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Definition and characteristics of banking products

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									            Definition and characteristics of banking products
1.1. Characteristics of banking products and services

          The product is the firm‖s reason for being. All firms (including banks) are in the business
of satisfying customer needs, and they do this through their product. A firm that does not deliver
a need-satisfying product has no reason to exist.
         Philip Kotler proposes the following definition: "A product is anything that can be offered
to satisfy a need or want‖1. Offering and solution are synonyms to the product in marketing
A product of offering can consist of as many as three components: physical good(s), service(s),
and idea(s).
         Also, Philip Kotler distinguished three components:
         - need: a lack of a basic requirement;
         - want: a specific requirement for products or services to match a need;
         - demand: a set of wants plus the desire and ability to pay for the exchange.
         In Principles of Marketing, Philip Kotler devised a very interesting concept of benefit
building with a product.

                        Figure 1.1.1. Concept of benefit building with a product

        Source: Kotler Ph, Managementul marketingului, Editura Economică, Bucureşti, 1998

          In a banking context, all banking services (including checking and savings accounts,
certificates of deposit, safekeeping services, lockbox operations, cash management services, and
loans) are also products.
          From a marketing point of view, a product has five different aspects:
    Kotler Ph, Managementul marketingului, Editura Economică, Bucureşti, 1998. P.167
       (1) the core product (benefit);
       (2) the generic product;
       (3) the expected product;
       (4) the augmented product;
       (5) the potential product.
      The core prinhut (benefit) is the essential benefit that the customer is buying (for example,
the convenience of being able to pay for goods and services with checks).
      The generic product provides that benefit (for example, the basic checking product).
      The expected product includes the produci features that customers assume will be part of
the product (for example, prompt and accurate clearance of checks, accurate monthly statements,
and ability to access ihe account through ATMs).
      The augmented product includes all the specific features and benefits ihat help the
marketer differentiate the product from its competitors (for example, package products link
accounts and can provide a number of customer benefits such as no-annual-fee credit cards. loan
discounts, and bonus rates on CDs), The customer shopping for a disposable razor is confronted
with a variety of razors, all having Ihe same expected features: a certain size, disposability,
sturdy plastic construction, and a shape that fits the hand.
      The reputation of ihe bank, the decor and physical environment of the bank, the brochures
and other primed materials provided to the customer, and any specific brand names given lo ihe
      The potential produci includes all ihe modifications that the product might undergo over
time (for example, access through a special display telephone or an ATM that dispenses a
snapshot checking statement). Product managers are oriented toward the potential product and
thus spend much of their lime researching and planning product enhancements.
      Kotler noted that much competition takes place at the Augmented Product level rather than
at the Core Benefit level or, as Levitt put it: 'New competition is not between what companies
produce in their factories, but between what they add to their factory output in the form of
packaging, services,     advertising,    customer    advice, financing,   delivery arrangements,
warehousing, and other things that people value.'
      Kotler's model provides a tool to assess how the organisation and their customers view
their relationship and which aspects create value.
      Value is the consumer’s estimate of the product’s overall capacity to satisfy his or her
needs.Value is ―the satisfaction of customer requirements at the lowest possible cost of
acquisition, ownership, and use.
         Before proceeding with the discussion of product strategy, ii will be useful to consid-er the
differences between products and services, since this text focuses on marketing in a service
industry. Although there are many similarities between the marketing of tangible products and
intangible services, there are also some important differences.
         First, it is necessary to define the term service: "A service is any act or performance that
one party can offer to another that is essentially intangible and does not result in the ownership
of anything. Its production may or may not be tied to a physical product." Health care, private
education, transportation, communication, medical and professional services, and banking are
examples of service industries.

                             Figure 1.1.2. Types of Marketing in Service Industries
            Source: Kotler Ph, Managementul marketingului, Editura Economică, Bucureşti, 1998.

         Services have certain characteristics that create special challenges for marketers. As a
result, the marketing techniques used by banks and other service industries arc often very
different from those found in product marketing.
         These characteristics are: Intangibility; Inseparability; Variability; Perishability. 2
         Since a service cannot be seen, touched, or otherwise experienced by the senses, customers
cannot shop for a service as they would for a tangible product—by picking it up examining it and
evaluating it. Yet, the prepurchase stage is important in that it enables the customer to assess the
quality and reliability of a product. Service marketers must compensate for the customer's
inability to physically examine the product by providing evidence of the quality of their service
and by building a reputation for reliability in delivering the principal benefits of the service.

