The Trade Name Trend

by Christopher J. Zinski

Marketplace Bank and DePaulBank.com have one thing in common. They are nonbanks selling banking products and services by leveraging their brand identities and established consumer relationships.

Stand-alone Internet banks have struggled financially and many have surrendered by consolidating with other institutions. Soliciting new accounts on the World Wide Web one customer at a time inflates account acquisition costs and can send them spiraling out of control. Indeed, acquiring critical mass has proven prohibitively expensive for many stand-alone Internet banks. This has resulted in a shakeout among the stand-alone banks and in the process startup capital has been incinerated, careers disrupted, and business plans tested and modified only to eventually be scrapped.

The problems and hurdles that ravaged so many would-be startups are well known and the Internet banking model has been re-engineered as a result. It is too early to tell whether these second generation Web banking ventures will succeed or not; however, they have improved their odds by addressing the fundamental problems that plague their stand-alone counterparts. Trade name banks are half full-fledged-bank and half marketing machine. They have the propensity to work in large part because the business model is basic and simple.

The Basics

Brick and mortar banks that want to grow their balance sheets see the Internet as an attractive delivery system for banking products and services and a venue for attracting new customers to the bank. Indeed, most banks offer some form of Internet banking service, whether it is accepting loan applications on the Web, soliciting deposit accounts, or bill payment functions. E-commerce capabilities require large capital expenditures, and, to make the expenditures financially viable, heavy traffic must run through the site. Many institutions offer e-banking services to customers only to remain competitive with their peers and some are resigned to losing money from the activity. But the prospects for success, however, need not be so dim.

An emerging Internet banking model is one in which a bricks and clicks bank affiliates with a successful commercial enterprise to provide banking products and services to the customers of the enterprise. For example, a large retail department store may have one or more successful brand names and thousands of loyal customers, however, no desire to enter the financial services business on its own. A bank may have the capacity to add a substantial number of new accounts and the infrastructure and e-banking architecture to support a large customer acquisition initiative but no logical target market apart from its existing customer base.

For the bank, marketing its products and services the same old way has limited growth potential. For the retailer, finding new ways to capture more revenue from its customer base without significant new capital outlays helps defray the cost of supporting its brands. From their respective needs and capabilities, a productive strategic alliance becomes possible that utilizes a time tested strategy -- affinity marketing.

The retailer chooses one of its successful brand names and invents a new Internet bank around the moniker. Marketplace Bank, for instance, is a trade name bank for the Winn Dixie Department stores. It leverages the Marketplace brand name that is familiar to Winn Dixie customers. To shoppers, the Winn Dixie bank has the look and feel of a captive financial firm of one of their favorite stores; however, creating the bank has not drawn Winn Dixie into the banking business. Instead, an unaffiliated depository institution, an Internet bank subsidiary of Canadian Imperial Bank of Commerce (CIBC), performs the banking function. The concept uses a storefront to take advantage of customer loyalty and brand identity while driving traffic to the underlying banking institution.

In this kind of model, the bank would pay its strategic partner a cash referral fee, while the new loan and deposit customers belong to the bank provider. The relationship between the bank and its commercial partner would be memorialized in a strategic alliance contract between the two parties.

Bells and Whistles

An important advantage of this business proposition is that the brand partner has existing customer relationships and knows its customers. This enhances the prospects for a successful marketing strategy and tactics. Which of the two parties has primary responsibility for the marketing effort would be negotiated as part of the alliance contract, but it would not be uncommon for the commercial firm to take on that charge. After all, the commercial firm knows its customers’ preferences and how to sell its brand. The commercial firm also has established distribution channels, whether it is onsite signage, newsletters, billboards, email marketing, or mainstream media outlets.

The branding partner will have good ideas for the types of banking products and services that will appeal to its customers based on customer demographics and customer buying patterns. A strong commitment to the marketing effort is a breeding ground for product invention and creative ideas. For example, a collegiate institution might design savings products that appeal to alumni who might one day choose to send their child to their alma mater. The account, of course, would carry the institution’s brand name.

The basic Internet model can be extended beyond clicks to include a physical presence. Kiosk banking can be coupled with the Internet to give customers a physical touch-point with the trade name bank. For example, the retail partner would permit its banking partner to install kiosks in its stores, which offer customers a multi-dimensional facility for executing banking transactions. The name of the trade name bank would hang over the kiosk, promoting the store’s brand name in the process. Even though it would represent another banking channel, it would serve as a billboard for the Internet based venue. As a super-ATM, the kiosk may have a customary ATM, an account application center, an Internet module, and a phone center for reaching a customer service representative.

