"We need Hawaii just as much and a good deal more than we did California. It is Manifest Destiny." –William McKinley

As many institutions can attest, with short-term interest rates continuing to rise, the liability side of the balance sheet is becoming increasingly difficult to manage. More and more depositors are joining the ranks of the rate-sensitive. The required pace of deposit rate increases now more closely parallels those of the capital markets.

As president of Community Sample Bank, you’re a firm believer in managing your costs at the margin, and you’ve executed various promotional strategies with the goal of paying your depositors the “best rate, not the best rates.” You know that it’s essential to segment your market and to avoid paying up on existing funds. Still, it’s a challenge to attract new depositors from the markets in which you operate.

At last week’s ALCO meeting, you disclosed the results of your latest high-rate DDA promotion. Your mission (you chose to accept it) was to gather as much new money as possible and attract funding at the lowest possible marginal cost. Sadly, the results of your effort, as outlined in Table 1, failed to yield a marginal cost that was below your wholesale benchmark source of funds.

Table 1. Results of Recent High-Rate DDA Promotion

Ouch! After introducing a new high-rate DDA program at a rate of 2.20%, you successfully raised $5 million for the new category, but at the expense of 40% of your existing >$25,000 DDA depositors (who had been receiving only 50 basis points). The marginal cost [(difference in before vs. after expenses) / (difference in before vs. after balances)] of executing this strategy was a stratospheric 9.0%. Not a bad case for considering geographic segmentation and the valuable role of new markets as a source of new funds.

Building the Case for Geographic Segmentation
You can count on the marginal cost of raising funds from a new market area as being lower. Why? It’s new, rather than cannibalized money. By tapping into a new market, where your market share is already low, you will attract far more funds from new, rather than existing customers. By marketing and pricing locally, you can avoid the errors made in your previous promotion.

In order to limit exposure of your new campaign to existing depositors, you may be best served if your new market is serviced by different media and is far enough away from your existing markets to avoid any cross-over with current customers. It’s not at all unusual to see national banks, or retailers in general, offer different products or charge different prices in different markets. For example, a New York-based institution will offer rates in a de novo state, such as Georgia, that are different from the rates it offers in New York to generate new funds with as little cannibalization from existing relationships as possible—all in the name of obtaining funds at the lowest marginal cost.

1. Strong levels of income-producing assets and household wealth. Factors could include high penetration rates for brokerage and investment services and strong forecast household income.
2. Positive competitive dynamics. Variables could include high deposits per location and evidence of well-established institutions losing deposit share over time (indicating potential market receptivity to new entrants).

As a service to Seattle Bank members, the Library Services team provides a cadre of tools to aid in market decisions. Among these is the Claritas P$Cycle segmentation tool. P$Cycle provides market data, based upon a nationally syndicated survey of household financial behavior and current-year and five-year projections of such variables as household formation and income growth. The tool helps institutions:

	Ascertain which households are using which products and what the average balances are for those products
	Access household-based segmentation systems for consumer financial behavior
	Differentiate households based on financial services product usage and balance patterns
	Focus on markets with favorable deposit demand characteristics
	Assess demographic characteristics known to have the greatest correlation with specific consumer financial behavior

Let’s assume that you now seek to validate the potential for marketing deposit products to a de novo market that is 150 miles away from your home market. That market’s media and advertising coverage is known to be distinct enough to placate any concerns about potential exposure of differentiated pricing to your existing market.

We’ll begin the validation exercise with a review of P$Cycle’s precision household segmentation for financial services marketing. Claritas delineates multiple consumer groups on the basis of two key components: (1) affluence (as measured by income and assets), and (2) life stage (as measured by tenure, age, and urbanity). Table 2 illustrates the characteristics of 10 upper affluent market segments in the U.S.

Table 2. Characteristics of Upper Affluent Market

Segments 4 – 10 would seem to be good candidates for our target market. These segments represent 16.07% of U.S. households. These households have income-producing assets in excess of $100,000 and total household income of more than $75,000 and are headed by rising young executives, ages 35 to 54, with high usage rates for retirement and investment products, credit cards, annuities, and personal lines of credit.

Now let’s take a look at the P$Cycle report for your potential new market area:

Table 3. P$Cycle Report for Community Sample Bank's Potential New Market Area

The P$YCLE Profile shows that over half of households in your potential market area are categorized within desirable market segments for marketing of a tiered, high-interest DDA product; 19.0% of area households represent the seven specifically targeted market segments.

Now let’s delve into a product preference report that details average product balances and percentage of household penetration for the identified segments. Multiple deposit, investment, fee-based, and credit services and products are readily available for analysis.

Table 4 details select segments that would likely have desired characteristics of income producing assets and household wealth that would generate interest in the proposed premium DDA product. The data shows that household penetration and average balances of select investment products by these segments within the target market are well above national averages. Of particular interest are the high average balances within asset/cash management accounts. These balances, the majority of which are currently residing at brokerage institutions, could represent potential sources of new funds that could be directed toward the new deposit product.

Table 4. Select Product Penetration and Average Balance Report for Community Sample Bank’s Potential New Market Area: Segments 1 – 16, 36

Now, let’s review the area’s competitive dynamics. This analysis, shown in Table 5, entails an assessment of deposits per location, historical market share trends, and competitive locations.

Table 5. Deposit Market Share Analysis of Community Sample Bank’s Potential New Market Area

The analysis shows that Mountain Bank, an established player, has been losing market share. Conversely, upstart De Novo National and 1st Interregional have been able to gain share in a market that has appeared somewhat receptive to new price-competitive entrants. The market area supports an average of $28.7 million in deposits per branch location. This is higher than your current market area average of $22.3 million in deposits per branch location.

As your management team becomes convinced of the value of developing a localized pricing and product strategy for the new market area, it will seek tools for selecting a specific location.

By further refining the above variables by zip code, or square mile, the Seattle Bank can also provide a finely tuned view of specific site candidates.

Figure 1. Map of Competing Branch Locations for Community Sample Bank’s Potential Market Area

John Biestman is assistant vice president, IMS consultative sales advisor at the Federal Home Loan Bank of Seattle.

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