Publications & Resources
March/April 2008
Focus: Building Franchise Value
Niche Banking – A Silver Bullet for Building Franchise Value
By Steve Cotton
Virtually all institutions cite maximizing shareholder or franchise value as their primary strategic objective, but how many of those institutions have actually constructed their plan around what truly drives that value? The critical driver of franchise value is earnings growth. Institutions that can establish the precedence (and expectation) of strong earnings growth will generally experience higher appreciation in franchise value.
Bank management has two routes towards accelerating earnings growth – profitability enhancement and franchise growth. Interestingly, most analysis focuses upon profitability enhancement, rather than franchise growth; perhaps this is because there is a better developed structure for analyzing financial statements.
One, however, can effectively make the argument that franchise growth is the more critical driver of earnings growth. To illustrate that assertion, let’s use the example of a bank that is highly profitable, generating more than a two percent return on assets and 25 percent return on equity after taxes. This bank’s ability to grow earnings going forward is almost solely predicated on the ability of its footprint to grow and how well-aligned its strategy is with the higher velocity components of that footprint. For that highly profitable bank, and really all banks, intermediate to long-term earnings growth is a function of its footprint and the bank’s strategic match to its higher velocity niches.
Earnings growth is easier to achieve for institutions fortunate enough to reside in the highest growth markets. However, the reality is that most institutions are not in high growth markets and therefore, it is even more crucial that they identify higher velocity niches within their footprint that can enhance their growth potential.
To illustrate how a niche strategy improves your franchise growth potential, let’s inject some much needed analytical structure into the assessment. Same store growth, typically of deposits, is a very high-profile metric for financial institutions, as it is a great gauge of organic growth. To simplify, same store growth is the average annual growth in deposits per branch location. Average projected same store growth can be developed for any market to assess that market’s relative growth potential. By dividing projected market growth in deposits (both consumer and commercial) by the number of competitor locations within the market, you can assess the relative growth potential of their footprints.
If your market’s relative growth potential is poor, then you must either increase the numerator (market growth potential) or decrease the denominator (number of competitors); you can accomplish both of these actions by identifying attractive market niches. For example, if medical professionals are growing at well above market growth rates, then focusing upon this niche will improve market growth potential; by focusing on a specific niche, you also lessen the number of direct competitors.
From a strategic perspective, focused niche strategies are ideal for community banks unable to sustainably compete on cost leadership. A community bank can quickly become a market leader within the confines of a market niche.
As part of the strategic planning process, banks should:
Define Market Area – The defined market area (“DMA”) can be based on geography (radius or county) or other variables (drive time or population density);
Identify Niche(s) – A significant commercial niche can be determined as a percent of DMA revenues, employees or business establishments for either SIC or NAICS industry classification codes. Consumer niches of significance can be identified through consumer segmentation data by households or household income. Growth projections of these same variables are vital to identifying a niche with higher velocity than the aggregate DMA; and,
Determine Service Deficiency – Are there special needs of the identified niche that are not being met? Have other market competitors specifically targeted this niche?
Identifying a viable niche through this process is an important initial step, but by no means does it ensure success. You must then customize your offering to the unique needs of the market segment. Developing that customization is best achieved by listening to the prospective customer. For example, if the identified niche is dental professionals then you must gain insight into their special needs. This understanding can help determine how technology, such as remote deposit capture, can enhance your offering.
So, if you want to maximize franchise or shareholder value, avoid the masses through a focused niche strategy aligned with the higher velocity market niches. Which customer niches can help you outgrow the market? Could it be medical doctors, CPAs or wealthy seniors? The answer can be confidently determined by aggregating publicly and commercially available market data that affords you the ability to “listen to the marketplace” and develop a strategy supported by quantitative market data. Utilizing a decision tree decomposition of growth potential, based on those numbers, it’s possible to quickly identify strategic niches that merit pursuit and drive franchise growth.
Steve Cotton is president and CEO of BancIntelligence, an Atlanta-based company delivering online advisory solutions to financial institutions. He can be reached at 678-323-3220 or scotton@bancintelligence.com.
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