T he marketing of financial services is a unique and highly specialized branch of mar- keting. The practice of advertising, promoting, and selling financial products and services is in many ways far more complex than the selling of consumer packaged goods, automobiles, electronics, or other forms of goods or services. The environment in which financial services are marketed is becoming more competitive, making the task of market- ing financial services increasingly challenging and specialized. Financial services market- ers are challenged every day by the unique characteristics of the products they market. For example, often financial services cannot be visually communicated in advertisements as easily as consumer goods can. Furthermore, the relatively unexciting nature of financial services makes the task of attracting consumer attention and inspiring consumer desire a difficult one. However, the study of financial services marketing is in many ways far more fascinating than other areas of marketing. There are many predictable behaviors that con- sumers often exhibit in their dealings with financial services providers. The predictability of these behaviors and the abundance of data on existing and potential customers enable a uniquely scientific approach to developing and executing successful strategies for the marketing of financial services, much more so than in other markets. EVIDENCE OF A QUICKLY CHANGING MARKET ENVIRONMENT There is mounting evidence that suggests the environment in which financial services are marketed is becoming more complex and challenging. In the early 1930s, a series of bank failures resulted in the heavy regulation of the financial services sector in the United States. These bank failures forced legislators to implement stringent regulations that pro- hibited commercial banks from participating in investment banking activities. Regulations such as the Glass-Steagall Act of 1933 and the Bank Holding Act of 1956 limited the types CHAPTER ONE The Challenges of Marketing Financial Services 1 of products and services that financial institutions could offer. As a result, for decades many financial services organizations were limited to a narrow range of markets in which they could legally operate. However, in 1999 the Financial Services Modernization Act reversed many of the antiquated regulations that had limited the development of competi- tion in financial services markets. Since then, as shown in Exhibit 1.1, the financial ser- vices market environment has significantly changed. Below, we will discuss some of the evidence to illustrate the notable changes that characterize the financial services markets of today and tomorrow. Industry Consolidation and Concentration Since the relaxation of regulations governing the U.S. financial services industry in 1999, the level of marketing activity undertaken by financial services organizations, and the resulting competitive intensity, has increased significantly. 1 Deregulation has allowed the financial services markets to cross after being separated from one another for decades. For example, prior to 1999 banks were allowed to sell insurance products but were limited in their ability to underwrite them themselves. Insurance agencies were allowed to sell insurance products but not to provide banking services such as deposit accounts. The new regulatory environment is removing many of the barriers between the various financial institutions. Furthermore, the level of concentration, consolidation, and mergers within the industry has grown significantly. For example, in the credit card business a total of 5 banks account for over 60% of all credit card lending that takes place in the United States. The top ten commercial banks control over half of the industry’s assets, and the top ten mortgage companies control almost 40% of the U.S. mortgage market. Similarly, the top ten life insurance companies account for approximately 45% of the industry’s assets. The concentration of business among a select number of companies has also affected the way financial services are distributed. For example, mutual fund companies rely heavily on others for the sale of their products, such that third parties such as brokers and banks now account for nearly 80% of all fund sales. Similarly, in the online trading business approxi- mately a dozen Internet brokers control three quarters of all stocks and securities traded online. 2 These figures suggest that marketing power is being concentrated in many finan- cial services categories, and thus there is a need for focused and well-calculated marketing strategies to ensure long-term success. In addition to the changing market conditions, the process of providing financial services is undergoing revolutionary change. Recent figures suggest that the practice of offshore outsourcing (whereby a service organization utilizes a workforce outside of the United States to provide customer service or other forms of service activities) is likely to grow steadily in the U.S. service sector, including financial services . 