 employees. Add to this the 6 million home-based businesses - many with a single owner who may work part time.

In short, banks are sitting on a potential gold mine of small business accounts. But although most institutions realize high profits and a sizable return on equity from the small business sector, much more can be done to significantly increase small business banking profitability.

Despite large numbers of small business customers, banks often do not know what specific actions they should take vis-a-vis the ones that are seen as "key". Banks must learn to use new segmentation tools and database marketing techniques to determine what to sell to whom - and how to link personal wealth with business wealth. In order for banks to optimally tap the small business market, they must use analytic tools that allow them to profitably leverage information.

Success largely depends on old-fashioned relationship banking. But even though they are using that method, many banks don't cross-sell products effectively, nor do they provide compelling reasons for customers to consolidate their personal and commercial banking. Thus, more than 50 percent of business customers use more than one financial institution for their business needs - and fewer than 50 percent have personal accounts at their business banks. In order to take advantage of this untapped opportunity, bank sales and marketing resources must intelligently target the best small business customers.

Small business market opportunities

Our firm's research, based on an analysis of eight million small business customers, documents the truth in the old maxim that a bank's most valuable customers are its existing ones. It cannot be over-emphasized that the small business market offers a significant opportunity to retain customers by re-inventing old-fashioned relationship banking. Giving priority to existing customers - and developing and expanding these relationships - will increase their profitability. The length of time a business has been with a bank translates into higher balances and greater use of multiple products. Although profitability increases significantly with an increased share of the customer wallet, banks usually have less than 40 percent of most customers' total balances.

The small business market offers banks the opportunity to link personal and business wealth. According to current figures, only about 45 percent of all deposit relationships have both commercial and consumer balances with the same bank. At the same time, combination-customers' average balances are about 36 percent greater and have a profitability 53 percent greater than business-only relationships. Banks, then, should consistently emphasize cross-selling commercial and consumer products to increase profitability.

Cross-selling is both an easier and more profitable sale. Profitability increases almost geometrically as the number of products a customer uses increases numerically. Cross-selling enables banks to capture the overall investment wealth of small business owners and increase business owners' use of such expanded services as private banking, insurance, or retirement programs. Profitability further increases when banks hold their small business customers' non-interest bearing deposits. For example, while 18 percent of a typical commercial bank's deposits are derived from non-interest bearing deposits, over 70 percent of small business deposits are interest-free checking accounts.

To effectively implement cross-selling, banks should first use their branch networks as a sales force with the ability to sell multiple products to the same account without triggering additional personnel costs. Studies of the small business market show that 62 percent of firms with under $10 million are within two miles of a branch, and, in terms of profitability, 90 percent of a bank's business comes from within 10 miles of a branch.

New profitability strategies

The most effective strategies involve targeting and maintaining the most profitable customers. Then, after finding a successful model for those customers, using that formula to target others like them.

Customer retention is important: As the old Russian proverb states, "One old friend is better than two new ones." First, it is costly to attract a new customer. It costs somewhere between $1,800 to $2,500 to acquire a new small business relationship. In addition, most banking relationships do not break even for three years, and half of them end after seven years.

The concept of Pareto's Curve also comes into play here. It reminds banks that 80 percent of all business activity results from 20 percent of current customers. And in small business banking, this ratio is even more extreme - with fewer than 10 percent of a bank's relationships producing 90 percent of its activity.

In fact, our figures show that the typical ratio is 8 percent producing 92 percent of the activity - and it can range up to 13 percent producing 87 percent of the activity. Surprisingly, most banks do not have any programs to monitor the small group of most profitable customers whose loss could have a major impact on overall profits.

A key to achieving greater profitability, then, is to learn which customers in that small group should be targeted for retention and cross-selling. Even a slightly tighter focus on fewer, more profitable customers can significantly enhance the bottom line. Our findings show that focusing on a 25 percent to 75 percent ratio of the most potentially profitable small business customers can increase an institution's overall profitability by some 130 percent. And even more tightly focusing on the "right" 15 percent of those small business customers can more than double profitability.

Thus, the question becomes: How do you engage these most-profitable customers? There are three principal ways to achieve this goal:

* First, design marketing programs that build deeper relationships with exiting customers.

A bank's share of customer wallet is often below 40 percent in small- and middle-market business relationships. Increasing share of wallet improves profitability tremendously: A relationship with a wallet share above 80 percent is up to 20 times more profitable that the average small-business relationship.

