Banking Distribution Strategies for the Next Decade

Jim Marous:
So Kevin, I'm glad you could join us today. You know, as I mentioned in the intro, we go back a ways. We've been in a lot of the same events and we're both legacy financial institution people now you've been with Novantas for quite some time and you know I was really taken, I love your distribution discussions and one of the things you wrote recently was it's time to create your own successor bank. It was done for Novantas review and before we look at the distribution options and the need to create a successor bank could you discuss some environmental issues that are facing the industry right now that is really prompting the need to look at distribution.

Kevin Travis:
Yes, absolutely. I think if you look at our research going back almost 15 years, we've seen a couple of inflection points. One was when the majority of customers coming into the bank were digitally enabled, which was around 2006 and seven. We're at another inflection point in terms of the customers, where today a significant number of younger customers are opting in to non traditional bank options like neo banks and direct banks. And what has happened is that fundamentally, the network scale, network density, which used to be a competitive advantage for most banks, I think is increasingly certainly for regional banks and to some extent for national banks is becoming a bit of an albatross.

Kevin Travis:
And so the challenge is of course that banks have a financial disadvantage in that they have to make a profit all the time. No one is going to let them make big losses to fund transformation, but they are competing against private equity funded Neo banks and other FinTech plays who actually don't have to make money in the short run. And I think that this fundamental trap, if you will, is pushing people to make some pretty radical decisions about how they think about their highest cost infrastructure, which is the network.

Jim Marous:
Well, isn't it also a challenge that the consumers now are more aware of banking? Of the way that banks can be done, how it can be delivered. And that's even driving the change where you're saying, okay, so I have less people coming in the branches. I have less people wanting to branch, but there's still some, and at the same time they want a better digital engagement and an experience therefore pushing even further isn't it?

Kevin Travis:
Absolutely. I mean consumers don't, if you think about branch convenience or what makes banks convenient to consumers, branches used to be the leading driver and now they're one of the smallest drivers of convenience in banking. And I think consumers have more information about their options. They have more transparency about pricing, they get more advice from social networks and other places. And so I think that as consumers have understood the trade off between the fees they pay and the services they get. A lot of younger consumers in particular, but even older consumers in many segments are saying, I don't quite understand what I'm paying for. If I can get the same basic services in a cheaper model that's more convenient and more efficient through a digital only player, I'm now willing to consider that and I think that shift in the willingness to consider that as an alternative is something that's a big, big change in the last two to three years.

Jim Marous:
Yeah, and in your article for Novantis, you stated successor bank transformation is necessary regardless of the economic environment. Can you elaborate on that a little?

Kevin Travis:
But yeah, precisely, because the economic pressures obviously come and go depending on the interest rate conditions, the growth in the market, credit conditions and we don't know sometimes those are going to be better. Sometimes those are going to be worse, but the structural transformation that's needed is going to be needed whether margins improve, whether margins decline, anything on a sort of quarter to quarter and year to year basis is not the problem we're dealing with. We're dealing with essentially a secular change in the industry where the relevance of the core of the bank depends entirely on your ability to get customers to want to do business with you. And I think that no matter what happens, the way in which consumers are going to make decisions and how they're going to choose their banks is changing dramatically. So this transformation isn't so much about short term economics, although short term economics play a role, it's definitely about this longer term issue of the customer basis, moving away from the things that it used to care about and caring about new things.

Jim Marous:
Well, and it's a challenge too as you mentioned, because internally at the financial institution level, a lot of institutions in not wanting to or are feeling like they're not able to close branches, continue to look at just at digital transformation as a cost cutting play. Now they can call it customer experience, but the reality is it starts to feel more and more like everybody's trying to do digital, do digital is in quote marks to save money and the challenges, the customer starts to feel it because they're not going to get the upgrade and experience that they expect from doing things differently.

