Banking on the Middle Market

North American banks are becoming more attentive to midsize companies now that a soft market and fierce competition are cutting the profits to be made from serving big corporations. But pursuing the middle market with credit offerings, as most banks are, and investing in industry and investment-banking expertise in hopes of generating future business may not be the way to go, recent McKinsey research shows. (1) For many midsize companies are not primarily interested in such offerings or expertise. But by giving these companies what they do want--and nothing more--a bank will improve its performance for customers and shareholders alike. Midsize companies (those that have annual sales from $10 million to $250 million) generate an estimated $20 billion in profits for North American financial institutions every year--about equal to the profits from the large corporate market, though the middle market is, of course, more fragmented. The current approach of the banks is based on their historic practice of making loan officers the main point of contact for midsize companies. Banks are now attempting to capture a larger share of this business, but they haven't changed that fundamental focus on loans. This means that, in addition to pushing credit, some banks have made efforts to differentiate themselves and to bolster their credibility by adding expertise in the industries in which their middle-market customers compete. Others are trying to tap into the estimated $1.2 billion in investment-banking profits that these companies generate annually. Meanwhile, for most banks, cash-management activities (basic payment, disbursement, and collections servi ces, for example) have remained within the sleepy purview of lower-level product specialties, despite the fact that such work actually generates about a third of the banks' economic profit from middle-market companies. Our survey, however, revealed that almost half of all midsize companies consider cash management at least as important as credit (Exhibit 1). Moreover, an analysis of which relationships are most profitable for banks shows that the two groups of companies with a significant interest in cash management generate almost as much profit per for company for their lead banks as do companies in the much smaller group that is most interested in investment banking (Exhibit 2). Some banks, largely by changing the way their relationship managers work, are already capturing higher revenues from midsize companies that care about cash management. These banks use total customer profitability rather than credit revenue (or, even worse, loan volume) alone to measure and reward their relationship managers. Indeed, to serve the 20 percent of customers whose overriding concern is cash management, some banks have gone so far as to substitute relationship managers with expertise in cash management for traditional lending officers. Such banks can generate up to half of their middle-market revenue from cash management, compared with about a third for typical banks. In order to meet the needs of the segment of midsize companies interested in a complex mix of cash- and credit-management services, banks can expand their existing offerings. Here, too, the role of the relationship manager is changing, toward a model similar to that of the large corporate market. Some banks are now using credit specialists to handle the details of loans, thereby freeing relationship managers to concentrate on the overall needs of customers and to develop the industry expertise necessary to integrate those needs. Banks taking the lead in serving such customers have created teams of specialists, all of whom interact with them, across product lines. This approach further frees relationship managers to focus on generating new business, while customers get the expertise they most need at any given time (Exhibit 3, on the next page). These banks are far more successful in selling new products to existing customers, thus generating higher revenues. …