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Financial Services


May 16, 2006

Banking on small business

What can banks do to compete in a richly promising sector that is attracting more and more non-bank competition?

The US small business banking market is huge, accounting for an estimated $120 billion of annual revenues for the financial services industry. The market has long been seen as mainly local or, at most, regional in nature. A highly fragmented customer base has offered many attractive features for banks – clients have tended to be heavily dependent on good service, while being profitable, loyal and excellent sources of referrals for financial institutions.

But banks have also found the small business customer base to be a source of frustration. Every year roughly 10% of customers have disappeared as their businesses failed or owners retired. No two customers have identical needs, making it difficult for institutions to gain a strong foothold. Banks’ penetration and market shares in this segment are typically well below their penetrations in other segments. Research by Deloitte Consulting LLP suggests that the top 10 national small business lenders have only 16% of the market, versus 75% in credit cards and 60% in home loans.

These challenges are increasing as fundamental changes in the market attract the interest of non-bank competitors. “Small business banking is evolving into distinct segments driven by different payment types and by different forms of communications,” says Frank Sui, a principal with Deloitte Consulting LLP. “Specifically, advances in payments technologies such as remote check deposit and increasing adoption of electronic payments are driving a new market segment where regular visits to the local bank are no long necessary. Customers in this growing segment choose financial providers primarily by the products and services that meet their needs rather than the traditional factor of branch convenience.” Capitalizing on emerging small business segments, non-bank aggressors are growing rapidly by offering segment-focused, small business relationship propositions that range from enhanced face-to-face services to remote, automated services.

The challenge is being felt most acutely by national branch-based banks, which are particularly vulnerable to segment-based competitors compared with, say, their community bank rivals. For these national banks, the first challenge is to manage the retention of customers so that revenue and growth targets are met while the institution moves to a segment-based approach.

They must then decide whether to concentrate on a single segment, a strategy that requires them to become distinct in that segment and grow by broadening and deepening relationships within a narrow customer set. Alternatively, they can embrace a multi-segment approach, knowing that if (as seems likely) further segmentation continues, they must be ready to migrate towards a much more complex segment strategy. Growing, integrating and tailoring the infrastructure needed to support that strategy will be a significant management challenge.

“These are tough questions to address,” says Sui, “and most of banks’ eventual success will be determined by the skill of their execution.” Often small business banking has sat awkwardly within bank structures, belonging neither to the retail, commercial or wealth-management business lines. Concerns about duplicative infrastructure may compound this issue. But those banks that get it right have an opportunity to be big winners in a sector that might at last be showing its true potential.