Kevin Travis:
I think you've seen that cycle before. We saw it with call centers, we saw it with ATMs, there's always I think a desire, which I think is a reasonable desire on the part of the banks to find ways to reduce the cost of operations. I think that, but I would argue that the digital for let's say the last 10 years very much, I would agree with you, it was very much about cost cutting and the idea that if we could migrate transactions, we would save money. I think what we now face is this existential problem, which is we can, yes, we can continue to do that, but fundamentally if we do that, all we're doing is essentially shrinking the ways in which we interact with our customers. And what we're finding is is that customers who have switched to digital generally are less loyal.

Kevin Travis:
They generally are harder to acquire, they generally are less valuable. And there's an interesting dilemma for the banks, which is they don't want to lose the core valuable customers they have today that use the branches. On the other hand, if they don't make the switch, I think that what's going to happen is they're going to find that there are no new customers coming into the system in the future. And I think that's the difference. This is about an acquisition of customers and retention, less about the basic servicing, which is what I think the focus was on over the last 15 years.

Jim Marous:
So when you talk about success or bank strategy, what are you actually talking about? Are you talking about just changing what's currently in place? Are you talking about building a brand new entity?

Kevin Travis:
It's interesting. A success successor bank to me, I've always talked a lot about the old, the sort of feud, the good bank, bad bank, old bank, new bank, bank A, bank B. I think that the logic of trying to undo a whole 20 years, 30 years, 50 years of a created technology created audit comments is very, very difficult. So I think one model that we are looking at more and more is can you build a bank that is fundamentally separate from the one that you run today, grow it and get good at it on a new core and then eventually that bank can slowly but surely overtake the existing bank.

Jim Marous:
And who do you see that being built by? Is this entity going to be built and structured by current people in place of the bank? Or does this have to be a brand new group to avoid what I'll call legacy thinking or modern thinking with the background of the old bank being instilled in your mind?

Kevin Travis:
I see two ways that could play out. I think one model certainly, and you've seen a few folks go down this path is a totally separate, not just brand, but also technology stack. Totally separate staff. Totally separate call centers. The other model of course is that it's a group of folks who are hived off from the day to day operations, but where they're fundamentally still operating inside the existing franchise. I think there's different trade offs for either one. I think the benefit of the separate organization is you get to, in a way, you're building a challenger bank the same way as if you were running a startup.

Kevin Travis:
And so you can start with a clean sheet of paper and ask yourself questions about what the business should look like if it were built today versus if you think about most banks, most banks systems, most bank, the way they operate were defined probably in the early part of the 20th century. And then we've been tweaking it ever since. The benefit of using an in house team is that you get some of the economies of scale around the brand, around some of the existing technology, etc. So I think there's a trade off, but, but I certainly see more and more people thinking about doing it as a separate entity these days.

Jim Marous:
So in your writing you talk about four options, you talk about a build, buy, rent and share option. What are the advantages or disadvantages of the strategy from your perspective?

Kevin Travis:
Well, you think about build or buy, rent or share. What we mean by that is obviously build means you build it in house you use your technology resources, you spend money and capital to build straight infrastructure internally. Buy of course means you go to an outsource or a fidelity or a Jack Harlan or something like that and you buy it straight off the shelf. Rent is essentially you use somebody else's infrastructure and they white label it for you. And share is something that's new, which is we have heard and talked to some folks who are considering pooling their infrastructure into a new operating entity and then investing together multiple organizations investing together to build a scalable technology stack. And then each of them having their own front end on it. Bought building is extremely expensive and can be very risky.

Kevin Travis:
That's the downside. The upside of building it yourself is that you can actually put proprietary features and functions and so on into it. And I think one of the big challenges in the digital environment is that digital innovation has a shelf life, right? If you create a killer app, it's great for six months and then it gets superseded. One of the risks of building is that you have to stay ahead of that curve. And that's very, very challenging for most organizations that don't have the scale of a Wells or of a Chase, for example. Buying it I think is going to be more and more of the model for let's say the largest regional banks in the US and the largest banks. I think when you buy it, you're going to have a fairly similar experience from the core, but it allows you not to have to worry about the nuts and bolts of operating at which is a great management benefit and you can concentrate on the customer franchise and most likely it's going to be cheaper to do that.

