PROFITABLE PATTERNS
Identify revenue producers to build stronger member
relationships.  By Karen Bankston

Measuring profitability may seem like a straightforward yes-or-no and by-how-much proposition, but the process of coming up with that data and putting it to work varies widely.

Often, just gathering necessary information—type/number of member accounts, balances, frequency of use and preference for delivery channels, and cost of providing those products and services—inspires discussions on how best to use the data.

Ideas develop around how to use those numbers to analyze strategies for producing deeper member relationships. Even a few examples demonstrate the usefulness of profitability analysis:

• $400 million IBM Southeast Employees Federal Credit Union, with 50,000 members, in Boca Raton, Fla., is so sold on member segmentation as the way to "deliver the right message to the right member at the right time" that it organized its marketing department by segment manager. A key component of its sophisticated member segmentation is a relationship-pricing fee schedule.

• The pros and cons of new strategies like risk-based lending are easier to examine when credit unions are measuring profitability, says Len Broderick, president of $81 million Tremont Credit Union, with 13,000 members, in Boston. The credit union also uses product profitability data to ponder the "what-ifs" of product bundling and impact of marketing efforts.

• Zeroing in on profitability by member households allows credit unions to identify the mix of products and services that reaps the most revenue and to promote that mix to less active members, says Steve Bouras, VP/marketing and business development for $117 million Denver Municipal Federal Credit Union, Denver.

Profitability measurement offers its share of challenges; chief among them is harnessing the predictive and analytical power of data from multiple systems (see"Connect Data Silos"). And, unless your credit union already has a cost-accounting system in place, gaining an accurate picture of the expense side of the profitability equation may entail some investigative legwork.

UNLOCKING KEY RELATIONSHIPS
Those snags aside, Bouras says household profitability is a critical measurement in identifying and measuring marketing strategies for Denver Municipal FCU.

The 19,500-member credit union uses the Raddon Financial Group, Oakbrook Terrace, Ill., profitability model and was converting this fall to the RFG’s system for maximum data compatibility.

"What we try to do is build a profile of members and look at what services make them profitable," Bouras says. "Then the key question becomes, how can we get other households to look like this?"

For example, if the most profitable households have checking and money market accounts and active Visa and home equity products, Bouras’ job is to come up with strategies to convince members with two or three products to round out their relationship. Ensuring members with Visa cards and home equity lines use those services is another key goal.

When credit unions assess profitability by product, "you can see how important account balances are," notes Bob Lawhead, RFG’s executive vice president. "A lot of the equation gets down to usage. When you offer a checking account with no minimum balance to open and no fees, the member doesn’t even have to use it."

The more members use checking accounts and lines of credit—instead of just maintaining them—the more likely they are both to generate revenue and to pick up other credit union services, he says.

"This is all about relationships," he adds. "The central question is, how do you promote relationship building for the benefit of all members?"

RFG’s CEO Strategies Program, typically involving CEOs, chief financial officers and marketers, categorizes five household groups by profitability:

A. most profitable members (net profitability over $500/year);
B. still profitable (net profitability $100 to $500 per year);
C. profitable (net profitability up to $100);
D. not profitable (net profitability is negative to -$100 per year); and
E. most unprofitable (net profitability is below -$100).

"What we do for credit unions is drive tactics based on segments members are in," Lawhead says. Maintenance and retention tactics obviously apply to A category members; the challenge is applying various strategies to members in other categories to meet the credit union’s strategic objectives.

Category A members generally maintain multiple accounts, including loans with high balances. Conversely, he adds members in category E are the "cherry pickers," who join the credit union to take advantage of high share certificate rates and open no other accounts. The credit union must convince E members to accept other revenue-producing products to offset their dividends.

RELATIONSHIP PRICING
IBM Southeast EFCU, responded to that challenge by developing a fee structure based on relationship pricing. Fee categories, ranging from bronze to diamond, are received and successful in promoting products to members who previously had only one or two services, says John Zells, CCE, SVP/marketing and business development.

The system rewards the most profitable members and seeks to ensure that members with fewer services pay their share. The more products and services members have with the credit union, the lower and fewer their fees. At the highest tier of the fee structure, even foreign ATM fees are eliminated.

"The objective of our relationship pricing is not to collect fees, but to produce behavioral changes to increase our share of wallet" with members who have fewer services, Zells explains. "We view it as an issue of fairness."

IBM Southeast EFCU combined its product profitability data with available member information to create over 100 membership market segments. The next step is to build a predictive behavior model that identifies members most likely to purchase highly profitable products or use their existing accounts in ways that produce more revenue and also points out which products members in certain segments are most likely to purchase next.

Zells sees the collective power of profitability analysis and market segmentation as key to anticipating members’ financial needs and serving them better. To segment membership, IBM Southeast EFCU started with five common demographic standards. It grouped members into those standards by services each uses, based on a member’s demographics—for example, are they "credit-driven, upscale, depositors, middle market and fee-driven."

Applying the seven levels of its profitability model to each group quickly subdivided membership into 35 market segments, which were further broken down with product correlation data, or predictive information on each group’s propensity toward
certain products and channels.

