5 Winning Strategies for Serving the Small Business Market

By: Joseph Sullivan

Introduction

Small businesses are the number one engine for job growth and contribute to the changing face of employment in this country. The changing workforce in this country has resulted in the dissolution of many middle management positions whereby they elect not to return to employment in the traditional method. The SBA estimates there are approximately 25 million small businesses across the US which employ nearly one half the country's workforce. The growing entrepreneurial trend has contributed to small businesses expanding by 14% per year. Small business is one of the most profitable segments in financial services industry with everyone from traditional financial institutions, to credit unions to American Express jumping on the band wagon to pursue this niche. It is estimated that this segment generates approximately $50 billion in annual revenues with an estimated market for services of $120-$138 billion.

Market Insights, Inc. has compiled the research insights in this article through ongoing secondary research as well as primary research programs such as a new wave of focus group meetings with small businesses to engage them in dialogue and identify their core financial needs. We will provide for a more thorough understanding of the small business market, outline their financial needs, what they expect from a financial institution and outline 5 winning strategies for serving this increasingly important segment.

Understanding the Small Business Market

There is a disconnect between how small businesses view their financial needs and the way financial institutions view these needs. For example, financial institutions often view the products for the small business market as mainly checking, short-term investments, lines of credit, mortgages, term loans, and a few other services. Using that definition the typical small business generates approximately $5,000 in net revenue for financial institutions. With this view of the small business market, financial institutions see themselves as the dominant provider of services to small businesses with a share of over 70%. However, the small business owners themselves view their financial service needs as much wider. They include leasing and payroll needs, tax services, a range of insurance products (both life and property & casualty), and health benefits for employees. Consequently, it is a much larger market than financial institutions first recognize. The average small business tends to be two to three times as profitable as the average retail customer and generates closer to $13,000 per year in financial service net revenues.

Needs/preferences are Diverse and Rapidly Changing

While financial institutions can categorize small businesses by number of employees, sales size, SIC codes, rate of growth, or life cycle behavior, market research indicates that small businesses have very diverse needs and preferences. Rapid changes are occurring in the small business sector: more service businesses; more small businesses with fewer employees; more homebased businesses; and a greater usage of technology. Given these changes, the preferences and behaviors of customers are getting more diverse rather than becoming more homogeneous, a tremendous challenge for financial institutions. Customers who seem the same are behaving very differently.

The linkages to the personal financial services of the owner are Critical

Compared to the average U.S. household, small business owners are much more attractive personal customers. Small business owner's account for $27 billion in net revenue and close to $8 billion in profits to the personal financial service industry. Clearly, these are retail customers that warrant active pursuit.

In most financial institutions, about 60% of small business customers have common relationships for both their personal and business needs.

Many small businesses establish their personal accounts first, then bring across the retail business later. Still close to 40% of customers keep them separate, a great prize for financial institutions given their attractiveness.

Top Critical Issues Facing Small Businesses

Rising costs of health care and operating expenses in general

Education: Helping them succeed through education regarding business planning, marketing and tax issues, etc.

Competition: managing customer perceptions against deep pocketed competitors. Helping a small local office supply company thrive among large national chains.

Top Financial Needs According to the Small Businesses Themselves

Asset allocation: Investment Options (advise regarding excess funds)

Loans: For operations, expansion, etc.

Cash Flow: Management of day to day cash flow

Response time: Quick resolution when financial provider is contacted

Small Business' Top Requests - It's All About the People

Dedicated personal banker for my accounts

People acclimated personnel: "I want a banker to visit me and inquire about my business"

Education: seminars regarding business planning, financing, marketing, etc.

Quick Access by phone: "it's frustrating not being able to reach a live person"

Someone to expedite things internally

Where Financial Institutions are Missing the Opportunity Boat

Small business owners want to be recognized based on a combination of their personal and business relationships yet they are seldom asked questions regarding their needs and preferences.

Few financial institutions interview Small Business account managers to tailor product and service selections to meet their specific needs, yet doing so would allow the provider to:

Demonstrate understanding of customer's business

Recommend intelligent solutions

Provide perceived and actual value-added

Additional insights also reveal the following miss-steps by financial institutions:

Few financial institutions develop portals for small businesses

Few financial institutions effectively promote or identify range of products and services offered to small businesses on their web sites

Most financial institutions only offer basic online transactional services for small businesses

Few financial institutions "Answer the Call" for small business customer service

Customers are directed to call 800#

Some financial institutions offer small business help desk

Meeting this challenge is a new group of aggressive competitors

Aggressive financial institutions like Wells Fargo are using lower cost customer acquisition and credit management processes to reach beyond their traditional geographic markets.

