FINANCIAL SERVICES

Dorlisa K. Flur, Lenny T. Mendonca, and Patricia Nakache

Five key trends need to be recognized Success will rest on knowing what customers really want

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are in the midst of a transition. Once, competition was largely dened by regulation and geography; now, the industry is starting to be organized around consumer needs and around the underlying economics of products and their delivery. As in other deregulating industries, margins are declining, though so far the impact of this decline has been masked by favorable interest rates.
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But make no mistake: PFS companies still have ample opportunities to prosper, both during the transition and beyond it. The trick for them is to gure out how to exploit what is likely to be a lengthy transition while simultaneously preparing themselves to compete in the more distant future. We believe that focusing on distribution channels and developing a deep understanding of consumer buying behavior are the way to accomplish this dicult task. Channels have always been important in PFS. Indeed, distribution channels account for over half the cost structure of most traditional players. But in the current environment, channels have become the premier battleground
Dorlisa Flur is a principal in McKinseys Atlanta oce; Lenny Mendonca is a director in the San Francisco oce and Patricia Nakache is a consultant in the Silicon Valley oce. Copyright 1997 McKinsey & Company. All rights reserved.

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ABOUT THE RESEARCH

uring the rst half of 1997, McKinsey developed a model of the protability of the PFS industry by product, customer segment, and channel, and analyzed how protability levels have changed since 1993.

Six focus groups comprising both rst-time and experienced mortgage customers. Four focus groups in which employees discussed their attitudes toward worksite marketing of nancial services (two focus groups of manufacturing and administrative employees and two of managerial and professional employees), and 15 interviews in which employers expressed their views on the subject. A phone and mail survey of 500 auto insurance customers to investigate why they buy auto insurance and what attributes they value in their agents.

Over the past two years, study teams have also conducted primary market research on consumer purchase behavior and attitudes towards a variety of PFS products. Research efforts have included: A one-hour survey of 1,000 middle-income and affluent households to explore their attitudes toward life insurance and personal investment products. The survey was supplemented by four focus groups of consumers and one of life insurance agents.

for the $120-billion-plus prots available each year in PFS. Consumer product preferences have reallocated assets and liabilities among providers: from 1993 to 1995, for example, consumer balances in securities (largely sold by brokerage rms) rose by $782 billion, while balances in bank-dominated traditional deposit products rose by a mere $84 billion. As a result, large traditional players, such as commercial banks and insurance companies, have steadily lost market share to new entrants. In fact, between 1992 and 1996, the proportion of consumers that viewed their bank as their primary nancial institution fell from 59 to 49 percent. But today, managing channels means much more than simply mastering individual channels like ATMs, branches, telephone, on line, or direct mail. It means understanding what PFS consumers want and creating new ways to meet their needs protably. In this critical transitional period, a host of new channel opportunities are emerging. In the articles that follow this overview, we sketch out three of them: bancassurance, a combination of banking and insurance; the creation of an integrated provider for residential real estate closings; and the sale of PFS products in the workplace. Each of these opportunities bundles existing nancial (and sometimes nonnancial) products and delivers them in a new and potentially powerful way. Each is anchored in the economics of product delivery and in a practical understanding of consumer needs based on extensive consumer research into all aspects of PFS. Moreover, each is closely tied to the trends driving the transformation of PFS, and thus points the way for large traditional players to thrive in a rapidly changing environment. There are ve such trends:

