Personal financial services are in the midst of a transition. Once, competition was largely defined by regulation and geography; now, the industry is starting to be organized around consumer needs and around the underlying economics of products and their delivery. As in other deregulating industries, margins are declining, though so far the impact of this decline has been masked by favorable interest rates.

But make no mistake: PFS companies still have ample opportunities to prosper, both during the transition and beyond it. The trick for them is to figure out how to exploit what is likely to be a lengthy transition while simultaneously preparing themselves to compete in the more distant future. We believe that focusing on distribution channels and developing a deep understanding of consumer buying behavior are the way to accomplish this difficult task.

Channels have always been important in PFS. Indeed, distribution channels account for over half the cost structure of most traditional players. But in the current environment, channels have become the premier battleground for the $120-billion-plus profits available each year in PFS. Consumer product preferences have reallocated assets and liabilities among providers: from 1993 to 1995, for example, consumer balances in securities (largely sold by brokerage firms) rose by $782 billion, while balances in bank-dominated traditional deposit products rose by a mere $84 billion. As a result, large traditional players, such as commercial banks and insurance companies, have steadily lost market share to new entrants. In fact, between 1992 and 1996, the proportion of consumers that viewed their bank as their primary financial institution fell from 59 to 49 percent.

But today, managing channels means much more than simply mastering individual channels like ATMs, branches, telephone, on line, or direct mail. It means understanding what PFS consumers want and creating new ways to meet their needs profitably.

In this critical transitional period, a host of new channel opportunities are emerging. In the articles that follow this overview, we sketch out three of them: bancassurance, a combination of banking and insurance; the creation of an integrated provider for residential real estate closings; and the sale of PFS products in the workplace.

Each of these opportunities bundles existing financial (and sometimes non-financial) products and delivers them in a new and potentially powerful way. Each is anchored in the economics of product delivery and in a practical understanding of consumer needs based on extensive consumer research into all aspects of PFS. Moreover, each is closely tied to the trends driving the transformation of PFS, and thus points the way for large traditional players to thrive in a rapidly changing environment. There are five such trends:

Trend 1: Growing use of remote channels. The volume of sales and service transactions conducted through lower-cost remote channels is growing dramatically. In many sectors of PFS, remote channels are already widely used. In 1996, for example, 65 percent of consumers claimed to have used their bank’s telephone service, and 1,000 banks had Web sites, up from only 20 in 1994. Roughly 1.2 million households currently use PC banking.

While agent-based insurers still dominate property and casualty insurance with nearly 90 percent of the market, direct insurers are providing formidable competition. Foremost among them is Warren Buffet’s GEICO, a telephone-based insurer that has grown at twice the industry average over the past decade. In 1995, 11 percent of auto loans in the United States were purchased through remote channels. In the United Kingdom, the direct marketing company Direct Line has become the market leader in automobile insurance, increasing its market share from 2 to 22 percent in just four years.

Trend 2: Decoupling of distribution and manufacturing. As competition in PFS intensifies, companies are increasingly deciding to specialize in either the distribution or manufacturing of financial services. Players that are product innovators—the financial services equivalent of category killers, such as Fidelity—may focus their resources on their strength in the manufacturing end of the business and seek third-party distribution. Companies that have innovative or highly efficient distribution channels, like Schwab, or enjoy geographic dominance, like many super-regional banks, may seek to become third-party distributors for a range of "best in class" products. PFS companies won’t necessarily abandon manufacturing or distribution if they decide not to specialize in it; they may simply choose not to use it as the basis for further expansion and growth. Some insurance companies may continue to distribute through their agency channel, for example, while simultaneously playing a manufacturing role for banks and brokerage firms wishing to sell insurance.

PFS companies will be compelled to reinvent—but not eliminate—their traditional face-to-face channels

Trend 3: Reinvention, not elimination, of traditional channels. As distribution-focused PFS companies compete head to head with remote players, they will be compelled to reinvent—but not eliminate—their traditional face-to-face channels. The role of insurance agents, for example, may shift from front-end prospecting (often involving cold-calling) to following up on warm leads generated centrally. Similarly, a bank branch’s role might evolve to that of a sales center for major PFS purchases, such as mortgages or investments.

Though traditional PFS channels have changed little in the past few decades, concept renewal is pursued aggressively in other retailing businesses. By revising their value proposition, such retailers as Walgreens, CompUSA, and Lowe’s have been able to create substantial shareholder value. The need to renew retail concepts has become more pressing because retail life cycles are shrinking. The average time for a retail concept to reach peak earnings growth and then decline by 10 percent dropped from 16.4 years in 1965–75 to 7.7 years in 1986–90.¹ Moreover, preemptive renewal is critical because recovery becomes much more difficult to accomplish once performance starts to decline. Since life cycles are dwindling in PFS too, financial institutions must take preemptive steps to reinvent their retail concepts in the same way.

