To Main Proceedings Document
A SYSTEMS APPROACH FOR CHANNEL MANAGEMENT IN FINANCIAL INSTITUTIONS
Funda GURGOZE
Nevra YENER
Consultants, A.T. Kearney istanbul
June 2000
ABSTRACT
Increasing customer sophistication, broadening competition and changing technologies have significantly
impacted retail financial services and the channels through which customers interact with financial
institutions. It’s not only the number of channels that has increased dramatically, but also the functionality of
those channels has expanded significantly.
This paper is based on a recent study completed using System Dynamics methodology to demonstrate the
challenge of managing the broadening channel network to achieve the best financial performance in the long
term. It first elaborates on the A.T. Kearmey approach to channel management in the financial sector -
Integrated Channel Management -, which forms the basis of the study. In the second part of the paper, the
System Dynamics model and the Flight Simulator will be briefly depicted.
A Disciplined Approach To Channel Management: INTEG RATED CHANNEL MANAGEMENT
Highlightened competition and the increasing sophistication of customers in the sector have forced financial
institutions to provide their customers with a greater variety of distribution channels and, more importantly,
coordinate the marketing and distribution strategies across all channels.
Figure 1. Evolution of Channels
== 3 ry ie i me Thanks to recent
improvements in technology,
Focuwed pathos, retail customers now have the
opportunity to benefit from the
Suki feaoe | | spe |_| Frmchise
Banh sharing Bnches cost advantages and
Sea a ate convenience provided by
Sate eal Cane Meaguoet institutions that have made
Dina Davbase heavy investments in channel
development. However, recent
cwatcaa [Sp per cat sun Card A.T. Keamey research shows
that the second part - effective
am Kiok fm] Bemet Lp] Witte management of the channels -
is an important issue, which
Bane Phone becomes more challenging
with the development and
Pe iemet ronan :
Baling Baling wv evolution of each channel:
Local
Sales Force
cumce: AT. Keay analveie
* Channel strategy and planning is not coordinated across all channels with focused roles and
responsibilities being assigned to each channel
¢ Channel economic data, such as activity cost by channel, is not fully analyzed for channel strategy,
capacity and investment decisions
¢ Channel capacity and investment decisions are not made from a cross-channel perspective
* Customer preferences by segment are not considered in determining channel roles, and capacities
¢ Proactive strategies are not used to migrate customers between channels
Enhanced competition is forcing all financial institutions to improve and optimize the value of their evolving
channel networks. Some manage channels to reduce costs, some manage channels to enhance sales, but few
if any, succeed at both. A sales and service focus results in untargeted cross-channel marketing and
distribution strategies which requires heavy investment, whereas focusing on cost reduction makes it difficult
to maintain a competitive service and distribution offering.
Optimizing the channel _ network,
however, is not an easy task and demands
an integrated approach across all
channels. Effective channel integration
should start with the development of a
channel network plan and an integrated
channel strategy. This includes
determining which channels will be used
to sell or service specific customer
segments for specific products or services
taking into account several dynamic and
interrelated factors. Channel network
capacity allocations should then be
derived from the channel strategy. Some
of the benefits of an integrated approach
to channel management are:
« Reduced channel costs and increased
revenues
Figure 2. Sales&Service vs Cost Focus in Financial Institutions
High
Low
Generic delivery, servicing and
migration strategies for generic
customers
+ Expensive distribution
network remains
+ Sales and service best
practices implemented
Focwsed channel roles &
responsibilities by customer
segment
Customer migration strategies
targeted customer segments
*Optimaized chafinel ne twork for:
— reye nue and cost
© differentiation and customer
satisfaction
+ High redundancy across channel
and low utilization
+ Poor implementation of Gales and
service tactics
Generic delivery,
servicing& migration strategies
for generic customers
* Channels maybe rationalized,
but not optimized
+ Weakened sales and service
capebilities as a result of
reduced, over-burdlened
resources
Low
Cost Focus
High
¢ Improved customer loyalty, retention and "share of wallet"
¢ Significant market differentiation and, thus, competitive advantage
Integrated Channel Management is an approach to manage evolving channel networks as an interdependent
and integrated portfolio aiming at delivering all the significant benefits stated above by taking into account
the myriad of competing, complex and subjective factors related to:
* Customer preferences and needs,
* Customer segment profitability and strategies,
¢ Product profitability and strategies,
¢ Channel economics and performance,
¢ Organizational capabilities and channel competencies
In addition to considering all these factors, developing a cross-channel strategy requires determining which
channels are more effective in which of three types of activities that take place between the retail customer
and the financial institution:
Figure 3. Integrated Channel Management Framework
Strategy Steal Network
ning,
Chi ‘
Roles ‘anne! Strategies.