Kevin Travis:
I think renting it and sharing is something that smaller banks are going to have to think about. And it may be the outsourcers themselves that help put some of these coalitions together, but there may also be some banks to begin to talk to each other about, gosh, we are noncompetitive in the front end of our business. We could share back end functions. I almost think of it as the airline Alliance model of operations. I think the benefit of this last one would be that fundamentally it's hard for most banks to have enough scale to have this be able to invest what they need to. So pooling their resources in a cooperative way may make sense for a lot of the smaller banks in the country.

Jim Marous:
So this obviously is a completely different way of doing business, but it initially is at least a better of almost like a win-win. You're building for the future, while you're not letting go of the past, what are you seeing as the challenges of truly embracing a successor bank strategy?

Kevin Travis:
I mean, I think the first challenge is always going to be cultural. Banks are large and I think of them as historical organizations in some ways. Banks have been a part of the economy for at least the last 200 years. They operate the way they operate and most banks have succeeded not least because of their culture. Some banks you might argue have failed because of their culture as well. But most banks have a fairly successful and deeply embedded culture, so to say to the existing organization, thank you very much. But everything you do is now legacy. And these other people over here are going to have the future of the organization in their hands can be a bit challenging to a company's culture. So you have to be very careful about how you think and talk internally about that.

Kevin Travis:
So I think that's one big challenge right there is culture because you can imagine that if 80% of your staff work in a bank, in the core bank and yet you now begin to message that that core bank is in fact a legacy platform. A back book, if you will. How are you going to retain the best staff, et cetera. So I think that's one big challenge. I think the other is of course sustaining the momentum for investment.

Kevin Travis:
Banks operate quarter to quarter, they focus very much on the latest interest rate conditions and how that affects their Nim and their spread. And so it is very, very hard for most banks in the face of changing economic conditions. If you announce a hundred million dollar or a $200 million a year investment plan targeting new technology, etc. Targeting a new brand, you can think about all the places you'd be spending money and things get really bad in the third quarter. Can you maintain that focus on the challenger or does the challenger become a little of a hobby? Where do it when times are good, but you cut back when times are tough. I think that's the biggest risk is you can end up spending a bunch of money but not ever getting real lift out of it because you're not as committed to it in the longterm financial sense.

Jim Marous:
So if we look at that. The good news and bad news is the success of the successor bank where if it does really well, that may be great, but it's probably going to be at the expense of the legacy organization. If it does really poorly then you cut it off. The challenge then is let's take fin Chase, they use their digital bank strategy as a way to what I'll call fill in the gaps in their non branch areas. They only promoted it for the most part in those areas that they didn't have branch exposure, but they kept on building branches.

Jim Marous:
And as you mentioned, one of the challenges is what happens when it grows up and we can challenge the fact that fin was really built the right way with the right people in the right back office. But overall I found it interesting that when they stopped it, they made their own excuses. But it almost felt to me like they somehow had to answer to the 57 stories in New York that were all branch based banking and say, geez guys, I'm not too sure if I have a stomach for building a digital bank that may eat the parent. What's your thought on that?

Kevin Travis:
I think of it two ways and I'll parse them. One issue is that Chase, and let's say to a large extent, Wells and city, not city B of A, have a fundamentally different role in the banking system than say many of the super regionals and the regionals, they do in fact have it. Chase's formula works extremely well. Branches plus digital plus marketing very, very effective acquisition engine. And they can afford to run three, four or five different value props in the system and make money in most of them, whereas most banks can barely afford to run one or two. So they already have a scale advantage and so they're, as I've said many times, they could afford to spend $1 billion on branch transformation in a year, which far outstrips any budget that anybody else could and they could still win.

