VIRGINIE LAGOUTTE BAEBA IV

THE DIRECT BANKING CHALLENGE

“This study is submitted in part fulfilment of the requirements of the degree of B.A.
(Hons) in European Business Administration.”

MIDDLESEX UNIVERSITY 15th APRIL 1996

ACKNOWLEDGEMENTS

This paper could not have been completed without the support of all those who devoted their
time and effort to make a contribution to this project.
I would first like to thank Mr Jim Downie, manager at the Unisys Financial Services
Knowledge Centre, for his valuable insight into the financial industry trends and issues.
Mrs Breeda Joyce, from Lafferty Publications, Mr Jonathan Regnard, from Deloitte and Touche
Tohmatsu International (France), for helping me to acquire relevant information;
Mr Jonathan Lang, from First Direct, for according me an interview and providing me with
very valuable information regarding the bank’s activities.
and finally, Mrs Vicky Allsop, my academic tutor, for all her help and advice throughout the
working of my project.

2
ABSTRACTS

During my third year placement at Unisys Corporation, an information company addressing the
financial services industry, I was struck by the rapid and provocative changes facing the retail
banking sector.

Whilst the pace and direction of change seems to vary somewhat from country to country, retail
banks everywhere are working vigorously to address new technological, regulatory and
competitive realities. Collectively they are trying to determine strategies and tactics needed to
secure their franchises and their futures. Direct services provision is one of the major strategies
that banks, all over the world are nowadays putting forward.

This project addresses four questions. First (part I), what are the forms of direct service
provision which are developed in the financial services industry. Secondly (part II), which
factors have caused the growth of remote delivery systems worldwide. The third part deals with
one of the specific forms of direct service provision, that is to say telephone banking. The First
direct case study, in a fourth part, demonstrates how the Midland Bank developed and
implemented such a new strategy.

3
INTRODUCTION...........................................................................................................6

CONCLUSION.............................................................................................................58

APPENDICES.............................................................................................................59

4
INTRODUCTION

Traditional retail banking is typically characterised by “brick and mortar” branches.

Competitive advantage in the banking industry in earlier days came from careful planning of
the branch network. Accessibility of banking services to the customer meant branches on every
street corner.

Expectations of bank customers have risen sharply and they now request banking services to be
available any time. The boom of Automatic Teller Machines (“The single biggest change that
the banking industry has witnessed this century”1) has shown that customers are willing and
able to perform standard banking activities via self-service machines if this means that they
have access to their bank accounts at any time they want. Convenience seems to be the keyword
for the banking industry in the future. Accordingly, most larger financial service institutions are
experimenting with the use of services such as telephone and home banking.

At the same time banks have recognised that traditional banking is costly for the organisation
and competitive pressure leads to more cost-awareness. Staff in “brick and mortar” branches are
heavily occupied with paper work regarding standard transactions which could be automated.
Automation not only means major cost reductions for the banks but also a high increase of
accuracy and reliability, since technology, provided that it is set up correctly, is able to perform
routine tasks more accurately than humans.

With deregulation in all of the Western European countries, barriers of entry to providing
banking services have declined. Furthermore, insurance companies and other non-financial
institutions are entering the market taking away large numbers of traditional retail banking
customers. The intangibility of services facilitates the swift copy of any innovative ideas and
the number of financial products and services on offer is constantly growing.

The telephone has revolutionised the way banking is done in the USA and Europe. Many banks
now offer banking via the telephone and direct banking has had a huge take up in recent years.
The immense success of First Direct in the UK is one example which has shown that the
introduction of electronic delivery channels is one way forward for European retail banks.

1
Stuart Chandler, “The changing Face of Retail Banking in the 1990’s”, Speech delivered to the 7th
annual conference, Technology for retail banking, London, 23 November 1994.

5
THE FORMS OF DIRECT SERVICE PROVISION.

The term “direct service provision” refers to a wide range of media used to make contact with
the customer. Initially, it could be thought of as direct contact between suppliers and customers
without an intermediary network or person. Media such as the post, the telephone and direct
interface with a supplier’s computer can be used, not only to initiate contact between the
customer and the supplier, but also to provide information about services and products, and, in
an increasing number of instances, the means of supply.

In its simplest form direct service can be provided and accessed through the postal service. The
telephone and payment cards can also be used to provide direct access to the customer. Such
operations often work hand-in-hand with a direct marketing campaign which segments the
market-place ( a critical process in identifying potentially profitable business prospects). It is
important at this point to distinguish between direct marketing (a means of making contact with
customers) and direct service provision (which concentrates on servicing the needs and wants of
customers).

The direct sector breaks down into four key groups relating to financial services: postal
delivery, payment cards, telephone systems and screen-based systems where the customer
communicates directly with the supplier’s computers.2

Direct postal provision.

Postal-based accounts have provided a growth opportunity for organisations which want to
increase their range of services without substantially increasing overheads. This particularly
true of countries where the residents are scattered over a wide area, away from cities. The post
have played a crucial role in both traditional and new delivery systems. It is the usual medium
through which bank branches and other financial services suppliers communicate with their
customers base. Even more technologically advanced delivery systems ultimately rely on the
post to some extent. Instructions often have to be confirmed in writing: facsimile documents
were still not, as a rule, legally binding in the early 1990’s.

The postal system can also be used to service customers directly from a centralised base.
Deposit and payment instructions can be sent by post. Insurance products can be bought by
post; shareholders wishing to buy and sell shares can issue instructions by post.

Taken in conjunction with direct debit, a postal-based banking system can be quite
sophisticated for retail customers as well as for small corporate entities. Many banks provide
2
“The Direct Banking Services”, Lafferty Business Publications

6
this type of facilities, particularly for customers who live in remote locations or cannot easily
reach a bank branch.

A number of institutions have used the post to get access to cheap retail deposits. This is the
case in the UK, where a number of building societies led by the Cheltenham & Gloucester and
Bradford and Bingley building societies have used the mail to supplant their branch networks in
taking small deposits. One in three of Cheltenham & Gloucester’s 1.2 million account holders
has a postal based account. With no need to meet the costs imposed by a branch network, such
accounts can pay higher interest. However, they do not usually carry a cheque or payment
facility.

Postal accounts, being a new feature for many of these businesses, have attracted many new
customers. Postal operators generally provide first-class freepost envelopes to make deposits
and withdrawals which generally processed on the day of receipt. Some operations have
dispensed with the need to send in the passbook to minimise the chances of loss in the post.
When used in conjunction with Automatic Teller Machines (ATMs) and payment cards, a
postal-based system can be quite sophisticated. In France the investment fund company Cortal
uses post for interest-bearing cheque accounts, as well as to provide investment products. In
Germany, postal accounts are very common.

Postal-based direct marketing tools

Coupon-based selling.

Coupon-based selling, which is normally aimed at a wide audience (newspaper or magazine),

can be used by any financial services provider. A variety of products can be purchased through
this avenue, particularly in the life insurance and investment services sector.

Fidelity Investments, for example, has increasingly used coupon-based marketing material on
both sides of the Atlantic to attract new business. Indeed, to promote its products and services,
Fidelity Investments relies heavily on mass media advertising, primarily print and television, as
well as direct mail. Although Fidelity does not reveal its annual advertising budget, an
estimation for 1991-92 fixed expenditures at $55.6 million excluding expenditures in the Wall
Street journal, including them the figure would be as high as $ 72.2 million. Fidelity has also
expanded its mass marketing utilising regional daily newspapers as well as national
newspapers. According to a company spokeswoman, coupon-based marketing is very important
in reaching new customers.

Governments sometimes impose restrictions on this type of activity. In the UK, although
regulators do not review all financial advertising, there are regulations to prevent customers
being misled. Similar restrictions exit in Germany and Portugal. In Belgium and France, each

7
advertisement is individually examined by a relevant authority. Although coupon-selling is
widely used in the US, it is strictly controlled. Advertising which might invite the vendor to call
for further information is also scrutinised closely.

Direct mail.

Direct mail, regarded as a “junk” for most of the 1980’s, has been revitalised in the 1990’s. It
has been useful for companies seeking new ways of attracting clients without relying on a
costly street presence. Direct mail is used most by insurance companies throughout Europe and
the US, where insurers have found that direct mail provides a good way of overcoming barriers
imposed by the traditional broker approach. It gives the client the opportunity to begin a direct
relationship with the company.

Selling by direct mail is permitted in the European Community, although there are a large
number of regulatory controls. In France for instance, mailing list access is controlled by the
Commission Nationale Informatique & Libertés. Elsewhere, access to mailing lists is freely
available.3

Cards.

The ultimate direct service vehicle is the credit card, particularly those which provide a credit
facility, such as charge or revolving credit cards. American Express4, for example, has built a
whole range of financial and other products around its card. Indeed, the classic green American
Express card is not only a charge and credit card. In addition, it also offers cardmembers 24
hour customer service, legal and medical assistance, automatic travel accident insurance, and
travel booking facilities. Many other institutions in the US and the UK are following American
Express’s lead. Non-bank institutions are becoming particularly active and are using the card as
a vehicle to move into financial services. With its Universal card, AT&T has become a strong
competitor in consumer lending in the US. Rather than opening financial services branches, it
uses the card in conjunction with the telephone and mail to maintain a customer relationship.
General motors, for instance, in a tough market hit by recession, launched a co-branded card
with Mastercard in 1992. According to Ronald Zebeck, General Motor managing director of
credit operations, “the GM card is viewed by the company as a marketing tool”. Even so the
card has a valuable financial aspect: it offers a revolving credit at interest rates much lower than
those offered by bank competitors, together with discount and rebate facilities. Within five
month of its launch, GM credit card became the most successful card ever in terms of account
holders gained. In that short time it has attracted over 3.5 million accounts. The card represents
one of the biggest non-automotive launch in the GM’s history, allowing GM to use credit card
as a mean of building direct relationship with clients.

3
Direct Mail: ”Targeting for Success”, Charles Hinkle, Bruce Alexander, Journal of Retail Banking
4
American Express Information Pack.

8
Usually sold as a separate product from a bank’s mainstream account facilities, the payment
card allows an institution to capture new clients from outside its existing customer base. A
revolving credit facility can be exercised remotely through repayments and deposits can be
made by post or direct debit. This can then provide a cross-selling opportunity for further
products from the bank. The delivery of a charge or credit card is usually followed by mailshot
inviting the card holder to take advantage of the issuer’s other loan, insurance and investment
products. Some institutions have used cards as an integral part of their direct operation. This is
the case with Save & Prosper , a UK mutual funds company. Save & Prosper adopted, indeed,
a unique attitude towards its credit card products. Instead of viewing them as a basic product
operating on one business level, it began to use the card as a strategic tool which could allow
the organisation to exploit cross selling opportunities. Lindsey, the director of the company,
said: “We looked around for some other way to expand the annual market. We, then, came
across the idea of a low interest credit card. Basically this was aimed at various customer
grouping, the intention being that we should have lower than average bad debt provision and be
able to pass this benefit onto our customer. We know that between 25 to 30 percent of our
customers have bought other products from the group and this is growing at about five percent
per annum. So in a way, instead of viewing credit card as a product, we looked upon them as a
distribution network.”

