Personal Financial Services a Question of Channels

7/29/2019 Personal Financial Services a Question of Channels

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116 THE McKINSEY QUARTERLY 1997 NUMBER 3

FINANCIAL SERVICES

Five key trends need to be recognized

Success will rest on knowing what customers really want

PERSONAL FINANCIAL SERVICES are in the midst of a transition. Once,competition was largely defined by regulation and geography; now, theindustry is starting to be organized around consumer needs and around

the underlying economics of products and their delivery. As in other deregu-

lating industries, margins are declining, though so far the impact of thisdecline has been masked by favorable interest rates.

Dorlisa K. Flur, Lenny T. Mendonca,

and Patricia Nakache


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THE McKINSEY QUARTERLY 1997 NUMBER 3 117

Dorlisa Flur is a principal in McKinseys Atlanta ofice;Lenny Mendonca is a director in the San

Francisco ofice andPatricia Nakache is a consultant in the Silicon Valley ofice. Copyright 1997 McKinsey & Company. All rights reserved.

But make no mistake: PFS companies still have ample opportunities toprosper, both during the transition and beyond it. The trick for them is tofigure out how to exploit what is likely to be a lengthy transition whilesimultaneously preparing themselves to compete in the more distant future.We believe that focusing on distribution channels and developing a deepunderstanding of consumer buying behavior are the way to accomplish thisdificult task.

Channels have always been important in PFS. Indeed, distribution channelsaccount for over half the cost structure of most traditional players. But inthe current environment, channels have become the premier battleground


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for the $120-billion-plus profits available each year in PFS. Consumer productpreferences have reallocated assets and liabilities among providers: from 1993to 1995, for example, consumer balances in securities (largely sold bybrokerage firms) rose by $782 billion, while balances in bank-dominatedtraditional deposit products rose by a mere $84 billion. As a result, largetraditional players, such as commercial banks and insurance companies, havesteadily lost market share to new entrants. In fact, between 1992 and 1996, theproportion of consumers that viewed their bank as their primary financialinstitution fell from 59 to 49 percent.

But today, managing channels means much more than simply masteringindividual channels like ATMs, branches, telephone, on line, or direct mail. Itmeans understanding what PFS consumers want and creating new ways tomeet their needs profitably.

In this critical transitional period, a host of new channel opportunities areemerging. In the articles that follow this overview, we sketch out three ofthem: bancassurance, a combination of banking and insurance; the creationof an integrated provider for residential real estate closings; and the sale ofPFS products in the workplace.

Each of these opportunities bundles existing financial (and sometimes non-financial) products and delivers them in a new and potentially powerful way.Each is anchored in the economics of product delivery and in a practicalunderstanding of consumer needs based on extensive consumer researchinto all aspects of PFS. Moreover, each is closely tied to the trends driving the

transformation of PFS, and thus points the way for large traditional playersto thrive in a rapidly changing environment. There are five such trends:


During the first half of 1997, McKinseydeveloped a model of the profitabilityof the PFS industry by product, customer

segment, and channel, and analyzed how

profitability levels have changed since 1993.

Over the past two years, study teams have

also conducted primary market research on

consumer purchase behavior and attitudes

towards a variety of PFS products. Researchefforts have included:

A one-hour survey of 1,000 middle-income

and affluent households to explore their

attitudes toward life insurance and personal

investment products. The survey was

supplemented by four focus groups of

consumers and one of life insurance agents.

Six focus groups comprising both first-time

and experienced mortgage customers.

Four focus groups in which employees

discussed their attitudes toward worksite

marketing of financial services (two focus

groups of manufacturing and administrative

employees and two of managerial and

professional employees), and 15 interviews

in which employers expressed their viewson the subject.

A phone and mail survey of 500 auto

insurance customers to investigate why they

buy auto insurance and what attributes they

value in their agents.

ABOUT THE RESEARCH


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Trend 1: Growing use of remote channels. The volume of sales and servicetransactions conducted through lower-cost remote channels is growingdramatically. In many sectors of PFS, remote channels are already widelyused. In 1996, for example, 65 percent of consumers claimed to have usedtheir banks telephone service, and 1,000 banks had Web sites, up from only20 in 1994. Roughly 1.2 million households currently use PC banking.