Revolution and Evolution

Entrepreneurs who started or tried to start stand-alone Internet banks either did so from scratch or sought to acquire a small depository institution and transform it into an Internet only bank. Either strategy required enormous capital commitments, expensive management teams, and an elongated regulatory approval process. The business plan had to pass regulatory scrutiny, which was easier to accomplish in the early stages of the revolution because empirical data supporting the model was virtually nonexistent.

As more stand-alone Internet banks came to market and brick and mortar banks added transactional Web sites, the universe of empirical information exploded and began to cast doubt on early anecdotal data and the very viability of the stand-alone structure. Startups had great hopes that growth in Internet use would automatically cause a migration of customers from brick and mortar banks to the more nimble, electronic banking variety. That proposition proved untrue. E-banks found themselves competing intensely for customers on the Web, and as large brick and mortar banks added functional transactional Web sites, the luster of the stand-alone Internet bank began to fade rather quickly. Those that had launched their banks increased marketing initiatives, often at a huge cost, to attract customers and new accounts, which became the common measure of success among e-banking firms.

The economics, however, gradually became apparent. The enormous marketing cost could only be justified if waves of new accounts flowed in, which, for many of these Web-based banks, did not occur. Analysts and the mainstream media began to focus on account acquisition cost, representing the direct and indirect costs associated with generating one new account. Even those numbers became suspect and serious scrutiny revealed that many accounts represented hot money and where inherently transitory. Creating stickiness became paramount.

The banking regulators started to view applications for startup Internet banks with a jaundiced eye, the initial strong pace of approvals was quickly interrupted, and new applications began to dwindle. Long term profitability concerns and the feared rate of capital erosion were causing regulators to stop some applications midstream. Regulator requests for huge amounts of initial capital, extensive marketing surveys, solid proof of business plan viability, proposed exit strategies in the event capital deteriorated significantly and the uncertainty of the regulatory approval process, both as to length and outcome, brought the stand-alone proliferation to a virtual standstill. Internet banking had a place in the financial services industry, but the fundamental weaknesses were begging to be addressed.

The concept had to evolve and it did. In a matter of months, many of the stand-alone Internet banks began to announce strategic partnerships with insurance companies, utilities, retailers and other large commercial enterprises. They recognized that affinity marketing could boost customer account acquisition so the often unaffordable cash investment directed toward banner ads and television marketing was redirected toward strategic alliances. The natural migration to the affinity marketing model set in motion a trend that continues today.

The Regulator’s Perspective

The banking regulators appear to have turned cool to the notion of stand-alone Internet banks -- at least those that are not backed by substantial capital at the bank or holding company level. The trade name bank model continues to have solid support from a legal standpoint.

In July 1999, the Office of the Comptroller of the Currency (OCC) issued a conditional approval order approving the Winn Dixie banking model. CIBC chartered a new full-service national bank, representing CIBC’s de novo entry into the United States with a Federal Deposit Insurance Corporation (FDIC) insured institution. The application for the charter provided that the bank would deliver products and services primarily through a variety of electronic delivery channels.

CIBC’s strategy involved entering into a joint marketing agreement with Winn Dixie. The proposition did not involve an ownership stake in the bank by Winn Dixie and Winn Dixie would have no operational responsibility for the bank. Operating as Marketplace Bank, the venture would offer deposit and credit products and services to customers of Winn Dixie through the Internet and kiosks in stores. The hub and spoke model would permit CIBC to enter into contracts with other commercial enterprises, including other retailers, to establish other kiosk and Internet based banking programs, branded for their particular store or business line.

The OCC’s decision in the CIBC case built on previous regulatory authority applied to brick and mortar banks that wanted to operate one or more branch offices or other facilities under different names. The four federal banking agencies issued a joint statement in 1998, in which they acknowledged that institutions had flexibility to operate a branch office under a trade name, so long as appropriate safeguards were in place to ensure that customers would not become confused and believe that its facilities are separate institutions, or that deposits in the different facilities are separately insured.

