Steven Y. Eulig, Consultant, Simon-Kucher & Partners Strategy & Marketing Consultants
The introduction of the Second Payment Services Directive (PSD2) has forced banks to find answers to many complex questions: How can banks retain existing customer relationships and sell more products? How can banks transform the dull experience of buying financial products into something more exciting by activating our hunter-gatherer instincts? How can banks systematically benefit from behavioral effects? How can banks employ smart digital tools making use of gamification and thereby upgrade the customer experience with a positive emotional twist?
In these cases, it’s all about creating loyal customers and simplifying their decision-making in a complex world. For this reason, the best answer to PSD2 is to implement a digital loyalty program.
Implications of PSD2
PSD2 went live on January 13, and it will have implications for every company in Europe that deals with payments. The core of PSD2 is the principle of “access to account” (XS2A). This principle transfers data sovereignty from banks to their customers, meaning that customers are able to give any third party access to their data. For banks, this means that fintechs and software giants, e.g. Google, Apple and Amazon, will also have access to bank accounts if customers grant them permission.
Armed with this account information, these new competitors will be able to offer their customers all kinds of financial products. For example, account information may reveal that customers pay too much for insurance products. A competitor could compare offers on the market and provide a cheaper alternative. This can, of course, also be carried out for various other products (mortgages, loans, etc.).
Essentially, third parties, such as fintechs, will be able to do the cross-selling that banks have missed out on. In addition, they can replace the products banks and other financial companies currently provide by offering the customer a better deal on each product.
This is a huge risk for banks. In the past, banks actively sold products to their customers based on their personal situations and prior product usage. With the arrival of XS2A, banks will no longer have exclusive access to this information, paving the way for others to benefit from it, too. Given that many fintechs are very good at drawing conclusions from large amounts of data, while many banks merely administer their data, it is likely that fintechs will be better than banks at identifying cross-selling potential.
In short, PSD2 erodes the current account’s function as a hub to sell various other products. It is possible for customers to simply use their accounts solely as underlying infrastructure while using a third party’s interface, meaning that the user experience is designed and led by the third party. The fact that banks have traditionally been rather poor at cross-selling only aggravates the situation (most banks sell between two and three products, although most customers should have between 10 and 15 products).
Imagine how much more banks could earn just by selling an additional 0.5 products per customer on average. Interest products have particularly high contribution margins, e.g., a typical mortgage easily generates 1,000 euro per year or more.
What can banks do?
One answer to this challenge is to implement tools that invite customers to do banks’ cross-selling for them (“pull” instead of “push” selling). They shouldn’t wait too long, though, as XS2A is likely to decrease customer loyalty as soon as fintech solutions become more widespread. Gamification is the method of choice to significantly increase cross-selling and help customers choose the right products.
How does this work? The process follows three main steps: First, define how bank customers are rewarded; second, define how they can spend their loyalty points; and third, implement this structure as a digital, mobile-first sales solution that makes extensive use of behavioral pricing effects and gamification.
From a customer’s perspective, getting an overview of the myriad of financial products is hard, so many don’t even bother. To address this, banks should categorize their products into intuitive clusters. In retail banking, these could be “daily banking”, “savings”, “investment”, “mortgage”, “insurance” and a “bonus” field for other elements the bank wants to reward.
When thinking about categorization, it makes sense to be consistent in the way the bank provides financial advice; otherwise customers may be confused, and advisors will be less likely to accept the new system.
A digital platform like this has the potential to become customers’ key go-to point for checking their financial health. There is a “good-better-best” approach behind each category. For example, in daily banking, “good” coverage could mean having a current account; “better” coverage having an overdraft facility on top; “best” having a credit card as well. This very simple and intuitive story can be told for each of the categories. Moreover, lumping products into one coverage level (e.g., all types of bank accounts or credit cards) greatly reduces complexity, both for the customers and financial advisors. Naturally, only products that actually make sense for the bank should be rewarded.
What about products from other banks? We recommend actively asking customers about third-party products, but these should be presented differently in two key ways: First, a visual difference should be made between the bank’s products and ones from third parties (e.g., represented by colored vs. gray item). Second, third-party products should not be given any further rewards because the quality of these products cannot be assessed in order to estimate the customer’s overall financial health. From the bank’s perspective, it is sensible to collect information about third-party products in order to be able to offer alternatives. Moreover, presenting a comprehensive “banking ecosystem” to customers makes them more likely to return and use the loyalty program.
Spending loyalty points
To finish off the story, banks should apply the fairness principle: Customers buy products and get something in return. As a monetary incentive, this could either be a cash discount or a discount on a specific product, such as a credit card or a voucher for a local or online retailer. Non-monetary incentives are equally important since people react differently to hard and soft incentives—some prefer money, others prefer exclusive services and status. Therefore, we recommend that banks use both types of incentives.
Implementing the solution
Customers expect the solution to be mobile-first and fully integrated. When logging into their online banking platform, they should be able to see their individual product usage, how many loyalty points they have earned, and what they can use them for. Here is an example of how the “Daily Banking” product cluster appears on a smartphone. As explained above, one/two/three active sliders indicate good/better/best coverage respectively:
We highly recommend engaging customers on a regular basis. One measure that has proven to work very well in practice is a price change on their current account. Since PSD1 was introduced, banks have to inform all current account-holders about price changes. This means the bank has to send a letter to the majority of their customers. If the message about higher prices is combined with information about the loyalty program, significantly more people will want to find out how they can earn cashback bonuses. This is because customers will try to recoup the recent price increase by using more products. This psychological effect (behavioral economics) is called mental accounting. Customers compartmentalize different kinds of resources into separate mental accounts and only assign a certain amount of money to each area.
For a successful implementation of digital (loyalty) tools, different behavioral effects should also come into play. Some of these include the compromise effect (customers tend to choose the middle option), the anchor effect (customers can only perceive the value of a service if a price is shown), the separation effect (customers often prefer flat rates over individual billing) and the endowment effect (customers find it harder to unselect a default option than to actively select additional options). Implementation is not a trivial matter. Banks should be aware of the relative strength of each effect and the complex ways in which they interact with one another. Our project experience shows that full implementation of such a program leads to a significant increase in product usage (around 20 to 30 percent in the first year).
PSD2 poses a substantial risk to banks’ traditional approaches to cross-selling and retaining customer relationships, including the ability to design the user experience. Whether this is a threat or an opportunity depends on how banks deal with it. It is important to understand that the more products a customer uses, the more loyal they will be. Until now, many banks have sold financial products relying mainly on what Daniel Kahneman calls “system 2” (i.e., a slow, logical and mentally taxing thought process). System 2 is entirely appropriate when it comes to calculating the risk premium of a mortgage or deciding whether to grant a loan or not. However, when it comes to selling products, banks have to appeal to their customers’ emotions, i.e., their “system 1” (automatic, emotional, subconscious, and fast). In our view, this holds the key to the future of selling financial products.
In terms of customer satisfaction, a digital loyalty program is likely to increase measures such as the Net Promoter Score. This is due to the fact that customers feel good about their product decision because different behavioral elements smoothed out the decision-making process.
As real customers don’t act rationally, these concepts describe their behavior well. As far as we are aware, this is the first time that banks have been able to systematically and substantially increase usage of their products—the untapped profit potential is enormous. Increasing loyalty and cross-selling is the safest bet to achieve this.
- Trevisan, E. (2016): The Irrational Consumer: Applying Behavioural Economics to Your Business Strategy, 1st edition, Routledge