Many customers are, in fact, dealing remotely with their bank though they may not realise it.
On an everyday basis the debit/cheque card can be used to access remotely an account
relationship with a bank. Deposits and withdrawals can still be made remotely through the post
or ATMs. As a result a customer never really needs to enter the bank.

9
 Telephone

There are two main methods of providing direct service by telephone. The first is through
person-to-person contact by telephone. The second and much more simple approach is by
automatic voice response systems accessed by telephone.

The Human-operated direct service sector.

This area has been perceived as epitomising direct service provision following the success of
First Direct in the UK, which I will study later on. Direct service provision has come to
prominence in almost all financial sectors as a way of establishing a strong remote relationship
with a consumer without the need for a branch network. 5 While ATMs and branches are used to
support the service, they do not take away from the essence of the direct relationship. Direct
service provision by telephone has also become an increasingly important part of many
companies’ strategic planning process.

Voice response.

Voice response services offered over the telephone have been extremely attractive to financial
institutions. they are frequently used by banks to give customers direct access to their accounts.
It is a more limited option than the direct models described above, but it has the advantage of
providing direct access to an entire customer base while minimising capital expenditure. Such
telephone usually require the use of a multifrequency (MF) handset which allows the customer
to press particular buttons in response to synthesised voice responses. This can also be done by
hand-held tone makers. As a result the services provided, such as balance enquiries, are limited,
but can be accessed quickly and with minimum effort from the user.

As a whole direct service sector is currently dominated by three approaches: the stand-alone
unit, the add-on option, the niche non-bank that I will study later on.

Screen-based systems.

In most cases, screen-based systems, also called direct computer interface, allow the customer
to interact directly with the bank or service provider, that is to say, to access the computers of
the financial services providers. Screen-based systems break into two main groups: videotex
and PC-based services.
Although many banks have initiated programme based on direct computer interface, results
have been mixed. Users must own, or have access to a computer. This has been a constraint in a
number of instances. With the exception of France, where home computers were distributed
free of charge (Minitel), the number of household in possession of a computer is low. In the US
5
“Telephone Service Dominate the Personal Market”, Banking World, January/February 1990, pp 48-50

10
for example, lees than one third of household are equipped with PCs. As a consequence, these
facilities have tended to be used by corporate bodies, this is what is called office banking, or by
relatively affluent retail customers (home banking, smart phones).

Office banking.

Direct service provision has been especially successful in servicing the needs of corporate
customers. Typically, these services offer business customers: balance reporting; interest rates
information updated; access to full statement details, including ledger balances; electronic
reconciliation of cheques and identification of outstanding cheques; input for payments
systems; and transfers between accounts held at a customer’s branch.

Home banking.

The traditional screen-based home banking service can suffer from customer resistance to the
gadgetry involved. France's Minitel6 - an interactive teletext attached to the phone - has brought
a minor revolution to French domestic life, sweeping away paper, providing unparalleled
information and offering new forms of entertainment such as home banking services. In the
European market videotex systems which can operate through a customer’s television receiver
have had the best results. A recent development in this respect has been in television dedicated
services.

Smart phone.

A smart phone is not a computer terminal but an enhanced telephone, offering a range of
telephonic services as well as access to network services. Although the customer will see it as
just a telephone, it can offer the power of a personal computer (keyboard, display, processor,
memory) with built-in communications and security via smart card capabilities.

Smart phones have not yet had a full impact on the remote financial services sector. The cost of
expanding and developing these services further has been a limitation. AT&T just began to
market its video Phone in 1993. Its impact on the financial services sector has not yet been
assessed.
To conclude, while it is easy to identify different forms of direct service provision, to categorise
each individually is a complex affair which has to take account of marketing, logistics and
technology. Direct service is in effect an all-inclusive term, encapsulating a movement away
from traditional “bricks and mortar” financial institutions. Debate might still take place as to
what should be included in this concept, but its effect on financial institutions worldwide
cannot be doubted.7

6
26th February 1995, “France: Minitel's Next French Revolution”, Observer.
7
“The Direct Banking Services”, Lafferty Business Publications, 1995

11
The growth of remote delivery systems.

A long history.

Although direct service provision seems set to dominate distribution strategies during the 90’s,
the concept already has a long history. In remote, sparsely populated countries, production
suppliers were forced to develop direct delivery methods at a very early stage. The concept was
pioneered in the United States by Sears, Roebuck & Co. From the 1890’s onwards, it supplies
the american west by mail order, with a vast range of goods from its Chicago headquarters. The
Sears, Roebuck Model was easily adapted to the banking and financial services sector. Banks in
rural areas began to develop rudimentary postal banking facilities. In some countries the postal
service took a dominant role in providing products and services. During the 1920’s, the US
Automobile Association (USAA) was established to provide motor insurance for US army
officers. Because of the lifestyles of army persons USAA was forced to rely heavily on the mail
first, and then the telephone to communicate with its customers and deliver insurance policies.

Other groups, such as postal life insurance company of New York and department store groups
such as JC Penney, Montgomery Ward started to market and supply life insurance products by
post during the 20’s and 30’s. These campaigns were directed at customers prevented either by
lack of income or physical remoteness from dealing with conventional suppliers.

The arrival of the charge and credit cards during the 50’s enabled the direct service sector to
make a significant move. Within a short period of time, companies like American Express built
an extremely large direct business on the back of the charge and credit card.

With increased use of computers, the development of ATM and bank payment cards, automatic
credit transfers and direct debit facilities, many banks were able to offer relatively sophisticated
direct banking facilities such as bill paying by telephone from the 70’s onwards.

The development of these services was rather limited, however, and restricted to remote
customers. Direct banking received low priority. In an era when non-price competition
predominated the majority of banks, efforts were concentrated on increasing their physical
presence.8

Keys factors driving changes in the 1990’s.

Long ignored by strategic planners, distribution strategies have been regarded traditionally as
local decisions for low-level management. These decisions were usually based on short term
8
“The Future is Direct”, Lafferty Business Publications, Executive Summary

12
concerns rather than the long-term good of the organisation. In some cases distribution channels
evolved by chance, rather than through conscious planning. Despite this random development,
direct service provision looks set to play a key role in distribution strategies across the financial
services spectrum.

Indeed, direct service provision is set to transform the retail financial sector during the 1990’s.
Retail banking and insurance markets around the world are experiencing fundamental changes.
Many of the changes taking place are nothing less than revolutionary. The process of change, or
the transformation of a relatively stable financial service market, where outcomes were
predictable, to a dynamic market where outcomes are very unpredictable, is undoubtedly “the
trend”.

Far from being confined to individual country market, they seem set to have an impact on
financial markets throughout the rest of the world, although there will of course be differences
in timing. Throughout Europe and North America, direct interface with banks’ computers and
the use of the ATM card, telephone or mail to supply a variety of financial services directly to
the customer has become increasingly widespread.

In the UK, every major bank has introduced at least one direct, or telephone banking initiative.
Midland Bank’s First Direct subsidiary has started to built up significant market share despite
having no conventional branches. Continental European banks are also showing considerable
interest in the possibilities presented by remote delivery. A similar situation prevails in the
United States. Although banks have been particularly active in this field, non-bank institutions
like American Express have pioneered new levels of service quality.

A number of initiatives have been made in this respect elsewhere. Banks in Hong-Kong, for
example, have introduced a range of direct facilities that compare favourably to, if not surpass,
initiatives elsewhere. In Thailand, it is possible to buy and sell mutual funds through an ATM.
A bank in Israel is experimenting with ATMs which allow customers to buy and sell bonds. In
Singapore, it is possible to buy and sell securities via an ATM.9
Nowadays, to succeed, and even to survive in this new environment, players are faced with a
dilemma: stick to the status quo and lose both market share and profitability, or cut costs,
rehabilitate their product range and adapt their distribution channels into a new competitive
weapon. Strategists can no longer rely on chance events to provide success. Going direct is now
not only a growing feature of financial services but also of the retail sector generally. In fact, it
is rapidly becoming a cornerstone of all retail operations. A recent survey in the US found that
29.8 percent of the population, or 54.4 million people, purchased clothing directly from home;
16.7 percent, or 30.5 million, brought magazine by phone or mail; and 3.2 percent, or 6.7

9
“Distribution 2000”, Lafferty Business Publications, 1995

13
million, purchased food by phone or mail in 1991. 10Bank products differ from say clothing.
When buying clothes, customers feel the need to touch the material, to try them on to see if it
fits. This is of course not applicable to banking products. Then, one can expect even better
results for direct banking.

Direct service provision has developed as a reaction to the pressure and opportunities in the
financial services sector over the past decade. A number of factors have caused the international
growth of direct service provision. For convenience these can be divided into supply and
demand factors.

Supply- side effects.

Need for costs reduction.

The most important reason for adopting direct services comes from financial service providers’
need to reduce costs in dealing with customers. Deregulation and liberalisation in the financial
services sector has made financial services markets increasingly competitive, with the emphasis
on price. Indeed, new competitors, offering innovative products and services and not burdened
by the expense of running large expensive physical branch network, are able to attract many of
the banks most profitable customers and offer high margin products that do not require any
physical presence.11 Consequently, cost structures assume much greater importance. With
financial institutions facing greater constraints on how they can pass on increased costs, the
ability to provide products and services on a cost-effective basis may not only increase margins
but also create an advantage over competition.12

In both banking and insurance effort is being spent on reducing costs while maintaining, and in
many instances enhancing, service quality. This has resulted in all products and systems being
examined in minute detail. Building and manpower, which make up the vast proportion of
costs, have come under particular scrutiny.

A common feature of both banking and insurance sectors has been the emergence of the
“factory” and “showroom” concepts. With the arrival of new technology, many of the functions
traditionally carried out by humans can be replaced by machines. Indeed, increasingly, the
world of banking and insurance is moving away from one denominated by hybrid
paper/electronic systems to one in which a process is automated. Since automation usually
brings economies of scale, this has tended to result in automated processing operations being
“clustered” in centralised institutions. This has often meant that processing has been completely

10
1992/93 Statistical Fact Book, The Direct Marketing Association, US
11
“Distribution 2000”, Lafferty Business Publications
12
“The Direct Banking Services”, Lafferty Business Publications

14
separated from the showroom or branch, which can be used for other functions, typically selling
products.