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Trend 1: Growing use of remote channels. The volume of sales and service transactions conducted through lower-cost remote channels is growing dramatically. In many sectors of PFS, remote channels are already widely used. In 1996, for example, 65 percent of consumers claimed to have used their banks telephone service, and 1,000 banks had Web sites, up from only 20 in 1994. Roughly 1.2 million households currently use PC banking. While agent-based insurers still dominate property and casualty insurance with nearly 90 percent of the market, direct insurers are providing formidable competition. Foremost among them is Warren Bufets GEICO, a telephonebased insurer that has grown at twice the industry average over the past decade. In 1995, 11 percent of auto loans in the United States were purchased through remote channels. In the United Kingdom, the direct marketing company Direct Line has become the market leader in automobile insurance, increasing its market share from 2 to 22 percent in just four years. Trend 2: Decoupling of distribution and manufacturing. As competition in PFS intensies, companies are increasingly deciding to specialize in either the distribution or manufacturing of nancial services. Players that are product innovators the nancial services equivalent of category killers, such as Fidelity may focus their resources on their strength in the manufacturing end of the business and seek third-party distribution. Companies that have innovative or highly ecient distribution channels, like Schwab, or enjoy geographic dominance, like many super-regional banks, may seek to become third-party distributors for a range of best in class products. PFS companies wont necessarily abandon manufacturing or distribution if they decide not to specialize in it; they may simply choose not to use it as the basis for further expansion and growth. Some insurance companies may continue to distribute through their agency channel, for example, while simultaneously playing a manufacPFS companies will be turing role for banks and brokerage rms compelled to reinvent but wishing to sell insurance. Trend 3: Reinvention, not elimination, of traditional channels. As distributionfocused PFS companies compete head to head with remote players, they will be compelled to reinvent but not eliminate their traditional face-to-face channels. The role of insurance agents, for example, may shit from front-end prospecting (oten involving cold-calling) to following up on warm leads generated centrally. Similarly, a bank branchs role might evolve to that of a sales center for major PFS purchases, such as mortgages or investments. Though traditional PFS channels have changed little in the past few decades, concept renewal is pursued aggressively in other retailing businesses. By revising their value proposition, such retailers as Walgreens, CompUSA, and

not eliminate their traditional face-to-face channels

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Lowes have been able to create substantial shareholder value. The need to renew retail concepts has become more pressing because retail life cycles are shrinking. The average time for a retail concept to reach peak earnings growth and then decline by 10 percent dropped from 16.4 years in 196575 to 7.7 years in 198690.* Moreover, preemptive renewal is critical because recovery becomes much more dicult to accomplish once performance starts to decline. Since life cycles are dwindling in PFS too, nancial institutions must take preemptive steps to reinvent their retail concepts in the same way. Trend 4: Integration of multiple channels. Over the next decade, most large PFS players will ofer both traditional and remote channels, and most customers will continue to graze across the range of channel options. To manage multiple channels efectively, PFS institutions should set overall standards for oferings to customers, but rely on internal competition between channels to allocate resources eciently. This managed marketplace model encourages product and channel business units independently to pursue opportunities to achieve their nancial targets while staying within the strategic boundaries set by senior management and collaborating between themselves when this is in their mutual interest. Trend 5: Consolidation. Anyone who reads the headlines knows that consolidation in PFS in part a response to excess distribution capacity is well under way both within and across industries. In fact, the market share (based on net income) of the top 10 US commercial banks grew from 19 percent in 1985 to 31 percent in 1995. In insurance, American General, GE Capital, Aegon, Jeferson-Pilot, and Conseco are gobbling up players. And the pace is unlikely to slow as companies under pressure to create shareholder value hunt for revenue growth and opportunities to rationalize costs. We foresee a future in which there are many small banks that play a community service role and a handful of truly nationwide megabanks. Medium-sized players can expect to be squeezed, and will need a superior value proposition in the markets in which they choose to operate.

How consumers buy nancial services

Over time, margins will certainly decline as these trends unfold. But opportunities abound for players that understand how consumers are likely to respond to them. Through extensive customer surveys and focus groups conducted across PFS sectors, we have identied a number of recurring, oten counterintuitive and nuanced, themes about consumer buying behaviors. Players that are attuned to these customer behaviors will be able to manage a protable transition to the new era of PFS distribution.
For more on this topic, see Kathryn Bye Burns, Helene Enright, Julie Falstad Hayes, Kathleen McLaughlin, and Christiana Shi, The art and science of retail renewal, The McKinsey Quarterly, 1997 Number 2, pp. 10013.