    Dumitrescu Luigi, Marketingul serviciilor, Editura Imago, Sibiu, 1998, p.117
      Bank product has a life cycle. The first phase in the life cycle of a product is characterized
by slow growth in sales as the product is introduced and the market gradually becomes aware of
it. The profit curve shows a loss during this phase because of the heavy expenses incurred in
introducing the produci. In addition to the research and development costs, there is the cost of
putting in place the distribution system to deliver the new product to the market and the
substantial advertising expense required to make consumers aware of the new product.
      In banking, significant costs are involved in developing the computer systems required to
deliver a truly new product (that is. one that is not simply a modification of an existing product).
These up-front expenses make it impractical for banks to test-market products the way consumer
goods manufacturers do.
      The length of the introductory stage depends on the rate at which consumers accept the
product. Home hanking by personal computer has been оn the introduction stage of its life cycle
since the early 1980s. Because it involved changing customer banking and bill-paying behavior,
the initial growth in numbers of customers using the service was slow. However, the numbers are
now increasing as more customers grow comfortable with technology and seek ways to save
time. Advertising strategy has concentrated on educating the public about the benefits of the
       The debit card is another banking product that has been in the introduction stage for many
years. The marketing challenge for this product is not only to overcome consumers' resistance to
the loss of float on their funds, but to persuade merchants to install the necessary equipment and
to agree to accept and promote debit cards. With a credit card, consumers retain the use of their
funds until the month' ly bill is paid. With a debit card, however, the funds arc taken from the
checking account immediately. When the number of debit card transactions per year increases at
a faster rate, more banks will offer debit cards and a period of rapid growth can be expected.
       The growth stage in a product's life cycle is characterized by an acceleration in sales as
more people become aware of the product and buy it The increased sales will also attract
competing firms lo enter the market. However, until they can do so. the firm (hal introduced the
product has the edge in an increasing market—an ideal situation. The combination of limited
competition and accelerating sales allows the product to quickly become profitable. The Sony
Walkman is an example of an innovative product that became very successful and was soon
copied by many electronics manufacturers. Because of the profil potential of marketing products
that arc in their growth stage, highly competitive firms such as Sony spend heavily on consumer
research and on the development and marketing of a steady stream of new products.
       One example of a growth product in banking is the home equity line of credit. This
product was available in some banks in the early 1980s. When the tax-deductible status of the
interest on installment debt was eliminated, interes! on equity-secured debi continued to be
deductible and borne equity lines of credit became increasingly attractive.
       The profitability of a product in the growth stage attracts intense competition as the
maturity stage approaches. Maturity is characterized by a slowed rate of sales growth, as most of
the prospective buyers of the product have already purchased it. This stage is also characterized
by aggressive advertising (in an attempt to boost demand), which increases the cost and. thus,
reduces profit.
       Many traditional banking services are in the maturity stage. In this stage, competing tirms
often cut prices to increase sales. Checking accounts provide an example of this. In the mid-
1970s, some banks moved to free checking in an effort to increase their market share for this
product. (Before that time, free checking was a rarity) The strategy backfired when many banks
followed suit, thus reducing revenues for all involved and cutting seriously into bank profits. In
1996 and 1997. however, free checking once again gained popularity as banks raced to capture
customers left looking for a new bank after a merger, and to increase market share. Some
bankers want to establish customer relationships through checking accounts now because they
believe paper checks will become obsolete by the lum of the century. Free checking remains a
somewhat volatile issue as banks define free checking as free under certain conditions (with
direct deposit, with a minimum balance, with certain fees).
       New Product Development Stages
       Regardless of whether a product is new to the bank or new to the market, the foremost
challenge is to maximize new product.
       The certificate of deposit was designed lo be mark eted when Interest rate were
exceptionally low. Although there is no magic formula, a firm can go a long way toward
generating new ideas and reducing risk by establishing a formal procedure for new product
development. The market point of view must be built into such a system from the start. One type
of system for developing new products is the eight-stage product development system. A new
product idea must survive each phase of development before proceeding.
      Extension of a product line. The development of a basic or "lifeline" checking account for low-
