Faculty of Economic Sciences
Master Thesis in Service Management Research
Guo Qingyu
Strategies of Customer Relationship Profitability in Retail Banking
Date: June, 2009
Supervisor: Lars Haglund
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KARLSTAD UNIVERSITY
Faculty: Service
Degree Program: Master Program in Service Management Research
Author: Guo Qingyu
Title of Thesis: Strategies of Customer Relationship Profitability in Retail Banking
Supervisor: Lars Haglund,
Date: June, 2009
Keywords: relationship marketing, relationship revenue, relationship cost, customer relationship profit
Abstract
The thesis aims to explore the strategies or tactics which make the retail banking profit from customer relationship. Through analyzing RR (relationship revenue) and RC (relationship cost), the report gets the strategies or tactics for the profitability in customer relationship base (CRP - customer relationship profitability).
Relationship is the basis for the customer between the retail banking. The stable and sound long-term relationship makes retail banking profit RR (relationship revenue) from it. And in the same time to maintain and enhance customers‘ relationship will incur RC (relationship cost). Certain of RC (relationship cost) it is compulsory if the banks try to get RR (relationship revenue) from customer relationship. The point is to find out the strategies which will make retail banking can benefit its CRP (customer relationship profitability) and still serve their customers effectively and efficiently by their limited resource simultaneously.
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Table of Content
1. Introduction... 3
1.1 Customer Relationship... 4
1.2 Relationship problems in Retail Banking...5
1.2.1 Invaders...5
1.2.2 Cross-subsidizing...6
1.3 The Aim of Study...7
1.4 Outline of Thesis...7
2. Methodology ... 10
2.1 Method of Research ... 10
2.2 Data Collection ... 11
3. Customer Relationship... 12
3.1 Background and Concept... 12
3.2 Relationship Marketing ... 13
3.3 Service Production Process... 16
3.4 Relationship-based Profitable Elements ... 19
4. Analysis of Customer Relationship Profitability ... 23
4.1 Relationship Revenue... 23
4.2 Relationship Costs... 27
4.2.1 Relationship Cost Typology...28
4.2.2 Relationship Cost Calculating...28
4.3 Strategies in increasing RV and decreasing RC ... 32
4.3.1 Increasing Relationship Revenue...33
4.3.2 Decreasing Relationship Cost...38
4.4 Access Channel ... 40
5. Further Analysis and Interpretation ... 43
5.1 Relationship Market Analysis ... 43
5.2 Customer Portfolio Analysis ... 46
5.2.1 Segmentation based on RR and RC...46
5.2.2 Volume-based Segmentation...48
5.2.3 BCG Growth Matrix Segmentation...50
5.2.4 CRP-based Segmentation...55
6. Conclusion ... 57
6.1 Summary ... 57
6.2 Further Research ... 60
Reference ... 62
Glossary ... 65
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1. Introduction
―Banking is usually divided into wholesale banking and retail banking. Retail banking serves private consumers and small-scale business, a characteristic feature being a large number of small transactions‖ (Channon, 1986).
The banking market changes fast. Over the last ten years, many banks, such as KBC, Unicredit, RBS, and Société Générale, have focused on internationalization, and some new entrants, such as PayPal, exploded on the financial market scene and quickly became intermediation giants. PayPal is revolutionizing the payments systems industry, attracting significant, fast-growing financial flows. Other IT providers have become payments leaders in Europe. Non-banks, including retailers and insurance companies, meanwhile, are also distributing more and more banking products and they constitute real competitive threats as they win market share. The sub-prime turmoil of 2007, which led to a cash shortage in Europe and the US and froze inter-bank credit, has ushered in a new era in which banks will no longer be able to rely on real estate or capital market bubbles to fuel their growth. The low interest rate period seems to be finished, and with it the easy lending market. Banks will need to develop a growing and sustainable retail business to avoid being an acquisition target open to attack from larger banks or even non-banks. Middle East funds entering Citigroup‘s or UBS‘s equities, or Chinese banks entering the top 100 assets ranking, have taught banks a hard lesson. From now on, banks will be living by the mottoes,
―There is no easy money‖ and ―Get back to basics‖ (Capgemini, EFMA, ING, 2008).
Successful banks will rely on stable and loyal private customers and do a better job of managing credit risk, while finding and adopting renewed ways to support continued growth in their domestic markets. Banking‘s golden past, therefore, may be over.
―The US led the way, with the Nasdaq 100/bank index falling off precipitously in June 2006 (see Figure 2.10). The three other major indexes—EuroStoxx 50/bank (Europe), Nikkei 225/bank (Japan), and ASX 200/bank (Australia)—soon began to follow suit. The continuing US tailspin over the past six months clearly indicates the need for retail banks to sit up and take notice. The rise of risk and shrinkage in liquidity is now limiting growth opportunities for banks in high income markets.
Some forward- looking banks will focus on retail banking as a stabilizer. To succeed, however, they will need to understand and respond effectively to structural changes resulting from legal and regulatory constraints, radical advances in technology, changing customer behavior, and new competitive threats‖ (Capgemini et el, 2008).
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1.1 Customer Relationship
In the past a few years, the service firms just do its business in a market-oriented way, but the new service concept trends concentrate more on customer-oriented way. Firms compete with services instead of physical products; in the past, service firms have always done so, but there are few of exception within all of the firms today. ―Service competition can be defined as a situation where the core solution of a firm—a service or a physical good—is a prerequisite only for a competitive advantage, but where firms compete with a number of services surrounding the core solution (Grönroos, 2000). Firms in order to be successful in its business, they have to view their business and customers relationships from a service perspective. Services are inherently relational, managing customers out of service perspective benefit from a customer relationship management approach.
Relations between individuals and organizations present some difficult conceptual issues surrounding the ―existence‖ of those organizations and the ability of an individual to have a relationship with an organization. ―The difficulties step from two problems: (1) the problem that organizations are abstract entities, which makes it difficult to relate to them as a consumer and; (2) the problem that the relationship between organizations and individuals is asymmetrical or unconscious (consumers may not be aware of the existence of their relationship with a provider) ‖ (Czepiel, 1990).