The OCC, in the CIBC decision, had the same concerns and required that the host retailer and the underlying bank be conspicuously, accurately, and separately identified to the consumer. Thus, the Web pages for trade name banks will identify the underlying bank provider. The legal name of the insured institution must be used for legal documents, certificates of deposit, signature cards, loan agreements, account statements, checks, drafts, and other similar documents.

The extent of FDIC insurance coverage is especially problematic for Internet based trade name banks because a customer can have the impression that the deposits issued through each of several trade name banks are separately insured up to the $100,000 limit. If, however, the underlying bank serves as the hub for more than one trade name bank and the customer enters into deposit relationships through separate trade name banks using the same hub, the customer’s deposit accounts will be aggregated for purposes of the insurance limit.

To alleviate confusion, proper disclosures need to be made to the customer that emphasize this possibility, and staff of the hub-bank needs to be trained regarding the risk of customer confusion. Indeed the hub-bank might obtain a signed statement from customers opening new accounts through a trade name bank’s Web site. It would acknowledge that the customer is aware that the trade name bank is one of several serviced by the hub-bank, all of whose trade name banks are part of the same insured institution, and that deposits held at one or more of those trade name banks are not separately insured.

Referral fees are used to compensate the commercial enterprise for lending its brand name to the products and services of the bank provider. Fees have been a common remuneration technique used by banks to motivate and compensate third parties to direct business to the bank. While the terms of referral fee arrangements need to be carefully evaluated by legal counsel on a case-by-case basis, especially those for which special rules apply, the authority for referral arrangements, as a general matter, is longstanding.

The Perfect Host

The trade name banking model works well for some commercial enterprises but not for others. Successful hosting requires a large customer base and a strong brand name that transfers easily to financial services. Having a universe of tens of thousands of customers is optimal. Detergent brands, for instance, may not transfer well to banking products while expensive car and motorcycle brands probably would. Universities are excellent prospects because the larger ones have tens if not hundreds of thousands of alumni, most of whom are upwardly mobile. Educational institutions also replenish their customer base each year with new students and new alumni.

The products and services of the trade name bank can be marketed not only to customers but also to the host’s employees. Therefore, organizations having a large customer pool and many employees might find extra advantages by offering the products and services to their associates. The model, as expected, fits better in some industries than others. For instance, it has been applied to the utilities industry where a utility may lead the product menu with electronic bill payment services, marketing other financial products and services with the payment package. The concept may work well for utilities given the sheer number of customers and customer touch points.

The brick and click formula has many advantages. In some industries, like retail stores, gas stations, and pharmacies, kiosk or pavilion banking can be integrated with an Internet venue to give customers several points of contact with the trade name bank, and more contact points give it a promotional boost, as well. The key is to integrate the banking business plan as completely as possible into the enterprise’s core operations. Without operating synergy, marketing overlap, and deep systems integration the banking function risks becoming a sideshow and, thus, little or no utility to earnings growth.

Accountants and consultants who specialize in banking and e-commerce services can apply modeling techniques and determine penetration rates in relation to a host’s customer base. The result is to project with a fair degree of precision revenue streams and profitability for each of the two strategic partners.

Turbo Charging Community Banks

This model cannot only generate financial rewards for the commercial partner by adding referral fee revenue and cross-selling opportunities, it can also rejuvenate community banks experiencing lackluster growth. A community bank that believes it has extended its reach as far as it can in its local community faces a difficult choice. It can open branches outside its regular market area or acquire another institution in a new location. Expanding this way is costly and not without significant business risk. What many community banks need is a way to grow their balance sheet and customer base without investing more in bricks and mortar and marketing. A trade name bank may be a viable answer.

A community bank with a strong e-banking architecture can reach out for a strategic partner and quickly develop a conduit for new business. For instance, a bank in a local community could approach local businesses that have a large number of customers and would be natural providers of financial services. Indeed, the bank might have lending or deposit relationships with these local companies already and the strategic alliance of a lifetime may be only a phone call away.

Many companies may have never seriously considered providing banking products and services to their customers. Others may have thought about it but were deterred by the heavy regulatory framework applicable to banks. By explaining to a prospective host how the trade name bank concept requires no capital investment or operational commitment on its part, a community bank may find it easier than expected to lure a partner for a strategic venture. By joining forces with a strong partner, a community bank can spread the cost of its own Internet banking infrastructure and grow the bank without the cost and risk of physical expansion.