The US Federal Reserve Bank undertook two studies, separated by ten years, to understand the
cost dynamics of cheque processing and they give an illustration of the impact processing can
have on the costs of banking. At about 200 million items per year in 1976, dis-economies of
scale clearly set in. In other words, the unit cost per transaction rose above this number. Two
things happened in the second study. Firstly, the cost of processing per item did not begin to
rise until about 375 million transactions per year. In other words, in 1983/90 the optimum size
of a cheque processing centre was almost twice that of 1976. Equally interesting is the fact that
the unit costs did not rise anywhere as quickly beyond 375 million transactions per year. In
other words, if a 1990 processing centre had handled, say 600 million items per year, it would
not in cost terms have been significantly disadvantaged, unlike a 1976 one. It does not take a
particularly large leap of the imagination to conjecture that the next study by the Federal
Reserve might show a situation in which the cost to process would continue to decline within
any realistic size.13 Deloitte Touche analysts believe that the conclusions from this study are
actually generalisable to most areas of retail banking and insurance companies. In the future,
they say, ”there will be no cap to scale economies for most retail banking and insurance
activities, and larger banks will increasingly be able to obtain scale advantage over their
smaller brethren. This is because many of the activities within cheques processing are similar
to those found in other parts of retail banks and insurance companies.”14

Direct delivery is a natural extension of these concerns. In the new cost-conscious, competitive
environment, direct dealing can represent the ultimate in cutting costs. Provided that there are
facilities for making deposits or receiving cash, a completely automated retail financial services
sector where human participation is limited to the customer is not unplausible.

In practice, through, this is unlikely to happen. Financial products tend to be sophisticated in

their nature. Customers often need to speak or deal with humans, if only for reassurance. When
dealing with their finances, customers are definitely seeking for privacy and institutionalised
trust. So most direct operations usually put some emphasis on the human touch. Indeed, First
Direct, which has pioneered the concept of branchless banking, places considerable emphasis
on the fact that its telephones are operated by people.

For most financial institutions, direct service provision is likely to play a growing role,
displacing to an extent conventional delivery systems such as the branch network. Successful
financial institutions will attempt to optimise the delivery system by providing range of
delivery systems that will bring its products to market at a lowest costs.

13
“The Future of Retail Banking”, Federal Reserve/Braxton Analysis.
14
“The Future of Retail Banking”, A global perspective, Deloitte Touche Tohmatsu International, 1995

15
 Market Implications

Direct service provision is not all about saving costs. It can be used to move into new markets,
and in some cases to reassert control over existing ones. It is capable of transforming the whole
nature of the market.

Insurance companies have turned to direct selling as a means of gaining control of their market
place, in a situation where costs are under threat and underwriting losses mounting. Insurers
selling personal lines, such as car and property insurance, have used direct selling to reduce the
role of the brokers and intermediaries. Not only does this allow savings, it stops the distorting
influence that brokers have had on underwriting and pricing in particular. Direct selling then
enables insurers to price their products. This often benefits customers through lower prices. In
that case, direct selling, by cutting out the broker, allows an insurance company to capture the
customer relationship. Opportunities thus arise not only for repeat sales but also for selling
other products.

Direct service provision can help transform the markets through increasing service quality.
This, again, can be clearly seen in the insurance sector. Although intermediaries can often
provide a cost-effective service, a direct insurer can make sure that its customers receive
efficient treatment. The direct contact between customer and insurer provides increased quality
of services.

A branch network or a sales force have been traditional barriers to both banks and insurance
companies wishing to move into new geographical markets. With the advent of the European
Community’s single market, this barrier has taken on a new importance. Direct service
provision allows all ties to be broken. There are already examples of financial institutions
which have used direct methods to move into new markets. In Japan, Citibank used direct
banking to avoid the problems posed by a branch network, an important issue in Japan due to
the exorbitant land prices.

Technology.

Technology has been a major force behind the financial services’ move towards direct service
provision. As a consequence of technological developments, particularly in
telecommunications, information technology (IT) and data processing, the traditional customer-
supplier relationship can be restructured. Many functions for the supply of financial services
can now be centralised into the equivalent of “factories”. More and more complex products can
be handled with lower personnel costs. New technologies have created alternative distribution
channels for financial services products (see appendix I). Technologies in the form not only of
the ATM, but also telephone, home-based smart telephone, home-based computer and indeed

16
the domestic television set will in the future increasingly be able to be used as channels for
financial services activities.

Technology-intensive new channels indeed offer the opportunity to be considerably lower cost
than the traditional delivery channels in providing any given service. As an example, the
following chart taken from a recent BAI study of the US retail banking industry shows that a
telephone banking service can, for the same customer, be approximately 40% of the cost of a
similar customer operating through a retail branch. The main savings in using telebanking
accrue from the elimination of the branch personnel, as well as the resulting lowering cost of
the branch and branch network management overhead costs. This is a powerful conclusion. It is
rare in the history for the cost of distribution to be able to be halved. This create a strong force
for banks to wherever possible migrate to lower cost channels.

New channels are lower cost than retail branches

In the US, telephone banking is more than 50% cheaper than
branch banking
Annual cost per account (US$)

120
100
80
60
40 Direct Provision and Overhead
20 Branch & Netw ork Overhead
0
Nonbranch Delivery Costs
Bank Branch Telebanking
Benchmark Cost Occupancy
Benchmark Branch personnel

Source: BAI (USA)

Indeed, this trend would appear to be well underway. The following chart shows the evolution
in Europe of market share by channel for a number of commonly used retail banking products.
In almost all cases, either the “traditional alternative to bank branch, the independent or tied
agent or new channels such as telephone, direct marketing, and so on are gaining at the expense
of the traditional bank branch. This study, which was conducted for the majority of the
countries in the European Union, shows the evidence that these new delivery channels have the
potential to offer similar service, if not better, at lower cost.

Non-traditional channels are gaining market share, Channel share by product (Europe *)
Deposits Consumer loans Housing Finance Mutual funds Life Insurance
Bank Branch 99% 51% 73% 57% 13%
Traditional Tied Agent 0 1% 13% 29% 78%
Others 0 27% 14% 0 4%
Non Traditional Direct Marketing 1% 11% 0 14% 5%

* Belgium, France, Germany, Italy, The Netherlands, Portugal, Spain, Switzerland, UK

Declining
Growing
Stable

17
Technology’s impact on organisation’s cost structures can create dramatic cost reductions at all
points. With a carefully managed database, the possibilities for expanding customer numbers
are great. Cross-selling can result from the integration of all information held in the
organisation’s various systems in order to built a complete picture of the customer and identify
opportunities to sell further services. This is easier to manage with technology-based
management of the database. As a result, the operation is also able to design more focused
products. Products which are better tailored to specific customer’s needs will complement a
resulting movement to customer-based accounts rather than account-based systems to support
more focused products and cross-selling objectives.15

15
The Future of Retail Banking, A global perspective, Deloitte Touche Tohmatsu International, 1995

18
 Demand-side effects.

Lifestyles

Financial industry observers note that the sector is beginning to feel the influence of three broad
streams of change which are affecting consumer attitudes.16 First, there is economic change.
Consumers are considerably better off than in the past. But as Guy de Moutray notes, there is
more to this than an increase in wealth. Consumers are showing much greater discrimination in
their search for value. As Maynard Keynes predicted, “For the first time, man will be faced with
his real problem, how to occupy the leisure which science and compound interest will have won
for him, to live agreeably, widely and well.”

The second stream is demographic change, a worldwide phenomenon. In the US and Europe,
the demography is changing as a result of the ageing of the populations in general, and the
ageing of the post-second world war generation in particular. The post-baby boom generation is
in general better educated with more sophisticated tastes. As this group grows older, it will
invest more and borrow less, creating opportunities for manufacturers of a whole variety of
products (see appendix II)

The third factor is the changing role of women in society. This role is increasingly influenced
by the changing age structure, increasing participation in the work force, more divorce and
higher average age of marriage and birth of the first child. The proportion of women aged 15 to
64 in the labour force is becoming very high. In the UK the percentage of women at work was
61% in 1986 (second in Europe to Denmark, 75%). According to the OECD, the figure is
expected to rise to 65% by the end of 1996. As time is such a crucial factor for families in
which both parents work, direct service provision is highly attractive, if not essential.

Consumers’ general attitudes.

Based on various studies, two generalisations can be used to explain consumers attitudes
towards remote delivery systems.

First of all, consumers have become more comfortable with electronic distribution systems.
ATMs have made consumers comfortable with the use of technology for financial services
transactions. Other developments in the area of self-service systems, such as petrol stations,
telephone information and reservation systems, and self-service transportation ticketing
systems, have supported this change in consumer behaviour. Increasing use of PCs, fax
machines, VCRs, telephone answering machines and cellular phones is further conditioning
consumers to use more complex remote delivery systems.
16
“Banking is Not Like Selling Toothpaste”, Guy de Moutray, Journal of Long Range Planning, 1991

19
Secondly, consumers now expect and demand good service. Elements of good service include:
• Convenience, which itself include:
- being available when needed, wherever.
- speed in conducting transactions
- being situated close to home or work
• Control, including instantaneous customer access to information regarding personal
finances, and an enhanced facility to manage, record and analyse the information.
• Ease of doing business, including reduction and elimination of stress and complexity.17

In other words, consumers want control, information, a wide variety of options and flexibility
presented within a transaction framework that provide both convenience and choice. I believe
this general consumer attitudes to be crucial for the development of remote delivery systems.

Age/income correlation.

Research has shown a strong correlation between a user’s age and his usage of electronic
distribution systems. In general, younger people are significantly heavier users than are older
people. Given established habits and fear of technology, change and making a mistake, this is
very logical.

Income is also strongly correlated to use; with high income consumers being heavier users of
electronic systems. This may also be considered a self-fulfilling prophecy, because higher-
income customers have more assets and have a greater need to access and manage it. Higher-
income consumers tend to have more and varied accounts to meet specific needs (see appendix
III).

This two correlations also tend to explain the trend towards direct service provision. Indeed,
most of young people who are currently computer literate and feel no fear of technology are the
high income consumers of tomorrow. As a result, it can be easily concluded that consumers will
be more and more asking for remote delivery systems.

To conclude, as a result of the combined effects of deregulation, the advent of new technology
and behavioural change most, if not all, of the parameters which define financial markets are
experiencing a metamorphosis to the point at which it is becoming increasingly difficult to
identify separate individual product markets. At the most basic level, for example, it is
becoming increasingly difficult to define precisely the banking market in a number of countries,
particularly at the retail level. To an increasing extent, the term “retail banking” is having to be
replaced by “retail financial services”, a definition which encapsulates a much wider range of
17
“Distribution 2000: Consumer Attitudes and Opinions: Existing and Future Usage”, Lafferty Business
Publication.