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The myth about price sensitivity

Across PFS sectors, certain features oten associated with traditional channels are perceived by large customer segments as more important than price. This being so, new entrants competing exclusively on the basis of price may meet with only limited success, and traditional players may not need to cut their own prices to compete with them. Consider the following facts: In p&c insurance, price is the most important single attribute in buying decisions, but it is less important than the sum of agent attributes such as advice, responsiveness, and product knowledge. According to a 1996 PSI survey of US households, 72 percent rated proximity to their home or work as a reason for choosing the bank where they opened their most recent deposit account. Similarly, in a 1997 PSI survey of small businesses, 31 percent cited location as the main reason for choosing their primary nancial institution, while only 3 percent mentioned pricing. In mutual funds, performance ratings dwarf the importance of fees: in 1995, 90 percent of net ows into equity funds went to those with five- or fourstar Morningstar ratings. Among middle-income consumers of life insurance, 87 percent indicated that dealing with a person you can trust is extremely or very important, while only 76 percent thought that being ofered products at competitive prices or fees was this important. The size of genuinely price-sensitive customer segments is small. In p&c insurance, for example, the no hassle fast and cheap segment is only 17 percent of consumers. Further, consumers oten dont understand the full price of a nancial product, focusing instead on a single component of it. Price-sensitive home buyers, for example, tend to shop for the best interest rate but disregard upfront costs. However, inexpensive new delivery channels will enable PFS players to sell nancial services at lower prices and thus tap into previously unserved market segments. For instance, by selling life insurance through their branches, which costs less than using traditional agents, banks will be able to target middlemarket customers, a segment underserved by life insurance companies with expensive agent salesforces. By introducing cheaper products for selected segments, PFS players will be able to expand and capture a greater share of industry prots.

Who wants to shop around?

The lack of consumer interest in shopping for almost any nancial service is startling. Only 37 percent of p&c consumers shop in a three-year period, and almost half of those deal with just one or two companies. Among mortgage

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customers, 55 percent contact only one lender, and 80 percent contact three or fewer. Just 13 percent of middle-income customers contact more than one company or representative when they purchase life insurance, and only 14 percent do so when they buy annuities. Presumably, consumers simply dont want to spend the time to shop around for their nancial service purchases. As a result, if consumers encounter a face-to-face salesperson early in their search, chances are that individual will close the sale. Yet the Internet and the search agents that can be used to navigate it promise to make shopping for nancial services a lot faster. Using the Internet, a customer can obtain information on 25 diferent credit cards in under a minute, or identify 25 options for high-yield certicates of deposit (CDs). Moreover, the average rate obtained from an Internet search for a credit card is several points lower than from a telephone search. Similarly, an experimental Internet search for a CD yielded an interest rate of over 6 percent, while a phone search secured just 5.5 percent. But general customer inertia and consumers low emotional involvement with nancial service products mean that, despite the potential of the Internet, the propensity to shop may not change much. Take p&c insurance, for example. Of the 37 percent that shop every three years, only 17 percent actually switch providers. Diferences between providers are presumably not large Just 13 percent of middle-income enough to induce switching. In addition, some of the new channels that are beginning to evolve attract customers because they are convenient, and may increase customer inertia. An example is worksite marketing. Employers interested in ofering this service will want to have only one nancial service provider to minimize complexity. They are interested in ofering their employees nancial services at work, but not a selection of nancial service providers. As a result, employees who opt for the convenience of purchasing at work may be even less inclined to shop around.

customers contact more than one company or representative when they purchase life insurance

Theres no replacing face to face

Consumers are undoubtedly becoming more comfortable with technology in general, and more receptive to remote channels. For simple products and transactions, they are using telephone and online channels in ever greater numbers, particularly if they happen to be younger and more auent. Roughly 30 percent of p&c insurance customers use a direct channel, for example, and the segments that use direct channels most have the highest average income and are among the youngest. In long-term mutual funds, sales made through direct marketing rose from 23 percent in 1985 to 41 percent in 1995.