Segmentation accounts for such factors as age and approximate income of members, number of products and their relative profitability, preference for delivery channels, frequency of use and survey data.

By reorganizing marketing staff into segment managers, IBM Southeast EFCU has "seen a tremendous improvement in marketing efforts," Zells says. "Our cost per dollar of new sales decreased dramatically."

VERIFYING INSTINCT
Profitability by product is the unit of measurement at Tremont CU, which uses the software CU Profitability Decision Maker, by Profitability Decision Systems, Watertown, Mass. It measures product profitability in total dollars, per unit, as a percentage of assets and as a ratio of revenue over expenses.

Tremont CU uses those numbers in such tasks as setting rates, identifying potential loss leaders to bundle with more profitable services and weighing costs of various service options, Broderick says.

Its profitability data helped the Tremont CU board consider such proposals as market segmentation and risk-based lending. "We can download the data into Excel or our ALM package to look at the what-ifs," Broderick says.

Tremont CU directors are taking a cautious approach to market segmentation and tiered-loan pricing, in part because they want to be sure they are serving the wide range of members equally, Broderick notes. For the same reason, some expressed early reservations about measuring profitability.

"But our philosophy is, if we want to serve all members as well as possible, we need to know what our products cost," he says.

When members request new services in surveys and focus groups, the profitability data "help us consider what we can do to offer those products profitably," Broderick adds. "Numbers we’ve generated prove that this [software] helps. We’re above our peers in ratings on give-back to members."

Without a cost accounting system, Tremont CU collects expense data on its products the old-fashioned way—through annual job audits to determine how much time it takes staff to complete various tasks.

BIG WINNERS AND LOSERS
Often, the very process of collecting profitability model data can be quite instructive, says Roy Hodgdon, VP/customer service for Profitability Decision Systems Inc.

"Those numbers begin to tell you whether you might be able to find a better or cheaper way to provide the service and what will give you the biggest bang for the buck," Hodgdon says. "It’s quite educational to see how expenses and revenue interact. Many times, credit union managers feel they can make their service more efficient. This often spurs good ideas on how to do that."

Because staff time typically accounts for 35 percent to 50 percent of noninterest expenses to provide services, gathering those cost estimates is crucial, he says, but he adds total accuracy is impossible to achieve. He recommends credit unions strive for 80 percent to 90 percent accurate expense estimates.

The first step in measuring profitability is typically to identify the big winners and losers by product, Hodgdon says. "From there, you need to answer the question, ‘Why?’"

For the big winners, volume might be the key, while unusually high staff expenses might tip the scales against the losers. By the time they’ve assembled the data for profitability analysis, most managers have a good idea where along the profit continuum most products fall, Hodgdon adds. Software analysis provides quantifiable confirmation.

Measuring member or household profitability and segmenting membership is a powerful analytical tool, but it requires an MCIF system or data warehouse loaded with demographic information, Hodgdon notes. Smaller to mid-sized credit unions tend to start with product profitability "because you can’t do member profitability until you know how much your products cost."

Hodgdon suggests profitability analysis probably wouldn’t be cost-effective for credit unions with less than $25 million in assets. $25 million to $50 million credit unions may get some pay-back. "It’s almost certainly worth it" for those with assets of more than $50 million. Profitability packages cost from $7,500 to $50,000 or more, not including staff time to get products up and running.

Required staff time can be a significant investment, Hodgdon adds. He cites the example of credit unions that must restructure their general ledger to provide necessary data, such as separate interest accounts for each loan product.

PROFITABLE CHANNELS
In this home branching and call center era, credit unions may want to measure profitability by checking account delivery channels. To develop an in-depth profitability model, for example, Lawhead says RFG examines checking account activity by transaction, asking: how many checks does the member write each month, how many ATM visits, how many transactions were completed at the teller window, how many via the call center, does the member use a debit card and how many times, and how often did the member complete transfers via the online branch?

"We gather that from the credit union for every account, and it goes into RFG’s profitability model," he notes. "We can translate it right into the methodology, so each member’s checking account has a different expense load based on how each member uses their account by delivery channel."

A member who visits an on-line branch and writes checks has a lower cost structure than "lobby lizards" who stop at a branch six times a month, he says.

"When members have a higher expense to the credit union, they’d better have a higher return to offset that," Lawhead notes. Thus, their delivery channel preference determines, in part, whether members fall into the A or E category, or somewhere in between.

TRUE TO THE MISSION
Does measuring profitability run counter to credit union missions to serve all members? "We’ve struggled with this. Many CEOs don’t even want to hear the word ‘profitability,’" Lawhead says. "But one of their tasks is fiscal responsibility. If they don’t have revenue coverage, ROA, they’re not going to be around for long.

"What we look for is, what is the relationship with the member?" he adds. Profitability analysis can help quantify what makes a credit union different from a community bank, Lawhead suggests. "We show them the give-back, to put numbers to why they’re a better deal for members.

As powerful as profitability analysis can be, credit unions move in the strategic direction it indicates through "a series of small steps," Bouras notes. "This has to be part of your long-term strategic planning process."

Karen Bankston is a free-lance business writer and editor based in Stoughton, Wis.

© 1999 Credit Union Executives Society