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The Actuary The magazine of the Institute & Faculty of Actuaries
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A question of channels

Personal financial services (PFS) are in the
midst of a transition. Once, competition was largely defined by regulation and geography; now, the industry is organising around consumer needs and the underlying economics of products and delivery. As in other deregulating industries, margins are declining.
But personal financial services 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 behaviour help to accomplish this difficult task.
Channels have always been important in PFS they account for over half the cost structure of most traditional players. But in the current environment, channels have become the premier battleground. Consumer product preferences have reallocated assets and liabilities among providers; from 1993 to 1995 in the US, for example, consumer balances in securities (largely sold by brokerage firms) rose by $782bn, while balances in bank-dominated traditional deposit products rose by a mere $84bn. As a result, large traditional players such as commercial banks and insurance companies have steadily lost market share to new entrants.
But today, managing channels means much more than simply mastering individual channels like 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 emerge. 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.

The 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. While agent-based insurers still dominate household insurance, direct insurers are providing formidable competition. The ability to manage personal assets through the Internet is becoming commonplace.

Decoupling of distribution and manufacturing
As competition in PFS intensifies, companies are increasingly deciding to specialise in either the distribution or manufacturing of financial services. Players that are product innovators 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 Charles Schwab, or enjoy geographic dominance, like Northern Rock, 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 specialise in it; they may simply choose not to use it as the basis for further expansion and growth. Some insurance companies continue to distribute through their agency channel, for example, while simultaneously playing a manufacturing role for banks and brokerage firms wishing to sell insurance.

Reinvention, not elimination, of traditional channels
As distribution-focused PFS companies compete head-to-head with remote players, they are compelled to reinvent, but not necessarily eliminate their traditional face-to-face channels. The role of insurance agents, for example, has for some companies shifted from front-end prospecting (often involving cold-calling) to managing an existing client base or following warm leads generated centrally.

Integration of multiple channels
Most large PFS players are increasingly offering both traditional and remote channels, and most customers will begin 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.

Consolidation
Anyone who reads the headlines knows that consolidation in PFS, in part a response to excess distribution capacity, is well under way. The pace is unlikely to slow as companies under pressure to create shareholder value hunt for revenue growth and opportunities to rationalise costs.

How consumers buy financial services
Over time, margins will certainly decline as these trends continue, but opportunities abound for players that understand how consumers are likely to respond to them.

Price sensitivity
The size of genuinely price-sensitive customer segments is small. 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 back-end penalties or up-front 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, thereby capturing a greater share of industry profits.

Who wants to shop around?
The lack of consumer interest in shopping for almost any financial service is startling. Among mortgage customers, 55% contact only one lender, and 80% contact three or fewer. Just 13% of middle-income customers contact more than one company or representative when they purchase life insurance.
Yet the Internet promises to make shopping for financial services a lot faster. Using the Internet, a customer can obtain information on most high street UK mortgage products in less than two minutes.

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 on-line channels in ever greater numbers, particularly if they happen to be young and affluent.
As remote channels continue to grow, they will be used increasingly for more complex transactions and by broader segments of the population. Technology is becoming cheaper and more user-friendly, and therefore more accessible to lower-income and less technology-orientated segments.
Use of remote channels will also be prompted by financial service providers. Some institutions are taking steps to shift their customers to lower-cost channels. In a pilot market, one large North American bank was able to increase the proportion of transactions conducted by ATM from 65% to 92% in just six months, while Prudential’s Egg shut its doors to new business other than via the Internet. PFS providers are discovering that customer behaviour can be influenced, and they will try to do so with increasing frequency.
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. Even Fidelity and Schwab, with their strong remote distribution capabilities, have reported that two-thirds of the new assets they attract are received through their branch networks.

Educate me, please!
While consumers show little interest in shopping for financial services, they do have a growing appetite for education, particularly if it is marketed around a significant life event such as retirement or sending your children to university.
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. 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.
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 behaviour. They can increase the productivity of existing channels and improve co-ordination 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.

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