20
activities and includes other institutions as well as banks. The changes have also affected the
behaviour of the institutions concerned. Institutions with financial services interests are
evolving into a completely new environment. It has certainly an impact on the way in which
institutions are organised and structured, the products they supply but most of all on the
manner and basis upon which they are supplied and distributed.

21
Telephone banking.

Background

Telephone banking is an area which has taken off, and has captured the interest of all banks and
building societies as well as the public. Home banking by telephone and post was once seen as
only for movement of cash between accounts or bill paying. In recent years the emphasis has
moved to telephone rather than postal use, while it is now seen as a full telephone service
offering as much and perhaps more than a conventional branch can.18

As both traditional and new players jockey for position in the deregulated retail banking
industry of the 90’s, telephone banking has emerged as a key competitive weapon. By shifting
resources from sprawling branch networks to centralised direct distribution points, banks can
score on two fronts: lower distribution costs which translate into a more competitive product;
and greatly-increased access for customers, who can bank by telephone whenever they choose
and from wherever they happen to be.

Although market penetration varies by country, all banks that have invested in telephone
banking report that it is especially popular with younger, well-educated and more affluent
individuals: in other words, the type of customer who tends to generate a disproportionately-
large share of retail banking profits. A recent Keynote research shows that 50 per cent of
telephone banking users in the UK are aged between 18-34 years old.

UK Users of Telephone Banking

50
% of Telephone Banking

40

30
Users

Series1
20

10
0
18 - 34 35 - 54 55+
Age Group

Source: “The Retail Banking Industry”, Keynote

By the mid-1990’s, telephone banking was well established in the US, the UK and in the
Nordic and Benelux countries, while a rush of initiatives in Germany and Spain made them

18
“Developments in Electronic Banking”, Mintel International Group, 1994

22
markets to watch. Market surveys predict that in countries such as the US and the UK, up to
one-third of customers will be banking by telephone by the year 2000.

By 2000, 30% of transactions will be conducted over the

Telephone in the USA
Proportion of Transactions

100%
80%
60%
Other
(%)

40% Telephone
20% ATM
0% Branch
1994 2000

Source: BAI

While some of the world’s most innovative direct banks are located in Europe, telephone
banking in general has had a slower start there than in the US. According to Datamonitor, a
market-research consultancy, some 6 percent of Europeans conducted their financial business
by telephone in 1994 and the market was worth about $200 billion. By 2000, however,
Datamonitor predicted that the figure will have grown to $1,000 billion. 19As regards telephone
banking, Datamonitor found the highest usage rates in the Benelux countries, followed by the
UK and France. By 2000, however, the UK is set to take over as Europe’s telephone banking
powerhouse, with about one-third of customers banking by telephone.

Penetration of Telephone Financial Services (1994)

25

20
Penetration (%)

15
Retail Banking
10
Property and casualty Insurance
5 Investment management

0
UK

Belgium
France

Germany

Italy
Netherlan

Spain
ds

Source: Datamonitor.

19
“European Telephone Financial Services”, Datamonitor, London, 1995

23
 Penetration of Telephone Financial Services (2000)

40
35
30
Penetration (%)
25
20 Retail Banking
15 Property and casualty Insurance
10 Investment management
5
0
UK

Belgium
Germany

Italy
France

Netherlan

Spain
ds
Banking penetration refers to number of customers using telephone banking.
Insurance and investment refers to the percentage of transactions carried out over the telephone.
Source: Datamonitor.

Telephone banking encompasses a wide range of service options, ranging from limited-menu
automated voice-response units to the wide range of products and services available from a
person-to-person direct banking operation. Telephone banking can be used simply to support
the efforts of a bank’s branch network, or as the bank’s only distribution channel.

Types of telephone banking initiatives.

Telephone banking initiatives can be classified in three types: add-on services that give
customers of traditional branch-based institutions the option of banking by telephone; stand-
alone direct operations set up as branchless banks by traditional players in the retail banking
market; and niche direct banks that seek to capitalise on the cost advantages of direct
distribution to offer customers a better deal on a limited range of financial products.20

The add-on option.

This approach uses human operators as an “add-on” support facility, to augment existing
services. This was the case in Girobank’s support phone facility. Girobank has, indeed, become
an increasingly important player in the UK banking retail market. A telephone banking pioneer,
Girobank recorded a profit of £48.4 million in 1991 and in 1992 began expanding its distinctive
range of product through its parents, the Alliance & Leicester Building Society. It turned to
direct service provision in the mid 80’s as a way of forming a direct relation with its customer
base, which was previously serviced solely through the UK’s post offices network. Girobank is
then increasingly turning to high service quality telephone banking while at the same time
broadening its customer base at little extra cost.
20
“From Teller to Telephone”, Lafferty Business Publications, 1995

24
With an add-on direct banking facility, the key question is how to position it in the market
relative to the bank’s existing branch network. Direct delivery has advanced to the stage where
most of the products and services available in a branch can be delivered by telephone. In theory,
therefore, the branch, as a distribution outlet, is redundant.

In practise, people’s innate conservatism when it comes to financial matters means that banks
which start hanging “for sale” signs outside their branches may be acting with undue haste. A
large proportion of customers will continue to want the option of over-the-counter banking so
that the Branch is likely to remain a key element in the distribution mix for the foreseeable
future.
The problem lies in reaching an accommodation with a competing and more cost-effective
delivery channel - the telephone.

The solution adopted by more aggressive banks is to seize upon direct delivery to push through
cost savings by pruning their branch networks. Many banks are shifting routine enquiries and
transactions to add-on telephone banking services, thereby freeing up their branches to
concentrate on selling. The likely losers are banks that are simply responding to circumstances,
launching telephone banking services as a “me too” reaction to their rivals, without any clear
strategy for what this will mean for their existing distribution channels.

Another consideration is that direct banking tends to gain greatest acceptance among more
affluent customers. This leaves banks with a dilemma of having their best customers use a low-
cost distribution channel, while their less-profitable customers continue to seek service through
the high-cost branch network.

Moreover, another reason why banks are sometimes reluctant to push direct banking more
aggressively is that it would have serious implications for their traditional distribution vehicle,
the branch network. Research by accountants Deloitte Touche Tohmatsu International (DDTI) 21
concluded that, because of the emergence of low-cost distribution channels, branch networks in
countries such as the US and the UK would shrink by up to half in the ten years to 2005. In the
UK, this would mean the closure of over 9,000 branches and the loss of up to 50,000 jobs; in
the US, as many as 450,000 bank jobs could disappear (see appendix IV).

Banks with big branch networks are therefore facing a dilemma: they must provide some form
of direct banking as a “me too” reaction to moves by their traditional rivals and the growing
ranks of niche direct banks. Unless they compensate with cost savings in their branch networks,
however, their direct banking initiatives will become little more than another layer of cost.

21
The Future of Retail Banking: A global perspective, Deloitte Touche Tohmatsu International, 1995

25
 The Stand-alone option.

The most noted example of this type of operation is First Direct, the parent firm of which is the
Midland bank. As part of an overall strategy, direct operations are usually separated from the
parent organisation as strategic business units (SBUs). This may occur for a number of reasons.
There may be simply too many constraints to incorporate the new service as a mainstream
component of the existing business. Secondly, an SBU can enable a company to develop its
direct service facility on an experimental basis. Thirdly, separate marketing images also helps
reduce the danger of excessive cannibalisation of the parent group’s customer base, as in the
case of The Insurance Service (TIS), a direct insurance subsidiary of Royal Insurance (UK)
ltd. It was launched in 1988 and is now the second largest direct insurance in the UK after
Direct line. It is an example of “an insurance company within an insurance company. In late
1992, the operation, which sells mainly motor insurance, moved into profit with a customer
base of 360.000 customers. Over 30% of TIS’s business comes from personal recommendation.
Around 100.000 policyholders join TIS each year and around 85% of policyholders renew their
policy each year. This is a unique example of a composite insurer ignoring cultural conflicts to
address the direct sector. Indeed, three in every ten Royal market policyholders mow buy their
policies from TIS according to sources within the group.

Finally, maintaining the separate existence of the direct operation also helps organisations avoid
the danger of a possible culture clash between direct units and the parent operation.

A number of banks, especially in Europe, have attempted to emulate the success of First Direct,
the direct banking arm of the UK’s Midland Bank, by setting up stand-alone branchless banks
(see appendix V). The move is typically designed to win new up-market customers who are
attracted by the convenience of being able to conduct all of their banking business by
telephone. The reality is that the stand-alone operation will inevitably cannibalise a portion of
its parent bank’s customer base, often the more profitable end.

Because they start from scratch, stand-alone offspring can avoid some of the problems that have
plagued their parents. They typically have the types of flexible working practices necessary to
make round-the-clock service a viable proposition. They also have the opportunity to break free
of their parent’s legacy information systems, which are typically centred on products rather than
customers.

Not all stand-alone direct banks offer a full range of products and services. Some are nothing
more than discount investment brokers that plan to expand their product ranges gradually in
response to customer demand; others have designed their own core products for direct
distribution but also rely on their parents to provide some products.

26
For stand-alone banks which offer current and savings accounts, deposit-taking has proven to
be a problem. Although ATM interoperability facilitates cash dispensing, nothing more than
high technology than the post exists for remote lodgements. This means that in spite of bold
claims that they offer a branchless-banking alternative, most stand-alone direct banks must rely
on their parents’ branch networks for collecting customers’ cash and cheque deposits. This
reliance on their parents’ resources has raised questions about cost allocation: if the stand-alone
offspring do not have to bear any of the cost of their parents’ branch networks, can they truly
claim to be independent financial entities?

While the emergence of electronic money in the shape of smart cards will make deposit-taking
less of an issue, the era of genuinely-branchless banking is likely to remain sometime in the
future. This is because customers will still want some point of physical contact with their bank,
typically a place where their complaints can be dealt with a person, even when they opt to
conduct all of their banking business by telephone.

This means that the medium-term market for the stand-alone players is limited. Success will
depend on capitalising on an “early mover” advantage so that critical mass is attained before the
market is swamped with imitators. First Direct has achieved such a position in the UK, making
it difficult for another retail bank to launch a rival stand-alone brand. In other countries, such as
Germany where no less than three stand-alone direct banks have been launched within 18
months of each other, the ability of any one player to gain a similar reputation as the direct
banking leader is less certain.

Niche direct banks.

Apart from regulatory restrictions, the need for an extensive branch network has traditionally
constituted the main barrier to entry into the retail banking industry. Direct distribution has
removed that obstacle.