income customers is an example of a new product being added to a hank's checking product line.
     Development of a banking-related product. Banks that have introduced the sale of annuities
or mutual funds have added a new. banking-related product line to their product mix. Such
products arc clearly new to banks, but not to the financial services market.
      Diversification into new product cale-gories. Some bank holding companies have
expanded into noniraditional banking services, such as insurance products. Again, this is a
service thai is relatively new to the banking industry but not to the market.
      How a bank approaches product development generally depends on its size and structure.
More than any other area of bank marketing, product development has a considerable operational
component. In some banks, the product development department reports to the director of
marketing. In others, the responsibility for product development lies within the relevant line
function of the bank (retail, commercial, or trust). In still others, a team approach is used with
representatives from systems and programming, operations, and the relevant line department
coordinated and headed by the product manager or marketing head. Wherever the responsibility
lies, the business of developing a product to be marketed involves coordinating the efforts of a
number of different departments.
      Exploration.A company eager for new product ideas can conduci a formal search of the
market. In a bank, new product ideas might come from ongoing research to help identify con-
sumer banking needs that arc not being met. Or they might come from management or other
employees. Some firms offer cash incentives to employees for generating new product ideas.
Ideas might also come from customers, banks in other parts of the country, or from competing
hanks. Also, on idea for a new product occasionally comes from the banking regulators. The
money market deposit account arose from this source. The main point of idea generation is to
find, in a structured, goal-oriented manner, new ways to serve the bank's customers in a
meaningful way.
      Product Screening. Ideas for new products must be screened against product objectives,
product policy, and company resources. Not every new product idea can or should be pursued. A
preliminary judgment must be made as to whether an idea deserves further study. In an
aggressive and imaginative bank, an unusual idea thai at first appears to be unworkable and not
within present regulatory constraints will not be screened oul until it has been evaluated in more
detail. Each idea for a new product musl also be evaluated to ensure that it does not take business
away from existing products. The development of the NOW account, the predecessor lo i merest-
bea ring personal checkand sales promotions. Ideally, the (raining director has undertaken
programs to ensure that each customer-contact employee thoroughly understands the service and
how to sell it (that is. knows its benefits as well as its features). It is also critical to inform all
staff members of the advertising campaign that has been launched so they can be fully prepared
for customer inquiries. The launching of a new product is often tied to an employee incentive
campaign to boost initial sales. At the same time the bank might offer a premium to the customer
for purchasing the new product
       One of the problems that banks face when introducing new deposit services is the
resulting drain on deposits in existing products—an effect called cannibalization. For example,
when the money market deposit account was introduced, dollars were drained out of lower-cost
regular savings and checking accounts, increasing the cost of these already deposited funds to the
hank. Because of this effect, banks must attempt to enter the market early with product
innovations that are likely to be offered by many competitors. This lead in entering the market
serves to offset the cannibalizing of their existing deposits by attracting new customers and
deposits from outside the bank. Naturally, the first banks into the market with a good new
product stand to gain. But it does not usually take long for the market followers to offer the same
product, thus diluting the competitive advantage and moving the product along to that part of the
life cycle where profits start to flatten out.
        Evaluation. The final stage in developing a new product involves the use of primary and
secondary research to monitor the progress of the new product in relation to the company's goals.
No product development plan is complete if it fails to include a system for monitoring the results
of the plan. Effective monitoring enables (he bank to take corrective action where needed, as well
as to gain additional knowledge that will facilitate the introduction of the new product.
        As banking products become commoditized, it becomes harder for banks to differentiate
themselves in the market amidst increased competition and decreasing loyalty. Despite best
efforts to understand customer value and potential, banks spend resources targeting customers
who are profitable today and alienate those who will be profitable later. Banks need a better
understanding of what financial incentives they can offer that will create more value and
incentives for loyalty and still allow them to remain profitable. A comprehensive view of the
customer as part of a continuum, man aged over time and across contact channels and products,
helps sustain market differentiation and increases overall profitability.

