Article from Mapinfo, on the BAI blog, discussing the the science of branch location selection. It reads more as an ad than anything else, but some good tips in there. I say ad, because it doesn’t address “why” branches and their location are important.

Banking Strategies Blog : The Laws of Customer Attraction

BY LYNN ELLEN QUEEN MAPINFO CORP.Relying on more “science” in branch location decisions can yield sharper analyses of (customer) demand and (branch) supply, minimizing costly mistakes.

| SYNOPSIS | A new branch office can cost $1 million to $3 million, reflecting premium pricing during this spike in de novo branching. Banks are encouraged to employ a more sophisticated analysis – one that includes more granular levels of detail – to choose the sites most appropriate for their overall retail strategy.

Identifying locations for new branches has always been part science, part art. Bankers over the years have developed many models for analyzing the demographics of a particular area. The models are then supplemented with local market knowledge or “gut instinct,” i.e., does this strip center or corner parcel feel right?

In today’s ever more competitive environment, financial institutions need to leverage the “science” more to sharpen their analysis of supply and demand in particular markets. This can be achieved on a macro level to determine whether an area is a good fit for banks in general. Or it can be taken to a micro level to determine whether the area is home to an institution’s specific targeted customer segment.

The importance of this exercise is underscored by the industry’s increased emphasis on de novo branching. Having “rediscovered” the branch after an infatuation with online banking in the last decade, major institutions are now scrambling to build new offices in the most attractive markets. Given that these investments generally cost $1 million to $3 million each and good sites are at a premium, mistakes can be expensive.

An institution’s determination of where to locate a branch needs to consider all the variables in the market as well as its specific retail strategy. The more detail that’s brought to bear and the more sophisticated the analysis, the greater the likelihood that the institution will realize its financial goals for the branch.

Gravity Model

As with real estate in general, the keys to a successful new branch are location, location, location. In a 2003 statistical study of deposit growth at more than 5,000 mature de novo branches (7 to 11 years old, excluding main offices and in-store outlets), MapInfo determined that location characteristics account for 65% to 75% of the success of a branch. These characteristics include the type of area around the branch (i.e., busy retail area, neighborhood street, etc.), branch visibility, the competitive intensity and environment, branch attributes and capacity, and demographics and population density.

The execution and performance level of the staff, by comparison, accounted for only 25% to 35% of a location’s success. An excellent staff and execution strategy cannot make up for a poorly placed location.

Where to start? In any given market, bankers face the same questions: Where are the customer segments we want to pursue? What is the demand for banking products in those segments? What is our potential profitability? How geographically concentrated is that specific demand? How much demand is located within a distance deemed convenient to that segment?

It is easy to get lost in the analysis. From traffic counts and market demographics to household growth and strength of the competition, it can be difficult to separate the data and assign relative importance to each factor. It helps, then, to start with a basic analysis of supply and demand.

A “gravity model” is recommended as a tool to sort through the complexities of the location decision. This model identifies the basic components of supply and demand, which need to be understood regardless of an institution’s particular retail strategy. With a thorough understanding of supply and demand, the gravity model can be used to answer the essential question: Where does a new branch stand to make the most money in accordance with the bank’s overall retail strategy?

With a gravity model, the share of the market captured by a particular location decreases as the distance increases, something referred to as distance decay. Think of the demand component as metal shavings. These are scattered at different locations around the market, separate shavings for separate products. Supply (branches) can be likened to magnets, which attract the demand. The strength of the magnet – or bank branch – depends on its facility characteristics relating to branch capacity, such as number of tellers, drive-through lanes, number of hours open, etc.

Supply includes the locations of a bank’s branches as well as those of the competition. Understanding the supply in the market and the impact of the competition on a possible location is essential. Who are the competitors, where are they and how strong are they? These questions must be answered.

While knowing where potential customers are is important, it is also important to know where they are in relation to competitors. Branching is a convenience play. For many bank products, especially transaction accounts, customers like having a branch that is close by, easy to get in and out of, and with a sufficient number of tellers and desks. All else being equal, the branch that is the most convenient to the customers will do best.

One mistake that many bankers make is to look for a location nearest the competition. They feel that if every other bank is in a certain area, they need to be there, too. There may be some truth to that, but it does not always drive the best decisions. The problem is that there is a fixed amount of demand in any given area, and the more branches there are, the smaller the slice for each branch. After a certain point of adding branches to an area, the slice of demand for a branch will be too small to justify the cost of building and staffing it.

In addition, branching amidst a cluster of competitors does not allow a bank to differentiate itself on the basis of convenience. This is particularly important to understand in the case of banks that have a specific retail strategy such as being a price leader for a particular product in the market. In a world where banking is nearly a commodity business, any way of setting one bank apart from the rest is helpful.

Degrees of Competition

There are several aspects to understanding the competition and its relative strength. Not all competitors are created equal. Credit unions, for example, interact with customers differently than commercial banks. A member of a credit union will feel a loyalty to the institution and be more willing to drive farther and perhaps wait longer for service than customers of commercial banks.

Even among commercial banks, the differences are apparent. A national chain will have more marketing dollars and more signage in a market than a smaller chain, which translates into a greater presence in the market. All things being equal, stronger advertising awareness pays off. An independent bank, by contrast, differentiates itself based on personal relationships. When a bank has a specific retail strategy, knowledge of the competition’s strengths and weaknesses is even more important.