Trouble Spots

A trade name bank offers many advantages to each of the two strategic partners that launch it. The venture, however, is not without some risk and expense. One of the first steps must be to conduct an in-depth market survey in order to project the financial potential for the venture. Analyzing customer demographics, competition, and product and service preferences is crucial. Market surveys and focus groups need to be conducted; however, this takes time and can be expensive. While a lot of this work can be outsourced, it will, to be effective, require a significant time commitment by senior management on both sides, and that too presents a cost.

The idea can be exciting and initial enthusiasm is often high. When the work begins, however, other priorities get in the way. To improve the venture’s viability, responsibility for the project needs to be clearly defined at the beginning and questions about who owns the project need to be addressed. A joint task force composed of officers and employees of both the bank and the commercial partner is often a successful way to organize the work in the initial stages. There is always the risk that the project will die due to lack of attention and follow through.

Both parties need to set realistic expectations. It is best to establish these after the marketing survey is completed and outside professionals assemble realistic financial projections. A cold, hard look at the numbers early on and a long-term commitment by both parties to the partnership will improve the chances for success. Internet banking has suffered from grossly exaggerated expectations and there is always that risk with a new line of business. Unrealistic expectations can cut the life of the venture short because management -- on one side or the other -- decides the financial results are falling short of goals.

For the commercial firm, one of the most significant risks is damage to its reputation. If it selects a bank provider that has problems performing, this alone can jeopardize its brand name and customer relationships in its core business. Thus, selecting a solid banking partner that can meet the specific banking needs of its customers is a crucial consideration for the commercial firm.

Deal Points

The strategic alliance between the bank provider and the commercial firm hosting the trade name bank would be memorialized in a contract. Its terms are completely negotiable and almost every aspect of the alliance can be crafted to meet the particular needs of the parties. The referral fee paid by the bank to the commercial firm can be based on simple formulas or more complicated ones that rely on average annual deposit balances, customer retention rates, and different pay rates depending on the product sold.

The bank provider has an incentive to argue for a long-term agreement while the host firm has the opposite motive. The bank’s view will be that it has a significant investment in the relationship, not the least of which is the high cost of Web-enabling the host firm and retrofitting its systems to meet the particular needs of the host firm’s customers. The bank will want some assurance that the host firm will not drop it for another provider, especially at the point when business is accelerating. The host firm, on the other hand, will have concerns about its reputation risk and that it might outgrow its initial bank provider. The host will want to keep its options open to enroll a better provider -- perhaps one with more variety in products and services. The competing interests will have to be reconciled and a compromise struck. One approach would be to enter into a two- or three-year contract that is renewable annually after the initial term. The host could terminate the relationship early, but only if it agreed to pay the bank a substantial penalty to defer some of the bank’s investment.

Both sides will have their own noncompetition concerns. The host will want to be sure that the bank provider is not soliciting its customers outside the scope of the trade name relationship and thereby bypassing the formula for the referral fee. Likewise, because the bank paid a referral fee for the deposits and loans it acquired through the trade name relationship, if the relationship terminates, the bank will want the host to agree not to solicit those deposits and credits. Who owns the customer relationships is central to resolving noncompete issues.

A trade name bank will succeed or fail based on the success of the marketing effort. The contractual relationship must be clear regarding which party assumes responsibility for marketing. If the responsibility is to be shared, then the contract must be specific as to the allocation of duties. In many instances, the host will take most or all of the responsibility for marketing because it is in the best position to know its customers and it has the distribution channels to make the marketing push.

From the bank’s standpoint, if the host assumes a major marketing role, the bank will want to know details about the marketing campaign, such as its breadth and intensity, the type and nature of marketing materials to be used, and frequency of customer contact. The level of the marketing effort will determine whether the bank is able to meet its financial projections for the project because the success of the model rests on the volume of traffic driven through the host’s site. The host will frequently have little experience marketing financial products and services, so the bank would want to have influence over the techniques and the materials. A shallow or misdirected marketing effort will affect the level of site traffic.

Conclusion

Internet based trade name banks can generate new and unexpected revenue for the host while building the balance sheet of the bank provider. Like all good strategic alliances, the brand sharing relationship melds the strengths of two disparate organizations to create value that neither partner could create alone. The relationship can work if the partners complement one another and if their joint business plan results from serious consideration about the marketing strategy and tactics for integrating the trade-name bank into the core business of the host.

Notes

Article used by permission.
By: Christopher J. Zinski
Website: www.schiffhardin.com