Customers do not look for goods or service, they look for solutions that serve their own value- generating process. How to produce a useful product, solution or to say value-in- use product or service? This refers to the quality of service, normally customers‘ expectation and satisfaction are perceived as the norm. ―Service quality is thus perceived and determined by the customer on the basis of co-production, delivery, and consumption experiences‖ (Edvardsson, 2005).
Relationship refers to the connection between service providers and consumers. How to provide consumer satisfied service or to say a satisfied solution, first we should analyze connection with consumers. According to Kaj Storbacka (1994), there are three stages, ―the first stage can be called the prospective customer stage, which ends when the prospective customer makes his/her final choice of service provider and a customer relationship is established; the second stage is the customer relationship stage, during which the customer has an ongoing relationship with the provider (the customer relationship), and is engaged in several interactions involving exchange of
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values and during which the provider can indulge in relationship development efforts (maintain and enhance relationships); the last stage is the post customer or lost customer stage, which starts when the customer decides that he no longer needs the provider‘s services or when he selects another provider from within the same industry‖. Basically, the customer becomes a prospective customer at the same time.
And normally, it is more difficult to regain a lost customer than to get a new customer.
1.2 Relationship problems in Retail Banking
―All financial needs deal with handling imbalances between production and consumption and the transaction of these between different actors ‖(Normann &
Haikola, 1986).
1.2.1 Invaders
―One driving force for development in retail banking has been that new actors entered the retail banking industry. The new actors can be called invaders. Invaders market entry was made possible by imperfections in banking caused by the regulated business environment, i.e the invaders have managed to gear their offering to fit the needs and wants of those bank customers who have been very profitable to banks. The invaders often work with a different cost structure, with unbundled products and with innovative use of access channels to customers‖ (Storbacka, 1993).
As the example mention above, Paypal or some insurance company can be considered as invaders. Paypal used a few innovative paying ways, which fits the needs and wants of bank customers, which attracted huge quantity of customers and financial flow.
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1.2.2 Cross-subsidizing
―Customer relations involve both of the logics – one saves or loans money form the bank (balance sheet business), using the payment brokering services. The fundamental problem for banks facing a deregulated environment is that the two businesses have been bundled into one offering and sold to customers at a single price. In practice this means that banks have charged for the balance sheet business while payment brokering has been free. The income-generating mechanism is based on the idea that banks make money on the interest margin between deposits and lending. Thus the income from a customer relationship is a function of the volume of deposits and loans and the interest rates. Each customer relationship also generates costs. The cost of serving customers is a function of the amount and types of interactions that are carried out during the relationship‖ (Storbacka, 1993).
The balance sheet business has thus come to subsidize the payment brokering business. And as individual customers use different proportions of the two logics, customers have come to subsidize each other, a customer who uses only savings and loans services subsidizes a customer who uses only payment brokering services, creating a situation where a large portion of the customer relationships of a retail bank are unprofitable (Channon, 1986). And, the fundamental problem for banks facing a deregulated environment is that the two businesses have been bundled into one offering and sold to customers at a single price
Usually, retail banking in a regulated market, price and the core of the product (interest rate) were regulated in a fixed level. Thus it is difficult to make differences for the competition, so the peripheral service – Place and Promotion – developed into the main competitive tools. For this reason, access to the bank was considered to be the most import elements to become competitive, the density of bank branch networks and the numbers of alternative deliver systems – such as ATMs, Internet bank, and Phone-call bank – were developed.
There are huge differences in customer profitability between the different customers groups served in retail banking. Customers who in their relations mostly use services related to the balance sheet logic are profitable, while customers who mainly use services related to the payment brokering business are unprofitable. ―Retail banks face the threat that they will loose customers who use mainly the balance sheet business, and will be left with customers using the payment brokering business ‖ (Storbacka, 1993).
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1.3 The Aim of the Study
In the past a few years, the service firms just do its business in a market-oriented way, but the new service concept trends concentrate more on customer-oriented way. Firms compete with services instead of physical products; in the past, service firms have always done so, but there are few of exception within all of the firms today. The core solution became to the key element which firms compete with each other. Firms in order to be successful in its business, they have to view their business and customers relationships from a service perspective. Services are inherently relational, managing customers out of service perspective benefit from a customer relationship management approach.
―Customers do not buy goods or services, they buy the benefits goods and services provide them with‖ (Levitt, 1980). To give customer needs or to say satisfy customer want, it is can be considered as the basis of customer relationship. Good customer relationship definitely tries to be profitable. What relational approach can maintain and enhance relationships at a profit or to say to have profitable custo mer relationships? This is the aim of the thesis tries to explore.
The main purpose of the thesis tries to explore the strategies or tactics which make the retail banking profit from customer relationship. During the procedure of figuring out the strategies or tactics, this thesis tries to illustrate the developed theories by applying it into a real world context.
The research questions are:
How value is produced? What are the relevant issues related to improving customer relationship profitability? What are the solvencies for the retail banking to face their deteriorate profitability loss on customer relationship base?
As the report tries to analyze profitability of retail bank on customer relationship base, this report will be a useful reference for the mangers, work on retail banking field, when they want to increase customer relationship profitability.
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1.4 Outline of Thesis
1. Introduction
First chapter of the whole thesis, it is to present you an overview for the thesis on retail banking status in the market, the developing of new relationship marketing theory and the aim of this thesis.
2. Methodology
In the second chapter, it will show you how this research be done, the research method – descriptive way was used in this report, there are five different alternatives can be used but in this report only the linear-analytic and the theory-building structure alternatives were used – and the data source.
3. Customer Relationship
In this chapter is tries to present a comprehensive vie wpoint for the customer relationship, the background, the development, and be used by the service enterprises.
And it is a chapter to connect theoretical relationship marketing concept with the empirical adopting in the retail banking.