While agent-based insurers still dominate property and casualty insurancewith nearly 90 percent of the market, direct insurers are providing formidablecompetition. Foremost among them is Warren Bufets GEICO, a telephone-based insurer that has grown at twice the industry average over the pastdecade. In 1995, 11 percent of auto loans in the United States were purchasedthrough remote channels. In the United Kingdom, the direct marketingcompany Direct Line has become the market leader in automobile insurance,increasing its market share from 2 to 22 percent in just four years.

Trend 2: Decoupling of distribution and manufacturing. As competitionin PFS intensifies, companies are increasingly deciding to specialize in eitherthe distribution or manufacturing of financial services. Players that areproduct innovators the financial services equivalent of category killers, suchas Fidelity may focus their resources on their strength in the manufacturingend of the business and seek third-party distribution. Companies that haveinnovative or highly eficient distribution channels, like Schwab, or enjoygeographic dominance, like many super-regional banks, may seek to becomethird-party distributors for a range of best in class products. PFS companieswont necessarily abandon manufacturing or distribution if they decide not tospecialize in it; they may simply choose not to use it as the basis for furtherexpansion and growth. Some insurance companies may continue to distributethrough their agency channel, for example,while simultaneously playing a manufac-turing role for banks and brokerage firmswishing to sell insurance.

Trend 3: Reinvention, not elimination,

of traditional channels. As distribution-focused PFS companies compete head to head with remote players, they willbe compelled to reinvent but not eliminate their traditional face-to-facechannels. The role of insurance agents, for example, may shit from front-endprospecting (oten involving cold-calling) to following up on warm leadsgenerated centrally. Similarly, a bank branchs role might evolve to that of asales center for major PFS purchases, such as mortgages or investments.

Though traditional PFS channels have changed little in the past few decades,

concept renewal is pursued aggressively in other retailing businesses. Byrevising their value proposition, such retailers as Walgreens, CompUSA, and

PERSONAL FINANCIAL SERVICES: A QUESTION OF CHANNELS


PFS companies will becompelled to reinvent but

not eliminate their traditionalface-to-face channels


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Lowes have been able to create substantial shareholder value. The need torenew retail concepts has become more pressing because retail life cycles areshrinking. The average time for a retail concept to reach peak earningsgrowth and then decline by 10 percent dropped from 16.4 years in 196575 to7.7 years in 198690.* Moreover, preemptive renewal is critical becauserecovery becomes much more dificult to accomplish once performance startsto decline. Since life cycles are dwindling in PFS too, financial institutionsmust take preemptive steps to reinvent their retail concepts in the same way.

Trend 4: Integration of multiple channels. Over the next decade, mostlarge PFS players will ofer both traditional and remote channels, and mostcustomers will continue to graze across the range of channel options. Tomanage multiple channels efectively, PFS institutions should set overallstandards for oferings to customers, but rely on internal competition betweenchannels to allocate resources eficiently. This managed marketplace modelencourages product and channel business units independently to pursueopportunities to achieve their financial targets while staying within thestrategic boundaries set by senior management and collaborating betweenthemselves when this is in their mutual interest.

Trend 5: Consolidation. Anyone who reads the headlines knows thatconsolidation in PFS in part a response to excess distribution capacity is well under way both within and across industries. In fact, the market share(based on net income) of the top 10 US commercial banks grew from 19percent in 1985 to 31 percent in 1995. In insurance, American General, GECapital, Aegon, Jeferson-Pilot, and Conseco are gobbling up players. Andthe pace is unlikely to slow as companies under pressure to create shareholdervalue hunt for revenue growth and opportunities to rationalize costs. Weforesee a future in which there are many small banks that play a communityservice role and a handful of truly nationwide megabanks. Medium-sizedplayers can expect to be squeezed, and will need a superior value propositionin the markets in which they choose to operate.

How consumers buy financial services

Over time, margins will certainly decline as these trends unfold. Butopportunities abound for players that understand how consumers are likelyto respond to them. Through extensive customer surveys and focus groupsconducted across PFS sectors, we have identified a number of recurring,oten counterintuitive and nuanced, themes about consumer buyingbehaviors. Players that are attuned to these customer behaviors will be ableto manage a profitable transition to the new era of PFS distribution.



For more on this topic, see Kathryn Bye Burns, Helene Enright, Julie Falstad Hayes, Kathleen

McLaughlin, and Christiana Shi, The art and science of retail renewal, The McKinsey Quarterly,1997 Number 2, pp. 10013.