Kevin Travis:
I think that Finn, my hypothesis and I don't know anything specifically other than what I've read, but as I think about it and I look at the markets they operated in, etc. My hypothesis is that fin, that the system that Chase runs is so effective and so efficient as it is that they didn't get enough lift. Fin wasn't as differentiating and as exciting when they put it into the market as sort of ordinary digital marketing. And so, and that may be true for a bank like Chase, which is so big and so their brand awareness is so high that they don't necessarily have to eat themselves.

Kevin Travis:
They do have to figure out a transition plan. But as a big national bank they have a lot of built in advantages. So I'm curious about, I think it'll be interesting to watch because Chase has innovated in fin network distribution. If you look at all their branch expansion plans into these new markets like Boston and places like that, they're not building 200 branches in Boston, they're going to build 10, 20, 30, 50 right. And those numbers are far below the kind of numbers of any traditional branch expansion. So it feels like Chase is more thinking through what are the different formulas that work for us as Chase and they're trying to figure out what's the right place for them to spend their money.

Jim Marous:
Well, that's interesting. Because I think your point is that we have to be very careful for any organization out of the top five, to use Chase's reason to do something or to not do something. You and I both know that Chase continues to aggressively pursue acquisition using financial incentives that most organizations would not find viable. But they leverage those by getting the most out of each one. One of the customers they get on on top of that, Chase in my neighborhood, just built a two story brick branch one mile from my house that is not taking the place of, but it's closer than the one, two miles away. And I'm sitting there shaking my head going, I don't get it. But on the other hand, we can't use it as an example because again, Chase has the size and the distribution network and the marketing and a lot of the components that almost no other organization can afford and that model's working. So that's an interesting dynamic.

Kevin Travis:
And I would say, I think I agree with you completely on that. And I would say it's sometimes people look at that. I often will have clients say to me, well Chase is doing X so I should be doing X, and I say to them, Chase gets value. The reason Chase does what Chase does is because they get value out of it and they have such huge ubiquitous brand awareness. Remember they have a large card portfolio, they touch one in two, one in three customers in the US in some form or fashion.

Kevin Travis:
It's interesting, you look at the numbers and you say that can't be efficient and yet when you look at the volume of pull through and the success of cross sell and other things you can see how on a dollar per dollar basis they're actually quite efficient because they're so successful and I think that's one of the dilemmas for their people competing is if you are bank number, let's call it five through 20, sort of big enough to really matter, but not big enough to go head to head with a Chase or a B of A or a Wells, et cetera. In a way you're not going to the scale based battle.

Kevin Travis:
You're just not, you're not going to be able to build enough technology. You're not going to be able to build enough branches. You're not going to be able to spend enough marketing. Therefore, the reason challenger matters is because you need a plan B that does not require you to compete scale for scale with the biggest national players. And that's where I think you see some experimentation going on, whether it's P and C or union bank or citizens or others. Thinking about what are these non traditional out of footprint challenger models that we could adopt that will help us compete nationally and yet not cost us $1 billion a year.

Jim Marous:
Well, and you and I both know that also, there's probably no organization in the banking industry that measures what they do and the success of what they do better, any more than Chase.

Kevin Travis:
Sure.

Jim Marous:
You saw some incentives they'd offer for new account openings. You go, I could challenge and shake my head and wonder why, but I have to believe that Chase knows exactly why. It's that penetration strategy and they're big enough that new mover strategy, they have enough penetration, enough analytics to know where to be, when to be there, what to offer and and what the result will be to a degree that says, hey, you know what. I tell people, I say the reason why you know it's working, because they'd done it for 10 years so they would've stopped it by now if it wasn't. When we look at other organizations in the marketplace, do you see any organizations that you come across that are succeeding in the successor bank strategy or are well on their way to doing so?