Emerging non-bank competition is coming from a variety of places: brokerage firms such as Merrill Lynch and Fidelity entering through their retirement plans and investment products; American Express through its small business cards and other initiatives; software companies such as Intuit; service providers such as ADP; insurance companies such as State Farm; and dedicated lenders and lessors such as GE Capital.

The share of the actual small business market held by financial institutions is much smaller than most financial institutions perceive. Commercial financial institutions actually have less than half of the small business market today. In many lines such as leasing, insurance and payroll, financial institutions have an almost insignificant share of the market.

Small business lenders face specialized competitors

Traditionally, financial institutions have thought of lending to small business by product type. What has evolved over the last year, and continues to develop, is a fragmentation and specialization of the types of lending. Certain institutions will dominate each type of lending based on their skills, scale and distribution capabilities. The recent emergence of commodity lines of credit with pre-approved limits of $100,000, aided by automated credit scoring, is just a continuation of this fragmentation. One area that will see major growth over the next five years is sub-prime credit for small businesses.

The economics of pre-approved credit, such as provided by Wells Fargo and other direct originators, is significantly more attractive than the branch oriented credit process that exists in most financial institutions today.

Strategy #1: Be a "Category Dominator"

The formula is very simple; it often begins with a critical skill or advantage. It may be credit scoring for underwriting loans, an ability to underwrite difficult insurance claims or unique technology or processing skills. Those skills help develop brand recognition. As the brand equity grows, the firm develops greater scale as the dominant player.

Strategy #2: Aspire toward a relationship strategy

The focus of this strategy is to use a range of relationship approaches to meet small business owners' needs personally. Four types of relationship-oriented distributors likely to survive and win include:

Broadline distributors, such as Merrill Lynch, due to their strong brand and ability to source products

Local advisors, such as well-managed community financial institutions, because many owners still want personal attention and service

Specialists, such as CPAs, because the costs and risks in several products warrant investing in detailed knowledge

Customer segment "dominators" are likely to emerge and be successful because they have deep knowledge of an industry segment that overcomes the geographic diversity of their customers. They achieve superior economics by developing an outstanding reputation in their segment.

Strategy #3: Discount distribution strategy

The retail chains Walmart and Target are highly successful due to their one-stop convenience, aggressive pricing and superb ability to source products. Likewise, Vanguard has occupied a similar cost-effective niche for mutual funds.

Two thirds of all small business customers have less than $1 million in sales. Their product needs are much narrower and more simple than larger companies on average, and they generate less potential revenue per company. Cracking the economic formula for these customers is likely to be highly profitable in the long-run and has great growth potential.

Strategy #4: Be a part of the solution whether the solution belongs to you or someone else

Companies taking this approach will serve multiple distribution channels by providing bundles of multiple products from a range of different manufacturers. The economic leverage comes from serving financial institutions who are local distributors and independent advisors both of whom cannot afford to build their own product manufacturing capabilities across a wide range of products.

Strategy #5: Integrated payments and tax provider, a payments-oriented "Category Dominator"

Many small businesses want the ability to make a range of payments each day and keep the information about those payments in a timely and effective way - payments to customers, payments to suppliers, payments to government and payments to their employees

They want this payment and information system to be compatible with the range of other financial products they use, such as lines of credit, insurance products or health benefits so that the financial side of their business runs smoothly each day. These customers want to concentrate on the business side of their day-to-day operations, not the financial aspects.

Many people are lining up to be that integrated payment provider, whether it's the combination of Intuit and Checkfree, ADP and its Peachtree subsidiary, American Express, or Citi Financial institution. In the future, all may be able to offer integrated payment and tax services.

In Summary

Many financial institutions realize there are likely to be several winning strategies and have already been moving toward one of them. Most expect that in five years there will be significantly different competition than the kind of competition financial institutions see today, the future market share for small business could look very different than today. The risk for traditional financial institutions is that they become like department stores that have lost 1/2 of their market share to new format competitors since 1980. Financial institutions must be bold, they will need to choose a strategic direction and begin moving toward it or risk losing their small business franchise. Financial institutions must understand their economics and the value they can provide to customers. They must tighten the personal and employee linkage between their small business customers to get extra value out of those relationships. Looking at only one part of the overall relationship puts financial institutions at a disadvantage. Financial institutions should not try to do it all themselves. Leaders in all industries use alliances or strategic webs to extend their reach and reduce risks. Finally, financial institutions must be paranoid about the non-financial institution competitors. As demonstrated in mutual funds, mortgages, and credit cards, non-financial institutions are devastating competitors.