4. Analysis of Customer Relationship Profitability
This chapter it is the core part of the whole thesis. In this chapter it introduces the relationship revenue and relationship cost configuration and then from both of RR (relationship revenue) and RC (relationship cost) elicit the key concept in this report – CRP (customer relationship profitability). Through analyzing RR (relationship revenue) and RC (relationship cost), to increase RR (relationship revenue) and/or decrease RC (relationship cost) will leads to the increasing of CRP (customer relationship profitability), we can get the strategies or tactics for the profitability in customer relationship base.
5. Further Analysis and Interpretation
The fifth chapter tries to further analyze customer relationship marketing and the strategies in increasing CRP. In this chapter, a few of customer segmented methods were demonstrated. Those methods, as managing tools, can help the management of retail banking serve customer effectively and efficiently with the limited resource.
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6. Conclusion
The last chapter is to summarize the whole report and propose the further research questions.
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2. Methodology
In this Chapter describes the processes and methods I used for approaching the research for this paper.
2.1 Method of Research
Methodology is the theory of the creation of methodical procedures and methods. It connects the theoretical and substantive domains in research and plays crucial role in determining the validity and reliability of a study.
In this thesis, the focus is on exploring strategies or tactics for customer relationships profitability in retail banks. To better describe the strategies or tactics, the words will be in descriptive way. According to Yin (1989), ―there are five different alternatives for descriptive cases: linear-analytic, comparative, chronological, theory-building, and unsequenced‖.
The linear-analytic is the most usual structure of research reports. The consequence of choosing this way would be the traditional sequential structure of a research report:
problem, aim, research method, theory, data, and conclusions. For this point, the linear-analytic was used in the thesis primarily.
The theory-building structure also has been used. In this alternative, the present theory was applied into the thesis, which would help us better understand the developed theories application in the real world context.
A comparative structure would be best if I can get more data from different banks which from different countries. But, for me this is real difficult to do it, so this structure was not used in this thesis.
A chronological structure would be possible if the aim of the thesis is to show the development of the profitability of retail banks. But this obvious it is not the aim of this thesis, the structure was not used either.
An unsequenced structure is suitable when describing case organizations‘ history etc., but not when it comes to illustrate generated theory. So this obvious it‘s not suitable for the thesis.
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2.2 Data Collection
As the data collection method is critical in the whole research process, I tried my best to collect more multiple sources of information.
The two books, Customer Relationship Profitability in Retail Banking and the Nature of Customer Relationship Profitability, was written by Kaj Storbacka are the main source for this thesis. In Storbacka‘s books, the author propose a few new ways to measure profit and cost which we cannot capture it from the financial sheets depends on traditional accounting way. Traditional accounting calculation is:
Profit= Total revenue – Total cost
In customer relationship point of view, the author proposes profit is customer relationship profitability. So the customer relationship profitability (CRP) is :
Customer relationship profitability= Relationship revenue (RR) – Relationship cost (RC) Keeping Customer relationship profitability (CRP) in positive number, the Relationship revenue (RR) should bigger than Relationship cost (RC). If we wanted to increase the CRP, we need to increase Relationship revenue (RR), or to decrease Relationship cost (RC), or the best it‘s to increase Relationship revenue (RR) and decrease Relationship cost (RC) simultaneously.
The thesis aims to explore strategies or tactics for customer profitability in retail banks, the formula can be considered as the basis for all of the strategies.
The other source includes a few books about customer relationship, journals and some electronic source. Thanks for the Journal, The International Journal of Bank Marketing, which make me get abundant material for the retail banking.
World Retail Banking Report 2008，World Retail Banking Report 2006，gave me an overview about present trend of the whole world retail banking.
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3. Customer Relationship
The aim of this part is to understand the nature of relationships and the development of theories, as well as to widen horizon for analyzing customer relationships.
3.1 Background and Concept
―Since the 1970s a new marketing approach notion — interaction, buyer-seller interaction, has emerged which are important elements in marketing. And the way these interactions are managed has an impact on the purchasing behavior of customers.
The focus on interactions between producer and customer, which in addition often are ongoing, either on a continuous or discrete basis, makes it possible for the marketer to view the customer not only as someone who from time to time buys from the firm, but as relationship partner‖ (Grönroos, 2008).
With the development of the new theoretical concept, the service provider or suppliers of goods realize the service process leads to some form of cooperation between customers and service providers.
―And, historically, when mass production was made possible by new production methods and the increasing wealth of the quickly growing middle class led to mass consumption, mass distribution and mass marketing was needed. The traditio nal ties between producers and manufacturers and consumers who were geographically far away were introduced on a large scale. After World War II, the consumer goods oriented marketing models that dominated marketing were largely adapted by service firms as well. This has led to a situation where service firms used their marketing budgets for mass marketing and the facilitation of exchanges, instead of spending marketing money on the management of ongoing interactions with their customers ‖ (Sheth & Parvatiyar, 1995). Now, the mass marketing approach is less effective and less profitable. ―As more and more markets are mature and oversupplied, new customers are more and more difficult to find. Therefore, it is becoming increasing important to keep a firm‘s existing customers. And as the tough competition, the customers will choose any service provider who can offer better service than their present provider, so how to keep customer become more difficult than before. Low price may keep the customers for some time, but in long-run the competitor and their economy scale will make this approach become more and more ineffective. In this situation, the firm should concentrate on managing the whole customer relationship
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including the quality and value of their goods and service and their level of overall service to the customers‖ (Grönroos, 2000).
The concept of ―relationship‖ is the different from the ―transaction‖. According to Kaj Storbacka (1994), he identified four dimensions in defining relationships:
(1) the frequency of interaction over a given time period ; (2) the regularity of interactions;
(3) the time elapsed since the first interaction, and ; (4) the monetary or other content of the interaction;
This means to say, for a fixed time period, for examp le, how many interactions a customer with the service provider (bank) during a year, or a month; what kinds of service a customer get involved with the provider; how much the interaction get involved? If the provider has only one interaction with a customer during a year we might be inclined to regard this not as a relationship but rather as a single transaction.
If on the other hand the provider has one interaction with the customer every week for a years we can say that there is a customer relationship; b ut if the customer has had one interaction every year with the customer and that the monetary value exchanged in this transaction is very high we again might be prone to talk about a customer relationship.