Kevin Travis:
It all depends on what you mean by his success. And I can only speak here to my research obviously in terms of what my research is telling us. What I would say is this. I would say that the banks that are experimenting with various types of successor or challenger models and I lumped together a bunch of things in that. Whether it's a citizens access out of footprint, direct play, whether it's a P and C, send network play or a pure point financial or some of the other things that are going on. What I will say is this, it's hard to know the answer at this point. We've seen really good deposit growth numbers from some banks that have challenger plays or have some sort of hybrid direct bank play in the market.

Kevin Travis:
And so in that sense, if your goal was deposit growth, some of those plays have been successful, but one could argue that they were based on rate to date. I don't think yet that anyone has had a successful primary checking national out of footprint expansion. And most banks would tell you, well we haven't done that yet. I think we're still early days in seeing will this model, will some sort of out of footprint play make a difference in the US market? It's been interesting. We've seen evidence, you've certainly seen evidence in the UK market of challengers growing customers and I think whether they're neo banks or their existing bank challengers, the customer growth numbers are pretty impressive and certainly we've seen some disruption like that along the lines of that with ING in Australia. But in the US I think we don't yet.

Kevin Travis:
I would argue there is not yet in the market a true full blown challenger play that is going after core checking primary relationships the way some neo banks are like Chime or Acorns or others. And I think it'll be interesting to look out into the next year and see what happens in that space. With interest rates in a different place now deposit valuations look different and see the previous comment about quarter to quarter earnings pressure. It'll be interesting to see who makes what steps in 2020 around that.

Jim Marous:
Well, that's interesting. You give a look back at the old online bank play, interest rates really played into that quite a bit in that you could buy deposits. And it would not be greater expense than your branch network. So you had that leverage that you can really play it.

Jim Marous:
But with interest rates so low, with spreads nowhere near what they were back in the day of the online banking movement, you don't have exactly the same equations to work with. And so it's challenging. As we get to the end of this discussion, when you sit down with a banker credit union today and you sit down with so many of them, what is the one thing you tell them that you believe is not negotiable as they try to better serve the customers? In other words, if you said, man, we can, we could hit with 20 things you got do, but no matter what, this is a non-negotiable, you have to do this, this year.

Kevin Travis:
Yeah. The one, the most important thing of all of them is you need to know who it is you are trying to bank. The biggest shift in banking for most banks and as I said earlier, national banks can afford to run five value props, most banks can run maybe two. The utility play of banking I think is dying. The sort of all things to all people, you know physically dominated, build a branch and whoever happens to live if they are rich or poor or businesses or whatever, I could bank them and I needed a way to do that. I think as things dematerialize and become digital, knowing who you want to serve and then determining what the right way to do that is the right answer for your bank.

Kevin Travis:
A challenger play because you need to be serving young, affluent customers who don't care about branches anymore versus if you're a community bank with a really strong local franchise, maybe spending all your money on digital is a bad idea because your most important customers are all near you in your local community footprint and you need to focus on them. I think a lot of banks need to know who are their customers and what are they trying to do for those customers and then based on that they can then make a whole series of decisions around what sort of strategy makes the most sense to them.

Jim Marous:
That's great Kevin and again I really appreciate you being on the podcast with me today and we continue to read all your information. How do people follow you and read your thoughts through Novantis?

Kevin Travis:
Normally they follow us through our website which is www.novantis.com and all of our articles and publications are available there. We publish a quarterly review called the Novantis review, which is available on the website to subscribers and obviously I'm on Twitter at Kevin. Dot. S. dot. Travis as well. But I tend to tweet very little. The easiest way to follow all of our content is to get it from our website where you can sign up for a list.

Jim Marous:
Great. Kevin, it's always great to talk to you. It's great to touch base and thanks for information on the future distribution. I think without, we've been talking about the death of branches, the dwindling branches, all these things for so many years. It feels like it's getting old, but we continue to see building them and different strategies. So it's going to be interesting to see what happens in 2020

Kevin Travis:
As always. For sure.

Jim Marous:
Thanks a lot. Thanks a lot, Kevin. Appreciate it.

Kevin Travis:
Thank you very much.