Pilgrim Bank - Análise de Rentabilidade do Cliente via Online Banking

9602104 R E V O C T O B E R 2 4 2 0 1 7 Professors Frances X Frei and Dennis Campbell prepared this case Some information and identities have been disguised HBS cases are developed solely as the basis for class discussion Cases are not intended to serve as endorsements sources of primary data or illustrations of effective or ineffective management Copyright 2001 2002 2003 2005 2017 President and Fellows of Harvard College To order copies or request permission to reproduce materials call 18005457685 write Harvard Business School Publishing Boston MA 02163 or go to httpwwwhbspharvardedu No part of this publication may be reproduced stored in a retrieval system used in a spreadsheet or transmitted in any form or by any meanselectronic mechanical photocopying recording or otherwisewithout the permission of Harvard Business School F R A N C E S X F R E I D E N N I S C A M P B E L L Pilgrim Bank A Customer Profitability It was February 2 2001 and Alan Green was finishing his first month as an analyst in Pilgrim Banks online banking group The words of his boss Ravi Raman who had just left his office lingered in his head Alan we have a meeting at the end of next week with the senior management team to discuss our Internet strategy There is substantial disagreement in our group on whether we should start charging fees for use of the online banking channel or if we should begin offering customer incentives such as rebates and lower service charges to encourage greater use of the channel The debate really hinges on whether online customers are indeed better customers and if adoption of the online channel actually produces better customers Since yearend 2000 data wont be available until next week why dont you spend the weekend looking over the relevant data from yearend 1999 Lets meet Monday morning to discuss your findings Although bolstered by Ramans implicit confidence in him Green was unsure how much he would be able to contribute Green who had just completed his MBA enthusiastically studied the retail banking industry but he still did not quite understand it An hour ago he looked at a chart on customer profitability that among other things demonstrated that more than half of Pilgrims five million customers were unprofitable Green knew that before he could analyze the data he needed to understand more about the economics of retail banking He decided to head over to Jane Raines office Raines was an experienced analyst in the group and was sure to be of help Later That Morning As Green sat in Raines office he explained his assigned project I need to do some analysis to figure out whether online customers are better customers for the bank and what the implications are for our online banking product As a first step I was thinking about comparing balance levels between online and offline customers Raines responded Do Not Copy or Post This document is authorized for educator review use only by Diego de Faveri Fundacao Getulio VargasFGV EBAPE until Jul 2020 Copying or posting is an infringement of copyright Permissionshbspharvardedu or 6177837860 602104 Pilgrim Bank A Customer Profitability 2 Balances are only part of the story If you are interested in how profitable customers are then look at profit directly You dont need to use balances as a proxy for profit as balances are a subset of our customer profitability measure which we have been assessing at the customer level for the past two years Roughly we calculate customer profitability at Pilgrim with a pretty straightforward formula Balance in Deposit AccountsNet Interest Spread Fees Interest from Loans Cost to serve Raines continued As youll notice balance levels really only capture one piece of overall customer value to the bank If you focus on balances only you are missing important components of revenue such as fees and ignoring the cost of serving individual customers Raines explained each of the components of customer profitability to Green in detail Green entered his notes into a Word document Exhibit 1 so he would not lose any of the information Raines also provided Green with a graph from an analysis she had done the previous year on the relationship between balances and customer profitability Exhibit 2 The graph demonstrated that the relationship between balances and customer profitability was not as straightforward as Green had originally thought In particular it showed many customers with lower balances had high profitability and many customers with high balances had low profitability Green made a mental note to understand what might be causing these results If Green grasped his conversation with Raines understanding profitability at the customer level was particularly important in retail banking because customer transactions generated incremental costs but typically did not generate incremental revenue In addition customer behavior seemed to be a key component of customer profitability For example given two customers with the same checking accounts and balances one who routinely called the bank to see if checks had cleared or visited a branch to get help with checkbook balancing would be far less profitable than one who rarely interacted with the bank apart from writing checks Although instinct dictated that to ensure profitability for each customer banks should charge for each transaction Green believed Raines assertion that banking history was littered with failed attempts to do so He recalled her story about how First Chicagos decision to charge for teller visits in 1995 contributed to the loss of onefifth of its customer base Something else that Raines had mentioned stuck in Greens mind She had indicated that banks had a history of channel innovation beginning with ATM machines more than thirty years ago followed by 24hour call centers automated voice response units VRU and most recently online banking Each additional channel had provided an opportunity to reduce cost per transaction over the previous channel The irony was that with the introduction of these lower cost channels came a higher overall cost structure which Raines attributed to customers increasing the number of transactions with the addition of each new channel rather than replacing one channel the branch for