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As remote channels continue to grow, they will be used increasingly for more complex transactions and by broader segments of the population. At the same time, technology is becoming cheaper and therefore more accessible to lower-income segments and more user-friendly. In the United States, 29 million households now own PCs equipped with modems, and 16 million are active on line. Telecommunications costs have plummeted, and the number of main telephone lines for every hundred people has skyrocketed. Consumers use of remote channels will also be prompted by their nancial service providers. Institutions are starting to take steps to shit their customers to lower-cost channels, with great success. In a pilot market, one large North An important majority of American bank was able to increase the procustomers will continue to prefer portion of transactions conducted by ATM traditional face-to-face channels from 65 to 92 percent in just six months. To for the foreseeable future do so, it launched a wide-ranging campaign: it informed customers about the benets of remote channels through signs, letters, and meeters and greeters; reduced the availability of tellers while increasing the capacity and functionality of ATMs; provided direct incentives for customers and employees; and issued many cards to customers. PFS providers are discovering that customer behavior can be inuenced, and they will try to do so with increasing frequency. But despite the growing acceptance of remote channels, an important majority of customers in most PFS sectors will continue to prefer traditional face-to-face channels for the foreseeable future. Ninety-eight percent of life insurance sales, 90 percent of p&c insurance sales, and 55 percent of brokerage transactions are still conducted through an agent, broker, or branch. Moreover, 81 percent of middle-income consumers claim they would prefer to purchase life insurance face to face in a representatives oce. Even Fidelity and Schwab, with their strong remote distribution capabilities, report that two-thirds of the new assets they attract are received through their branch networks. Similarly, according to PSI, 72 percent of households still use a bank branch once a month, while 76 percent of small businesses cite the branch as their preferred channel for routine transactions. Further, while 36 percent of US consumers have a modem-equipped personal computer at home, fewer than 3 percent currently perform any banking transactions on line.

Educate me, please!

While consumers show little interest in shopping for nancial services, they do have a growing appetite for education regarding PFS products, particularly if it is marketed around a signicant life event such as retirement or

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sending your children to college. Consumers interest in learning about nancial products is demonstrated by the dramatic increase in the number of printed and online nancial newsletters. In a series of interviews we conducted with employers about marketing nancial services in the workplace, nancial education stood out as the product they most wanted to ofer their employees. In particular, they were concerned that their employees should understand the importance of saving, both for retirement and for other needs. The popularity of nancial education suggests that opportunities exist to sell education (or advice) as an independent product or product feature, or to use education as a hook to capture new customers. Since customers shop little for nancial services, education may be an excellent rst step to crossselling a broad array of nancial products. In other words, once customers are educated about their needs, a large segment may purchase immediately from the educator without shopping around. It would follow that there is a big rst-mover advantage to reaching large groups of people with education or advisory services.

In search of trust
Finally, a large segment of customers across PFS sectors truly value a provider that they perceive as trustworthy. Trustworthiness in nancial services may take many forms: a brand name with a national reputation, unbiased and consistently sound advice, or a recommendation from a friend, employer, Once customers are educated or other trusted individual. Where advice is about their needs, a large concerned, for example, does a provider segment may purchase recommend only proprietary products, or immediately from the educator ofer a wide range of branded, best-in-class without shopping around options? Alternatively, is a realtors referral of a mortgage banker perceived as armslength? Although some direct, nontraditional players, such as Schwab, have succeeded in earning the publics trust by building strong brands, large traditional players are also well positioned to ofer trustworthiness as a core element of their value proposition. Building trust requires the solid management of either brand or relationships; the former may be a more protable approach over the long run because it entails less reliance on and sharing of value with relationship managers.

All told, channel management ofers perhaps the most fertile ground for growth in PFS. The industry will ultimately be structured around customer needs and the new distribution channels and technologies that best serve them. The number of channels available for delivering nancial services to

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consumers is exploding, creating huge opportunities for distribution-based competitive advantage. Two kinds of opportunity are available that exploit the transition to this new consumer-based world. Most institutions should pursue both, drawing on a fundamental understanding of consumer behavior. They can increase the productivity of existing channels and improve coordination between them. And they can place smart bets for the future, crating new value propositions around latent customer needs and launching new channels to meet those needs. The following articles sketch out three such opportunities.

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