3 This shift has and will continue to affect an array of jobs and will influence the future of the financial ser- vices marketing profession. The process of marketing of financial services is also chang- 2 Marketing Financial Services ing due to emerging regulations enforced by regulatory bodies that control the nature and extent of marketing activities of financial services providers. As a result of these changes, competition is increasingly intense and it has become more challenging to achieve mar- keting success. In such an environment, the optimization of marketing capabilities in a financial services organization is evermore critical for the long-term health and survival of the organization. Emergence of New Entrants in the Marketplace The traditional boundaries of financial services marketing are being challenged by the emergence of new competitors from both within and outside of the financial services sector. For example, in 2004, Volkswagen began to provide home equity loans to the public. 4 Customers who use Volkswagen’s home equity lines would gain credit towards the purchase of a new Volkswagen. Similarly, in contrast to less than a decade ago, where property and casualty insurance agents were primarily providers of a pre-defined set of insurance products, today’s agents are equipped to sell their clients products related to investments, time deposits, retirement planning, and other services traditionally provided by banking and investment professionals. These examples demonstrate a significant shift in the type of competitors that traditional financial services marketers have to compete with today. In addition to the introduction of new competitors in the financial services marketplace, the array of financial products and services has noticeably expanded. Some of these products and services are highly unconventional by any measure. For example, through a “life settlement contract,” a terminally ill person with a life insurance policy is Chapter 1: The Challenges of Marketing Financial Services 3 Exhibit 1.1 Evidence of Change in Financial Services Markets able to sell the policy to an investor. The investor pays an upfront dollar amount to the policyholder and also takes over the responsibility of making the monthly payments asso- ciated with that policy. Upon the death of the policyholder, the investor is able to collect the policy’s payout amount. Essentially, in a life settlement contract, the investor is betting on the policyholder’s death and using the financial product (life insurance policy) as the means to facilitate this bet. The existence of such unconventional financial transactions and the entrance of new competitors from outside the financial services sector are likely to change the shape of financial services markets within the next decade dramatically. Fragmenting Consumer Base There is also mounting evidence that financial services markets are challenged by a con- sumer base that is becoming highly fragmented. For example, despite the fact that the banking industry in the United States has been functioning in one form or another for centuries, there are approximately 10 million American households today who have no bank account. 5 Furthermore, the average consumer has over $10,000 in non-mortgage debt. Growing consumer bankruptcy rates, dramatic increases in consumer indebted- ness, and rising delinquency rates for both credit cards and mortgage accounts indicate a marketplace where portions of the population are struggling for their financial survival. 6 While groups of consumers are increasingly experiencing economic hardship, the picture in other segments of society seems to be much more positive. For example, the number of American households with a net worth level of $1 million or more has risen to record levels. 7 These facts indicate that the consumer base is becoming more partitioned, and as a result, financial services designed to serve these consumers may need to become more diverse in order to keep up with the market’s increased fragmentation. Demographic shifts in the United States are also likely to influence the way in which financial services marketers operate in the near future. Data from the U.S. Census Bureau indicates an aging U.S. population. For example, in the 1990 census, the percentage of the population over the age of 40 was 38.1%. In the 2000 census this figure had grown to 43.3%. In the same time period, the median age in the United States grew by 3 years. An aging population implies an increase in the demand for those financial services that are most relevant to consumers in higher age brackets. These may include products and services related to retirement planning, life insurance, and home equity loans and lines of credit. Income data also suggests that the U.S. population is becoming more diverse in terms of its income and wealth distribution. While the average income has steadily grown since the 1970s, the disparity among household incomes has also grown. As a result, the population is fragmenting into two distinct groups, one getting wealthier and the other get- ting poorer. The notion of “two-tier marketing” – that of focusing on the lower class and the upper class – has become an accepted principle in segment-based consumer marketing activities. 8 This principle suggests that the marketplace, which traditionally consisted of 4 Marketing Financial Services the lower, middle, and upper-classes, is transitioning into only two classes of upper and lower-class consumers. The potential effects of a polarizing population on successful positioning strategies of financial services providers may only become clear as the demo- graphics of the U.S. population further evolve. In addition, the consumer base seems to be increasingly moving into debt. For exam- ple, the volume of consumer installment credit has witnessed a consistent and notable growth over the past decade. This is evident in the growth of both revolving credit (for example, credit card debt), and non-revolving credit (for example, home mortgages). Between the years 1992 and 2004, the total amount of consumer installment credit has more than doubled. 