example with transactions at another channel the call center for example Green thought that encouraging transaction migration to lower cost channels was one way banks could improve customer profitability Do Not Copy or Post This document is authorized for educator review use only by Diego de Faveri Fundacao Getulio VargasFGV EBAPE until Jul 2020 Copying or posting is an infringement of copyright Permissionshbspharvardedu or 6177837860 Pilgrim Bank A Customer Profitability 602104 3 Let the Data Do the Talking Energized by his conversation with Raines Green visited Erica Dorstamp head of IT services in the building next door Erica he announced while stepping into her office I need to analyze customer profitability over the weekend and I was hoping that you could help me access some data Dorstamp was used to such requests No problem Weve just pulled and cleaned data on a random sample of 30000 customers for a separate IT project I can give you that dataset right away depending on what other variables you want included For the remainder of our customers I wont be able to get them to you until next week Are you alright starting with the random sample of 30000 What sort of information do you need besides customer profitability Green realized that he had not given this much thought but it being Friday afternoon this was his only chance to get started on the data before Monday morning Id like as many customers as possible Given the situation lets start with the 30000 he replied If you can give me their profitability for yearend 1999 as well as whether they use the online channel that would be great Alright Ill get this set up for you Dorstamp agreed Ill also put demographic information in there for you Whenever anyone analyzes profitability they always control for demographics Uncertain exactly what he would do with the demographic data Green nevertheless readily accepted it The First Glimpse Into the Data Returning to his office Green shut the door and opened the dataset on his computer He knew he better get started if he was going to have anything interesting to say to Raman Monday morning He tried to replicate from the sample data a customer profitability curve he had seen in Raines office that demonstrated the profitability skew amongst customers By sorting customers from most to least profitable and charting percent cumulative profitability versus percent cumulative customers Green recreated the profitability skew Exhibit 3 If his analysis was correct just over half the customers in the sample were profitable in 1999 and the vast majority of profit was derived from a relatively small number of customers This seemed to match what he recollected from the chart he had seen earlier which boosted his confidence that his sample was not biased Formatting the data and calculating summary statistics Exhibit 4 Green found that average customer profitability for 1999 was 11150 He wondered what he could conclude about the average profitability of the entire population of customers based on this relatively small sample Green subsequently found that the average profitability of customers who used online banking was 11667 which compared to 11079 for those who did not Although not surprised to find online customers to be more profitable than offline customers Green knew that he would have to determine if the difference was meaningful Even if the difference between online and offline customer profitability did prove to be meaningful Green was unclear what conclusions he might draw in terms of cause and effect Did the online channel make customers more profitable And what did this imply for the management teams decision regarding fees or rebates for use of the channel Do Not Copy or Post This document is authorized for educator review use only by Diego de Faveri Fundacao Getulio VargasFGV EBAPE until Jul 2020 Copying or posting is an infringement of copyright Permissionshbspharvardedu or 6177837860 602104 Pilgrim Bank A Customer Profitability 4 Green glanced at the columns of data on customer demographics such as age income and geographic region and wondered if there might be more to the story Do Not Copy or Post This document is authorized for educator review use only by Diego de Faveri Fundacao Getulio VargasFGV EBAPE until Jul 2020 Copying or posting is an infringement of copyright Permissionshbspharvardedu or 6177837860 Pilgrim Bank A Customer Profitability 602104 5 Exhibit 1 Notes from Discussion with Jane Raines on Customer Profitability in Retail Banking Revenue Customer accounts generated three types of revenue Investment income from deposit balances Every customer deposit generated investment income This revenue component was represented by netinterest margin the difference between the rate a bank paid on a deposit account and the rate at which it was able to invest that deposit through for example commercial and mortgage lending Fee income Increasingly important sources of revenue in light of recent declines in netinterest margins fees were variously assessed for checking accounts late payments and overdrafts Loan interest and base lending rates Loans were the dominant asset in banks portfolios and loan interest a primary revenue source Costtoserve Whereas measuring customer revenue was relatively straightforward estimating costs at the customer level was notoriously difficult Relevant costs included the following Transaction related costs The costs of customer interactions with banks varied A teller transaction for example was generally more costly than a transaction that utilized an electronic distribution channel such as an ATM network Allocated fixed costs The cost of indirect support resources eg the cost of electricity and physical infrastructure and salaries of network administrators although not transaction specific nevertheless represented resources that were consumed by customers Allocating these fixed costs ensured that the revenue generated by customers compensated for the resource costs required to serve them Moreover these general operating costs were only fixed in the short term Increases in customer transactions or demand for services could trigger a bank to consider for example opening a new callcenter or increasing the capacity of an existing call center by adding telephones computers and