The Network Effect…or not

There’s a phenomenon called the network effect that dictates that the value of some products or services, like say, phones or faxes, is directly correlated with the number of phones or faxes that are in use. Put another way, one fax machine is worthless, as it can’t send to anyone. But with every incremental fax machine, the value of the network increases exponentially. So how does this apply to banking?

I was recently in a small southern city and I saw a branch for a bank that’s headquartered in another part of the country. It’s a regional bank, so it’s not a national brand, and there it was standing by itself in this little southern city. I went online and found out that there are in fact three branches of this bank in that city. For perspective, both Wachovia and SunTrust each have 10 branches in this city. This bank from the Midwest, with no brand presence and no history in the market is trying to build business outside of its core footprint, in the face of well established and powerful competition. If you were to consider becoming a customer of this organization, you’d have to accept and trust a new brand and then you’d have to make sure that their three branches will meet your needs for convenience. That’s a tall order.

There is a network effect that impacts banking. It’s the combination of branches, ATMs, online, call center and advertising that creates the sense that the bank is big, everywhere and able to meet your needs regardless of channel. It works for the customer because they can do what they need to do wherever they need to do it, and it works for the bank because they can leverage their marketing and operating expense across a network of branches and ATMs. Plopping a few branches into a city and betting on organic growth seems to me to be an expensive use of scarce bank resources.

So how should a bank build a franchise in a new market if not through branches? Well, there’s this thing called the internet and there are a fairly large number of individuals who prefer to do their banking online or by phone and who have little need for physical branches. These people respond to offers that deliver value, just ask ING Direct. A bank that wants to capture customers in a market outside of their traditional footprint could probably do a heck of a job on marketing and customer value propositions with the money that it takes to acquire or build and run branches. It’s also an opportunity to establish a brand in a market fairly efficiently, and if it doesn’t work, there’s not much cost to bailing out.

Customers benefit from a well established branch and ATM distribution system in a market, and banks do too. Too few branches in a market limits the ability of a bank to meet their customer’s needs and from an operating point of view, it turns branches into the world’s most expensive billboards.

Leverage the network effect, either in the physical world or online.

BTW, there's an article in today's American Banker by Kate Berry that discusses USAA's planned expansion to additional segments related to the military. This is a bank that has one branch, but has millions of customers all over the world. They're a great example of how to penetrate a market with no physical presence, and I think that this model is a real threat to traditional brick and mortar banks.

Free book from Forrester

Bruce Temkin of Forrester Research has written a short online book entitled The 6 Laws of Customer Experience that's available on his blog, Customer Experience Matters. It's a concise statement of the truths that drive customer experience and it's worth your time.

Check it out.