The strength of the competition also has to do with the attributes of the competitor branch. Besides location, these attributes are what make a branch attractive to potential customers. Do the surrounding competitor locations have a drive-up ATM? Are they open Saturdays? Do they have extended drive-up hours? Is signage well placed? Is the branch on a corner? Is it easy to get in and out of the branch? How many drive-through lanes are there?

While customers may not explicitly state these preferences, MapInfo research has shown that these attributes contribute to an individual branch’s performance. In other words, the strength of the competition in terms of location and attributes relative to the location under consideration will influence the success of that new location.

The other component of branch placement is an understanding of the demand for financial products in the market. Just as competition is not all alike, demand can vary because the needs of customers vary. A branch in a retirement area of Florida, for example, can expect many deposits (especially if they offer attractive CD rates), but few loans. A branch in a mass affluent area will likely tout mortgages, retail equity loans and car loans. The demographics of the market area around a potential location determine the demand for each type of product.

More than that, the demographics drive the account balances that a branch can expect. But beware: assumptions can be dangerous at this point. Many bankers assume that they must locate branches right where the affluent market lives in order to bank all that money. While those households may be large borrowers (and savvy ones, too), they may keep most of their investments outside of the bank. In reality, a bank may gather more deposits and investments in a blue-collar area where loans are few.

Another factor influencing demand is demand density. As in the example above, bankers tend to be attracted to the estate home developments that seem to promise large balances, whereas tract home developments tend to be ignored. Because estate home developments have fewer households per square mile than tract homes, the density necessary to support a branch may not be sufficient. To truly understand a market, a bank must know how many households are in it and the volume of balances that those households will bring. Smaller, but more, balances could turn out to be more profitable than a few large balances.

Knowing a site’s potential also involves knowing the value of the demand in the market. Using expensive CDs to grow a large deposit branch will not yield a good return on investment. When forecasting the value of a location, it is important to understand the margin and costs of each product the branch sells, how much of each the branch can expect to acquire, as well as the ongoing costs associated with transactions made on accounts of each product type. Only then can a bank forecast a realistic return on the investment.

Targeting Your Niche

While some banks position their branches to appeal to the mass market, others try to align them with their core strength, be it commercial banking, mass affluent retail banking or banking for specific ethnicities or sub-markets. Such institutions require more focused strategies when deciding on retail branch locations, and that can add a layer of complexity to the process.

The basics of supply and demand still apply. But the importance of certain aspects of supply and demand need to be weighted differently depending on the strategy. Knowing who the competition is, for example, takes on a different emphasis. A bank that wants to target the Korean market in a given area should be very aware of Korean banks targeting that same market and less concerned about those banks that are not staffing to reach Koreans.

Likewise, a small bank that targets small- to mid-size commercial businesses may examine a market carefully for the strength of the major competitors. A market that has strong major players and few independent banks may be more attractive than a market with many other small banks competing with one another because the small bank will be able to differentiate itself more easily.

Depending on the strategy, supply may become less important than demand. In the case of a credit union for Ukrainians, the most important driver is not so much the competition as finding the highest density of Ukrainians when placing a branch location.

Just as a bank with a niche strategy should weigh aspects of supply differently, it should define demand to relate to its strategy as well. It needs to give more weight to the targeted demographics, understand balances of a given target market, and calculate the densities in that market.

There are numerous examples of this exhibited throughout the country. Many banks have relative strengths or are trying to attract certain product categories. An ex-ample is the way that some banks concentrate on attracting free checking accounts. Clearly, this strategy for profitability, with a specific product emphasis, should value checking demand more and look for the demo-graphics that drive these balances versus other types of demand. Pricing advantages relative to the competition often drive this product emphasis.

But even when targeting a certain type of customer, the analysis of a branch’s potential needs to include, in most cases, the general banking public. Rarely does a certain ethnicity or customer segment carry all the expense of a retail branch location. Most banks cannot ignore the need to minimize competition and maximize profitable de-mand density of the mass market, regardless of the specific niche strategy.

How much weight should be assigned to the targeted segment when looking at total demand? One way to answer this question is to analyze the bank’s previous success in targeting these segments. A bank that has achieved 20% market share among the targeted segment in markets with similar demographics and competition has some experience to guide it. The targeted segments should be weighted to mirror the strength of the bank’s previous success in pursuing those segments.

When determining the potential success of a location, it is important to take into account the differences in target markets as defined by the way they bank. For example, a branch focusing on small businesses will not only attract those businesses but also the personal accounts of the business owners. Banks targeting certain ethnicities such as people of Asian descent, for example, need to assume much higher deposit balances per account than for the mass market. To illustrate, the average savings account balance will be 32% higher in an area where 25% of the households are Asian as compared to an area that is only 5% Asian. Similar relationships exist for other products as well.

Knowledge-based branching decisions require the processing of hundreds of variables. Branching for specific strategies requires even more. Given the importance of location to the success of a branch, however, applied intelligence about locating branches can really pay off.

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Ms. Queen is a client manager with MapInfo Corp., a global provider of location intelligence solutions based in Troy, N.Y.