Add customers, grow profits: by applying an alternative cost model for checking accounts, you discover that most customers today are, in fact, profitable. Under this approach, therefore, the quickest way to increase profits is to attract more customers.

• Author: Griesel, Achim
• Position: Financial report

RECENT REGULATORY CHANGES are placing the checking account and its profitability under intense scrutiny. The overdraft fees that the industry experienced over the last 5 to 10 years have declined by an average of 20 to 30 percent per customer. The larger financial institutions with over $10 billion in assets have lost more than half the interchange revenue per customer. As a result, financial institutions have reviewed and changed account lineups. We're seeing many implement service charges or make adjustments to minimum balance, transaction and e-statement requirements.

But 20 years ago, banks all over the country were offering free checking accounts without any of these charges or requirements. They offered this product without the subsidizing effect of large amounts of overdraft or debit card interchange income. Back then, most banks used a "fully allocated overhead cost" model for calculating costs and profit. Most banks still use the same basic model today, although the quantity of costs that .are cranked into the model have increased, meaning that models today are showing higher costs and, thus, lower profits.

The allocated overhead model has some drawbacks. A major shortcoming is that it can give the banker a skewed perspective as to where the profit is coming from. It suggests that most customers are unprofitable. Therefore, it doesn't make sense for the bank to add more customers--since this will generate more added costs than profits. The model lulls the banker into thinking that the way to increase profit is to generate more fees and service charges and to change minimum balance requirements, etc.

But imposing more fees and restrictions tends to drive customers away. Is this the right approach to take in order to enhance profitability?

There is an alternative cost model that should be considered. This is called the "contribution cost" model. The contribution model, I believe, provides a more accurate picture of where the profit is located. This model says that most customers--usually more than 90 percent--are. profitable. Thus, if the bank wants to increase profits, the fastest way to achieve that goal is to acquire additional customers: the more customers you attract, the greater the profits.

The issue is not about offering free checking or not. The issue is about which cost model you use when making critical decisions involving profit. Using the right cost model is even more important in the current environment of declining...