This has paved the way for outsiders which have already recognised that by specialising on a
narrow range of the many products and services offered by today’s monolithic retail banks, they
could gain expertise and economies of scale and so provide the market with a better deal.

In a study of the industry, accountants Deloitte Touche Tohmatsu International (DDTI)22

predicted that traditional retail banks will face a growing threat from what it terms “product
formulators”. According to DDTI: this will be an organisation, either a new entrant or an
offshoot of an existing bank, that will focus exclusively on single product category with minor
variants. Competitive advantage for the product formulator will result from exploiting

22
“The Future of Retail Banking: A global perspective”, DTTI, 1995

27
economies of scale and focus expertise, and using this to develop products which are both
lower in price and superior features to alternatives.

Depending on which area of retail banking they choose to specialise, new entrants can use
direct delivery not only to gain a foothold in the industry, but also as a more cost-effective
distribution channel than the branch networks of their established rivals.

The new entrants typically seek to harness the power of the telephone to sell financial services
to a captive customer base. They include retailers such as Quelle in Germany and Marks and
Spencer in the UK, which have set up telephone-based banking units to offer financial services
to their existing customers.

Insurers have also entered the direct banking market. They include institutions that have
experience of distributing simple, single-premium products by telephone, such as the UK’s
Direct Line, as well as life insurers that want to bolster their positions in the market for savings
products. In Sweden for example, the country’s three largest life insurers have launched direct
banks that typically offer savers higher returns than traditional, branch-based banks.

For more sophisticated investment products such as mutual funds, US heavyweights such as
Fidelity Investments and Charles Schwab have demonstrated that the telephone can form an
important element of a multi-channel distribution strategy. In France, Banque Cortal has carved
out a valuable position in the market for the mutual funds by relying exclusively on direct
distribution. In the UK, Save & Prosper, already an established leader in mutual funds market,
has added standard retail banking products, such as current accounts, without establishing a
branch network.

Despite their success in carving out a niche in the retail banking market, the new entrants face
some pitfalls. The first is identifying potential customers. Most new entrants will initially try to
cross-sell their new line of retail banking products to existing customers. Their success,
however, will depend to a large extent on how much they know about their customers’ personal
finances. For example, the more than 2 million motorists which Direct Line insures constitute a
big market for cross-selling retail banking products. But motor insurance policies on their own
reveal little about how many policyholders are likely to be interested in personal loans, home
mortgages or saving products.

Another obstacle for the newcomers is that while they can establish effective direct delivery
channels, those that offer transaction-based products need some facility for customers to access
their funds, in other words an ATM network. Because of the high costs involved, establishing a
network from scratch is usually not an option. Therefore, the newcomers are forced to reach an
agreement with their chosen rivals, the established banks, for access to their ATM networks.

28
This places the newcomers in an uncomfortable position of trying to beat the established banks
on price and service while the established banks dictate the terms of ATM access.

Man or Machine.

Communications between the bank and customer can be one or a combination of the following:
- Telephone, using a tonepad on push button telephones. The facility is often very limited.
- Telephone, using voice response systems. These are still being developed as the recorded
voice and gaps for messages do not always work, particularly if the telephone line is poor.
- Telephone, with a human operator. This is the favoured route as it overcomes difficulties such
as misunderstandings or system problems. For both customer and bank the advantage is that the
range of services is infinite.23

Direct delivery is undoubtedly more cost-effective than delivery through a branch network.
Some forms of telephone-based delivery, however, are considerably cheaper than others, with
automated services costing a fraction of person-to-person direct banking (see appendix VI).

The disadvantages of automation, however, include the fact that personal contact with the
customer is lost, and that it is unsuitable for customers who want to use the telephone for more
than just routine enquiries and transactions. For branchless banks that rely exclusively on direct
distribution, there is no substitute for operator-assisted telephone banking. It ensures that
personal contact with the customer is maintained and, through intensive customer-focused staff
training, it allows them to offer a level of service that is often better than that available in a
bank branch.

Within any given market, the choice between person-to-person and automated telephone
banking is typically dictated by the early movers. This is most evident in the UK where First
Direct’s policy of having all calls answered by human operators has become the industry
standard. This means that, when the retail banks followed with telephone banking facilities of
their own, they had to provide something more than a simple automated voice-response unit.

Banks elsewhere are trying to capitalise on the advantages of both options by providing an
operator-assisted option for callers to their automated voice-response units. While the theory is
that the automated voice-response unit would be used for simple enquiries and transactions, this
can be difficult to achieve in practice unless callers are charged for availing of the person-to-
person option for routine matters.

The success of direct banking is partly attributable to the fact that the telephone is such a
widely-used and accepted means of communication. But, with advances in telecommunications,
Developments in Electronic Banking, Mintel International Group, 1994
23

29
bankers are exploring emerging technologies, such as screen or smart phones. The advantage of
such devices is that while they operate in much the same way as today’s telephones, they allow
customers to receive and manipulate information about their bank accounts, undertake and
confirm transactions or switch to a live representative. A disadvantage is their high cost, while
has led to a poor response from customers worldwide in market tests.

30
 Areas where telephone banking has met expectations.

In certain areas telephone banking performs satisfactorily and sometimes even exceeds the
expectation of the bank regarding specific business objectives:24

Keeping up w ith
competition

Reduce reliance on
branch netw ork

Enter new markets

Performance of TB
Importance of Objective
Image creation

Provide service
quality

0 0.5 1 1.5 2 2.5 3 3.5 4 4.5

Rating

Source: AMS Management Systems

Service Quality: Telephone banking has contributed substantially in this area as services offered
via telephone banking are normally standardised and operations are performed from one or few
call centres. This enables organisations to deliver service consistently. Additionally, due to the
“extended” hours of operation and convenience, factors regarding service quality have been
enhanced.

Image Creation: Telephone banking conveys the image of a progressively thinking

organisation offering convenience and quick service to the customer, since telephone banking is
still in its infancy and not all banks offer it yet. This has a positive impact on the customer.

24
European Telephone Banking Survey, AMS Management Systems, February 1996

31
The following chart shows the contribution of telephone banking to customer expectations:

Contribution of telephone banking to customer expectations

Interest on savings

Service charges

Reputation

Interest on loans

Quick service

Friendliness

Prompt loan approval

Convenient hours

Accessibilityof service

Accuracy

0 1 2 3 4 5
Mean UK Contribution Rating

1: no contribution; 2: little contribution; 3: medium contribution; 4: rather important contribution; 5: highly

significant contribution.
Source: AMS Management Systems

According to this, telephone banking contributes the most to accessibility of service, convenient
hours, quick service and reputation of the bank. It should be good news to bankers, that a study
by Khazeh and Decker in 1992 has revealed that the “reputation of the bank” is on top of the
list of customer selection criteria regarding their choice of bank.

Enter new markets: Bankers believe that telephone banking can be very helpful in the attempt
to enter new markets and reach new market segments, as it is easily accessible, convenient and
the product portfolio can, without a great effort, be extended into other related areas such as
insurance or ticket booking facilities.

Reduction of reliance on branch network: Although in the eyes of bankers this is not an
important business objective, telephone banking is seen to contribute substantially in this
respect. However, in the long run, as stated by many UK managers, telephone banking can be
quite helpful since standard transactions can be performed centrally by the call centre. This will
reduce costs within the branch networks, as the number of staff decreases and the role of branch
personnel changes.

Competition: Competition is a highly important business objective and telephone banking is

seen as a being crucial in this regard. Bankers find that they have no choice than to offer
telephone banking as a “me too” approach in order not to lose customers to competitors.

32
 Areas where telephone banking has not met expectations.

However, it is also possible to identify that telephone banking has not met some other
expectations that managers have when they set up telephone banking operations. The key areas
where telephone banking has fallen significantly short of expectations are:

Customer
retention

Cost reduction

New customer
acquisition Importance of objective
Improve Performance of TB
efficiency
Increase in
cross-sales

0 0.5 1 1.5 2 2.5 3 3.5 4 4.5

Rating

Source: AMS Management Systems.

Cross-selling: Telephone banking has not proven to significantly increase cross-sales. Cross-
selling is one of the areas to which bankers attribute a lot of importance. It appears that due to
the lack of sufficient IT infrastructure and non “face-to-face” selling, it is quite difficult to
further enhance this business area.

Improvement of efficiency: Telephone banking operation have been seen to be more efficient in
handling some transactions. However, overall the banks’ “throughput” has not increased whilst
the cost base has grown.

Cost reduction: Setting up telephone banking raises costs instead of reducing them. Most cost
reductions are expected due to less branch staff, but banks have not yet reduced branch staffing
levels or re-assigned staff to more selling based activities, which should impact overall sales
numbers. In general, the cost side has increased while the income side has stayed level.

33
Customer retention and new customer acquisition: The bank’s focus is on customer retention,
which has proven to be effective as customers have tended to stay with their bank. However, in
terms of new customer acquisition telephone banking is rather weak and banks find it difficult
to increase the number of overall personal customers. Although generally the number of
telephone banking customers is steadily increasing after the introduction of telephone banking,
banks often have problems in analysing whether it is new customers using telephone banking
(from the existing customer base) or existing telephone banking customers using it more and
more often.

Why do those shortfalls occur?

The introduction of telephone banking is mostly hindered by lack of commitment from staff
and senior management, lack of adequate IT and telephone integration and under-promotion of
telephone banking.

Customer management strategy: Often there seems to be a lack of commitment from senior
management and employees to provide the best service to the customer.
Organisation development: The project of introducing telephone banking as a new service
needs commitment from senior management and careful planning of the integration process of
telephone banking operations into the existing organisational structure. This includes the
development of the structure, policy, incentive schemes and employee development programs.
A coherent strategy of positioning telephone banking is often missing, which leads to a shortage
of skills, motivation problems, lack of efficiency and consistency.
Information technology: IT seems to be the basis for a lot of problems since it provides the
foundation for keeping track of the customer’s history with the bank. Customer data is often
kept in several places, there are multiple, non-integrated networks and databases, and legacy
systems hinder the efficient use of data for information generated for market segmentation or
targeted cross-selling.
Business Processes: Efficient and profitable telephone banking operations very much depend
upon the reengineering of certain business processes with the introduction of telephone
banking. If this is not performed, then cost reduction and a consistent service is not provided
which can result in the inability to offer competitive product and service charges, as well as
shortage or overcapacity of skills in certain areas.

