Banking for Small Business: Will More Competition Destroy the Returns?

Expanding services could easily triple revenues Acting like Wal-Mart and Ace Hardware could challenge traditional banking's dominance Will you end up last on the list of an integrated provider? For the traditional banker, serving the United States' 5.5 million small businesses is very good business. Generating $33 billion a year from checking accounts, simple credit, deposit products, and other services, this market provides many banks with returns on equity of over 30 percent. The contrast with consumer banking, where only the top customers produce profits, is marked. More than three-quarters of all small business customers are profitable over a three-year period. And again in contrast with consumer banking, small business is an area where banks hold a full 90 percent of the market. But this is only part of the picture. If we step back and take into account the activities of institutions other than banks, a more complex landscape emerges. Software firms, payroll processors, office product retailers, credit card companies, and a host of others are already serving or are poised to serve the financial needs of small businesses. Any organization seeking to capture or defend small business markets must base its strategy on this broader view. As competition begins to hot up, every player needs to examine its own competitive position - its skills, technology, cost structures, customers, geography, and aspirations - and those of its rivals before it can appreciate what strategic options are available to it Uncertainty abounds, and many fundamental questions must be answered: Which customers should I target? What products should I sell? How should I sell them? Where can I form alliances? Despite the uncertainty, the small business market offers tremendous promise. It is much larger than it at first seems. Small business owners have many financial needs beyond those currently served by banks: for payroll, tax services, life insurance, property and casualty insurance, and employee health benefits. Instead of producing a total of just $33 billion in yearly revenues (or $6,000 per business), small businesses actually generate close to $80 billion a year ($14,000 per business). That makes them equal in size to the US residential mortgage market, and twice as big as the credit card market. According to this broader view, banks hold only around 40 percent of the small business market. But we could step back still further. If we include the retail accounts of the owners and employees of small businesses, which we believe can be influenced by the small business market, another $122 billion in revenues is added to the picture, making a total of $200 billion per year. Many banks are going after this market with great fervor. In 1996, Mellon increased its reported small business loan portfolio by 136 percent to $1.4 billion, while Union Bank of California achieved a 35 percent rise to $1.3 billion. Over the next ten years, Wells Fargo Bank plans to lend $25 billion to small businesses, using an innovative approach involving nationwide direct mail. Banks such as Wachovia are bundling products and services to capture a larger share of the small business market. First Union is exploiting its size to act as a group buying agent for small businesses; it provides third-party discount services on major purchases such as long-distance phone service, overnight package delivery, and car rentals. Barnett Bank is teaming up with Staff Leasing to offer small businesses relief from the administrative burden of workers' compensation and compliance with unemployment and payroll tax regulations. KeyCorp has created PRISM Small Business to offer retirement plans to companies with fewer than 100 employees. In addition, it recently went into partnership with the OfficeMax retail chain to locate small business branches within OfficeMax and CopyMax stores. Outside the banking industry, interest in small businesses is equally intense. …