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Different business strategies in European Retail Banking

A close look at the European retail banking landscape immediately reveals the incredible diversity that prevails. In the period from 2002 through 2006, revenue growth varied from 3% per year in Northern Europe (NE) and 5% in Western Europe (WE) to 8% in Central and Eastern Europe (CEE) and 62% in Russia and Ukraine (CIS). Similarly, the cost/income ratio varied in a broad range of 30 points between NE (where costs were lowest) and the CIS (which posted the worst results on this score). Revenue per customer, which is nearly seven times higher in WE than in the CIS, is yet another ratio that clearly illustrates the colourful diversity of the European retail banking market.

Aside from this apparent lack of a coherent trend, two very different business strategies are currently shaping the European retail banking landscape.
  • First, in mature markets such as WE and NE, competitive
    advantage lies with those banks that succeed in maximising their revenue per customer ratio. Growth is limited, attracting new customers is becoming increasingly difficult and the number of multi-bank customers is increasing all the time. In this context, the number of products that customers use becomes a major differentiator due to its direct impact on revenue per customer. With 5.4 products and an average revenue of EUR 750 per customer, WE is the most advanced cluster in this field – and is still growing faster than GDP at a rate of 3.5% per year. At the same time, revenue per customer in NE too is six times higher (at EUR 630) than in the CIS (EUR 110). Even where it is not considered a priority, the acquisition of new customers should not be forgotten entirely. The Internet can be a powerful tool in the pursuit of such an objective.
  • In emerging and transitional markets such as the CIS and CEE, competitive advantage can be gained by quickly occupying the terrain in order to enlarge banks' customer base and increase their market shares. From 2002 through 2006, the number of customers grew at an impressive annual rate of 42% in the CIS, for example. The corresponding figure in NE and WE expanded by just 1% per annum.
    This very fast development of the customer base is driven by strong growth in the number of branches (4% in CEE and 17% in the CIS in the same period). Right now, revenue per customer in these two clusters bears no relation to the levels observed in WE and NE. Nevertheless, doubledigit growth should soon make this factor too an important source of growth.
A further striking characteristic of the European retail banking landscape is the two different philosophies adopted by most banks in WE and NE.
  • The majority of the banks that operate in NE have developed cost-driven models in which technology assumes tremendous importance. Understandably, therefore, these banks do very well on the cost side. They boast the best average cost/income ratio (55%) and the lowest level of personnel expenses (just 42% of total costs). The cost structure of banks in NE also shows that the proportion of sales and marketing costs (54% of total costs) is lower here than in any other region. This is due to systematic network downsizing and the lowest level of production costs (10% of total costs) as a result of heavy investments in technology.
  • On the other hand, banks that operate in WE have focused on the revenue side. Their distribution model is characterised by large networks, good geographic coverage and generally smaller branches. The average number of customers per branch perfectly illustrates this fundamental difference. At 2,500, this figure is three times lower in WE than in NE, whose chosen model is more heavily concentrated (7,200 customers per branch). Such strategic choices naturally come at a price. Personnel expenses are 13 percentage points higher in WE (55% of total costs) than in NE. Sales and marketing costs too (59% of total costs) are 5 percentage points higher, whereas production functions are less efficient, accounting for 12% of total costs.
    This difference between a high-tech model in NE and a model that focuses on the frequency of customer touch points in WE is vital to a clear understanding of the results of this study.
These significant differences in strategies and operating models can teach us valuable lessons in each of the four regional clusters.WE and NE are the most mature markets and can, in many respects, be considered a fruitful testing ground for developments in CEE and the CIS.
  • Sales efficiency is the key strength of the WE cluster. To achieve such impressive results on this score, banks in the region rely on a variety of factors. Segmentation, for example, is much more highly developed in this cluster than in any other. Banks in WE work with an average of 17 product segments and 10 customer segments. Western European banks also take less time (only 1.5 days) to prepare quotations for mortgages than any other region in Europe. They also have the highest proportion of loans that are granted automatically (73%). More important still, however, is the size and design of branch networks in WE. A figure of 2,500 customers per branch shows that banks in this cluster have clearly opted for close proximity to customers. To keep the distribution costs associated with such a strategy within reasonable limits, they rely heavily on light branches (54% of the total network). Finally, banks in WE also have the most flexible branch operating models. Half of them deploy a majority of variable or parttime staff. In addition, a large number of them vary their opening hours from location to location.
  • Conversely, banks in NE rely on specific cost expertise. They make more use of back-office sharing (15% of FTEs) than any other region. And they delegate more responsibility to their branches than banks in the other clusters (business objectives are defined at branch level in 80% of banks). Efficient cost management strategies likewise have a powerful impact on distribution channels. Banks in NE make most use of the telephone channel in Europe (44%) and are one of the biggest users of the Internet channel (36%). Although they make very little use of financial incentive schemes for branch staff, banks operating in NE reflect their great concern for their employees' motivation in the highest use of scorecard systems (100% of banks).
Banks in the CEE and CIS clusters are generally less advanced in their use of modern management tools. Even so, many already have experience with new ideas and strategies.
  • Banks in CEE have developed their use of the Internet so aggressively that their weighting for this channel is now on a par with that of banks in NE. Some banks in CEE also draw on the experience of their Western shareholders to quickly ramp up alternative branch formats. The best examples are the development of very light branches, which now represent more than 24% of the total number of branches, and the development of points of sales that are managed by third parties such as franchised networks. Moreover, most banks in CEE also operate powerful financial incentive schemes. Average bonuses for branch staff amount to 27% of their fixed salary – a figure way ahead of the other clusters and 27 times higher than average bonus levels in NE (1%).
  • Banks that operate in the CIS cluster also seek to use innovative drivers to raise their market share. Some banks, for example, fully customise the opening hours for their branches depending on the location. Multifunctional ATMs handle 27% of the total transaction volume, while average bonuses for branch staff (17%) are much higher than those at banks in NE and WE.
Market maturity partly explains the performance differentials between clusters:

On the supply side, the level of banking penetration defines the scope of financial services and, hence, the potential use of such services by the population. This issue can easily be measured on the basis of geographic and demographic indicators, all of which point to the unique position of WE on his score. For example, Western Europe has three times more ATMs per square kilometre than all other clusters.

The standard of living partly defines demand and therefore also broadly shapes the consumption of financial services. GDP per capita is considered the best measure to evaluate the differences between clusters on this score and therefore to explain differences in average revenue per customer. Average bank income per customer is the perfect metric to illustrate the impact of the standard of living on banks' performance. Adjusted for purchasing power parity, GDP is four times higher in NE than in the CIS, whereas revenue per customer is nearly six times higher in NE compared with the CIS.

The standard of living also explains the gradual transition from growth that is based on interest margins in emerging markets 82% of revenue in the CIS) to growth that is based on fees and commissions in mature markets (59% of revenue in NE).

On the cost side, unit labour costs are a key point in explaining part of the huge differences in cost structures. At present, labour costs are more than six times higher in NE and WE than in the CIS and three times higher than in CEE. This explains some of the difference in the weighting of personnel expenses as a share of total costs.

Overall productivity is another factor in explaining varying cost figures. Both capital productivity (the efficiency of IT systems) and human productivity (the number of people needed) affect cost levels. Discrepancies in productivity, for example, broadly account for observable differences in the ratio of production costs to revenue, which ranges from 5% in NE to 21% in the CIS.Four key business drivers largely explain banks' global performance:

In a technology-affine world in which the Internet is often seen as the distribution channel of the future, face-to-face contact remains the key to sales efficiency. Our study shows the importance of dense networks and demonstrates that proximity of branch networks to local customers generates faster growth, especially in the credit segment. Human contact is indeed pivotal to the exploitation of cross-selling potential and therefore to improving average revenue per customer. Banks must stay close to their customers to reach this objective, however. They therefore need to reduce the number of customers served by each advisor. Seen from this angle, the density of points of sales should also be regarded as a crucial lever in the development of tightly meshed networks. Mini-branches appear to be the most appropriate
solution to reach this goal. On the other hand, mega-branches
such as the Q110 branch recently opened by Deutsche Bank
in Berlin can likewise deliver a fascinating customer experience.