34
 The future of telephone banking.

The shortest distance between the present and the future of banking is the telephone line. Direct
banking makes that clear. But progress need not stop with the existing equipment: the telephone
can evolve into a more complete, efficient, personal, direct channel into financial services.
Europe, of course, advanced beyond the US in this area in 1990, with the emergence of France’s
Minitel and, since then, with more use of screen phones. In the US, we are beginning to see the
emergence of “smart” phones, telephones with touch-screens that not only connect customers
directly with information, but allow them to make and conform transaction decisions, entirely
through the exchange of electronic data signals (see appendix VII).

The strategy does not depend upon the style of telephone. The success of smart phones will
depend on two simple things. First, it must be the right product: highly functional, easy to
understand and use, and in conformity with the consumer’s existing telephone usage patterns.
Secondly, it must be offered at the right price: several testing show that a wholesale price of
$200-250 achieves the correct value balance between being affordable and perceived worth.25

Any smart phone unit that meets these criteria can be successful. More importantly, the
available communication technology makes it easy for any bank, consortium of banks or even
other service companies to deliver a wide variety of products across a common platform to
reach customers using any available smart phones. It may well be on this entirely new turf that
the competitive battles, between platforms and the group of institutions that use them, will be
conducted into the early part of the next century.

25
AT&T Huntington proprietary research, 1993

35
Case Study - First Direct.

The origins.

First Direct seems to be the ideal case study because of its unique position and success on the
UK market. First Direct was launched by Midland bank as a separate business unit on 1
October, 1989. At that time telephone banking was untested and was a completely new ideas to
the public at large. What First Direct means by telephone banking, is a full person-to-person
banking service available over the telephone 24 hours a day, seven days a week, 365 days a
year.26

First Direct was built from the ground up, starting from the proposition that there had to be a
viable alternative to branch banking and that the alternative should put the customer first. This
would require an autonomous banking service with its own systems, culture and operating
philosophy.

Before Midland entered direct banking it undertook market research to discover what the
customer really wanted. A public opinion poll, commissioned just before its launch and carried
out by MORI27, revealed that:

- one in five people had not visited their branch in the last month,
- 51% said they would rather visit their branch as little as possible,
- 48% had never met their branch manager,
- Half of the sample were interested in the concept of direct banking.
- 80% of these people said they would prefer to deal with a human operator.

This research was reinforced by the Henley Centre for Forecasting, whose studies found
consumer demand for better service was higher amongst banks than any other retail sector.
Their research revealed that friendly and knowledgeable staff were considered most important,
alongside convenient opening hours and quick and easy transactions.

The results of these research packs lead to the concept of a new bank which would need to stay
open 24 hours a day, offer immediate access, hence the telephone, and most importantly put real
people at the other end of the phone to answer customer calls.

Midland management believed at the time that direct banking was the way forward for the
group and in June 1988, it assembled a young development team called Project “Raincloud”. It

26
First Direct Information Pack
27
MORI Report, 1988

36
was given the task of creating a bank that was more customer focus and offered outstanding
service and access, and to form the First Direct “culture”.

Because First Direct is a bank with no high street presence, marketing has been crucial to the
bank’s major aims, one of which is customer acquisition. Initial marketing costs were estimated
at £500 per account (see appendix VIII). This has now dropped substantially. First Direct was
launched with a series of spectacular television advertisements costing almost £6 million,
which included simultaneous advertisements on two channels, using frozen images of fish,
buckets or dandelions. As a result, First Direct was greeted with cynicism.

In mid-1992 Midland was taken over by the HongKong and Shanghai Banking Corporation
(HSBC) and underwent major rationalisation, including branch closures and staff reductions.
Later the same year, the treasury divisions of the two operations were merged. During this
realignment First Direct played a major role in maintaining customer service levels. Where the
local branches closed, customers were automatically referred to First Direct.

In December 1993, First Direct moved into operating profit for the month. In December 1994,
just five year after its launch, the bank broke even after exceeding 450,000 accounts. It was
opening around 10,000 new accounts every month. Beyond disclosing that the direct bank
recorded its first profitable period in 1994, Midland at that time declined to quantify First
Direct’s financial results. The long period of start-up losses were attributed to First Direct’s
conservative policies: it expenses customers acquisitions costs as incurred. Because of rapid
growth in the customer base during First Direct’s early years, losses were therefore inevitable.

On February 27th 1996, HSBC disclosed the group results for 1995 announced that First Direct
recorded its first full year of profits in 1995. HSBC does not disclose profits figures for First
Direct, but Mr Keith Whitson, Midland’s chief executive, said its results were “not to be sniffed
at”. First Direct contributed to a 10 per cent increase in Midland’s pre-tax profits to £998m..
First Direct added 108,000 new accounts last year, of which said 80 per cent were won from
non-Midland customers, while 30 per cent came by personal recommendation. First Direct
added another 23,000 customers in the first six weeks of 1996. “I think First Direct is very
much now seen as a real competitor to the established banks”, Mr Whitson said.28

However, speculation about the direct bank’s finances has centred on the allocation of cost
between First Direct and Midland. The direct bank’s customers have access to Midland’s ATM
for cash withdrawals and they can also cash cheque free of charge and make deposits at
Midland’s 1,700 branches. How does Midland allocate the costs of such transactions to its
direct subsidiary?

28
“Midland expands 10% to £998m-full year contribution from First Direct”, Financial Times, 27th
February, 1996.

37
According to internal sources, First Direct was set up on the assumption that it would be
marginal to Midland’s cost base so that its share of expenses could be easily identified and past
onto the direct subsidiary. Six years on, it has been estimated that the direct bank was billed for
about 95% of the cost it created for the Midland group. The issue now, however, is that with
about 550,000 customers compared to its Midland’s five million, First Direct can no longer be
considered as marginal. In such circumstances, identifying the portion of Midland’s fixed cost
base that arises because of First Direct’s existence is much more complex.29

According to internal sources, First Direct has always reinjected most of his profit into
operations, namely building, technology, training and employees. I have been enabled to
acquire figures concerning the allocation of profit. Nevertheless, it will be obvious for the
reader, in the following parts, that First Direct has always put a great emphasis on investment.

29
First Direct Internal Sources.

38
 The services.

First Direct provides a full range of banking services over the telephone, 24 hours a day, 365
days a year. First Direct has never closed. It has been open the equivalent of 18 years based
upon conventional banking hours even though it was established in 1989.30

First Direct realises that, for most people, visiting a bank branch is frustrating and inconvenient
and that, with the general trend in the UK towards longer working hours and less free time,
customer focus is changing. Traditional systems which dictate how and when we can cash a
cheque, arrange a loan or organise car insurance are becoming less relevant. Instead, First
Direct focuses on real customer needs, such as needing to arrange a mortgage at 11.00 am on a
Sunday morning. This philosophy is also reflected in the service that First Direct offers. Its
mission is to become so close to individual customer’s needs that eventually it will be possible
to understand and anticipate what customer behaviour and consumer trends by sharing
information.

Its wide and distinctive product range has undoubtedly been a factor in attracting customers.
Motor insurance is the first significant addition to First Direct’s product range since its launch.
Of its 800,000 customer accounts, more than 500,000 are current accounts. First Direct,
however, does not disclose the mix of the remaining accounts between credit card, savings
products or mortgages and personal loans. In addition to those products, First Direct offers its
customers share-dealing services, travel services (foreign currency and travellers cheques are
delivered by courier to customer’s home), travel and home insurance, and a financial planning
service.

Newman is relatively happy with the cost position of First Direct. Despite the high set-up costs,
estimated between £10 million and £35 million, it now seems to be paying its way. The
management always maintained that figures in profit per person would be high, compared to
competitors like Natwest. This is due to the wide range of services which First Direct offers.

First Direct can offer lower-priced products because of its lower overhead. Costs are lower, as
are the margins on lending and borrowing. The operation’s movement into the insurance market
has profound implications for the future growth. The two main products First Direct used to
launch into market were life assurance and pensions.

30
First Direct Internal Source, February 1996.

39
 Cheque accounts.

• The First Direct Cheque account has an automatic fee-free overdraft facility of £250 and
£100 cheque guarantee card which comes as standard.
• The First Direct card has a number of features including Switch, cash machine card and
Cirrus and Maestro for use abroad.
• Customers can use their First Direct card to withdraw up to £500 a day from one of the UK’s
largest networks of cash machines (over 7000), including Midland, National Westminster,
TSB, Clydesdale, Northern Bank, Bank of Ireland or Royal Bank of Scotland cash
machines.
• The First Direct card allows customers to cash cheques free of charge at Midland branches.
• An automated bill payment service allows customers to pay bills with one phone call.
• Overdrafts over £250 can be arranged with one simple phone call.

Credit cards.

• The First Direct Visa card is accepted at more than 10 million outlets around the world and
is offered to customers free of an annual fee.
• Cardholders are provided with a free travel accident insurance worldwide.

Savings.

First Direct offers the following savings accounts:

• High Interest Savings Account (HISA) offers competitive rates of interest with instant access
to savings. No minimum deposit is required and interest is calculated daily and paid
monthly.
• 60 days notice accounts, with a minimum deposit of £2,500
• Money market account with a minimum deposit of £5,000
• TESSA which has a maximum value in the first year of £3,000
• Fixed Interest Savings account linked to the money markets

Mortgages.

• “What Mortgage” magazine has voted First Direct “Best Centralised Lender” over both two
and five years.
• Quotations and mortgages agreements (in principle) can be supplied over the phone seven
days a week, 365 days a year.
• A range of mortgages are available including repayment, endowment and pension with
variable or fixed rate options.

40
 Loans.

• First Direct provides a range of loans including personal loans and Flexiloans. These can be
approved in principle by a First Direct Banking Representative 24 hours a day, 365 days a
year.

Share dealing.

• Shares can be bought and sold over the telephone 24 hours a day with orders placed
immediately during trading hours or as soon as the market opens. First Direct has a
dedicated share dealing team and provides a guide to up-to-date share prices. This ensures
that customers’ buying and selling decisions are supported by the best possible information.

Travel services.

• Foreign currency and travellers cheques can be ordered by cheque account holders and
delivered direct by couriers to the customer’s door typically within 24 hours and
guaranteed within three working days.
• Eurocheques can be ordered by cheque account holders and delivered direct by couriers to
the customer within 10-14 days.

Insurance.

• In early 1993, First Direct announced its intention to begin selling insurance policies over
the phone. Previously, First Direct had sold life assurance and pensions at customer
request. First Direct , March 1995, offers a car insurance service to customers and non-
customer alike. The service is available 7 days a week.
First Direct offers a full range of personal insurance including house, travel, contents and
life.31

31
First Direct Internal Sources, February 1996.

41
 The customers.

In December 1990, already 50,000 customers had joined First Direct, 250,000 in March 1993,
and 500,000 in April 1995. The following chart shows the great evolution of First Direct
number of customers between 1990 and 1995.