Inputs
Channel
Economics
and Responsibilities (A/TIS)
Types of Activities
1. Acquisition
- Information
Dissemination
- Prospecting
- Sales
Ig - Cross-sales
fd 2. Transaction
- Applications Processing
- Account Activity
3. Service
- Account Inquiry
- Account Service
- Problem Resolution
Once the channel strategy has been defined, customers need to be migrated and the existing channel network
needs to be reconfigured. Finally, all the support practices should be in place to lead to successful
implementation.
CHANNEL MANAGEMENT MODEL
The objective of the study is to develop a prototype model for one component of the Integrated Channel
Management Framework - Channel Roles and Responsibilities- using a system dynamics approach to:
- Demonstrate and understand the
complexity of channel strategy and
capacity decisions given the myriad
of dynamic and interrelated factors
(channel, product and customer
related) to be considered
- Prove this complexity by only
demonstrating the impact of one
variable, - channel capacity decisions
on customer satisfaction and bottom
line profitability
- Demonstrate the benefits of other
approaches, such as customer
segmentation, on profitability
Figure 4. Channel Strategy Cube
Youg | AT
8
Affhurrt
= AT|AT/AT
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s|s|s
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at
sis
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ODARemanet rent lean FX Saved Small
Chavkingl ant Cartinne = m na
— Lowes
Products
Several assumptions and simplifications have been made for prototype purposes:
- 3 channels with fixed capacities were represented in the model which were chosen based on their
different cost structures, competencies and customer preferences
- Branch
- ATM
- Call Centre
- 3 products were selected , based on their different sales and service requirements, channel variations, and
customer preferences
- Investment Products
- Credit Cards
- Checking Accounts
- 5 different customer segments were included with different profitability levels, channel preference and
sensitivity to channel availability
- Best Customers
- Good Customers
- Marginal Customers
- High Potential Customers
- Unprofitable Customers
- Impact of competitive strategies (product features, price, promotions ...), product profitability etc. is not
factored into the model for the sake of simplification.
Data estimations were made for one large and one medium-size Turkish bank based on publicly available
information (Ex: Y early revenue, profit, channel capacities, channel activity volumes etc) and published
projections.
The impact of conscious capacity allocation decisions on customer satisfaction and profitability were
analyzed by developing three versions of the model:
Figure 5. Versions of the Model
Inputs Outputs
eeen ne + No customer segmentation + Reactive channel capacity allocation
Capacity + Channel capabilities are taken into
Utilization consideration
Indicators Decisions
+ Product and transaction figures + Capacity allocations at each channel
+ Channel Competencies and Utilization
+ Channel Financials Outputs
+ Financials
+ Customer Satisfaction
Inputs Outputs
+ Customer segmentation + Channel Roles
+ Channel capabilities + Channel Capacity Allocations
+ Channel economics + Customer Satisfaction
+ Customer channel preferences
Version 1: REACTIVE CAPACITY UTILIZATION
Figure 6. Loop Diagram for Reactive Capacity Utilization
This version assumes that there is
no intervention by the bank to
change customer behavior and
impact channel utilization. Thus,
channel capacities are utilized
reactively based on the customer
demand for activities and available
capacity at each channel.
Given a fixed capacity with no
assigned channel roles, the major
determinant of the revenues and
costs is the actual number of
activities done at each channel for
each product, which is constrained
by the fixed channel capacity. The
result is a pool of ‘acquisition,
transaction and servicing’ demand, which should be satisfied with the total existing capacity of each channel.
Thus, revenues and costs (fixed plus variable cost/activity) increase as long as the fixed capacity allows them
to do so and the negative loop of customer satisfaction starts dominating after this point.
Version 2: TRADITIONAL CAPACITY ALLOCATION
Figure 7. Decisions in Version 2
Some user intervention exists to represent the way today’s DECISIONS
executives make decisions. In this version, the user can review
indicators like total number of products, overall customer
satisfaction, number of activities at each channel, financials etc. —— $=
and is expected to make decisions regarding capacity
allocations for Sales and Non-sales activities at each channel.
6 -———— 10
es
Focated; 100
Unatocated: 0.