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The myth about price sensitivity

Across PFS sectors, certain features oten associated with traditional chan-nels are perceived by large customer segments as more important than price.This being so, new entrants competing exclusively on the basis of price maymeet with only limited success, and traditional players may not need to cuttheir own prices to compete with them. Consider the following facts:

In p&c insurance, price is the most important single attribute in buying

decisions, but it is less important than the sum of agent attributes such asadvice, responsiveness, and product knowledge.

According to a 1996 PSI survey of US households, 72 percent rated proxi-mity to their home or work as a reason for choosing the bank where theyopened their most recent deposit account. Similarly, in a 1997 PSI survey ofsmall businesses, 31 percent cited location as the main reason for choosingtheir primary financial institution, while only 3 percent mentioned pricing.

In mutual funds, performance ratings dwarf the importance of fees: in1995, 90 percent of net flows into equity funds went to those with five- or four-star Morningstar ratings.

Among middle-income consumers of life insurance, 87 percent indicatedthat dealing with a person you can trust is extremely or very important, whileonly 76 percent thought that being ofered products at competitive prices orfees was this important.

The size of genuinely price-sensitive customer segments is small. In p&cinsurance, for example, the no hassle fast and cheap segment is only17 percent of consumers. Further, consumers oten dont understand the fullprice of a financial product, focusing instead on a single component of it.Price-sensitive home buyers, for example, tend to shop for the best interestrate but disregard upfront costs.

However, inexpensive new delivery channels will enable PFS players to sellfinancial services at lower prices and thus tap into previously unserved marketsegments. For instance, by selling life insurance through their branches, whichcosts less than using traditional agents, banks will be able to target middle-market customers, a segment underserved by life insurance companies withexpensive agent salesforces. By introducing cheaper products for selectedsegments, PFS players will be able to expand and capture a greater share ofindustry profits.

Who wants to shop around?

The lack of consumer interest in shopping for almost any financial service is

startling. Only 37 percent of p&c consumers shop in a three-year period, andalmost half of those deal with just one or two companies. Among mortgage




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customers, 55 percent contact only one lender, and 80 percent contact threeor fewer. Just 13 percent of middle-income customers contact more than onecompany or representative when they purchase life insurance, and only 14percent do so when they buy annuities. Presumably, consumers simply dontwant to spend the time to shop around for their financial service purchases.As a result, if consumers encounter a face-to-face salesperson early in theirsearch, chances are that individual will close the sale.

Yet the Internet and the search agents that can be used to navigate it promiseto make shopping for financial services a lot faster. Using the Internet, acustomer can obtain information on 25 diferent credit cards in under aminute, or identify 25 options for high-yield certificates of deposit (CDs).Moreover, the average rate obtained from an Internet search for a credit cardis several points lower than from a telephone search. Similarly, an experi-mental Internet search for a CD yielded an interest rate of over 6 percent,while a phone search secured just 5.5 percent.

But general customer inertia and consumers low emotional involvementwith financial service products mean that, despite the potential of theInternet, the propensity to shop may not change much. Take p&c insurance,for example. Of the 37 percent that shop every three years, only 17 percent

actually switch providers. Diferences be-tween providers are presumably not largeenough to induce switching.

In addition, some of the new channels thatare beginning to evolve attract customersbecause they are convenient, and may in-

crease customer inertia. An example is worksite marketing. Employersinterested in ofering this service will want to have only one financial serviceprovider to minimize complexity. They are interested in ofering theiremployees financial services at work, but not a selection of financial serviceproviders. As a result, employees who opt for the convenience of purchasingat work may be even less inclined to shop around.

Theres no replacing face to faceConsumers are undoubtedly becoming more comfortable with technologyin general, and more receptive to remote channels. For simple products andtransactions, they are using telephone and online channels in ever greaternumbers, particularly if they happen to be younger and more afluent.Roughly 30 percent of p&c insurance customers use a direct channel, forexample, and the segments that use direct channels most have the highestaverage income and are among the youngest. In long-term mutual funds,

sales made through direct marketing rose from 23 percent in 1985 to 41percent in 1995.



Just 13 percent of middle-incomecustomers contact more than onecompany or representative when

they purchase life insurance


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As remote channels continue to grow, they will be used increasingly formore complex transactions and by broader segments of the population.At the same time, technology is becoming cheaper and therefore moreaccessible to lower-income segments and more user-friendly. In the UnitedStates, 29 million households now own PCs equipped with modems, and16 million are active on line. Telecommunications costs have plummeted,and the number of main telephone lines for every hundred people hasskyrocketed.

