Brett King and the Death of the Branch: Part 3

There has been some great analysis done on branch profitability over the last few years, and in markets like the US the data means we can very precisely predict when a specific branch is likely to close in the near-term. It turns out there are some fairly predictable pain points or metrics that are warning bells for heads of distribution. The first is simply number of deposits.

If you have a branch that has less than $15 million in deposits your costs are 10 times those of a larger branch. This means that 18% of branches in the U.S. today (or around 15,000 branches) are on the verge of collapse. On average these branches are losing around $50,000 to $75,000 a quarter. You can see a detailed analysis here from the team at Optirate.

The Death of the Branch

Account opening is also taking a hit. According to recent analysis done by Jim Bruene of NetBanker, 80% of bank branches in the U.S. open just two (that's not a typo) new account relationships per month for retail banking, and around two new business relationships per year. Higher performing branches do 15 times that volume, or 33 new accounts per month. At 10 new accounts per month the numbers start to stack up a bit better, but below that the likelihood of that branch being able to derive sufficient new revenue to sustain itself is unlikely.

The problem is that if your argument is that branches are the primary channel for account opening and that is the only reason you keep branches – then you're going to have a very hard time justifying keeping a branch open for two new accounts per month once you see account opening shifting to mobile or tablet (for argument's sake).

I guess now is the time to disclose that on a good day the likes of Simple and Moven get more than 100 new sign-ups. Nah, we don't want to rub it in …

We also know that transaction volume is a good indicator of branch viability. Basically 22% of branches do less than 3,000 teller transactions per month, and those branches are also the most likely to be unprofitable and dragging down the rest of the branch network, thus the best early candidates for closure.

(Above) Decline in Average Monthly Branch Transactions (Source: FMSI)

For community banks and credit unions average monthly transactions declined from 8,100 per month in 2010 to 6,800 per month in 2011 (Estimated decline takes us below 5,000 in 2013). That number was 11,400 in 2000.

This 60% decline in in-branch transactional activity will also have the effect of dramatically changing the face of the business. The likes of Novantas expect the number of tellers in the U.S. to drop to just 125,000 in the next five to seven years, down from 500,000 currently.

Part 3 continues …

The argument that the branch enables better cross selling and up selling of products to existing customers is also a myth. Here's a great quote on this from Bancology:

Ten years ago the average cross-sell ratio in U.S. retail branches was 2.2 products per household. Today, after years of investments in sales training and incentive programs, the average cross-sell ratio in US retail branches is… submit your guesses… 2.2 products per household! Yes, you read that correctly: 10 years of sales management programs, zero change in the depth of the relationships we're establishing. Across the industry, half of all relationships still include only a single product – Bancology Quarterly Report September 2011

So here are the early warning signals that you might have a branch (or branches) in your network that will close in the next five years:

1.      Total deposits under $15 million
2.      3,000 transactions or less per month
3.      Quarterly loss of greater than $50,000, and/or
4.      Less than one new account opening per day

This means that right now today somewhere between 18% and 25% of branches in the U.S. are no longer viable. They will be the first to close. But at least another 25% will come into the zone of disruption over the next three years.

Won't Regulators Prevent This Shift away From Branches?

There are some that believe that regulators will step in and enforce traditional branch modality because of mechanisms like IDV (Identity Verification) or KYC (Know Your Customer) that currently favor face-to-face interactions.

However, the issue with the assumption that regulators will favor traditional distribution mechanisms and keep the industry in stasis from an innovation perspective assumes that regulators don't want the industry to innovate customer engagement, onboarding and distribution.

I personally have not met a regulator who believes a healthy financial sector is a stagnant one from an innovation perspective.

Secondly, regulators can only innovate banks and payments participants in the system, they don't regulate customer behavior. So when customer behavior changes around branch activity, for example, it makes no sense for the regulator to simply say "Sorry, the only way you can open a bank account is in a branch."

This would be like the publishing industry saying "Sorry, we're not going to allow books to be sold electronically, you can only buy them in a store."

This is, in fact, what Barnes & Noble tried to do when in 1998 Amazon had started to materially effect book sales in the United States. Barnes &Noble sought to acquire Ingram Book Group. At the time Ingram accounted for around 60% of Amazon.com's supply. So rather than adapt to changing buying behavior around books – the incumbents in the business like B&N try to cut off Amazon's supply to reduce their effectiveness.

In that instance the Federal Trade Commission put the kibosh on the whole deal citing anti-trust concerns. However, the problem B&N and Borders faced was not Amazon's relationship with Ingram allowing them the supply needed to flourish – it was simply that consumers were visiting bookstores less, and therefore buying fewer physical books in-store.

This incumbent response is also representative of what the Recording Industry Association of America attempted to do when presented with changing buying behavior. From 2006 to 2008 the RIAA spent $58 million in litigation related to protecting traditional rights and distribution in an effort to stamp out digital distribution (downloads), with notable victories against the likes of Napster, Limewire and others.

While the RIAA did succeed for a while in shutting down start-ups who were trying to revolutionize music distribution, file-sharing activity went on through increasingly diverse mechanisms.

With the emergence of BitTorrent file sharing systems, the RIAA could no longer stop "businesses" from changing distribution mechanisms and so they attempted to go after individual downloaders with outrageous damages claims. When the media and public pushed back hard on these efforts, the RIAA shifted their approach and tried to convince ISPs to enact a three-strike warning policy for consumers who were found to be illegally downloading music. The problem was not people breaking the law, it was that people just wanted to download music and the industry was not adapting.

None of these approaches changed or slowed consumer behavior so as to give incumbent bookstores or music stores a return to the glory days of a physical product in a physical store.

Continuing to the Conclusion,
Consumer Behavior is the Killer App … : Consumer behavior is the killer app. Changing consumer buying behavior is what killed the majority of bookstores and music stores, and regulators simply can't regulate consumer behavior. Even if they could, they probably wouldn't because it would result in a hopelessly outgunned economy and financial system when compared with more progressive economies – like Kenya for example (see M-PESA).

For the bookstore it was eBooks and the Kindle emerging after the successful introduction of the new category of bookstore – Amazon's online bookstore. For music it was iTunes and the iPod, accentuated by the loss of the "Album" as the primary product. In video rental it was the destruction of the DVD and the VCR by movie downloads and streaming services like iTunes, Netflix and Hulu. For film it was the emergence of the digital camera and the smartphone camera. What will it be for banking?

While Internet banking and mobile apps could be likened to the emergence of Amazon.com, we're still selling a largely physical product, namely the physical bank account (based on debit cards, and check books). Once you digitize the physical bank account so that the smartphone is your modern day debit card and passbook and allows you to also circumvent checks by using P2P, then you have created the equivalent of the iPad or Kindle for the banking industry.