9 This increase can be attributed to two major factors. The first rea- son is the increasing value of real estate during this time period coupled with the public’s desire for home ownership. This combination has resulted in heavy borrowing in order to facilitate the purchase of real estate. The shifting trends in the U.S. real estate market will therefore help determine the extent by which non-revolving consumer debt is likely to grow in the next several years. A second factor that accounts for the growth in consumer debt is increased credit card borrowing and a lack of consumer discipline in controlling discretionary spending. In recent years, credit card companies and other providers of short-term revolving credit have successfully attracted consumers through aggressive marketing campaigns. These campaigns, combined with a low interest rate environment, have encouraged many individuals to take on considerable amounts of debt, resulting in the expansion of consumer debt. For example, the average debt obligation for college gradu- ates is estimated to be over $15,000 and individuals in the 25 to 34 year-old age bracket carry an average of $5,200 of credit card debt. 10 Consumer Trust Securing a sense of mutual trust between the consumer and the financial institution has at times been a challenge in financial services markets. Distrust affects both the consumer and the company, as both may feel uncertain about the underlying intentions of the other party. For example, a recent consumer survey shows that one in every four consumers will not hesitate to cheat their insurance company, if they have a chance to do so. 11 These consumers may, for example, choose to misinform their insurance company about their individual risk characteristics when signing up for an insurance policy, misrepresent the sequence of events that lead them to file a claim, or even neglect to disclose relevant infor- mation that may invalidate the insurance policy. Similar issues of distrust can be found in consumers’ and regulators’ opinions about financial services providers’ underlying intentions in a variety of marketing contexts in categories ranging from credit cards and home mortgages to securities brokerage services and insurance. The recent growth in law suits and punitive measures imposed by the Securities and Exchange Commission and various other regulatory bodies against major Chapter 1: The Challenges of Marketing Financial Services 5 investment and insurance companies has helped further strengthen consumer distrust of the financial services community. A study conducted by the Gallup Organization regard- ing consumer sentiment towards various professions indicates that in general consumers have a mixed view of financial services professionals. 12 Lack of trust therefore seems to be an inherent characteristic of many financial services transactions and a continuing chal- lenge to the practice of marketing financial services in the United States. SOURCES OF CHANGE IN FINANCIAL SERVICES MARKETS The manifestation of the changes outlined above can be attributed to specific factors that have transformed the competitive landscape in the financial services arena. Four factors account for most of the changes that the industry has witnessed in recent years and what it is likely to experience in the near future (Exhibit 1.2). One such factor is the deregulation of the industry which has resulted in the removal of barriers that had for decades insulated financial services providers from directly competing with each other. Deregulation has also enabled the entrance of new players into the industry. Furthermore, the changing economic landscape and the introduction of technological innovations to financial services markets will have a dramatic impact on the successful implementation of marketing strate- gies for years to come. Regulations In 1999, the U.S. financial services industry was deregulated, thus allowing financial insti- tutions from a variety of backgrounds to participate in markets they had not traditionally been active in. Industry deregulation was partially motivated by the argument that allow- ing financial services organizations to operate on a larger scale would result in numerous cost efficiencies that could then be passed on to the consumer in the form of lower prices. In other words, the ability to serve a larger customer base with a wider array of products would lead to lower cost structures due to more efficient operating infrastructures. What is interesting, however, is that evidence for the beneficial effects of operating on a large scale in the form of a better value for the consumer or the shareholder has yet to be documented. In fact, a study by the Federal Deposit Insurance Corporation (FDIC) suggests that smaller commercial banks, in comparison to their larger counterparts, are better able to serve their customer base and shareholders. Other studies also question the economic advantages of large-scale consolidations in the banking sector. 