The unprofitable customers challenge

Dec 12, 2013

By any measure, J.P. Morgan Chase's consumer banking business is huge. In the United States, it serves 21 million households through more than 5,600 branches and 19,500 ATMs. This activity generated $17.2B in net revenue and $3,3B in net income in 2012.1 Yet, nearly half of their customers are unprofitable, the bank acknowledged in one of its investors reports.2 In a similar vein, the head of an international bank commented that “80% of our customers add nothing but sand to our bottom line.”

Who are those unprofitable customers?

Chase reports that out of its customers with less than $100,000 in combined deposits and investments (D&I), 70% are unprofitable.3 This is quite startling as such D&I balances are well above the portfolio mean of many institutions.

Unprofitable Customer Challenge

Looking more closely at their statistics reveals that even customers with more than $25k in deposits and investments can be unprofitable. More precisely, at least 4% of the $25k-$100k D&I segment is unprofitable, which means a minimum of 200,000 wealthy, yet unprofitable households! Similar conclusions can be drawn for the $5k-25k segment.

What to do about the 50-80% unprofitable customers?

Unfortunately, this situation won’t improve on its own. Consumers are borrowing less as they pay down their mortgages and other debts incurred during the boom years. Competitive pressures make it tough to charge enough to cover the cost of the services it offers branch customers. Plus, new regulations limit alternatives for consumer banks to grow revenues, for instance by capping the amount banks can charge merchants for debit card transactions.

A somewhat extreme reaction would be to weed out the unprofitable customers. In Chase’s case, this implies focusing exclusively on mass affluent and high-net-worth individuals, i.e. radically changing the business model by becoming a private bank. This would, in principle,4 lead to an increase in profitability. However, competition for highly profitable clients among banks, brokerages, and credit card issuers is fierce, limiting growth perspectives.
So, unless you’re willing to accept a radical change in your business model, other solutions are needed. This is where a strategy to enhance the profitability of lower value relationships comes into play.

Customer development, i.e. trying to get more out of existing customers, is the first place to look at. However, previous studies on major US banks revealed that a very-well developed customer isn’t necessarily more valuable than an under-developed customer, especially in the lower segments.5 Moreover, customers in lower segments already tend to put a large fraction of their financial products into a small number of financial institutions. For example, Chase already captures more than 40% of the D&I wallet of the lower customer segment. Therefore, while it is useful to look for development opportunities, the upside to these activities will likely be limited.
Technology offers a second, complementary path to profitability. Modern product management tools can optimize sales by creating products with both the features and the pricing that the customers demand. Technology such as mobile, personal finance management and self-service can help make customers profitable by redefining the servicing cost model. And as channels become better integrated, banks can more easily rationalize their largely fixed, legacy infrastructure, bringing down costs and freeing up resources to focus on the selected set of long-time value customers.

David Andrieux, PhD

1 Figures from J.P. Morgan Chase’s website and 2012 annual report.
2 J.P. Morgan Chase 2012 Investor Day - Consumer & Business Banking.
3 This is the minimal figure compatible with the available data. It occurs in the extreme case where all customers in the lower segments are unprofitable. The actual figure is likely to be larger.
4 Weeding out customers would also affect investment capabilities so that the causal link is not necessarily straightforward.
5 Size and Share of Customer Wallet, Rex Yuwing Du et al., Journal of Marketing 71, 94 (2007).