Evolution of First Direct number of customers

600,000

500,000

400,000

300,000 Number of customers

200,000

100,000

0
1990 1991 1993 1994 1995 1996

Source: First Direct Internal Sources, February 1996.

First Direct views public opinion as crucial to its continued success: once a year the operation
carries out extensive customer polls to constantly monitor levels of satisfaction.
Most recent results show that:

- 87% of First Direct customers were extremely/very satisfied with

their service compared with an average of 51% for the high street
banks.
- 85% of customers have recommended First Direct compared with an
average of 16% for the main high street banks.32

This level of satisfaction is also confirmed by the high numbers of customers joining First
Direct from personal recommendations. Year to date, 40 percent of customers have joined
through word-of-mouth testimonials.

In a recent Which?33 report by the Consumers’ association into levels of service provided by the
major banks, First Direct was rated among the top three and became the first bank to be
included in the “Best Buy” section three year running. The survey went on to reveal “a
catalogue of incompetence” at other banks: one in five respondents had problems with a direct
debit or standing order in the previous year, one in seven had incorrect amounts taken out their
account, one in ten had been wrongly charged.

32
First Direct Internal Research
33
“Which?”, 5 November 1992

42
Research carried out by First Direct finds that its customers want speed and efficiency and 24-
hour telephone banking. But they also want real human contact and interaction.34 The largest
proportion of First Direct customers are aged between 25-44 with a broadly 50/50 split between
male/female and falls mainly in the ABC1 socio-economic category.

A more detailed analysis of First Direct’s customer profile follows:

Age Percentage of customers
21-24 3%
25-34 37%
35-44 34%
45-54 14%
55-64 7%
65+ 3%

Sex Percentage of customers

Male 56%
Female 44%

Socio-economic group Percentage of customers

AB 45%
C1 35%
C2 14%
DE 6%35

• First Direct has over half a million customers. 41% of new customer acquisitions are by
word of mouth and 73% come from Midland’s competitors.
• First Direct receives approximately 26,000 calls every day with an average call lasting three
minutes.
• 10,000 new customers join First Direct every month on average.

34
“Features-Kiss of The Cyberbank”, 25th February 1996, Sunday Telegraph
35
First Direct Internal Research

43
 The personnel.

Kevin Newman, chief executive of First Direct believes that “broadly speaking, this company’s
only long-term assets are its people and the culture in which they operate”. Newman attributes
the operation’s success to its people-orientated mentality: “In my view the banks are very
supply-led businesses. First Direct is the opposite, we are customer-led.” This high customer
orientation level is obtain through strict personnel policies.

In March 1991 First Direct employed 500 people, staff numbers rose to 1,500 in December
1993. First Direct currently employs around 2,300 people in its Leeds headquarters. Nearly
69% of First Direct’s staff are women and 25% of staff are part time.

The following chart shows the evolution of First Direct number of employees between 1991
and 1996.

Evolution of First Direct number of employees

2500

2000

1500
Number of employees
1000

500

0
1989 1991 1993 1994 1996

Source: First Direct Internal Research.

In five year, the number of employees has increased by 460%. This percentage not only shows
the fantastic growth that First Direct has been experiencing between 1989 and 1996 but also the
great emphasis that First Direct put on its employees. According to this figure, it is obvious that
First Direct heavily invests in people and consider them as long term assets.

Staff who answer the phone, known as Banking Representatives (BRs), are First Direct’s most
important ambassadors. The first experience a customer has of First Direct (speaking to a BR)
will form the foundation of their overall impression of the company. All the elements of
customer service are channelled through the BRs. Efficiency, consistency and a friendly
response are crucial in building customer loyalty.

Two factors, recruitment policy and the working environment, help First Direct to front
representatives who are able to demonstrate these key elements. First Direct’s approach to
recruitment is to employ people with excellent communications skills, who enjoy dealing with

44
people, on the basis that they can then be taught the necessary banking knowledge they will
need. First Direct also actively promotes a positive working environment, believing that high
levels of satisfaction amongst staff will translate into a more enjoyable banking experience for
the customer.

Candidates for employment undergo a four-hour psychometric test to reveal whether they have
the right mental attitude for the job. BRs recruits do not come into contact with customers until
they have successfully completed an intensive seven week training course. This include four
weeks spent on looking in depth at products, communication systems, and telephone
techniques, and most importantly, how to listen to customers. This is then followed by three
weeks concentrating on role playing calls. The new Banking Representative then has to
complete a further accreditation test before being allowed to take calls unsupervised and regular
feedback is given as how effectively and efficiently calls are handled. This training program
shows, once again, the great emphasis that First Direct put on enhancing the quality of its
resources and on investing.

More than 85% of requests and transactions are handled by BRs. Specialised enquiries such as
share dealing, car insurance and mortgages are handled by one of First Direct’s Financial
Services Advisors.

Staff are encouraged to value relationship with customer. To emphasise the individual’s
responsibility towards their customer, hierarchy is kept to a minimum and manager develop the
roles of leadership and guidance, not interference and instruction. All members of staff are on
the first name terms which, along with the open plan environment, contributes to a relaxed,
friendly atmosphere and to a flat organisation chart.

45
 The workplace.

The results of a recent opinion survey conducted amongst First Direct employees showed that 8
out of ten members of staff are proud to work at First Direct. As the largest private employer in
Leeds, it is vital that First Direct attracts and retains high-calibre staff. The working
environment plays a key role in achieving this aim.36

A 24 hours business requires a workforce and building that are unlike that of a normal nine-to-
five operation. First Direct is divided between two sites in Leeds, Arlington and Stourton,
which operate seamlessly through electronic and telecommunications links. The operational site
at Stourton, opened on November 3rd 1994, has been purpose-built to deal with the rigours of a
business that never closes. The building occupies a 14.3 ace site and is within three miles of
First Direct’s first offices at the Arlington Business Centre. First Direct’s operation is split
between two sites with senior management operating from both building. The new building at
Stourton is dominated by a rectangular 70,000 sq. ft open-plan trading floor (the size of
Wembley football pitch), meeting the need for maximum operational space. The new building
is considered as First Direct major investment to date.

Because of the shift patterns essential for a 24 hours business, it is important that the physical
environment be as flexible as possible. Providing a separate desk for every member of staff
would be impractical, so employees have moveable shelves containing stationery and
paperwork which they can easily pull up to any free desk. This approach has been internally
called “hot desking”.

Around 69% of First Direct’s workforce are women. For the Midland Bank, equal opportunity
has always been an important issue and this corporate culture has been replicated for First
Direct. The bank is, indeed, the first company in the UK to design an office specifically with
women mind. An example of this is that instead of the usual 50/50 split between men’s and
women’s toilets, 80% of the toilets at the Stourton site are for women!

Safety is an important issue for an office with the predominantly female workforce. With
women coming to work at night, standard safety procedures are not sufficient. Access to the
building is controlled electronically. The car parks are highly visible and kept well-lit
throughout the night.

First Direct operates a crèche at each site which looks after 70% children. This has enabled
many more women to return to work after having children, either on a part-time basis or full-
time basis. The crèche is hidden from the road and is not accessible through the main building.
Entrance can only be gained through an electronically controlled lobby.
36
First Direct Information Pack

46
First Direct’s chief executive Kevin Newman said: “Companies must react to the changing
need of their employees as well as the market place. Providing a user-friendly environment
translates directly into providing a better service for our customers”.

Technology.

Technology is at the heart of First Direct’s existence. Newman’s IT and banking background
has given the operational understanding of the strategic importance of the right technology. The
business was developed around sophisticated telecommunications and computer technology
which work together to provide a seamless, customer-focused operation. Current technology
assists First Direct in implementing one of the key factors that differentiates it from other
banks: all information related to a consumer is held and retrieved on a customer basis not on a
product or account basis.37

This has been achieved through First Direct ability to adapt quickly to changing market needs.
With the development of new technologies taking place at lightning speed, a state-of-the-art
communication system could be superseded with a matter of months. With this in mind, First
Direct has carefully planned for the future. The new operational site in Stourton in Leeds
houses 330 miles of cabling in a totally flexible, open plan environment, enabling the company
to adapt to new communications technology as needed and ensuring that customers benefit
from the most up-to-date systems.

Each Banking Representative (BR) has a Davox intelligent terminal (workstation) on their desk.
From this, they are able to access several systems simultaneously, providing them with a
picture of the customer’s entire relationship with First Direct from personal details to security
procedures and previous transactions. This is called the Customer Information System. The
benefit of this system are two-fold. From the customer’s point of view, it means a faster, more
efficient service (their instructions can be acted on immediately), and to First Direct advantage,
it means that over a period of time, a picture of the customer’s behaviour will emerge and the
bank is able to provide services to customers more appropriately and effectively.

In the financial sector, there are three main points which differentiate banks: firstly, whether
they are price competitive; secondly, the level of consumer service they provide; thirdly,
whether they can provide an intelligent service (for instance, whether they can forecast what a
customer will need and therefore provide them with information on services they are likely to
be interested in). Many banks provide the first two to a certain extent, but First Direct can claim
to provide all three.

37
First Direct Internal Sources.

47
Indeed, two years after launching, First Direct purchased the MIND (Management Information
Database) software, developed by Admiral, and had it fully operational by May 1992. The basic
principle behind MIND is combining profiles of individuals with a built-in predictive model.38
The database marketing system builds customer profiles, it allows the bank to know if their
customers are price-driven, service-driven, or short of time and to identify the next product the
customer is most likely to buy by combining transactional information with behavioural data.
“We take in data from a number of sources to aid us ascertaining what customers will want
next. Bank transactions are a key source, as it feedback we get from our promotional
campaigns. In the future, we will be looking to augment our information with market research
from outside organisations. We are also seriously looking at incorporating census and electoral-
roll data,” says Simpson, First Direct’s commercial director.

“We can predict that a particular 30 year-old family man with a mortgage is most likely to
purchase a new car next week, so we will target car loan information at that customer,” says
Peter Simpson. The bank claims it has cut marketing costs by 40 per cent as a results of lower
cost promotions yielding higher returns. The system allows First Direct to mark on the database
appropriate and inappropriate customers for particular products and then target or bar those
customers in mailshots accordingly.39

Information Technology forms the backbone of First Direct’s banking services, providing staff
with customer details at their fingertips. Enabling the full automation of many routine banking
processes, IT helps to keep costs down and allows savings to be passed on to customers.
Furthermore, it presents the opportunity to fully exploit the sales potential of the customer base
by allowing staff to offer the correct product or service to customers when they need it rather
than in a haphazard way.

The Information Technology infrastructure also includes a Credit Monitoring System which is
used to monitor credit and risk and again is available 24 hours a day, 365 days a year.