* Second, cross-sell to develop broader product representation with regard to individual customers. While 80 percent of commercial customers are single-product users, customers using five products are likely to be as much as ten times as profitable.

* Third, replace marginally profitable customers with new relationships in market niches with higher profit potential. The single-most important element determining product usage is the life-cycle stage of each small business. More mature businesses have lower loan potential and higher deposit-generating potential. Less mature businesses, on the other hand, offer higher loan potential and lower deposit potential. Generally, though, we have found that the longer the relationship, the more profitable it usually is overall. Relationships of more than 15 years can be 10 times as profitable as younger relationships.

Another determining factor that is sometimes misleading when one looks at customers in the small business sector is business sales volume, as it relates to profitability. Sales volume as small as $600,000 can generate deposits of $100,000 from some industries, while $8 million in sales volume in other industries will generate the same amount in deposits. Therefore, marketing that is based solely on sales volumes does not automatically generate a predictable profitability level from a particular small business. To survive and profit, banks must be flexible and vigilant in meeting the new demands of a broad category of small businesses.

How analytic marketing tools implement strategies

According to Federal Reserve Chairman Alan Greenspan, the rapid growth of computer and telecommunications technology is the most profound development in banking - one which will increase competitive pressures in the financial services industry. Currently, banks are beginning to use advanced statistical techniques to identify the most profitable segments of the small-business market and their small-business customers. Yet, not every technology is effective.

A prime example of successful database use is US Bancorp's centralized computer system - which distinguishes profitable from unprofitable customers and products. According to an April 1998 article in Worth magazine, its modeling system allowed USB to pare its expenses from 70 percent to 43.5 percent. On the other hand, when American Express spent more than $30 million to build a data warehouse to target AmEx cardholders, an incorrect focus added almost nothing to its bottom line.

What is needed, then, is the application of clearly focused, appropriate technology.

Savvy banks and small-business financial-service marketers can use small-business segmentation and database tools to identify the most profitable opportunities with greater precision and effectively implement targeted marketing strategies aimed at the small business market.

Computer-based tools that use regional demographic and business information, profiling small business owners' personal and business wealth, enable banks to identify customers most likely to be profitable for both business and retail services, and to target businesses with lower credit-risk exposure.

An innovative use of database research is the identification of prospects for pension and 401(k) plans. Using database mining, a bank can ascertain the age of an owner, the value of the business, the life cycle of the business, and the wealth of the owner. This enables an institution to determine which small-business customers are ideal for the cross-selling of a 401(k) plan or other pension plan. Additionally, recent research has identified financial attributes of small-business owners. This allows banks to "score" businesses on their likelihood of using up to 16 different products - and to target businesses appropriately. (See sidebar.)

These database mining techniques can also identify small-business prospects in the market for private banking services. Today, small business owners have personal wealth that amounts to about $3.7 trillion - or nearly 20 percent of all private wealth in the country! Using a database that links personal and business wealth, a bank can successfully tap the retail and commercial needs of small business owners - which is a very high-profit market segment.

Addressing the private banking needs of the small business market can be particularly profitable. It is a rapidly expanding market, where the wealth level that defines a person as a high-net-worth individual is being lowered. Recently, PSI, Inc., a Florida-based research company, noted that high-networth individuals are those in the top 20 percent of the population - which amounts to annual incomes of only $75,000 and above or investable assets of only $300,000 or more.

In the near future, top lenders and the most successful banks will be those that most effectively mine their databases for marketing-critical information. These database programs run on personal computers and enable banks to identify opportunities in the small business market. Ideally, these databases should provide detailed information about small-business owner wealth from several different perspectives, include an adequate number of small businesses, and calculate the estimated total wealth and bank profit potential of the targeted prospects.

Database programs exist that provide detailed information on a small business owner's wealth from six perspectives, as well as full demographic information on the owners of 12 million businesses, with a total wealth of over $3 trillion. These databases not only link many different types of information, along with a company's wealth and worth, they also indicate the propensity of a small business to use various kinds of financial products and services.

In today's fast-changing small business market, these new analytic tools can give banks a competitive edge, open up opportunities to increase or deepen their relationships with small business customers, shore-up customer retention efforts, and produce dramatic results in profitability.

