US Middle-Market Companies: A Transitional Financial Services Segment
As competition intensifies in the banking industry, deposit-gathering becomes more difficult and expensive. In addition, as services to large corporations are commoditized, banks of all sizes find the middle-market segment of greater interest. Of the 24 million businesses in the US, only 1.5% (or approximately 360,000) are middle-market companies. It’s a small but lucrative segment for banks.
US middle-market companies invest a substantial (and growing) amount of money in financial services and tend to be very loyal bank customers. Fortunately, banks don’t have to invest heavily to service the middle market. The offerings they have in place for large companies tend to serve the segment well.
In March 2007, Aite Group conducted a phone survey with 200 middle-market companies with annual revenues of US$50m to US$500m. Respondents had responsibility for the financial activities of their companies. The purpose of the middle-market study was to determine the financial services needs of this segment and the extent to which middle-market companies are using banks’ online capabilities.
From analysis of the survey results, we identified key attributes of middle-market companies that make them a very attractive market segment for banks. Additionally, this segment has unfulfilled needs in cash management, business-to-business payments, and global trade that banks are well positioned to support.
Middle-market companies tend to be less price-sensitive with regards to fees than the largest corporations. Perhaps most importantly, middle-market companies are loyal to the banks that initially funded their formation. These companies often have management that remembers those institutions that understood and supported their business proposition when other banks failed to do so. As a result, it takes drastic circumstances to disrupt a banking relationship with a given middle-market company.
Middle-market companies are looking for operational efficiencies to aid in their domestic and global trading activities. Services offered by their banks that are enabled by new technologies are desired. Increasing globalization, operational efficiency opportunities, and technological solutions will contribute to growing financial services expenditures by US middle-market companies. In 2002, this market segment spent just over US$100 on financial services. In 2007, that amount will increase to US$110, and it could reach US$156 in 2013 (see chart below).
Survey respondents report that superior customer service is the most important factor influencing their companies’ choice of a primary financial institution; of those surveyed, 80% rank it as a factor in selecting their current bank. Online cash management capabilities receive the second highest rating, with 63% citing it as a major reason. Cash management functionality is a particularly ‘sticky’ service, so it is good news for the chosen banks that online cash management is important. Rates and fees (61%) are only the third-highest rated factor. US middle-market companies appreciate lower costs, but they do not value them above customer service and product capabilities. As a result, middle-market companies are willing to pay a fair price for services that they receive and are not inclined to change banks based on small cost increments.
Online cash management is advancing in capabilities and acceptance. US middle-market companies report using a wide range of services: check imaging (78%), cash position report (71%), balance notification (69%), full reconciliation (63%), cash concentration (62%), positive pay (62%), international wires (60%), and foreign exchange (40%). However, US middle-market companies’ use of electronic invoicing (20%) is lacking. Based on US middle-market companies’ expressed interest in converting from paper check payments to electronic payments, electronic invoicing is an opportunity for banks for this market segment.
Many payment options have evolved, based on the value of the payment being made. Checks can accommodate any payment amount, but they neither provide the ability to track where in the clearing and settlement process they are, nor can they ensure when they will be received and posted. Automated clearing house (ACH) payments originally were used for low-value payments and provide some tracking and the ability to schedule settlement dates. Wire transfers are the payment method for high-value, time-sensitive payments. Wires can be tracked, and settlement is with a same-day guarantee once the payment is released to the Federal Reserve (for FedWire payments) or to the Clearing House (for CHIPS payments). Today, factors other than payment value are becoming more important in deciding how a payment will be made.
US middle-market companies indicate that cost is most important when they are determining the payment method to use. In fact, 67% of respondents rated it as a major deciding factor. Other factors that are rated higher than the value of the payment (45%) include ease of use (65%), the ability to track the payment (53%), the ability to schedule the payment (50%), and automated initiation (46%).
Regardless, the predominant payment method for both making and receiving payments remains checks. Checks are the first choice for making payments for US middle-market companies. Among those middle-market companies with annual revenue of US$50m to less than US$200m, 86% prefer checks as their primary payment option; among those middle-market companies with annual revenues of US$200m to US$500m, 80% prefer them. An even higher percentage of both groups of middle-market companies place checks in the top three choices for making payments (98%).
Although the percentage of check payments received is less than those making payments by check, the lower percentages reflect the adoption of check-electronification solutions (imaging and conversion) rather than the issuing of fewer checks. Of US middle-market companies with annual revenue of US$50m to less than US$200m, 79% report checks as the primary method by which they receive payments. For the US middle-market companies with larger annual revenue (US$200m to US$500m), there is a significant drop to 59% of primary payments received by check. These larger companies have developed (or responded to) trading partner agreements to move more payments to electronic formats. Still, when combining the top three methods by which payments are received, 93% of US$50m to less than US$200m in annual revenue companies and 89% of US$200m to US$500m in annual revenue companies indicate that checks are the payment type received. The use of checks will decline slowly, even as there is movement towards electronic payments.
Since 22% of survey respondents indicated that offering purchasing cards is a factor in choosing their primary financial institution, Aite Group considered the level of acceptance of card payments by US middle-market companies. Of survey respondents, only 17% currently accept card payments. For the vast majority of US middle-market companies that do not accept card payments (83%), Aite Group inquired about factors that would encourage them to accept card payments – automatic posting to internal accounting systems, interchange percentage scaled to the size of the charge amount, being able to offset interchange charges through higher pricing, and guaranteed payment in 48 hours. None of these factors moved 51% of the respondents to agree to accept card payments. For those that would accept card payments under certain circumstances, many chose multiple factors that would apply. Generally, each of these factors is nearly evenly weighted at around 33%.
A meaningful percentage of middle-market companies transact trade globally, based on 47% of survey respondents with annual revenue of US$50m to less than US$200m and 33% of survey respondents with revenue of US$200m to US$500m, which indicated that they use foreign suppliers. The group with the higher annual revenues included a greater representation of service industries such as banking, insurance, health facilities, and recreational services, whereas the lower annual revenue group had a greater representation of manufacturing companies. As a result, the lower revenue group has a greater percentage of foreign suppliers.
As trade continues to expand globally, US middle-market companies will increasingly need to do business internationally. Banks that aid in that transition provide value that will be substantiated by client retention and the cross-selling of international cash management, foreign exchange, and trade finance services.
Banks can benefit from better meeting the needs of the middle-market segment without significant increases in investments in technology or staff by focusing on electronic invoice/billing presentment and payments; electronifying payments; strengthening interfaces with middle-market companies’ internal accounting systems; providing guidance and support for international trade; and responsibly providing credit for the ongoing growth of the company. US middle-market companies represent opportunities to expand existing banking relationships in profitable and tolerant ways. Of the market segments based on size of company, the middle-market is a jewel for banks and their vendors.