Segmenting small-business customers: while most banks segment small businesses according to revenue size or number of employees, it's far more effective to do so according to the lifecycle needs of the business and the owner.

• Author: Neckopulos, Jim

SMALL BUSINESS BANKING continues to offer attractive opportunities for banks of all sizes, be they national giants like Bank of America, JP Morgan Chase and Wells Fargo & Co., or local community institutions. Moreover, because small businesses have been traditional sources of job creation in the U.S. economy and are likely to lead us out of recession, business banking opportunities should become even more pronounced in the coming months and years.

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Being able to capitalize on business banking opportunities requires careful thought and analysis. The question that we explore here is: What is the optimal way to segment these businesses to best meet their financial services needs while also optimizing the returns to the banks that pursue them?

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Historically, banks of all sizes have used metrics related to size to determine how best to sell to and support the banking needs of business banking customers. Typically, this has meant looking at company revenues and setting cutoffs to segment prospects and customers, e.g.: $1 million to $5 million for--small businesses; greater than $5 million to $25 million for small- and mid-sized businesses; and, $25 million or more for middle market businesses. The results of this business customer segmentation then are used to make decisions on:

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* The channel(s) used to sell and service these companies.

* The skill set and experience level of the resources dedicated to them.

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* The set of banking product and services offered to them.

Unfortunately, using revenue-based segmentation has sometimes resulted in frustrated and unhappy business customers and significant missed opportunities for the banks that serve them. As one example, many small-business owners are often good candidates to become wealth management clients. However, many banks, including many national and regional banks, tend to sell and service their small-business customers through consumer banking channels. Some of these channels (e.g., retail branches or call centers) are not sufficiently focused on or skilled enough to meet the needs of these customers. Other channels (e.g., consumer online banking) may not provide the bank with sufficient visibility to, or functionality for, meeting the business or wealth management needs of these customers. Whatever the cause, the result is that the small-business customer does not believe its preferences or needs are fully understood or are being met.

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Another common size-based segmentation scheme used by banks for small businesses is focused on the number of employees. In the United States there are nearly 27 million small businesses with fewer than 500 employees:

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* 25.7 million U.S. businesses with between one employee (the owner) and 19 employees.

* About 600,000 businesses with between 20 and 49 employees.

* Roughly 200,000 businesses with between 50 and 99 employees.

* Fewer than 100,000 businesses with between 100 and 500 employees.

The needs of businesses within each of these employee tiers can differ dramatically. As a result, the number of employees may or may not be indicative of the best approach for banking them. On the one hand, employee numbers may be helpful in offering a company payroll services or direct deposits for their employees. On the other hand, the number of employees may provide little insight into understanding...