In modern business society, the customer may have interactions with several different individual bank employees, or may have interaction with a number of different resources of the provider, such as ATM, internet bank, phone-call bank.
3.2 Relationship Marketing
The term ‗relationship marketing‘ was first used by Berry (1983), who first emphasized the importance of relationship building strategies in retailing and banking.
The emergence of relationship marketing with its emphasis not just on getting customers but on keeping them, then this can turn to profitability for the companies.
―The logic of relationship marketing perspective is that a focus on relationships will generate customer loyalty and commitment – and eventually profits‖ (White &
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Schneider, 2000).
Historically the traditional marketing emphasizes the 4Ps strategies, product, price, promotion and place as the cornerstone of strategy development. In this environment, retail marketers can come to believe that profits come from products, not from customers. The focus then becomes selling more products and increasing market share.
A new customer is treated as though he or she is equally as valuable as a long-term loyal customer. Some retailers, however, have recognized the drawbacks of the product-based approach. They know that certain customers are more valuable than others. Some customers are regular purchasers and are relatively easy to serve.
Therefore, they cost the retailer less. Other customers, particularly new customers, are more expensive to look after. They demand more information and make more store visits or ask for more sales assistance before they buy; and they buy in smaller quantities, even though the cost of processing a small transaction is often the same as the cost of processing a larger one. These customers cost the reta iler more to serve.
They are therefore less profitable. For this reason, ―loyalty programmes are widely used in retailing. Loyalty programmes are a sign of a shift to a customer (relationship) focus from a product focus‖ (Ryals, 2002).
Relationship refers to two parties, service provider and customers. With the development of the new service concept, companies concentrate more on customer-oriented way instead of market-oriented way like before. Then customer not only a purchaser but also they are the co-producer too. According to Rmirez (1999),
―the goal of a service provider is not so much to make or do something of value for the customers but to get customers involved to create values for themselves ‖. This process called ―co-production‖. Value can be defined as the amount of information, knowledge, and other resources that an economic actor has access to in order to leverage the actor‘s own process of value creation. Scheneider and Bowen (1995),
―proposed that service firms literally select, train, and motivate customers so that they can effectively play service production roles. The coproducing customer not only as (a) an input or resource in production but also as (b) a user, buyer, and product of production as well‖. As users of the service that has been produced, customers are invaluable as feedback mechanisms for organizations. A service firm can benefit from having complete information on how customers experience what they buy – if they take advantage of such information to improve their service. As buyers of the service produced, customers who are viewed as resources and are included in the production of a service might be expected to develop deeper relationships with the firm – and to keep buying services (transaction with bank) from that firm (bank) in the future.
But coproduction does not eliminate the variability that customers bring to the production process. Managing variability in service delivery should be attached more importance to solve this problem. According to Chase and Stewart (1994), there are
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three important steps of customer participation should be noticed; ―(1) preparation for the customer encounter, (2) the customer encounter itself, and (3) resolution of the encounter‖. Preparing the customer for the encounter is frequently overlooked as a tactic in reducing customer variability, but it can be an important step in efforts to approach uniformity in service delivery. Customers do not usually have prior information about what their roles are or should be, or what knowledge, paperwork or other tangibles they must bring to the encounter. In other words, customers are often unaware of the requirements for an encounter, so they do not prepare. Differences in preparation in turn yield differences in service delivery. Finally, the service providers can evaluate the encounter itself and derive bases for action from these assessments.
Customer gain experiences in all types of interaction. The more personnel and personality intensive the interactions are, the more the actual experience of the interaction dominates the total value from the interaction. During the interaction, it refers to the customer loyalty and customer satisfaction. Different customers group has different demands and attitudes for the providers. Some customers are quite ignorant for the service, but some customers are expertise. ―Customers with lower expertise may be loath to change partners because to do so is to reestablish risk. The costs of switching may easily outweigh the marginal benefits of establishing a new relationship. Thus, the lack of expertise increases customer dependence on the service provider‖(Bendapudi & Berry, 1997).
Every interaction between the customer and the service-provider has the potential to strengthen, weaken or even destroy the relationship between them.
―Services vary in the frequency of interaction between the customer and the service provider. Greater frequency of contact typically implies greater transaction costs when each encounter is handled as a discrete transaction. Frequency of contact can thus increase customers' dependence on the relationship partner, assuming the contacts are perceived as inter-related and as affecting one another‖ (Bendapudi &
Berry, 1997). Frequency of interactions may also affect trust in the relationship partner. Frequent interactions may create greater trust in two ways. ―First, the more the customer interacts with the partner, the more opportunities (s)he has to evaluate the service. To the extent that these interactions are satisfactory, frequency should lead to greater trust. Second, more frequent interactions can strengthen social bonds with the partner. Person-perception literature shows, for example, that when individuals expect repeated interactions with others, they are more attuned to them and make a greater effort to know them than when they believe the interaction to be a one-time encounter‖ (Neuberg and Fiske, 1987).
The ‗customers as assets‘ analogy suggests that these assets needs investment, just as tangible assets do, but customer relationships are not assets in the sense that tangible
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assets are. They are not owned in the same way. In fact, if they chose, they can defect to competing suppliers. This has led to an ―interest in valuing and in managing customer relationships‖ (Ryals, 2002). For example, to enhance customer relationship the retail banks improve the front-counter service, shorten service time, update its service computer system, and increase its branch and ATM teller. All of these investments on the tangible or intangible assets are the concrete moves to increase customer satisfaction then keep customers. Because the process of building and maintaining customer relationships involves both investment and opportunity costs, service firms can benefit from identifying those customers who are most receptive to maintaining relationships. Investment costs in relationship building include the costs of prospecting, identifying customers' needs, modifying offerings to meet these needs, and monitoring performance. Given these costs, firms must make choices concerning which customer groups to target for relationship marketing.