<< |
{asm
The same feedback loops work for the number of activities
other than the channel capacity allocations. Since the user —— oe
makes conscious decisions as to what percentage of the channel ce
capacity to allocate to specific type of activities, the channel Sn sms
capacities allocated to different types of activities are dynamic aE
although the sum is still fixed. This way, the user can control act
the fixed cost associated with three distinct types of activities ———— come
and their volume at different channels.
——= ||...
a... 5
Pocated 100
Unalocated: 0
f
| Review History of Decisions
Figure 8. Loop Diagram for Traditional Capacity Allocation
compels
Ce)
1) TinefActivity by product at charte] 5) Tetal costby cham] df ined costfor
= 2) Number of Activites by product chanel
ae 3) Sales by product and sales by carmel 6) Reverme by product
\Oe 4) Leeses by prodxt, 7) Overall com, revermes and profit:
Chanel
A Find
Competencies a
Capacity
+ +99
id ¥,
¥ + capacity a ‘Utilisation % +
Charme] Role
+ Weike a Albcation
‘4
Version 3: INTEGRATED CHANNEL MANAGEMENT
The objective of this version is to demonstrate the complexity of all the factors ICM covers and how this
impacts the financial performance, as well as customer satisfaction and channel utilization. The model
considers all the factors in the framework and makes an allocation decision on behalf of the user. There is no
interaction by the user other than altering such high level strategic variables as segmentation targeting and
management sensitivity to customer satisfaction.
The model assigns a “role” to each channel, which defines the relative weights for the three types of activities
provided to the five different customer segments for the three different products by considering target
segments at each channel, channel competencies and the relative unit activity cost for the different products
at each channel. The third component of the channel role definition, - channel unit activity cost- is again a
dynamic variable that changes with the capacity allocated to each type of activity at each channel for specific
customer segment and product.
Finally, the role assigned to each channel gets weighted again with the estimated activity demand at each
channel, which then gives a percentage of channel capacity to be allocated to the three types of activities for
each product and customer segment.
RESULTS FROM INITIAL RUNS
The first runs of the model demonstrated some useful insights regarding financial performance and customer
satisfaction, which are the key important performance metrics to balance when managing channels
In the absence of a structured approach to channel strategy, number of products boost initially, assuming
more than enough channel capacity to serve our customers. This results in increasing revenues and increasing
costs. Since fixed costs are not managed to get the biggest revenue by utilizing the channels in the most
effective way, the ultimate goal, profits, is not very satisfactory. On the other hand, since all demand from all
the customers is satisfied, good customer satisfaction has been achieved initially. However in the long term,
the uncontrolled increase in the number of products has resulted in a scarcity of channel capacity and, thus,
decreasing customer satisfaction. This, in turn, has had its major impact on our sensitive profitable
customers.
It has been observed that users can make clever decisions if they are given some high level indicators as in
the second version. In the absence of customer segments and unit activity costs by product and channel, it
proves difficult to allocate channel capacities to different activities. In addition, the lack of a mechanism to
assign capacity to specific products makes it difficult to control the service provided for different products
which have their own cost and revenue structure. Making these simple allocation decisions proves very
difficult even for 3 channels and 3 products with the limited number of indicators. Overall, the financial
performance has been considered as satisfactory, whereas customer satisfaction suffers in most cases.
The last version has been found quite useful in determining the impact of different segmentation decisions on
a variety of performance measures. As the allocation decisions, in a way, force customers to migrate to
channels other than the ones they’ d prefer, customer satisfaction has suffered during some runs, depending
on the management sensitivity to this factor. Financial performance has tended to exceed the satisfactory
levels, even with relatively low levels of number of products and loss of customers, which were not targeted.
On the other hand, even reading the allocation decisions done by the model has been difficult. Trying to trace
the decisions back to the logic made the users lose the overall picture.
CONCLUSION
Effective Channel Management requires defining a cross-channel strategy considering a number of complex,
dynamic factors regarding customers and products. This nature of the problem makes it suitable for adopting
a System Dynamics approach to help today’s financial executives in making clever decisions.
This study helped A.T. Kearney consultants to develop a good understanding of the dynamics involved in
channel management. There are still opportunities to improve the model by integrating new dynamics related
to capacity increase decisions, competition factors, etc., however the large number of channels and products
makes it impractical to do so.
Finally, the model has proved to be an effective way of communicating the Integrated Channel Management
concept and, more importantly, understanding the dynamics behind it, which will aid today’s executives in
making their decisions about one of the most important components of Integrated Channel Management, -
Channel Strategy- which is the starting point for a really integrated channel network.
