Economies and Diseconomies of Scale
Economies of scale are baked into the DNA of larger companies. It is true for financial services firms, health services, manufacturing firms – in fact for all organizations. Try as they may, large banks will always have difficulty making small loans. They need high volumes to move the bottom line and return on capital an iota. The larger the bank (and its capital base) the greater the volumes they need. Even when they delegate locally, they standardize offers and insert controls to manage credit and operational risks. The larger the bank the more levels of control need to be inserted. Predictably, small local customers are not always served well.
Credit Unions have a different mission, they operate by and for the benefit of their members. It is built into their DNA and their ownership structure. Their return on capital calculation is a quite different one. Historically there are two basic organizational structures, Select Employee Group (SEG) and Community Charters. Traditionally SEGs are oriented around a specific company or industry which bring an existing ‘standardized structure’ that the credit union can tailor its services and delivery channels to serve. Traditionally Community Charters restrict services to designated local communities. Both structures sidestep the diseconomies of scale faced by larger companies.
While scale and size can translate into faster adoption of technology, smaller size can translate into a more personal and responsive relationship. That makes a difference in building trust.
Current State of “Trust”
Morning Consult’s, Most Trust Brands 2021 and its Trust in Financial Services Series indicates the only industry where trust is more important for consumers than financial services is the health care industry. However, what ‘trust’ means, how to earn it, and how to lose it have many facets.
61% of people trust banks and credit unions by default, and just 27% think they need to earn that trust. (Likely because their regulatory structures are designed to proactively protect them.)
That ‘unearned halo’ of trust is important, but only table stakes and can be lost easily. Banking, like medicine, creates sticky relationships. But the pain of moving, not necessarily loyalty, makes that so.
The consequences of lost trust are high. Asked how loyal they’d be if their trust was broken, 40% said they’d only use a competitor, 42% would still use them, but use competitors more, and just 20% they’d continue using them as before.
The ongoing pandemic has and is causing a further erosion of trust, some areas more than others. Chicago Booth Kellogg School’ s Financial Trust Index measures the overall trust in American institutions. For the 1st year of the Pandemic (2020) trust in financial institutions dropped from 33.3 to 31.3. While banks and credit unions were higher than investment, payment, and insurance services, they weren’t immune. Large corporations (and by implication large banks) started significantly lower and dropped further, from 21.9 to 18.9. Morning Consult’s survey in March of 2021 confirmed the drop in trust throughout financial services. Year over year, trust in financial service firms dropped 17%. That was offset by 13% whose level of trust rose, to limit the net decrease to 4%. (Notably only frontline businesses like restaurants, homecare products, and healthcare companies achieved a net zero or positive change in trust level.)
Why Trust Matters
Trust is powerful for many reasons. It generates recommendations, increases usage, and share of wallet, and it tips the scale among alternatives. A company’s loyal customers are more willing to: forgive mistakes, try to find, and use them, pay them more, share personal information, and follow them.
How Is Trust Lost and How Is It Earned?
The ways to break a trust range from the egregious “took my money” to a lack of follow through on a social cause or issue. Two useful sets are:
- Consumers functional and experiential They expect companies to offer products that work, live up to their commitments, behave legally and ethically, advertise honestly and forthrightly, and more.)
- Consumers social and emotional They are observant and want to know their vendors to: treat customers well, be inclusive, be honest and authentic, give back in positive ways, etc.)
The first are elements of trust that drive purchase decisions. Customers give banks and credit unions the benefit of the doubt on this first category.
The second are elements that drive loyalty. They can differentiate a bank or credit union, and therein lies the hidden advantage.
While scale can enable a more robust functional and experiential product suite, it seeks the common denominators and tailors its delivery for it. That requires standardization, control, and automation which make personalization difficult to pull off authentically. It deletes many opportunities to build loyalty.
Once one could walk into a local bank, drop off a bundled deposit for the teller to sort, proof, and process. The teller would ask what else they needed and know that the head teller could fix any account problems on the spot. Or talk face-to-face to a person with the authority to make a loan. That scenario offers numerous opportunities to build social and emotional trust – if your frontline people are empowered to do it.
Contrast that with a scenario of never entering a bank, deposits done on an app, you process and proof each check for the bank, and ensure no glitches in the bank’s or another technology. (Getting cash requires a debit card at the right store.) Any problems you encounter are directed to an online chat-bot or into an automated phone tree, neither of which is empowered to solve a problem. The lending process is equally impersonal. There is little or no discussion of the business needs first. It is a mass market sales process, prospects are targeted using a FICO score, home value, a portfolio’s size, or an existing loan. There is no commitment, just a sales process. The commitment is made by a rigid and automated set of rules. This scenario offers few opportunities to build social or emotional trust – and no person is empowered to solve a problem.
What Does It Mean To Small Business?
Typically, small business owners personally provide the financial wherewithal for their businesses. Exposure to the 2nd scenario can quickly undermine trust, specifically in an unknown commercial lending process. For small businesses a loan facility is a critical element of solving their business problems. For any commercial lender, credit quality is the critical element, and that requires ‘knowing the company’s business, not automated scoring.
A prior post revisited the “Caring Company” and what care giver support meant to them. Credit Unions who support their members in the face of emotional, physical, and financial stresses can benefit in similar ways and earn loyalty. When they do, they are also supporting their small business members too. Opening a parallel, and more personal, line of communication is a good offset when personal elements are stripped out of other processes for needed efficiency. Also, support associated with a sector (health and care) that requires and earns even higher levels of trust can be more powerful than associations with low levels of trust (real estate and online companies).
If credit unions enable small business members to take another next step and provide employees with access to the same support, support that would otherwise stretch their resources, they can build loyalty from both, and potentially recruit new members.
The credit union benefits financially in another way too. By helping both mitigate the emotional, physical, and financial stresses of caregiving, they protect the revenue and income streams that enhance the quality of loans made to either.