Trend 4: Integration of multiple channels. Over the next decade, most large PFS players will offer both traditional and remote channels, and most customers will continue to "graze" across the range of channel options. To manage multiple channels effectively, PFS institutions should set overall standards for offerings to customers, but rely on internal competition between channels to allocate resources efficiently. This "managed marketplace" model encourages product and channel business units independently to pursue opportunities to achieve their financial targets while staying within the strategic boundaries set by senior management and collaborating between themselves when this is in their mutual interest.

Trend 5: Consolidation. Anyone who reads the headlines knows that consolidation in PFS—in part a response to excess distribution capacity—is well under way both within and across industries. In fact, the market share (based on net income) of the top 10 US commercial banks grew from 19 percent in 1985 to 31 percent in 1995. In insurance, American General, GE Capital, Aegon, Jefferson-Pilot, and Conseco are gobbling up players. And the pace is unlikely to slow as companies under pressure to create shareholder value hunt for revenue growth and opportunities to rationalize costs. We foresee a future in which there are many small banks that play a community service role and a handful of truly nationwide megabanks. Medium-sized players can expect to be squeezed, and will need a superior value proposition in the markets in which they choose to operate.

How consumers buy financial services

Over time, margins will certainly decline as these trends unfold. But opportunities abound for players that understand how consumers are likely to respond to them. Through extensive customer surveys and focus groups conducted across PFS sectors, we have identified a number of recurring, often counterintuitive and nuanced, themes about consumer buying behaviors. Players that are attuned to these customer behaviors will be able to manage a profitable transition to the new era of PFS distribution.

The myth about price sensitivity

Across PFS sectors, certain features often associated with traditional channels are perceived by large customer segments as more important than price. This being so, new entrants competing exclusively on the basis of price may meet with only limited success, and traditional players may not need to cut their own prices to compete with them. Consider the following facts:

• In p&c insurance, price is the most important single attribute in buying decisions, but it is less important than the sum of agent attributes such as advice, responsiveness, and product knowledge.
• According to a 1996 PSI survey of US households, 72 percent rated proximity to their home or work as a reason for choosing the bank where they opened their most recent deposit account. Similarly, in a 1997 PSI survey of small businesses, 31 percent cited location as the main reason for choosing their primary financial institution, while only 3 percent mentioned pricing.
• In mutual funds, performance ratings dwarf the importance of fees: in 1995, 90 percent of net flows into equity funds went to those with five- or four-star Morningstar ratings.
• Among middle-income consumers of life insurance, 87 percent indicated that dealing with a person you can trust is extremely or very important, while only 76 percent thought that being offered products at competitive prices or fees was this important.

The size of genuinely price-sensitive customer segments is small. In p&c insurance, for example, the "no hassle—fast and cheap" segment is only 17 percent of consumers. Further, consumers often don’t understand the full price of a financial product, focusing instead on a single component of it. Price-sensitive home buyers, for example, tend to shop for the best interest rate but disregard upfront costs.

However, inexpensive new delivery channels will enable PFS players to sell financial services at lower prices and thus tap into previously unserved market segments. For instance, by selling life insurance through their branches, which costs less than using traditional agents, banks will be able to target middle-market customers, a segment underserved by life insurance companies with expensive agent salesforces. By introducing cheaper products for selected segments, PFS players will be able to expand and capture a greater share of industry profits.

Who wants to shop around?

Just 13 percent of middle-income customers contact more than one company or representative when they purchase life insurance

The lack of consumer interest in shopping for almost any financial service is startling. Only 37 percent of p&c consumers shop in a three-year period, and almost half of those deal with just one or two companies. Among mortgage customers, 55 percent contact only one lender, and 80 percent contact three or fewer. Just 13 percent of middle-income customers contact more than one company or representative when they purchase life insurance, and only 14 percent do so when they buy annuities. Presumably, consumers simply don’t want to spend the time to shop around for their financial service purchases. As a result, if consumers encounter a face-to-face salesperson early in their search, chances are that individual will close the sale.

Yet the Internet and the search agents that can be used to navigate it promise to make shopping for financial services a lot faster. Using the Internet, a customer can obtain information on 25 different credit cards in under a minute, or identify 25 options for high-yield certificates of deposit (CDs). Moreover, the average rate obtained from an Internet search for a credit card is several points lower than from a telephone search. Similarly, an experimental Internet search for a CD yielded an interest rate of over 6 percent, while a phone search secured just 5.5 percent.

But general customer inertia and consumers’ low emotional involvement with financial service products mean that, despite the potential of the Internet, the propensity to shop may not change much. Take p&c insurance, for example. Of the 37 percent that shop every three years, only 17 percent actually switch providers. Differences between providers are presumably not large enough to induce switching.

In addition, some of the new channels that are beginning to evolve attract customers because they are convenient, and may increase customer inertia. An example is worksite marketing. Employers interested in offering this service will want to have only one financial service provider to minimize complexity. They are interested in offering their employees financial services at work, but not a selection of financial service providers. As a result, employees who opt for the convenience of purchasing at work may be even less inclined to shop around.