Traditional marketing strategies based on conventional profit-based thinking focus on increasing the returns from low value customers. Returns are increased by increasing the income from those customers (weight of purchase, frequency of purchase, etc.) and/or reducing their costs (incentivizing them to shop at off-peak times, introducing self-checkouts for loyal shoppers, switching them to Internet or telephone ordering rather than counter service and so on).
The relationship marketing, in this thesis, tries to present a relationship-based profitable mode.
3.3 Service Production P rocess
―The service production process is the process by which a particular service package is delivered to the client. It consists of the resources necessary to produce the particular service package, and the management systems necessary to govern the production process in order to achieve the planned quality level and maintain efficient utilization of the resources available ‖ (Grönroos, 2000). And there are three types of resources are involved in the production of services: the customer and his/her resources (intellectual, time etc. resources); contact resources (employees and equipment); and physical resources (equipment, surroundings and goods).
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Chase & Bowen (1991) proposed that a production process has three components considering production from an operations management perspective:
1) people, the selection and training of employees;
2) technology, process technology; physical facility; the extent of routine operations;
reliability and consistency of transformation process;
3) systems, primarily production control systems, and procedures for routing inputs to the transformation process, particularly the customers themselves;
Most of the innovations pertaining to payment instruments and transaction instruments in retail banking are technology driven. Technology makes a new type of service possible, and the banks try to introduce these new services on the market.
Technology is also the main driving force for creating possibilities to shift activities in time and space, means to shift some activities to be performed by the customer.
Technology is therefore certain to be an important ingredient in the management of customer relationship profitability. Technology-based systems usually require new types of performances from customers. A key concept in analyzing service production processes is therefore ―customer participation‖, by which is meant the various ways in which the customer participates in creating the service that the customer has purchased.
From the present theories concluded, one of the key characteristics of the customer in present service business, the customers are closely involved in producing the service that he purchased they are the co-producer. The participation of the customers is the opportunity, from marketing, quality and production angel, for service providers. With the provider, the customers are co-creating service with them. So, from this point of view, customers are regarded as partial employees of the organizations.
Lehtinen (1988) reports that hotel business customers in which it became evident that large proportion (80%) of the customers had made their buying decision on the basis of recommendations from business associates or friends. And he concludes that the customer can function as marketing resource in two different ways:
1) Customers who perform marketing functions implicitly, without being aware of it.
The marketing functions of these customers is usually word-of- mouth communication;
2) Customers who are explicitly recruited as marketing resources, i.e. customers who combine their customer role with an entrepreneurial role ;
The customers of a service provider always function as quality managers giving their subjective perception of the quality produced. Within a service firm, employees usually try to produce the kind of service experience that they think customers expect.
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It is the job of the management to use internal marketing to ensure that employees have the right ideas about what customers expect. An essential part of internal marketing is to find effective ways to communicate the customer satisfaction information that is gathered.
Both the provider‘s employees (contact resources) and the customer have a certain role behavior in the service encounter, and they try to act out their role to their own satisfaction. ―The ―code‖ that influences the role playing is called a service script.
Both parties to the encounter have their own script. The more experienced the role player is, the more elaborate the script is and the less explicit it is to the role player.
This would indicate that changes in the service script should enco unter greater resistance from the experienced role player‖ (Storbacka, 1993). After the employee knew the service script of the organization, the service employees and the organization share common role expectation, role clarity and job satisfaction increase.
In here the code or to say the service script can be say it is core part of the corporate culture of an organization.
―Culture means values that can be thought of as residing deep in the organization‖(Bowen D.E & Schneider B, 1988). ―Corporate culture is used to describe a set of common norms and values shared by people in an organization.
Hence culture is an overall concept that explains why people do certain things, thinks in common ways, and appreciates similar goals, routines, even jokes, just beca use they are members of the same organization‖ (Grönroos, 2000). In service organization, corporate culture can be labeled as service culture. Service culture exists to serve and interact with the customers. Customers are a part of the service culture.
In strength intensity of corporate culture, there two kinds of corporate culture: weak corporate culture and strong corporate culture.
―A weak corporate culture, where there are few or no clear common shared values, creates an insecure feeling concerning how to respond to various clues and how to react in different situations‖(Grönroos, 2000). In this situation, the employees do not have any clear or ambiguous norms to relate, some skills like, sales training, service skills course then they do not know how to response an unexpected request or complaining from the customers.
―A strong corporate culture, however, enables people to act in a certain manner and to respond to various actions in a consistent way‖ (Grönroos, 2000). A strong culture which makes employees be confident to handle some unexpected situation. A strong corporate culture service organization not only can guide employees behavior with the company‘s culture values but also can attract bunches of service-oriented employees enter into this organization and be influenced in a favorable way by the existing service culture. Of course, every coin there is two sides. A strong culture is not always
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good. When corporate culture is not consistent with current strategies and service concept, the strong corporate culture may lead to resistance to change which make it difficult for the organization to respond to external challenge. In such situation, a strong culture may become a hindrance to change. Above mentioned, change in the service script will cause encounter greater resistance from the experienced role player which it‘s the hindrance was paid for its strong corporate culture.
Shared values and norms by people within the organization are the foundation for the corporate culture. According to Deal & Kennedy, an organization with strong shared values there are three common characteristics:
1. The shared values are a clear guideline for task performance;
2. Managers devote much of their time to developing and reinforcing the shared values;
3. The shared values are deeply anchored among the employees (Deal T.F & Kennedy A.A, 1982)
Strong corporate cultures can attract service-oriented employees then all of the employees with shared value in the same organization can improve their performance.
Because managers and employees, were inspired and motivated by the shared values, devote themselves more to issues and ways of performing that are emphasized by the shared values.
As the service employees, with common role expectation, role clarity, they increase the customer satisfaction. Customer satisfied for the service, and then they would be active to participate for the service script and changes of service script. ―They even can act themselves as ―part-time‖ manager or employee of the organization through helping other customers. A customer with clear view of the script of the service interaction usually performs his/her role more productively than a customer who does not know the presumed script‖ (Storbacka, 1993).
3.4 Relationship-based Profitable Elements
Loveman (1998) presented us a relative complete test of his version of the service
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profit chain (retailing banking).