Flexibility can significantly increase the positive impact of customer proximity. Flexibility is a key driver of both business performance and cost efficiency. We identified three main dimensions of flexibility in branch operating models:
  • The use of variable and/or part-time staff allows banks to adapt staff sizes in line with footfall patterns and to adapt staff qualifications to accommodate customers' needs.
  • The use of varying opening hours at different locations is another key driver to better serve customers' needs and accommodate their behavioural patterns. It also creates more selling opportunities for branch staff.
  • Financial incentive schemes impact sales efficiency directly by motivating sales staff. Focused schemes can also help banks to favour higher-margin products.
These three dimensions all affect revenue by boosting cross selling and/or better satisfying the needs of customers. They also have a powerful impact on costs. Our study reveals a strong correlation between the intensive use of flexibility drivers and lower sales and marketing costs.

Commonly considered as the secret weapon for future battles in the banking arena, Internet banking is in fact the Janus of modern retail banking. It creates genuine potential but also poses two serious challenges. Ultimately, the real issue is to find the appropriate use of Internet banking with which to tackle these challenges.
  • Getting customers online triggers a virtuous circle. The less operations are performed in branches, the more banks can reduce transaction costs and thereby increase their margins. In addition, they can also benefit from more selling time in the branches and, finally, by driving up revenue per customer. The two main challenges to banks should not be ignored, however.
  • Firstly, banks eager to develop the Internet channel must find solutions that turn the web into a transaction delivery channel. All too often, customers see the Internet as a place to gather information but not to conduct transactions.
  • Secondly, getting customers online gives banks less face-to-face contact with them and therefore reduces cross-selling opportunities. Sales organisations must therefore be remodelled to fully leverage the upside revenue potential afforded by Internet banking.
Finally, to establish Internet banking as a positive experience, banks should find solutions that reward customers who perform transactions online. They should switch from a passive to an active mode to keep customers active. And they should regard customer proximity as a crucial complement to any Internet banking strategy. Though shared production may be a more traditional driver, we are convinced that it still harbours unexploited potential for most banks. It has a positive impact on both production costs and sales and marketing costs. The study shows a strong positive correlation between the level of resource sharing and outstanding loans and savings per FTE. This fact underscores the positive impact that sharing production can have both on the development of IT systems and the experience it gives to employees. In NE, for example, increasing the volume of production sharing from 45% of FTEs to 65% of FTEs can yield a EUR 5 million increase in outstanding loans and savings managed per production FTE.

To remain on top, European Retail Banks must not only resolve the current dilemma between customer proximity and advanced technology. They must also leverage innovation and productivity to actively shape the future.

Today's European retail banking landscape is already richly diverse. The landscape is changing, however, and new challenges are arising every day.
  • The future winners must first develop their use of the Internet in response to the emergence of direct banks while increasing the density and flexibility of their networks.
  • They must also reconcile the apparent contradiction between the growing need for more customer-oriented and tailor-made products on the one hand and tougher cost management on the other.
To reach what we have called the "Garden of Eden" and prepare to tackle the challenges that are emerging, banks should naturally rely on their existing strengths but should also learn from banks operating in other clusters.
  • Most banks in NE operate "factory" models that use state of-the-art IT architectures to gain a clear cost advantage. This advantage is reflected in lower cost/income ratios (CIR). In such a context, the challenge for NE banks is to improve the top line by fully exploiting the potential benefits of web-banking thanks to an increased proximity and a more intensive use of flexibility.
  • On the other hand, banks in WE operate "convenience store" models, stay close to their customers and thereby achieve excellent results on the revenue side. Legacy networks are very expensive, however, and moves to optimise production are still a work in progress. To reach such an objective, production sharing and Internet banking can both be powerful weapons for banks in this region. Moreover, many banks can still do much to improve their customer proximity and flexibility.
  • Banks in CEE are seeing growth slow down and must activate both the revenue and cost levers if they are to rival the cross-selling levels of banks in WE and the cost efficiency of the Nordic countries.
  • Meanwhile, banks in the CIS are struggling to ride the wave of strong growth without driving up costs and exposing themselves to undue risks. Managing growth is taking precedence over "optimisation". The need to switch from volume-driven growth to value-driven growth will quickly arise. Banks operating in this cluster should therefore prepare themselves to use all four business drivers in order to benefit from their European competitors' experience and optimise their own value creation.
Maurizio Panetti
Roland Berger Strategy Consultants Italy
Nov 1, 2008
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