During the past ten years, credit union strategy has been mostly the attempt to extend existing businesses’ capabilities. This includes adding new markets, improving balance sheet products and developing new channel outlets such as shared branches or indirect auto lending. The result is a bigger credit union, but with the same financial model of earlier years.
At the same time, a number of credit unions experimented with initiatives that go beyond the traditional efforts. This has included buying into a new business, expanding a capability to a new customer set, and creating a startup with a partner from the ground up. What is common to all these is the desire to diversify beyond traditional credit union business thinking.
But diversification comes with risk. One classic way of looking at the degree of risk is shown in the matrix below. Typically the least risky effort is offering a new product to one’s current customers, followed by expanding with existing product to a new market. The most risk is incurred in introducing a new product to a new market. In the cases to follow, all three strategies are used by the credit unions.
But why diversify? Last year total revenue in credit unions fell 1%. To grow, credit unions need new members or to serve existing customers better. Some credit unions have reached marketplace or product saturation with credit card or share draft accounts, for example.
Many credit unions are trying to reduce their dependence on the net interest margin, especially in this era of unusually low rates. With 0% options, the financing decision becomes a much less important part of the purchase decision in a new car, for example. The challenge for credit unions is to find new revenue sources.
The Business-to-Business Market
Some credit unions have developed services to sell to other credit unions. The traditional providing of wholesale services has fallen to the trade associations, corporate credit unions or in some instances, multi-owned CUSOs. But this is not the case anymore with almost 100 credit unions with assets over $1 billion who believe that serving the needs of the 8,000 credit unions under $50 million is a logical business extension.
One credit union in the Northeast is providing full-scale mortgage services to approximately 60 other credit unions in its market area. There were two reasons the credit union extended its mortgage capability. First, it believed that all sizes of credit unions should offer a complete mortgage program. Mortgages, they believe, are as much a core service as share draft accounts and smaller credit unions were not meeting member needs effectively.
The second reason was that the credit union had already invested in the technology and secondary market expertise necessary to be a full-service mortgage partner. Sending more volume through the production process was a way to enhance economies of scale and Return on Investments (ROI).
As the business grew, the credit union opened ownership in the CUSO to other users. The CUSO retains all servicing, a tactic which it believes provides a competitive advantage over other mortgage models. With more than $1.2 billion in servicing rights, the CUSO has enough cash flow to sustain revenue through the ups and downs of mortgage demand.
This is just one of several CUSO businesses that this credit union offers. A car buying and leasing agency also serves other area credit unions, although leasing has not proven to be a growth market in a period of 0% financing.
Right now the mortgage business is booming. The goal is to open up the mortgage CUSO as a “street” business so that it can originate loans for the public without first requiring the applicant to be a credit union member. The business is over 10 years old, has successfully navigated several mortgage origination cycles, and today provides a valuable “off balance sheet” return to its founder.
Buying a Business
A more recent diversification into the B-to-B market is a credit union that decided to buy a 15-year-old consulting company that served credit unions nationally with planning, training, and Internet hosting services.
Why buy a consulting business? There were three assumptions:
The credit union wanted to leverage some of the investments it had been making in its core businesses to serve other credit unions;
By serving other credit unions, it hoped to expand the career opportunities for its own staff and even provide additional income opportunities;
It hoped to take away learnings from the consulting assignments that could be applied in its own shop.
The credit union believed multiple opportunities for learning would occur with the acquisition. Moreover, with a flexible work force to draw from, the consulting company could meet the periodic peaks of business demand without turning away work.
With multiple new business initiatives now being funded, the business has grown so rapidly that there has not been enough time to work on the synergies. Even though the business had a relatively long track record, the integration of the two organizations had many of the same challenges of a start up operation. But the new parent has given the business a much more stable platform for long-term growth.
Buying a Retail Business
Over the past 20 years a number of credit unions have bought local insurance agencies as a way to deliver property and casualty as well as life products to their members. Insurance services are seen as a logical extension of serving members’ financial needs. Recently, however, a large credit union decided to buy more than just a local agency. Rather it purchased a long time family-run business selling retail policies in 12 states. What motivated the credit union to get into the insurance business with a multi-million dollar investment, instead of continuing to refer members to its current insurance partners?
The credit union thought it saw a special opportunity in this business. Unlike a number of other agencies on the market, this firm concentrated on retail policies using an affinity marketing strategy with employers. The credit union believed this model was similar to its own and that in fact the credit union had an important advantage in its knowledge of when members would be in an insurance buying mode. For example, every time a member finances a car or home, insurance coverage is needed.
Second, the credit union wanted to diversify its capital. To protect the membership, the credit union believed that an investment outside its core balance sheet was desirable, if not necessary.
Finally, the revenue model of insurance was very different from the asset-based model of the credit union. Generally the revenue flow was recurring as policies renewed, often with a modest price increase year after year. In contrast to a CUSO broker-dealer business in which the credit union had also invested, the certainty of income flow seemed much greater than the income from stock and mutual fund trades.
The lessons learned so far are similar to those of the other two businesses. The time frame to implement and realize results from the strategy take longer than anticipated. Integrating family-owned business practices with the more formal processes of the credit union took longer than planned. But the financial model looks to be even better than anticipated — annual revenue was up 18% last year. There was also a 14% return on the investment. Still, the credit union is just beginning to learn how to cross sell members, with 54 insurance sales through the credit union platform last month.
To Diversify or Not?
All three credit unions had similar advice for credit unions contemplating new businesses. The efforts take much longer than planned to achieve momentum. The key is hiring experts to run the business into which you are expanding.
But the most important experience was learning that one new effort leads to others. New business opportunities were now being brought to the credit unions by other businesses and credit unions in their markets. Credit unions are seen as sources of capital and with a distribution system able to reach consumer/members quickly. Senior managers of the credit union now see other avenues to expand their own careers, if not running their own business.
Getting into a new business is therefore not likely to be a one-off effort. The enthusiasm and drive necessary to research and commit to one venture continues after the business is up and running. Diversifying energizes strategy. That may be the most important return of all.