Above, Loveman shows us a process about customer relationship with the profit.
Service quality, employee satisfaction and loyalty then its customer satisfaction and loyalty, then the firms (retail banking) can get profit. In this chart, we can see the service quality it‘s the basis for all of the processes.
In Loveman‘s article it describes the service profit chain ―is a theoretical concept and teaching framework that contains a set of hypotheses about how service companies make money. The chain hypothesizes that profit and growth, partic ularly but not exclusively in service-providing organizations, is directly linked to customer loyalty and satisfaction, the value provided to customers (measured in terms of the value of results provided), the productivity and quality of the work of employees, employee loyalty, employee satisfaction, and the capability (measured in terms of job latitude, care in selection, training, technical and other support, and results-related compensation) with which employees are able to deliver a service ‖. A simplified customized version of service profit chain can be expressed as
―employee-customer-profit chain‖.
In this thesis, it aims to explore the strategies and tactics of retail banking profitable from customer relationship, so it will focus mainly on customer-profit facet.
In order to describe the behavioral aspects of a customer relationship we should understand a few important concepts, within retail banking customer relationship profitable system.
The relationship generates a certain income that we call relationship revenue (RR).
The relationship revenue in a retail banking context is based on two revenue streams:
volume-based revenue and fee-based revenue. Volume based revenue is generated on the different types of relationship volume (RV) that the customer has with the bank.
Relationship volume is the share of the total volume that the customer spends in the particular industry (for instance retail banking) – the total industry volume (TIV). For instance, the customer may have deposits in several banks, or may have other means of saving, such as retirement insurance or investments in bonds and shar es. The total industry volume, in turn, is a segment of the total amount of money that the customer
Internal Service Quality
Employee Satisfaction
Employee Loyalty
External Service Quality
Customer Satisfaction
Customer Loyalty
Revenue Growth
&
Profitability
7
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has at his/her disposal, the customer‘s total volume (CTV) and they divide this money among many different sectors of their life, including saving, housing, food, clothes, hospitality services, etc. An important part of the CTV is the volume that customers choose to invest in other financial services industries, such as insurance, stocks, bonds, and mutual funds.
Figure 1.
Customer
RR
(Storbacka, 1994)
Relationship volumes include, for instance, deposit volume (DV) and lending volume (LV). Each account type has its specific role relative to the client‘s general financial needs. The deposit account can be divided into two main categories: payment accounts and savings accounts. The payment accounts are used as a basis for the payments of different bills using the bank‘s payment infrastructure. Due to this the funds in payment accounts are liquid and the account balance changes frequently. The customer usually ties different types of payment media to the account, such as ATM or bank cards. The deposits to a payment account are for most customers‘ regular salary or pension payments. As the money is basically used to make payments the interest levels are usually low on this type of an account.
―Saving accounts are basically to be regarded as investments. The customer invests a certain volume and expects a certain return on the money; a certain interest rate. The saving account can be divided into two variants based on the customers‘ situation:
long-term saving and target saving. By long-term saving we mean saving which relates to customers‘ needs to generate a certain buffer of liquidity, which can be utilized when needed, for instance after the customer is retired; target saving is related to the customers‘ need to generate financing for the purchase of a product or service, for example a car or a holiday trip.
Loan accounts can be divided into two main types of loans: housing loans and consumption loans. Consumption loans are used to finance the purchase of a investment product or service, like a car or a holiday trip. The duration of the loan is usually short, months or a couple of years, and many of the variants are so-called
CTV Service
Provider TIV
RV
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blanco loans, i.e. without any security. Housing loans usually have a long duration, ten years, and the purchased house or apartment inevitably functions as security for the loan‖ (Storbacka, 1994).
Each account type has its specific role relative to the client‘s general financial needs.
In service, we call it as ‗heterogeneity‘. For example, one customer might enter a bank wanting to make a deposit, while another wants to make a withdraw simultaneously; one has several accounts with large balances and the other only uses his or her account for cashing checks. Each of these bank customers is availing himself/herself of ‗bank service‘, but they present different sets of demands, expectations, and desires, and the service delivery staff must continually adapt to these differences. In the other side, the different bank tellers may give customers different service. One teller might be new to the bank and unable to process the withdrawal without assistance form another teller, while another teller might process the transaction with no assistance at all. Because service production and delivery, due to the frequently interactional nature of production and delivery, is less standardized than the production of goods. Heterogeneity makes services more difficult measure and to do quality-control checks ahead of time to ensure that they meet uniform standards.
This also can be other evidence to show, some service require expertise of customers, if customers are not expertise at it, which will increases customers dependence on the service provider
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4. Analysis of Customer Relationship Profitability
In previous parts, this report discussed issues of customer relationship and some concepts about banks in its relationship. In this chapter, it will focus on describing relationship profitability.
Relationship revenue (RR), income of the account, and relationship cost (RC), costs of serving.
The fundamental formula was demonstrated before, CRP (customer relationship profitability) = RR - RC
The simple equation gives us the basic dimensions by which we can analyze customer relationship profitability.
4.1 Relationship Revenue
The relationship revenue in retail banking consists of the interest margin that the bank earns on the relationship volume, like the deposits and loans of the customer and the fees that the customer pays for transactions, counseling and specialist services, and the fees that customers pay for other components in the relationship (such as bank cards).
The relationship revenue that is based on the relationship volume is called volume-based revenue (RRv). ―RRv (volume-based revenue) is a function of the interest margins in use. The interest margins depends on the funding to the bank, or the average cost of capital (COC) that the bank has as the starting point for its calculations (also called the internal interest rate)‖ (Storbacka, 1994) .
RRv (volume-based revenue) includes deposit volume (DV) and lending volume (LV).
To calculate both the volume based revenue, we can refer to the Table 1 below.
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Table 1.