13 While the deregulation of financial services, which came into effect with the Financial Services Modernization Act of 1999 (also referred to as the Gramm-Leach-Bliley Act), cre- ated an environment that fosters competition, several additional regulations which limit or control the marketing activities of financial services organizations have been implemented since then. For example, the Telemarketing Act of 2003 limits a marketer’s ability to call 6 Marketing Financial Services consumers, especially those who have requested to be on a national “do not call” list. In addition, other regulations have been implemented in the past decade that address how information about consumers can be shared across financial institutions. For example, the Fair and Accurate Credit Transactions Act of 2003 requires credit bureaus to allow individuals to control the amount of their credit history that is made publicly available. In addition, the 2003 act now requires credit bureaus to notify consumers of any negative information that may have an adverse effect on their credit history, and since 2005, cus- tomers have been entitled to one free credit report every year. Another regulation which has significantly boosted the operational efficiency of the banking sector is the Check Clearing Act for the 21st Century, otherwise known as Check 21. This regulation, which went into effect in 2004, has enabled financial institutions to treat electronically scanned copies of a written check as the legal equivalent to the original, hand-written check. The result has been a monumental reduction in the volume of paper checks that banks need to handle, thereby decreasing processing time, and increasing the overall cost efficiency of the banking sector. Consumer Loyalty It has been well established that in the majority of financial services categories, customer defection rates are significantly lower than they are in most other markets. The tendency of customers to remain with their current financial services provider has traditionally been quite strong. It is important to note though that defection patterns vary significantly by the financial service category. For example, life insurance policyholders have an intrinsic Chapter 1: The Challenges of Marketing Financial Services 7 Exhibit 1.2 Sources of Change in Financial Services Markets interest in staying with the same insurance provider, since changing insurance carriers may result in the reassessment of the application, a need for new health exams, and possible higher rates and lower coverage levels. On the other hand, credit cards accountholders may feel less obligated to stay with the same company because the negative impact of switching is limited, and changing credit card companies may in fact considerably lower borrowing costs due to intense competition within this category. The incentives offered by competi- tors in the credit card markets often outweigh any potential switching costs, resulting in lower rates of customer retention. Despite the benefits that low consumer defection rates present to financial services marketers, they are not necessarily reflective of customers’ true preferences for their cur- rent financial services provider. Nevertheless, this pattern of behavior may limit financial services providers’ desire to improve their offerings and to be competitive. Customer retention in financial services may often be indicative of the fact that, many customers lack initiative to find the most competitive offerings, are not necessarily attracted to the very best deal, and may in fact fail to consider all possible competing options available to them. Even with the knowledge of competing offers, a customer may still choose to remain with the current financial services provider once considering the possible incon- veniences associated with switching. Inconveniences in switching may be reflected in the elaborate transactions that often have to take place, billing arrangements that may have to be rearranged, and contracts and paperwork that would have to be redrafted, negotiated, and signed. The traditional resistance that consumers have towards switching financial services providers has for decades created a sub-optimal, non-competitive environment. Since customers tend to remain with their current provider, they may seek very little informa- tion on competing offers and the chances of them terminating their relationship with their current financial services provider has been minimal. The end-result is that financial services organizations may lack motivation for self-improvement, offering their customers sub-standard products and services. The harmful impact of this on the management and leadership of today’s financial organizations is notable. For example, a study conducted by the American Bankers Association has revealed that more than half of all bank CEOs do not have formal plans to guide their short-term and long-term marketing activities. 15 While this figure is alarming, it is indicative of an industry that, due to a highly regulated environment and lack of intense competition, has not been forced to develop strategies to better market its products and serve customers. The relaxation of industry regulations will however challenge this mode of conduct and the need for strategic marketing will signifi- cantly increase in the coming years. The shape of the financial services sector in the next decade is also likely to be significantly different from its current form, largely due to the rapid integration of new technologies into financial services and changing consumer tastes. Furthermore, consum- ers’ growing level of education on financial decision making and a marketplace that is 8 Marketing Financial Services becoming increasingly fragmented will require thoughtful approaches to the marketing practice. For example, the number of consumers who bank online has doubled each year over the past few years. At the same time, the number of checks that consumers write is declining on a steady basis, while the number of prepaid debit cards used is growing at explosive levels. 