By John J. Coffey, C.P.A. and Gene Palm, www.profitres.com

Conventional Wisdom

You've always heard that it costs 5 to 7 times more to get a new customer than it does to cross-sell your products to an existing customer.  It seems like this is true, but have you ever run the numbers to prove it?  Probably not!

Anecdotally, you could make the case that it takes more time and effort to sell to a new customer than it does to sell to an existing customer, especially if the cost of failure (declined loans and new accounts) were factored into the acquisition cost.  Additionally, you could also make the case that you need to spend more marketing dollars to get the message across to a new customer, since they do not know you like an existing customer would.  But, are new customers really more expensive than existing customers?  Is it possible to make the case that in some cases new customers may be less expensive than existing customers?

Knowing Your Fixed Costs

In order to understand the costs of your marketing efforts, you need to know a few accounting terms.  There are two types of costs in the bank - fixed costs and variable costs.  When all of the fixed and variable costs have been included in the cost of a product, or in the cost of an existing customer, then these costs have been "fully costed" or "fully allocated" to that product or customer.

The top 3 costs in your bank are the cost of your personnel, the cost of your physical infrastructure and the cost of your data processing.  We call these costs "The 3 P's" and they may account for up to 80% of your total non-interest expenses.  Largely, your personnel and physical infrastructure costs are fixed, while your data processing has elements of fixed and variable costs.

In the manufacturing industry, industrial engineers use "Time-Driven Activity-Based Costing" studies to quantify the direct cost of a product, including raw materials and personnel time.  To perform this study, someone literally uses a stopwatch to time how long it takes for the manufacturing process to be completed.  This works really well in a production line environment where the process is physically oriented and very controlled (e.g., it takes 50 seconds to assemble a clock).

However, the idea breaks down in a service environment like a bank.  Sure, it's possible to use a stopwatch and time how long a teller takes to complete a particular type of transaction and then calculate the cost of the transaction.  The problem is that it doesn't adequately reflect what is really going on - the single-most expensive thing a bank provides is on-demand service; someone waiting for a customer to come in the branch!  If no one comes in, then that expense is sunk!  And, unlike other companies that have huge physical infrastructure expenses, a bank's largest expense is people; and, if those people are not utilized, you still pay them!

Someone has to pay for the availability of personnel.

Now, let's apply this to your marketing efforts.  If you sell more accounts, the likelihood of having to hire more people; build more branches, ATMs, and web sites, to service these new accounts is quite low.  By selling more accounts and keeping the overall costs of personnel and physical infrastructure the same, you may be able to make your delivery channels more efficient.  This means that you don't need to factor in the fixed cost of your personnel and physical infrastructure as a cost of adding new accounts.

Knowing Your Variable Costs

If you don't factor in the fixed costs of your personnel or physical infrastructure, what costs should you use?  The answer is, only those costs that are variable, or "incremental."  These are the costs that would increase directly as a result of adding new accounts.  Incremental costs include such things like the cost of the:

§         Incurred marketing expenses

§         Loan processing fees and credit reports

§         Anticipated loan losses and collection expense increases

§         Additional check processing and correspondent bank fees

§         Increased postage and statement rendering

§         ATM and POS usage fees

As such, the incremental cost is only a fraction of the fully allocated costs.  When viewed from this standpoint, it may actually cost less to add new accounts than it does to maintain your existing accounts!

When you put together a pro forma for a marketing campaign, always make sure you use incremental costs instead of fully allocated costs.  You're much more likely to forecast a profitable marketing campaign if you use this approach - and as a result, you are much more likely to receive the funds to do the campaign in the first place!

In your post campaign analysis, make sure to continue using incremental costs and you will likely see that you have completed yet another profitable marketing campaign - a result you will want to share with everyone in the bank!

John J. Coffey, C.P.A. and Gene Palm are the principals of Profit Resources, a consulting company that specializes in MCIF technologies.  (c) Profit Resources, Inc. 2006.