Retail banking profitability

Problem Definition

Your client, a regional commercial bank, wants you to evaluate their CFO’s proposal. The CFO proposes to increase sales by implementing a commission-based incentive program for the bank’s salespeople. Your client wants to know how this program would affect the bank’s profitability. What must occur in order to make this program feasible?

Comments

Since this is an interviewer-led case, the interviewer should guide the candidate through the interview.

This case has a conversational style hence no specific framework approach is required. Given the exploratory and qualitative nature of this case, the approach taken and sequence of events is dependent on the interviewer’s line of questioning and alternate scenarios are certainly possible.

Short Solution (Expand) (Collapse)

Detailed Solution

Paragraphs highlighted in green indicate diagrams or tables that can be shared in the “Information to share” section.

Paragraphs highlighted in blue can be verbally communicated to the interviewee.

Paragraphs highlighted in orange indicate hints for you how to guide the interviewee through the case.

Suggested case structure:

I. Products

The interviewee should gather information about:

Products

The interviewee should ask for more information about each product in order to determine each product’s profitability.

Revenue Streams

Ask the interviewee to suggest potential revenue sources for each of the bank’s products.

Information that can be shared if inquired:

The bank will sell  4 products through this incentive program:

	CDs (certificate of deposit)         
Checking accounts                     
Mutual funds                               
IRAs (individual retirement accounts).
Examples of the products’ revenue streams include monthly fees, interest generated, commission earned, overnight float options, and cross-selling.

II. Profitability

The interviewee should determine each products’ profit margin:

In order to improve the bank’s profitability, the interviewee might want to analyze both costs and revenues. If asked, tell the interviewee that the bank has already reduced costs as much as possible. It wants to increase revenue through this new incentive program.

Share Table 1 with an overview of the profit margins if the interviewee inquires it.

Key Insights

Each product has a different profit margin.
However, the profit itself (margin times the average deposit) is the same ($80) for each product.
The maximum incentive that the bank can give employees per product sold is $80.

Knowing this, let’s see what the options for incentive programs are.

III. Incentives

The interviewee should now ask about the incentive program’s structure.

You can ask the interviewee to suggest different ways to calculate incentives.

Information that can be shared if inquired:

There are three obvious incentive options (many others might be contemplated):          

	a fixed commission per product sold                       
a percentage of the profit generated                      
a combination of the first two methods

Key Insights

It is cheaper to keep current customers than it is to acquire new ones. An incentive program should account for this.
A fixed commission per product sold incentivizes acquisition of new customers.
A percentage of the profit incentivizes keeping current customers.
The best option is to use a combination of the first two methods.

IV. Conclusion

The interviewee should now calculate the incentive program’s profitability and give the client a solid recommendation.

Ask the interviewee to think about what happens if revenue increases due to the program. Does this increase in revenue exceed commission costs?

Share Table 2 with an overview of the granted commissions if inquired by the interviewee.

Information that can be shared if inquired:

Average lifetime of client (time the customer u a product):
3 years
	Commission is paid when a product is sold. Commission is also paid for each year the customer keeps the product.

Costs

These commissions are a fixed one-off cost and a recurring cost.

One-off: the bank salesman earns $4 for each product sold.

Recurring: each year, they will receive 5% of the profit generated due to their existing clients.

This equals to an average of about $4 per year:

The incentive program will be profitable and compensate the recurring commission costs if the sales increase more than 5%:

However, we need also to cover the fixed one-off commission when a product is sold. Since the average customer lifetime is 3 years, these 5% must be paid in 3 years.

In order for the incentive program to be economically feasible, sales should increase by approximately 6.92%.

Difficult Questions

If a salesperson sells 5 products per week, by what percentage will the salesperson’s salary increase?

Suggested answer:

If the salesperson works 50 weeks each year, the salesperson will sell 250 products each year.

The salesperson’s one-off commission is $1,000:

Since average customer lifetime is 3 years, every year, the salesperson will receive 5% of the profits of 750 products.

The salesperson’s recurring commission is $3,000:

The salesperson’s salary increases to $29,000:

The percentage increase is 16%:

2. What are the risks of implementing this incentive

Suggested answers:

Competition between employees (who sells more?) can affect teamwork.
Employees in non-sales departments may also want salary increases, thus increasing the bank’s costs.
If the incentive for selling a product is too high, the salesperson might put his or her own interests above the customer’s. (e.g. to earn more commission, the salesperson might push customers to buy expensive products that do not suit them.)

More questions to be added by you, interviewer!

If the interviewee solves the case very quickly, you can come up with more challenging questions to ask them.