Consumers use of remote channels will also be prompted by their financialservice providers. Institutions are starting to take steps to shit theircustomers to lower-cost channels, with greatsuccess. In a pilot market, one large NorthAmerican bank was able to increase the pro-portion of transactions conducted by ATMfrom 65 to 92 percent in just six months. Todo so, it launched a wide-ranging campaign:it informed customers about the benefits ofremote channels through signs, letters, and meeters and greeters; reducedthe availability of tellers while increasing the capacity and functionality ofATMs; provided direct incentives for customers and employees; and issuedmany cards to customers. PFS providers are discovering that customer be-havior can be influenced, and they will try to do so with increasing frequency.

But despite the growing acceptance of remote channels, an importantmajority of customers in most PFS sectors will continue to prefer traditionalface-to-face channels for the foreseeable future. Ninety-eight percent of lifeinsurance sales, 90 percent of p&c insurance sales, and 55 percent ofbrokerage transactions are still conducted through an agent, broker, orbranch. Moreover, 81 percent of middle-income consumers claim they wouldprefer to purchase life insurance face to face in a representatives ofice. EvenFidelity and Schwab, with their strong remote distribution capabilities, reportthat two-thirds of the new assets they attract are received through theirbranch networks.

Similarly, according to PSI, 72 percent of households still use a bank branchonce a month, while 76 percent of small businesses cite the branch as theirpreferred channel for routine transactions. Further, while 36 percent of USconsumers have a modem-equipped personal computer at home, fewer than3 percent currently perform any banking transactions on line.

Educate me, please!

While consumers show little interest in shopping for financial services, they

do have a growing appetite for education regarding PFS products, parti-cularly if it is marketed around a significant life event such as retirement or



An important majority ofcustomers will continue to prefertraditional face-to-face channels

for the foreseeable future


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sending your children to college. Consumers interest in learning aboutfinancial products is demonstrated by the dramatic increase in the number ofprinted and online financial newsletters.

In a series of interviews we conducted with employers about marketing finan-cial services in the workplace, financial education stood out as the productthey most wanted to ofer their employees. In particular, they were concernedthat their employees should understand the importance of saving, both forretirement and for other needs.

The popularity of financial education suggests that opportunities exist to selleducation (or advice) as an independent product or product feature, or touse education as a hook to capture new customers. Since customers shoplittle for financial services, education may be an excellent first step to cross-selling a broad array of financial products. In other words, once customersare educated about their needs, a large segment may purchase immediatelyfrom the educator without shopping around. It would follow that there is abig first-mover advantage to reaching large groups of people with educationor advisory services.

In search of trust

Finally, a large segment of customers across PFS sectors truly value aprovider that they perceive as trustworthy. Trustworthiness in financialservices may take many forms: a brand name with a national reputation,

unbiased and consistently sound advice, ora recommendation from a friend, employer,or other trusted individual. Where advice isconcerned, for example, does a providerrecommend only proprietary products, orofer a wide range of branded, best-in-classoptions? Alternatively, is a realtors referralof a mortgage banker perceived as arms-

length? Although some direct, nontraditional players, such as Schwab, havesucceeded in earning the publics trust by building strong brands, largetraditional players are also well positioned to ofer trustworthiness as acore element of their value proposition. Building trust requires the solidmanagement of either brand or relationships; the former may be a moreprofitable approach over the long run because it entails less reliance onand sharing of value with relationship managers.

All told, channel management ofers perhaps the most fertile ground forgrowth in PFS. The industry will ultimately be structured around customer

needs and the new distribution channels and technologies that best servethem. The number of channels available for delivering financial services to



Once customers are educatedabout their needs, a largesegment may purchase

immediately from the educatorwithout shopping around


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consumers is exploding, creating huge opportunities for distribution-basedcompetitive advantage.

Two kinds of opportunity are available that exploit the transition to this newconsumer-based world. Most institutions should pursue both, drawing on afundamental understanding of consumer behavior. They can increase theproductivity of existing channels and improve coordination between them.And they can place smart bets for the future, crating new value propositionsaround latent customer needs and launching new channels to meet thoseneeds. The following articles sketch out three such opportunities.



Personal Financial Services a Question of Channels

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