Relationship volume type
Volume variant
Interest rate
Interest margin Volume based revenue
DV DVi...n DIRi..n IMdvi..n=COC-DIRi..n RRDV= 𝑛𝑖=1𝐷𝑉𝑖 ∗ 𝐼𝑀𝑑𝑣𝑖
LV LVi...m LIRi..n IMlvi..m=LIRi..m-COC RRLV= 𝑚𝑖=1𝐿𝑉𝑖 ∗ 𝐼𝑀𝑙𝑣𝑖
IM= interest margin, DIR= deposit interest rate, LIR= lending interest rate (Storbacka, 1994)
From above table, we can see the number of RRDV (deposit volume based relationship revenue) depends on the DVi (deposit volume variant) and IMdvi (interest margin of volume variant). If we can increase any number of DVi (deposit volume variant) or IMdvi (interest margin of volume variant)or increase them both, then we can increase the number of RRDV (deposit volume based relationship revenue), or to say we already increase the revenue of deposit volume.
To increase DVi (deposit volume based relationship revenue), the key point is how to increase the volume of transaction. The tactics can be adopted to expand its service categories; for example the retail banks can offer customers more various service or service packages, which will expand retail banks market, and attract more new customers. And as talked before, the number of branches and ATM tellers are the important competitive edges of retail banks. Increasing number of branches and ATM tellers, on the other way, will augment bank‘s investment.
Increasing IMdvi (interest margin of volume variant), from the equation IMdvi..n=COC-DIRi..n, we can see, the interest rate play an important role in this equation. COC (cost of capital) usually keeps a stable level, so the changing elements it‘s DIRi..n; if the interest rate too high it may leads IMdvi..n (interest margin of volume variant) to a small number or even to a negative number, so the interest rate can be considered as the key elements to decide how much of IMdvi..n (interest margin of volume variant) it is. In this point of view, the higher interest rate to attract customers, it is not a good idea for the deposit volume of relationship revenue (RRDV).
RRLV (lending volume based relationship revenue), if to increase this number, similar to the RRDV (deposit volume based relationship revenue), the number of LVi (lending volume variant) and IMlvi(interest margin of volume variant) are the very important
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elements.
The rise of LVi (lending volume variant) will leads to the increasing of RRLV (lending volume based revenue). The lending volume can be decided by the lending rate, service package and related business with the customer. The lending rate decides the price of the lending, how much money the customer has to pay for the banks when they ―purchase‖ the mortgage. According to Matzler, Wurtele and Renzl (2006),
―price transparency, price-quality ratio, relative price, price confidence, price reliability, and price fairness all of these constitute the customer‘s price satisfaction. It explains - in price level- why the customers would prefer to lend a loan from a specific bank‖. Service package means what kinds of service package were offered to the customers. There are lots of service which be bundled together offered the customers, if a customer save money or do some transaction in the banks, for the bundled package service they may prefer to lend loan the bank. Related business, for some customers, banks it‘s an intermediary of business, they transfer money or some transaction from the banks to their customers. So, the customer‘s customer can be the customers for the banks. For some related business, the banks can expand its business (lending business) with some potential customers.
IMlvi (interest margin of volume variant) was decided by the LIRi (lending interest rate variant), according to the equation LIRi..m-COC. It means higher interest rate can get a big number of IMlvi (interest margin of volume variant), which it‘s contrary to the DIRi..n (deposit interest rate variant). But for the competitive reason and saving- lending related reason, the lending rate can not be increased at random. ―If customers have price comparisons available during the decision- making process, they will compare the price of the product or service with that of the competitor, and the outcome of this comparison process will directly influence price satisfaction‖
(Matzler et el, 2006). The customers definitely will have comparison of lending rate with other retail banks. Saving rate and lending rate are related to each other tightly, increase/decrease one factor will definitely leads to other factor goes up /down too.
That‘s why we can not augment IMlvi (interest margin of volume variant) by increase lending rate unilaterally.
The relationship revenue that is related to the fees earned by the ba nks is called fee-based revenue (RRF). The fees that the provider collects for performing transactions, counseling, and specialist services are more complex to model, since they are often treated in a different manner. Some of the transactions are bundled with the deposit and lending services, and often all of the transaction types have different price carriers.
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Table 2.
Interaction category
Variants Demand Price level(of each variant)
Fee based revenue
T T1..n NT1..n PT1..n RRT= 𝑛𝑖=1𝑁𝑇𝑖 ∗ 𝑃𝑇𝑖
DL DL1..m NDL1..m PDL1..m RRDL= 𝑚𝑖 =1𝑁𝐷𝐿𝑖 ∗ 𝑃𝐷𝐿𝑖
CO CO1..r NCO1..r PCO1..r RRCO= 𝑟𝑖 =1𝑁𝐶𝑂𝑖 ∗ 𝑃𝐶𝑂𝑖
SS SS1..s NSS1..s PSS1..s RRSS= 𝑠𝑖 =1𝑁𝑆𝑆𝑖 ∗ 𝑃𝑆𝑆𝑖
IS IS1..t NIS1..t PIS1..t RRIS= 𝑡𝑖 =1𝑁𝐼𝑆𝑖 ∗ 𝑃𝐼𝑆𝑖
T= transaction, DL= deposit and lending services, CO= counseling, SS= specialist services, IS= investment services, N= demand, P= price, RR= relationship revenue (Storbacka, 1994)
From above table 2, we see the fee-based revenue is demands (each variant) multiply price (each variant). So, demands and price, the two elements, are the key factors which will affect the final number of fee-based revenue. Either increasing of demands or price will make the fee-based revenue goes up.
But, as described before, if customers have price comparisons available during the decision- making process, this process will influence the final purchasing decision. It means to say under present competitive circumstance, there is no way to boost price randomly. Attribute to this reason, rely on normal service, the price it‘s quite stable.
Of course, each bank can develop some new service or service package for the customers or the specific customers, which would make them benefit higher than the normal service. According to Devlin (2000), the retail banks can ―deliver offerings which comprise a competitive bundle of benefits, or value... the process of adding value, in essence differentiating one's offerings effectively... through investigation which covering the nature of customer needs, customer evaluation of offerings and
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even elements of relationship marketing.‖ Offering differentiated service will definitely add benefit for the retail banks. The question it‘s not is there added value from the differentiated service; the question is how to differentiated service to add value. Service characteristics -- perception of consumer, consumer evaluation of service -- can be considered as the basic factors for the banks which want to achieve differentiation in service.