16 These trends indicate a marketplace that is rapidly evolving, and con- sumer preferences that are likely to change the way financial services providers compete in the years to come. Economic Forces One of the factors that make the marketing of financial services unique is the fact that most financial services have to be judged by consumers within the context of the current eco- nomic environment in which they are offered. The attractiveness of a savings product, for example, might be a function of the interest rates and expected rates of inflation. Similarly, investment options may largely relate to one’s expectations of how the stock market might behave in the near and distant future. Other factors, such as the cost of energy, expecta- tions of unemployment, exchange rate fluctuations, and general trends in the economy might encourage or discourage consumers from purchasing particular financial products and services. The overwhelming influence that economic forces have on the attractiveness of financial products and services greatly impacts their marketing. The current economic environment in the United States is in a unique historical phase. For example, interest rates in recent years have been at their lowest levels in decades, a main contributor to the high levels of consumer borrowing. Furthermore, leading eco- nomic indicators, such as the price of crude oil, suggest that we may be heading towards an economic cycle where increased production costs due to high energy prices may limit economic activity. It is noteworthy to point out that history has shown that when similar spikes in energy prices have occurred in the past, as for example seen in the mid and late 1970s, the economy was subjected to strong recessionary forces. The increased cost of energy will in one way or another have an impact on consumers’ budgets and reduce over- all consumer spending. Therefore, subsequent effects on financial services which support such spending, for example by providing consumers with credit, will likely follow. Technology The nature of how financial services are marketed is rapidly changing due to the emer- gence of revolutionary data-exchange technologies. This is due to the fact that financial services are largely information based. For example, rarely does a consumer come in contact with the actual currency that represents his or her financial assets. These assets are in fact stored in the form of data in a bank’s customer files. Therefore, the functioning of many financial services can often be best characterized as bits and bites of data trans- Chapter 1: The Challenges of Marketing Financial Services 9 formed on electronic networks of data exchange, rather than physical currency or paper contracts stored in bank vaults and filing cabinets. As a result, technologies that facilitate information flow will undoubtedly shape the future of financial services. The accelerated shift towards technology has already begun, evident in the increased use of both credit cards and debit cards in consumer purchases, the explosive growth of online banking, and the use of online securities trading web sites by the masses. Technology is also influencing the nature of interactions between the customer and the financial services provider. Many customer service contacts are increasingly automated through online means, banking-by-phone, or the use of ATM devices. The emerging generation of ATM machines will be able to conduct transactions beyond the simple dis- bursement of cash. ATMs planned for wide deployment within the next several years are for example capable of electronically scanning in paper checks that can be immediately deposited to a customer’s bank account and reflected in the account’s balance. This unique feature and other innovative features will significantly speed up the transaction time for common ATM banking activities while reducing transaction costs. The next generation of ATMs will also enable consumers to connect to the Internet and obtain valuable informa- tion that may be relevant to their financial activities. ATM devices are also being equipped with technologies to conduct biometric identification of the customer, by for example, conducting a retina eye scan to secure access to one’s bank account. 17 In addition, voice recognition technologies are being explored in telephone customer service interactions to conduct voice-stress analysis and help detect cases of insurance fraud. 18 The automobile insurance industry is also exploring the use of black-box devices on cars in order to better understand a policyholder’s driving habits and to assist insurance adjusters and accident investigators in determining the causes of accidents. 19 In the next decade, these technolo- gies will, in one form or another greatly influence the way we as consumers interact with financial services organizations. The emergence of these technologies may also present financial services providers with the possibility to create new markets for their services and increase marketing efficiency in serving existing markets. The shift towards technology brings about significant profit advantages to financial services marketers. For example, it is estimated that the average cost of a customer trans- action at a commercial bank is approximately one dollar. A shift to phone banking reduces the cost by almost half. Using an ATM machine brings down the cost to about a quarter, and Internet banking has an average transaction cost of only a few pennies. These cost differences have resulted in an accelerated cost-driven push towards the use of new tech- nologies. 