A vital component in efficient call handling is First Direct’s Power Dialling System. Used for
outbound calls, it dials multiple numbers and only passes on connected calls to the telephone
operators. By filtering out engaged or no answer numbers, the system allows First Direct to
improve productivity by 200-300%. Real time monitoring of calls rates allows the systems to
speed up or slow down the number of calls flowing through the system at any one time. In
other words, it maintains steady and efficient outbound calling without risking the quality of
service.

38
“Case Study-Reading Your Mind”, 22nd February 1996, Marketing
39
“Special Report-Database Marketing-Sorting Out The Wheat From The Chaff”, Precision Marketing,
5th February 1996

48
To maximise security for phone transaction, each customer is asked to provide a password of
his or her choice which is given only once to the organisation. In all subsequent dealing with
the bank, customer are asked to verify that password by giving two random characters from it.
For additional security, the customer is also asked to provide several memorable pieces of
information. According to First Direct there has been no breaches of security since the launch of
the service, even though eight million calls have been received.

First Direct is continually making enhancements to its IT systems and new applications are
constantly being introduced which improve both efficiency of the operation and the service
provided to the customer.

49
 Competition analysis.

First Direct has set the industry standard not only in its home market, but throughout the world.
Indeed, First Direct is now being copied overseas. It has demonstrated that by combining trendy
marketing, high levels of customer services and sophisticated information systems to track
customers’ needs, a new player can attract a rapidly-growing base of high income customers in
a mature market.40

Even before First Direct’s launch in 1989, direct delivery has been successfully used by the
Bank of Scotland. It became the first bank to offer a home banking service when in 1985 it
launched Home & Office Banking Services (HOBS) which uses PCs. Created to serve
customers remotely from its Scottish branch network, it has been operating since 1985, and
relaunched in October 1994 to boost appeal in the face of mounting competition.

Five year after the launch of First Direct, Midland Bank’s ground breaking direct bank, UK
retail banks were embracing telephone and direct banking. However, the new generation are
add-on units, designed to remove the need to visit branch for the majority of everyday services,
rather than clones of Midland’s unique branded operation. Given First Direct’s market
dominance, however, no other retail bank has made a serious attempt to take on Midland by
launching a rival stand-alone direct bank.

The remaining four leading retail banks now offer telephone banking services. Most of them
offer a central service for branches, intercepting calls to provide an on-the-spot solution to a
large number of requests, from balance enquiries and standing orders through to loan and
mortgage requests. Indeed, 1994 witnessed the launch of a host of such services, including
Barclaycall, Actionline & Primeline (Natwest), Lloydsline, Direct Banking from the Royal
Bank of Scotland, TSB’s Phonebank. One of the most innovative and widely used add-on
service belongs to the Co-operative bank, a small player which had a 3 per cent national market
share in 1995. It seeks to maximise staff utilisation at its Armchair Banking call centre by
combining telephone duties with centralised back-office processing for its branch network.

One can then conclude that the majority of banks see telephone banking as complementary to
the services offered through branch networks. Two exceptions are First Direct, the separate, all-
embracing service from Midland and the Home & Office Banking System offered by the Bank
of Scotland.

Today, First Direct claims to have 560,000 customers and has not a single branch. It operates
out of two buildings in Leeds and is the world’s leading telephone only bank. It is also Britain’s

40
“From Teller to Telephone”, Lafferty Publications, 1995.

50
fastest growing bank.41 First Direct spokesman Matthew Higgins said the total potential market
for direct banking is currently around three million although he acknowledged that definitions
of direct banking differ. “We would say that we have 25 per cent of the market and that would
be the biggest proportion by some distance. Co-op or Girobank may argue with that...they have
probably got more customers overall, but actually using telephone banking probably not”.42

Girobank, a part of Alliance & Leicester Building society, did dispute First Direct figures,
claiming that all its 1.3 million customers are direct, although they can use post office branches
to transact business. All of Co-op bank’s 1.5 million customers can bank direct, but in practice
only half do so on a regular basis.

Kevin Newman, First Direct’s chief executive, takes a bullish attitude to the new services being
offered by the other retail banks, regarding them as partly defensive in nature and partly a
reaction to demand. In terms of services and costs, he believes that the new telephone services
will not be able to compete with First Direct. Another advantage is that there is likely to be a
level of confusion between who the customer wishes to deal with, branch or service centre.
However , he admits that First Direct will have to continue to innovate if it is to have one
million customers by the year 2000, as Newman envisages. “At the moment our competition is
doing us a lot of favours by getting them used to the telephone. We are no longer having to
spend all the money ourselves”, says Newman.43

As far as First Direct is concerned one can conclude that it is a market leader in its sector, that
is to say the stand-alone approach, due to its “First Mover” advantage. Since then, no other
rivals have been launched. However, one cannot deny that since 1994 and the various launch of
a host of add-on service providers, First Direct is facing increasing competition. By removing
the need to move banks to experiment, its rivals may have cut away some of First Direct base.
Whether, or perhaps when, the main retail banks decide that they want to take on a broader
approach to direct banking, the winner will be the one offering the best service at the best price.

41
Weekend Money, Sydney Morning Herald, 10th February 1996
42
“Feature-Phone Rings Changes in Britons’ Finances”, The Times, 6th February, 1996
43
“Direct comes of age in UK”, Retail Banker International, 28th March 1995

51
 The future.

In the US, 15% of the banking market is served by telephone. First Direct research shows a
potential market in the UK of around 10% or three million, rising to 20% or six million by the
year 2000. Newman believes the “I cannot exists without a phone” concept will be a crucial
factor in the operation’s growth as the telephone becomes more and more accepted as a mean of
doing business.44

By the year 2000, First Direct aims to have 1 million customers. The current growth rate is
10,000 customers per month and indicates a continuing positive response from the public. First
Direct believes that a number of factors are contributing to its success, not least of which is a
growing trend for the UK population to work longer hours and have less free time. The First
Direct Time & Money report, published in May 1995, made some revelations about their use of
time and the way they feel about spending money to gain more free time.

In the time-constrained nineties, one in five of us is prepared to trade hard earned cash for more
free time. By the year 2000, free time will fall by five hours per week from 65 hours to 60
hours of total time use. This is due to a forecasted increase in work hours and time spent caring
for children. Because of this emerging issue, as well as generally higher expectations of service
standards, companies that offer products and services that are simple, painless and convenient
to use are becoming increasingly in demand.

The only danger to First Direct seems to be its own success. As the gap appears to grow
between the customer service levels available in Midland and First Direct, there is an increasing
risk of a disproportionate move to the direct service. First Direct denies that cannibalisation is a
key factor in its success. However, 20% of customers coming from Midland is quite a high
percentage, considering Midland’s market share, which is estimated at about 30 percent of the
UK market. Nonetheless, Newman believes the positions of the two remain complementary:
“Within the corporate strategy of the group the two are viewed as a partnership, providing
service in a different albeit related market”. He considers that the experience gained by the
group through First Direct could be invaluable in any future European expansion.

However, the effects of its growth on First Direct’s parent bank are not all positive. Midland has
repeatedly rejected claims that the operation is in effect “creaming off” the bank’s most
profitable customers. A Midland source disclosed that morale within the bank was at an all-time
low in early 1993. With job losses in 1993, an increasingly resentful attitude towards the
operation seemed to be emerging. The question remains as to how big the operation will be
allowed to grow, and how much Midland’s branch network will be reduced as a result.
44
First Direct Internal Sources.

52
Moreover, even though it led the market for a number of years due to its “first mover”
advantage, it is now facing increasing competition.

53
 First Direct Analysis.

First Direct SWOT Analysis

Strengths Opportunities

“First mover” advantage Increased cross- selling

opportunities

Market leader in the stand-alone Rapidly growing base of

sector potential customers

Low cost baseand lower priced Possibility of selling more

products complex products

High recognition in domestic

market

Customer focus bank

Heavy investment in people,

workplace

Sophisticated information systems

Weaknesses Threats

Excessive cannibalisation of Rising competition in sector

Midland group customers

Possible security problems The threat from within

Midland itself

54
With arguably the world’s most successful direct bank in its arsenal, there has been much
speculation that HSBC could try to harness the First Direct formula to increase its market
penetration in some of the other 67 countries where it operates. Most attention has focused on
Australia, which has many cultural similarities with the UK and where HSBC is a minor player
in the retail market with just 32 branches.

HSBC is not the only bank that would like to built on First Direct’s success. The number of
visitors from around the world that are making a pilgrimage to Leeds to learn more about First
Direct has led the International Herald Tribune to conclude that the City in England’s industrial
north has become for bankers what Lourdes is to Catholics.

All are likely to hear the same message: direct delivery as practised by First Direct is not about
cutting costs, it is about finding a better way to serve customers; and the ability to serve
customers whom bank not longer meets on a face-to-face basis depends on the quality of its
information systems.

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CONCLUSION

We are witnessing the beginnings of a fundamental shift in retail banking. Tomorrow, the bank
will not be concentrating on achieving competitiveness across the board. Rather, fostered by
deregulation and technological change, it will revolve around achieving excellence in only a
small number of areas in which it genuinely believes it can achieve advantage.

Retail banks today depend heavily on their branch networks and see it as a core of their
business. In the future the branch network is but one of the several channels with which the
bank accesses its stand-alone client base. Indeed, the branch network is in the future a
privileged channel, used only for accessing that small percentage of the client base which offers
the potential for a genuinely profitable relationship. The rest of humanity will deal with
technology to transact its banking. Alternatively, it will use the telephone or a home TV based
system as its access to retail banks.

Clearly, there will be significant advantage to those banks which move quickest and move in
the right direction. What then must all banks be looking to do today? First and foremost, then
need to understand based on activity analisys, which businesses they operate in, and hence
comprehend the true costs within these businesses. Equally, banks have to place more focus on
understanding what drives customer profitability. Only by proper segmentation of the entire
client base can the clear break points at which one tackles the retail client base from a product
or from a relationship viewpoint be fully understood.

Finally, banks will understand their competitiveness not in broad-brush terms but highly
specifically, business unit by business unit, in each of the product, channel and service areas in
which they operate. This will involve extensive competitive benchmarking both from cost and
service viewpoint, as well as more intensive focus on only those parts of the other banks with
which they are directly competing.

Retail banks will develop specific strategies at the channel, product, and service level. They
will win or exit at this level. Those that hide within the supposed safety of protective barriers
and monolithic structures face the same daunting challenges which today confront other
industries such as the airlines one.

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APPENDIX I

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APPENDIX II

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APPENDIX III

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APPENDIX IV

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APPENDIX V

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APPENDIX VI

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APPENDIX VII

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APPENDIX VIII

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APPENDIX IX

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APPENDIX X

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