Besides price, the other important factor for the RRF (fee-based revenue) is the demands. How to increase customers demands, it sounds like an old question. Above, this report already described a few tactics to achieve volume demands.
According to the Table 2., RRF (fee-based revenue) can be expressed as:
RRF = RRT + RRDL+ RRCO+ RRSS+ RRIS
The relationship revenue (RR) of a particular customer thus consists of the sum of the revenue from the customer‘s deposits and the revenue from the customer‘s loans (volume-based revenue RRv) and the total fees paid by the customer during the period under consideration. This can be expressed as:
RR= RRv+ RRF
4.2 Relationship Costs
To maintain and enhance customer relationship all will incur cost for the retail banking. Like it described before, the increasing number of branches and ATM tellers will maintain and enhance customer relationship for the banks, but it will augment the cost of banks too. But from customers‘ point of view, the increasing number of branches and ATM tellers will decrease their travelling time and waiting time from shopping site, home or anywhere they departure, which will decrease customers‘ cost to have transaction with the banks. So, this will increase the switching cost for the customers if they want to change a new bank. From this point, we can see some cost for the banks it is inevitable.
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4.2.1 Relationship Cost Typology
Relationship costs can be divided into two basic types of costs, the direct costs (production costs) and the indirect costs.
―Direct costs, consists by direct variable cost and direct fixed cost.
a) Direct variable cost, caused by the delivery, invoicing, technical service, complaining handling etc;
b) Direct fixed cost, meant the costs related to the management of the relationship such as service training, product development, delivery systems development;
Indirect cost,
a) Indirect variable costs (quality costs), meant the costs of poor quality pertaining, for example, mistakes during work which need to be corrected, unclear invoices that need to be clarified, or phone calls that need to be returned;
b) Indirect fixed costs (psychological costs), meant the cost of the mental efforts related to problems in the relationship;‖
(Storbacka, 1994)
Although the cost for each customer it‘s same, the profit from different customer it‘s not same, this makes opportunity cost of certain customer relationship it‘s different.
For example, ―20% of a retail bank‘s customers may account for more than 100% of its profit‖ (Hartfeil, 1996). If these are new customers, buying infrequently and in small amounts, they may become profitable as the relationship develops and sales increase and/or costs reduce. What if those are not new customers? In this angle, we can see it is important to choose right customers for the banks. Then the bank can allot limited resource to the maximum profitable customers.
4.2.2 Relationship Cost Calculating
In chapter 4.1, we see there are different kinds of relationship revenue, relative to the different RR (relationship revenue), there are different kinds of RC (relationship cost) too. The different types of interactions incur different costs.
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The New York Times published an article on November 1, 1992, in which the Gemini Consulting/Mac Group is quoted regarding the banking industry‘s average costs for each type of transaction. The figures are shown in Figure 2.
Figure 2.
(USD)
(According to our previous cost categories, this chart only refers to the direct variable cost.)
From the Figure 1, we find, normally, a teller (bank employee service) transaction is about four to five times as expensive as a Telephone or ATM transaction.
In order to allocate the customer-specific cost of different interaction types and variants of each interaction type, the customer-specific demand for the different variants must be calculated as table below. Table 3, shows the calculation of the relationship cost for different interaction types and variants.
0 0.2 0.4 0.6 0.8 1 1.2
Teller Mail Check Telephone ATM Pre-authorized transfer
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Table 3.
Interaction category
Variants Demand Cost (of each variant)
Relationship cost types
T T1..n NT1..n CT1..n RCT= 𝑛𝑖=1𝑁𝑇𝑖 ∗ 𝐶𝑇𝑖
DL DL1..k NDL1..k CDL1..k RCDL= 𝐾𝑖 =1𝑁𝐷𝐿𝑖 ∗ 𝐶𝐷𝐿𝑖 CO CO1..m NCO1..m CCO1..m RCCO= 𝑚𝑖 =1𝑁𝐶𝑂𝑖 ∗ 𝐶𝐶𝑂𝑖 SS SS1..r NSS1..r CSS1..r RCSS= 𝑟𝑖 =1𝑁𝑆𝑆𝑖 ∗ 𝐶𝑆𝑆𝑖
IS IS1..s NIS1..s CIS1..s RCIS= 𝑠𝑖 =1𝑁𝐼𝑆𝑖 ∗ 𝐶𝐼𝑆𝑖
T= transaction, DL= deposit and lending services, CO= counseling, SS= specialist services, IS= Investment service, N= demand, C= cost, RC= relationship cost
(Storbacka, 1994)
Corresponding with the relationship revenue (especially with RRF, Table 2), Table 3, relationship cost, it‘s the same category of cost for the creation of revenue.
Relationship cost is that demands multiply cost (of each variant). To decrease either demands or cost, it will reduce the relationship cost. But the demand of cost it‘s corresponding with the demand of revenue, it can be say it‘s nearly same number for both categories. The decreasing number of demand will cut cost down, but also can cut revenue down too. Obviously, to reduce demand it‘s not a regular alternative to lower the relationship cost. The other factor is cost. Reducing cost, it‘s the most popular way to reach the goal of relationship cost decreasing.
According to Figure 1, the different types of transaction cost differently. From this point of view, it demonstrate us a good alternative to lower cost from each non-decreasing demands transaction. Phone-call bank, internet bank and ATM transaction, all of these kinds of transaction will reduce the cost of bank effectively.
―The role of technology in service organizations has been predominantly employed to reduce costs and eliminate uncertainties‖ (Kelley, 1989). The advantage of technology not only on cost reducing, but also on the convenient and flexible too. Internet bank or ATM teller can be used 24 hours a day, seven days a week, which beat every employee service up. There is no any bank can provide teller service for 24 hours, seven days a week. So, in this angle, we are not surprise that technology improve service quality and customer satisfaction levels.