20 These cost differences are simply too hard to ignore by the average financial services organization seeking to maximize profits. It is important to acknowledge though that such a shift towards new technologies may lead to the gradual elimination of human contact with customers. Encouraging customers to use an ATM device or to conduct their banking online, though cost-effective, reduces the personal contact and human interac- tions that traditionally characterize many encounters with financial services institutions. 10 Marketing Financial Services [...]... aspects of marketing financial services Market Clustering: One of the other unique aspects of financial services marketing is the fact that consumers’ needs for financial services vary significantly from one customer to the other As a result, the types of services that a financial services organization introduces to the marketplace may be best suited for specific groups of consumers rather than for the. .. profile the major regulations that influence financial services marketing practice in the United States Chapter 11 provides a perspective on the future of the financial services industry, and establishes a framework for building successful marketing strategies Chapter 12 will conclude the book by providing a series of case studies on the marketing of financial services The practice of financial services. .. usage level of these methods of service delivery An additional limitation of cost-based pricing is the challenge of pinpointing fixed costs The complexity of the cost structure of financial services organizations makes the allocation of fixed costs across the multitude of services provided by the organization a numerically challenging task In addition, for certain types of financial services, the costs... correctly in financial services In this chapter, we will discuss methods for pricing financial services The complexity of financial services prices and the cost structure of financial services organizations have a great impact on how financial services pricing is practiced We will discuss the unique aspects of pricing in financial services and how it differs from the practice of pricing in other contexts... and researcher in financial services marketing The book is different from other books on financial services marketing in several distinct ways First, this book examines the marketing of financial services from a consumer decision-making perspective There is extensive discussion about the psychology of decision making in financial services Second, in contrast to several other financial services books that... for financial services, and a discussion of how new forms of financial services are introduced to the marketplace is provided in Chapter 7 14 Marketing Financial Services As outlined earlier, the marketing of financial services is a unique practice due to the abundance of data on individual consumers This enables financial services organizations to use market segmentation technologies for matching the. .. complicated nature of financial services often results in poor recall of the prices of financial services For example, many consumers have a difficult time remembering the cost of their banking services, such as the monthly maintenance fees for checking account services and ATM transaction charges, or what yearly premiums they are paying for their automobile insurance As a result, the general level of price... markup reflects the general objectives of the business and the financial risks of providing the service Higher markups would be associated with higher levels of profits, while lower markups could enable the generation of a larger volume of customer transactions In addition, the markups that are applied may reflect the company’s norms and policies, the type of services it offers, and the risks that are... focused on the U.S market, this book solely examines the practice of marketing financial services in America The economic, demographic and regulatory environment of the United States requires a focused examination the marketing practice in the unique context of these environmental forces Finally, the book adapts a highly practical approach to financial services marketing, making it relevant to marketing. .. provide the psychological foundation for financial decision making, Chapter 2 will expose the reader to the principles of consumer information processing in financial services These principles are used to help explain the decision patterns of consumers when choosing among financial services providers Chapter 3 will provide a detailed view of the wide range of financial products and services available in the . an array of jobs and will influence the future of the financial ser- vices marketing profession. The process of marketing of financial services is also chang- 2 Marketing Financial Services ing. such as the Glass-Steagall Act of 1933 and the Bank Holding Act of 1956 limited the types CHAPTER ONE The Challenges of Marketing Financial Services 1 of products and services that financial. change the way financial services providers compete in the years to come. Economic Forces One of the factors that make the marketing of financial services unique is the fact that most financial services