2. Strategic map of commercial banking
Note: “Differentiated products” refers to the degree of personal
service, customized products, and/or brand image offered
by a bank.
to pay relatively high prices. Hypo-
thetical large regional or nationwide
banks are located in the lower left
corner. These banks operate at large
scale, incur low unit costs, operate
through a combination of physical
branches and the Internet, and offer
commodity-like products for which
customers are less willing to pay high
prices. In this example, the most prof-
itable strategy is to locate in the lower
right hand corner, operating at large
scale (which reduces unit costs) and
offering differentiated products (which
command high prices).
By definition, small banks cannot
migrate to this most profitable strate-
gy—unless they become large banks.
However, it might be possible for
large banks to implement this strate-
gy, depending on the skill with which
they can deploy personalized products
over electronic delivery channels.
Large banks currently customize finan-
cial services for some of their large
business clients (for example, M&A
financing); if large banks can custom-
ize financial services for retail and
small business customers on a large
scale basis—perhaps using electronic
delivery channels to reduce production
costs and make these services more
convenient—they will be able to take
away some of small banks’ most prof-
itable customers. The low-cost struc-
tures, wide product offerings, and
differentiated brand
images of large banks
would be difficult for
small banks to over-
come. However, if large
banks can only mass
produce commodity-
like products (such as
credit-scored small
business loans, stan-
dardized insurance
products, or automat-
ed asset management
without personalized
investment advice),
then relationship bank-
ing will continue to
provide a profitable
niche for small banks.
Conclusion
Just as the wave of do-
mestic bank mergers has produced
the first nationwide banks, the im-
plementation of new electronic deliv-
ery channels threatens to transform
the banking landscape once again.
This Fed Letter explores the prospects
for small commercial banks in a
post-merger-wave, post-Internet
banking industry. I argue that the fu-
ture success of small banks hinges on
their traditional advantages in rela-
tionship banking and personalized
financial services and on how these
advantages stack up against the com-
bination of low costs, convenient
one-stop shopping, and powerful
brand images that large banks may
be able to wield over electronic de-
livery channels.
As we consider how the Internet will
transform banking, it is important to
remember that this new delivery
channel is unlikely to change the
fundamental nature of the financial
products delivered over it. Consider
an example from e-commerce.
Amazon.com and its competitors
may be making the traditional book-
store obsolete, but they have not (yet)
made the printed book obsolete—
ironically, these Internet firms deliver
the books they sell not electronically,
but by surface mail. Whether e-bank-
ing leads to a substantial change in
the number and/or size of commer-
cial banks or just changes the way
that existing banks deliver financial
services to their customers remains for
now an open question.
—Robert DeYoung
Senior economist and economic advisor
1Robert DeYoung, 1999, “Mergers and the changing
landscape of commercial banking (Part I),” Chicago
Fed Letter, Federal Reserve Bank of Chicago, No. 145,
September.
2For a discussion of the post-merger experiences of
Bank One, First Union, and other ultra-acquisitive
banking companies, see Euromoney, 1999, “When
cutting cost is not enough,” November, pp. 58-60.
3By mid-1999, the top ten credit card issuers in the
U.S. held more than a 75% market share (see Chica-
go Tribune, 1999, “Cards getting less credit for bank
industry growth,” August 27). For evidence on scale
economies and growing concentration mortgage
banking, see Clifford V. Rossi, 1998, “Mortgage
banking cost structure: Resolving an enigma,”
Journal of Economics and Business, Vol. 50, No. 2.
pp. 219-234, and Mitchell Stengel, 1995, “From
traditional mortgage lending to modern mortgage
banking,” Office of the Comptroller of the Currency,
Quarterly Journal, No. 4, pp. 11-18.
4See Chicago Tribune, 1999, “Allstate points to new
future,” November 11.
5See Loretta J. Mester, 1999, “Banking industry con-
solidation: What’s a small business to do?” Federal
Reserve Bank of Philadelphia, Business Review, Janu-
ary/February, pp. 3-16.
6For an introduction to strategic maps, see Michael
E. Porter, 1980, Competitive Strategy, New York: Free
Press.
Michael H. Moskow, President; William C. Hunter,
Senior Vice President and Director of Research; Douglas
Evanoff, Vice President, financial studies; Charles
Evans, Vice President, macroeconomic policy research;
Daniel Sullivan, Vice President, microeconomic policy
research; William Testa, Vice President, regional
programs and economics editor; Helen O’D. Koshy,
Editor.
Chicago Fed Letter is published monthly by the
Research Department of the Federal Reserve Bank
of Chicago. The views expressed are the authors’
and are not necessarily those of the Federal
Reserve Bank of Chicago or the Federal Reserve
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