Punishment Fees, Innovation & Disruption

Five Dollar Bill

Bank of America are about to start charging their customers a flat $5 fee per month for using their Debit cards. The bank claims this is necessary because Congress recently capped the fees banks were charging merchants for Debit transactions. Congress claims that a cap was necessary because Visa and Mastercard (and hence the banks) were monopolistically gouging said merchants with fees some 400% higher than the cost to process.

Irrespective of who is right and who is wrong, what this new fee does is to quite starkly highlight the innovation challenge inherent in retail banking.

Retail banking, and in particular the checking product, is a highly inelastic environment. Essentially, this means very few people are in the market for a new checking account at any given time (on average only about 9% of the total population will open a new checking account in any given year, and the number actually switching banks is much lower).

As consumers connect more services to their checking accounts – credit cards, savings accounts, recurring payments, mortgages etc, then the pain of switching becomes ever higher and as a result most people don’t bother. No matter how the bank ultimately treats them.

As a result, when facing an enforced revenue decline such as that faced by BofA, the temptation is for the bank to squeeze consumers as hard as possible rather than to innovate, because the most likely scenario is that only a very small number of customers will actually switch.

Why does this matter?

It matters a lot because in an inelastic environment punishment fees like the $5/month debit fee will always be less costly and more profitable than true value-adding innovation could be. In a direct comparison, the potential success of a value-add innovation will always be competed out of the running by an almost guaranteed-return from a punishment fee.

Going further, I believe that the banking prediliction toward punishment fees as a means of generating incremental revenue serves to materially harm their ability to innovate in ways that actually add value to their customers. Like a muscle that never gets used, the customer centric value-add muscle eventually withers and dies.

Importantly this also creates a huge brand conundrum. For what is in the best interests of the bank (to squeeze as much fee income as possible from the consumer) is manifestly not in the best interests of the consumer (who doesn’t want to be squeezed and punished for simple levels of service provision).

Which becomes an even bigger conundrum when you consider that the banking sector overall is facing the worst levels of consumer sentiment ever. Something which is cutting across all brands, and from which none seem able to release themselves.

If BofA stays true to the formula used by banks in the past, it will add this punishment fee with one hand and engage in a significant advertising campaign aimed at bolstering consumer trust with the other.

They’ll then be confused as to why the advertising isn’t cutting through and seperating them from their competition.

The answer, of course, is that the customer is intelligent enough to understand that the brand is actually manifest in the actions of the bank rather than its communications. And when the actions are so manifestly anti-customer (as all punishment fees are) then they speak much louder than words.

The scenario outlined above is very real, and so tempting that almost certainly the other large banks will soon follow BofA’s lead. And considering the recent massive consolidation of retail banking in America, true choice will become seriously limited.

So how could this potentially change?

The only thing that will break the banking addiction to punishment fees and force true value-add innovation will be if the customers were to act en-masse to switch their banking relationships away from the banks with the highest level of punishment fees and toward those with the least.

I believe sheer anger will actually create a significant shift here, moving people away from the big banks into the hands of smaller regional players and credit unions. However, convenience is a powerful force and the hassle factor of switching will be too high for this to become a mass exodus.

For a mass exodus to truly happen, we will need to see technological innovation focused on increasing the convenience of switching. Someone needs to make switching your checking account as simple to do as switching your cellphone provider (in terms of the ease of porting your number rather than the cost of breaking your contract)

I believe there are only two types of actor who could do this, and in the process create the conditions for a large scale re-shuffle of the retail banking landscape:

1. A new intermediary
If you had the technology to make switching any checking relationship from any bank to any other bank, then you have the potential to create a highly valuable new relationship with the customer. You in effect become their banking broker. Aiding their shift from high to low fee charging institutions.

Doing this would mean either a new technology enabled startup focused on taking on this role, or some other trusted, non-bank, technology savvy player stepping into the breach. Amazon perhaps?

2. A medium sized bank
An aggressive, growth focused, medium sized bank could potentially make this play. Unlike an approach focused on moving any banking relationship from any bank to any other bank, this would be designed to create a seamless transfer of the checking relationship from any bank to their bank only.

Doing this would require investment resources and technology capability. The bank in the US which most closely reflects this profile is probably Citi.

In the consolodation of a few years ago, Citi were the manifest losers in US retail banking. In scale terms, Citi have found themselves stuck as a mid-weight regional player.

However, they have the brand, they have the technology and they certainly have the investment resources to make something like this happen. If they were to combine convenient switching with a game-changing low cost, low fee online distribution and service model then the potential for national disruption is absolutely there. Not only this, but the potential to meaningfully and positively improve the reputation of Citi in the process.

Could they do it? Do they have the capabilities and desire to do it? Has their value-add muscle withered too much? These things I don’t know.

It might be nice for all the $5 paying BofA customers to imagine they could though…

image borrowed from: http://www.valdosta.edu/~lomartin/fivedollarbill.jpg


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