There’s no replacing face to face

Consumers are undoubtedly becoming more comfortable with technology in general, and more receptive to remote channels. For simple products and transactions, they are using telephone and online channels in ever greater numbers, particularly if they happen to be younger and more affluent. Roughly 30 percent of p&c insurance customers use a direct channel, for example, and the segments that use direct channels most have the highest average income and are among the youngest. In long-term mutual funds, sales made through direct marketing rose from 23 percent in 1985 to 41 percent in 1995.

As remote channels continue to grow, they will be used increasingly for more complex transactions and by broader segments of the population. At the same time, technology is becoming cheaper—and therefore more accessible to lower-income segments—and more user-friendly. In the United States, 29 million households now own PCs equipped with modems, and 16 million are active on line. Telecommunications costs have plummeted, and the number of main telephone lines for every hundred people has skyrocketed.

Consumers’ use of remote channels will also be prompted by their financial service providers. Institutions are starting to take steps to shift their customers to lower-cost channels, with great success. In a pilot market, one large North American bank was able to increase the proportion of transactions conducted by ATM from 65 to 92 percent in just six months. To do so, it launched a wide-ranging campaign: it informed customers about the benefits of remote channels through signs, letters, and meeters and greeters; reduced the availability of tellers while increasing the capacity and functionality of ATMs; provided direct incentives for customers and employees; and issued many cards to customers. PFS providers are discovering that customer behavior can be influenced, and they will try to do so with increasing frequency.

An important majority of customers will continue to prefer traditional face-to-face channels for the foreseeable future

But despite the growing acceptance of remote channels, an important majority of customers in most PFS sectors will continue to prefer traditional face-to-face channels for the foreseeable future. Ninety-eight percent of life insurance sales, 90 percent of p&c insurance sales, and 55 percent of brokerage transactions are still conducted through an agent, broker, or branch. Moreover, 81 percent of middle-income consumers claim they would prefer to purchase life insurance face to face in a representative’s office. Even Fidelity and Schwab, with their strong remote distribution capabilities, report that two-thirds of the new assets they attract are received through their branch networks.

Similarly, according to PSI, 72 percent of households still use a bank branch once a month, while 76 percent of small businesses cite the branch as their preferred channel for routine transactions. Further, while 36 percent of US consumers have a modem-equipped personal computer at home, fewer than 3 percent currently perform any banking transactions on line.

Educate me, please!

While consumers show little interest in shopping for financial services, they do have a growing appetite for education regarding PFS products, particularly if it is marketed around a significant life event such as retirement or sending your children to college. Consumers’ interest in learning about financial products is demonstrated by the dramatic increase in the number of printed and online financial newsletters. In a series of interviews we conducted with employers about marketing financial services in the workplace, financial education stood out as the product they most wanted to offer their employees. In particular, they were concerned that their employees should understand the importance of saving, both for retirement and for other needs.

Once customers are educated about their needs, a large segment may purchase immediately from the educator without shopping around

The popularity of financial education suggests that opportunities exist to sell education (or advice) as an independent product or product feature, or to use education as a hook to capture new customers. Since customers shop little for financial services, education may be an excellent first step to cross-selling a broad array of financial products. In other words, once customers are educated about their needs, a large segment may purchase immediately from the educator without shopping around. It would follow that there is a big first-mover advantage to reaching large groups of people with education or advisory services.

In search of trust

Finally, a large segment of customers across PFS sectors truly value a provider that they perceive as trustworthy. Trustworthiness in financial services may take many forms: a brand name with a national reputation, unbiased and consistently sound advice, or a recommendation from a friend, employer, or other trusted individual. Where advice is concerned, for example, does a provider recommend only proprietary products, or offer a wide range of branded, best-in-class options? Alternatively, is a realtor’s referral of a mortgage banker perceived as arm’s-length? Although some direct, nontraditional players, such as Schwab, have succeeded in earning the public’s trust by building strong brands, large traditional players are also well positioned to offer trustworthiness as a core element of their value proposition. Building trust requires the solid management of either brand or relationships; the former may be a more profitable approach over the long run because it entails less reliance on and sharing of value with relationship managers.

All told, channel management offers perhaps the most fertile ground for growth in PFS. The industry will ultimately be structured around customer needs and the new distribution channels and technologies that best serve them. The number of channels available for delivering financial services to consumers is exploding, creating huge opportunities for distribution-based competitive advantage.

Two kinds of opportunity are available that exploit the transition to this new consumer-based world. Most institutions should pursue both, drawing on a fundamental understanding of consumer behavior. They can increase the productivity of existing channels and improve coordination between them. And they can place smart bets for the future, crafting new value propositions around latent customer needs and launching new channels to meet those needs. The following articles sketch out three such opportunities.