SHOPPER'S GUIDE

This company appears under "Small Business Banking Products & Services" in Bank Marketing magazine's Annual Buyer's Guide.

Financial Publishing Services Company(*) Northfield, IL Vince DiPaolo (847) 501-4120

These companies appear under the heading "Target Marketing" in Bank Marketing magazine's 1998 Annual Buyer's Guide.

Austin, Williams & Best(*) Hauppauge, NY Ken Greenberg (888) 281-9200

Bank Direct Welsh + Danielson(*) Minneapolis, MN John Welsh (612) 359-0401

Bankers Systems, Inc.(*) St. Cloud, MN Paul M. Kampa (800) 397-2341

Business Decisions International(*) La Grange, IL Steven Vitas (708) 354-9999

Claritas Financial Services Group(*) Arlington, VA Bill Harvey (800) 284-4868

Deluxe Direct Response Bloomington, MN (888) 292-2551

Fair, Isaac and Company, Inc.(*) San Rafael, CA Corporate Marketing (800) 999-2955

Fusion Marketing(*) Memphis, TN Donald C. Mann (901) 526-0088

Harland(*) Decatur, GA Diane Clegg (800) 723-2580, ext. 6090,

Interglobal Financial Systems(*) New York, NY Gary Christensen (212) 912-9300

Market Driven Chapel Hill, NC Tom Ficquette (919) 968-1774

Marketing Information & Technology, Inc.(*) Woburn, MA Tracey Guerra (781) 937-3311

Newkirk Products, Inc.(*) Albany, NY Jim Lawler (518) 862-3200

Priority Publications Minneapolis, MN Jim Larranaga (800) 727-6397

R. R. Donnelley & Sons(*) New York, NY James Bonaventura (212) 503-1229

Raab Associates Rose Valley, PA David Raab (610) 565-8188

Transcend Systems Group, Inc.(*) Sioux Falls, SD Dean Dziedzic (800) 995-0112

The Verdi Group, Inc.(*) Rochester, NY Kimberleigh Martin (800) 691-9010 ext. 8617

WordCom, Inc.(*) Ellington, CT George Wachtel (800) 822-0622

* Service Industry Member of the Bank Marketing Association

RELATED ARTICLE: 3 Databases, SMALL BUSINESS STRATEGIES

by Allan Bloomquist

Focusing on profitability. One large bank, with customers in three states, wanted to increase the profits from 15,0,000 small-business customers. Using their database, the bank first identified the most profitable 10 percent of its customers and developed a retention program for this group, which increased sales by 20 percent.

Then, using estimated values of loans, deposits, and fee income, the bank modeled this top-customer group and identified another 9 percent of customers with high-profit potential. The bank assigned a second-tier sales force to this group.

Profit data was then used to target 45 percent of the small-business customers for mass marketing. A low-performing 27 percent was also identified and were not included in any marketing programs. Additionally, the bank used the high-profit look-alike models it had created to cherry-pick the best available non-customer prospects, finding that 7 percent of the non-customer universe had high look-alike scores.

Expanding the private banking market. After exhausting the traditional targets for private banking, such as doctors, a moderate-sized bank began to focus on the small-business and professional market with a combined business and consumer net worth greater than $500,000. Using a database that linked business worth to personal worth, the bank found big profit potential in selected small business owners.

Since it was easier to sell to those already familiar with the bank, the institution ran a business owner's wealth data file against their huge consumer base records. This identified 4 percent of their consumer customers who had none of their business accounts with the bank. This group was then further refined in terms private banking needs, based on total estimated net worth and accounts currently with the bank.

Targeting 401(k) plans. A large Eastern bank already had in place a successful 401(k) program aimed at small and medium businesses. In order to expand this program, the bank used two strategies. First, it went after those customers who had 401(k) plans established with competitors. Second, it identified Likely prospects who did not currently have 401(k) plans.

The bank used existing Department of labor data to target those with existing plans. This data is extremely detailed and includes the number of dollars in the plan, dollars invested fixed income versus equities, and 3- and 5-year performance data (although there is a seven-month lag). The bank matched its customer base to those that had a 401(k) plan with a competitor, and instructed its sales force to go after those customers.

Allan Bloomquist is a senior vice president at Oxxford Information, Ltd. Mr. Bloomquist's background includes 17 years of banking - primarily strategic planning, marketing, and sales management. He has also taught banking in Notre Dame's and Johns Hopkins' MBA programs.