Strategy 101: Part III  

By Cass Bettinger, Cass Bettinger & Associates

As discussed in prior columns, in order for any for-profit company to control its own destiny, the organization’s leaders must develop, and execute effectively, the right portfolio of strategies for the six drivers of ROA - and for managing the equity multiplier - that will produce consistent, predictable, and acceptable returns to shareholders. In “Strategy 101: Part II”, we discussed the most powerful ROA driver, interest income/average assets.

The second ROA driver, interest expense/average assets, is also critically important and, due to increasingly intense competition for funding sources, the greatest challenge for many community banks.

Interest expense/average assets is driven by a) funding mix and b) funding cost/price. Therefore, all strategies for managing interest expense/average assets must be directed at these two drivers.

To change funding mix, banks must first understand the true total interest and non interest costs of each funding source. For example, if a $10 million bank branch is purely a funding source (no meaningful/profitable lending), and the interest funding cost is 3% and the noninterest funding cost 3.5% ($350k in total overhead expense), the actual funding cost from this source is 6.5%, not 3%!

Next, viable strategies must be developed and executed to generate relatively more lower-cost sources, e.g., demand deposits. This requires comprehensive marketing strategies directed at the right target market segments along with extremely effective selling at the point of sale. An effective strategy for mitigating switching costs (the perceived “hassle factor”) must also be in place. Other strategies might include leveraging business relationships with services such as “workplace banking,” a formalized program for capturing the checking accounts of the employees (especially officers and owners) of existing business customers.

Other funding mix strategies, of course, relate to using non-traditional sources such as FHLB.

Strategies for managing the cost/price of funding sources are almost exclusively marketing/branding related. Very few community banks effectively manage their brands despite the fact that the stronger your brand the less you have to compete on price!

Related to this reality is the fact that most banks are still marketing generic products to the mass market, which encourages the rational consumer to make his/her decisions based on price. It is essential that banks transition from this self-defeating model to a model based on selling differentiated value propositions to specific, highly-attractive target market segments. A value proposition is comprised of three components, as shown below:

Banks can lose the battle if the generic product and service mix is incomplete and/or perceived as inferior - and/or if your price is not within reasonable tolerances, but  can only win the battle based on how well the perceptions of target customers and prospects are managed with respect to value-adding differentiators. Because virtually all bank products and services are generic, all you really have to sell is what makes you different!

It is also essential that a bank have a continuous strategy for managing employee perceptions regarding value/price. If your own employees fail to perceive the added-value of the differentiators that make your offering unique (and most don’t) how can you possibly expect customers and prospects to do so?

Directly related to the strategic management of funding costs is the efficiency ratio. The reality is that any direct competitor with a significantly lower efficiency ratio can price both loans and deposits at rates where they can make a profit - and you can’t, which places you at a distinct competitive disadvantage.

If a bank is struggling to generate reasonable-priced core deposits, it is likely that a) its brand - and marketing in general - is weak, b) its efficiency ratio is too high, c) it is marketing generic products rather than differentiated value propositions, d) it is not selling effectively at the point of sale, and/or e) there is no sense of urgency from the top with respect to managing funding mix.

In the next column, we will discuss ROA drivers 3 and 4, noninterest income/average assets and overhead expense/average assets.

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