personnel Do Not Copy or Post This document is authorized for educator review use only by Diego de Faveri Fundacao Getulio VargasFGV EBAPE until Jul 2020 Copying or posting is an infringement of copyright Permissionshbspharvardedu or 6177837860 602104 Pilgrim Bank A Customer Profitability 6 Exhibit 1 Notes from Discussion with Jane Raines on Customer Profitability in Retail Banking contd The Profitability Problem Analysis of profitability at the customer level yielded some surprising profitability skews For example at Pilgrim 10 of the customers generated 70 of the profits Obtaining accurate reliable measures of customer profitability was a major challenge for retail banks Variations in the size of the profitability skew notwithstanding the problem was clear the contribution of individual customers to bank earnings varied widely with a small percentage of customers crosssubsidizing the profitability of the bulk of the customer base Such profitability suggested that better management of customer relationships might greatly improve retail banks profitability Managing Customer Profitability Retail banks reacted to the extraordinary variation in customer profitability with a variety of approaches that although somewhat different in method all shared the common goal of maintaining the most profitable relationships and migrating customers from lower to the higher profit tiers Tiered Service Banks developed profitability tiers to reallocate customer service resources away from customers in lower profit tiers to customers in higher profit tiers Some banks for example offered their most profitable customers discounts on mortgage rates or higher interest rates on certificates of deposit and route their telephone calls to specially trained personnel in the call center Tiering service in this way is aimed at increasing retention of a banks best customers Pricing Initiatives Fees and Crosssell Programs Retail banks commonly used pricing initiatives fees and crosssell programs to convert unprofitable customers into profitable customers Instituting fees for certain services for example was in attempt to encourage customers to migrate their transactions from high cost channels such as branches to lower cost channels such as the Internet and ATMs Repricing products and services was intended to motivate customers to use lower cost channels Many banks for example offered customers who transacted exclusively via ATM Internet and voice response units lower monthly fees on basic checking accounts Banks also pursued retention by selectively offering their highest profit customers feewaivers and ratebreaks Do Not Copy or Post This document is authorized for educator review use only by Diego de Faveri Fundacao Getulio VargasFGV EBAPE until Jul 2020 Copying or posting is an infringement of copyright Permissionshbspharvardedu or 6177837860 Pilgrim Bank A Customer Profitability 602104 7 Exhibit 1 Notes from Discussion with Jane Raines on Customer Profitability in Retail Banking contd Branch Consolidation Throughout the 1990s retail banks focused on migrating customer transactions from their highcost branch networks to lowercost electronic channels such as ATMs PCbanking and the Internet Many encouraged customers to alter their transaction behavior by attempting to educate them about the availability and convenience of alternative lower cost channels and changing physical infrastructure to deemphasize the branch network But as many banks discovered customers did not necessarily view alternative electronic channels as substitutes for the branch network In fact the number of US bank branches continued to rise throughout the 1990s despite the widespread availability of ATMs and call centers Convenience moreover often encouraged customers to increase transaction volumes to a level that offsets the costsavings of interacting through a lower marginal cost channel Anticipating Customer Behavior A final challenge to banks attempting to improve the management of customer profitability was that the available approaches employed static measures Many banks created profit tiers based on some measure of lifetime profitability that required a model linking current customer characteristics to the probability of retention as well as to future revenues and costs a daunting task given the large and diverse customer bases of most retail banks Source Created by case authors Do Not Copy or Post This document is authorized for educator review use only by Diego de Faveri Fundacao Getulio VargasFGV EBAPE until Jul 2020 Copying or posting is an infringement of copyright Permissionshbspharvardedu or 6177837860 602104 Pilgrim Bank A Customer Profitability 8 Exhibit 2 Monthly Customer Profitability versus Balance Levels Source Created by case authors Exhibit 3 Profitability Skew Source Created by case authors Do Not Copy or Post This document is authorized for educator review use only by Diego de Faveri Fundacao Getulio VargasFGV EBAPE until Jul 2020 Copying or posting is an infringement of copyright Permissionshbspharvardedu or 6177837860 Pilgrim Bank A Customer Profitability 602104 9 Exhibit 4 Summary Statistics from Sample Customers Customer ID 1999 Annual profit 1999 Online usage a 1999 Age bucket 17b 1999 Income bucket 19c 1999 Tenure years 1999 Geographic region 1100 1200 or 1300d 9Profit 9Online 9Age 9Inc 9Tenure 9District 1 21 0 not available not available 633 1200 2 6 0 6 3 2950 1200 3 49 1 5 5 2641 1100 4 4 0 not available not available 225 1300 31633 92 1 1 6 541 1200 31634 124 0 3 6 1750 1300 Mean 11150 012 405 546 1016 na Standard deviation 27284 033 164 235 845 na Source Created by case authors aOnline use 1 uses online banking 0 does not use online banking bAge buckets are as follows 1 less than 15 years 2 1524 years 3 2534 years 4 3544 years 5 4554 years 6 5564 years 7 65 years and older cIncome buckets are as follows 1 less than 15000 2 1500019999 3 2000029999 4 3000039999 5 40000 49999 6 5000074999 7 7500099999 8 100000124999 9 125000 and more dThe three geographic regions are designated 1100 1200 and 1300 Do Not Copy or Post This document is authorized for educator review use only by Diego de Faveri Fundacao Getulio VargasFGV EBAPE until Jul 2020 Copying or posting is an infringement of copyright Permissionshbspharvardedu or 6177837860