      1.2.Diversification, quality and profitability of banking products

      Commercial banks and thrifts offer various products to their customers. These products fall
into three major categories: deposits, loans, and cash management.
      Deposits. There are four major types of deposits: demand deposits, savings deposits,
hybrid checking/savings deposits, and time deposits. What distinguishes one type from another
are the conditions under which the deposited funds may be withdrawn.
      A demand deposit is a deposit that can be withdrawn on demand at any time and in any
amount up to the full amount of the deposit. The most common example of a demand deposit is a
checking account. Money orders and traveler’s checks are also technically demand deposits.
Checking accounts are also considered transaction accounts in that payments can be made to
third parties—that is, to someone other than the depositor or the bank itself—via check,
telephone, or other authorized transfer instruction. Checking accounts are popular because as
demand deposits they provide perfect liquidity (immediate access to cash) and as transaction
accounts they can be transferred to a third party as payment for goods or services. As such, they
function like money.
     Savings accounts pay interest to the depositor, but have no specific maturity date on which
the funds need to be withdrawn or reinvested. Any amount can be withdrawn from a savings
account up to the amount deposited. Under normal circumstances, customers can withdraw their
money from a savings account simply by presenting their ―passbook‖ or by using their
automated teller machine (ATM) card. Savings accounts are highly liquid. They are different
from demand deposits, however, because depositors cannot write checks against regular savings
accounts. Savings accounts cannot be used directly as money to purchase goods or services.
     The hybrid savings and checking account allows customers to earn interest on the account
and write checks against the account. These are called either negotiable order of withdrawal
(NOW) accounts, or money market deposit accounts, which are savings accounts that allow a
maximum of three third-party transfers each month.
     Time deposits are deposits on which the depositor and the bank have agreed that the
money will not be withdrawn without substantial penalty to the depositor before a specific date.
These are frequently called certificates of deposits (CDs). Because of a substantial early
withdrawal penalty, time deposits are not as liquid as demand or savings deposits nor can
depositors write checks against them. Time deposits also typically require a minimum deposit
     Loans. Banks and thrifts make three types of loans: commercial and industrial loans,
consumer loans, and mortgage loans. Commercial and industrial loans are loans to businesses or
industrial firms. These are primarily short-term working capital loans (loans to finance the
purchase of material or labor) or transaction or longer-term loans (loans to purchase machines
and equipment). Most commercial banks offer a variable rate on these loans, which means that
the interest rate can change over the course of the loan. Whether a bank will make a loan or not
depends on the credit and loan history of the borrower, the borrower’s ability to make scheduled
loan payments, the amount of capital the borrower has invested in the business, the condition of
the economy, and the value of the collateral the borrower pledges to give the bank if the loan
payments are not made.
      Consumer loans are loans for consumers to purchase goods or services.
      There are two types of consumer loans: closed-end credit and open-end credit.
     Closed-end credit loans are loans for a fixed amount of money, for a fixed period of time
(usually not more than five years), and for a fixed purpose (for example, to buy a car). Most
closed-end loans are called installment loans because they must be repaid in equal monthly
installments. The item purchased by the consumer serves as collateral for the loan. For example,
if the consumer fails to make payments on an automobile, the bank can recoup the cost of its
loan by taking ownership of the car.
      Open-end credit loans are loans for variable amounts of money up to a set limit. Unlike
closed-end loans, open-end credit does not require a borrower to specify the purpose of the loan
and the lender cannot foreclose on the loan. Credit cards are an example of open-end credit.
Most open-end loans carry fixed interest rates–that is, the rate does not vary over the term of the
loan. Open-end loans require no collateral, but interest rates or other penalties or fees may be
charged—for example, if credit card charges are not paid in full, interest is charged, or if
payment is late, a fee is charged to the borrower. Open-end credit interest rates usually exceed
closed-end rates because open-end loans are not backed by collateral.
      Mortgage loans or real estate loans are loans used to purchase land or buildings such as
houses or factories. These are typically long-term loans and the interest rate charged can be
either a variable or a fixed rate for the term of the loan, which often ranges from 15 to 30 years.
The land and buildings purchased serve as the collateral for the loan.
      The principal classes of credit are as follows:
      1) mercantile or commercial credit, which merchants extend to one another to finance
production and distribution of goods;
      2) investment credit, used by business firms to finance the acquisition of plant and
equipment and represented by corporate bonds, long-term notes, and other proofs of
      3) bank credit, consisting of the deposits, loans, and discounts of depository institutions;
      4) consumer or personal credit, which comprises advances made to individuals to enable
them to meet expenses or to purchase, on a deferred-payment basis, goods or service for personal
consumption (Credit Card);
      5) real-estate credit, composed of loans secured by land and buildings; (6) public or
government credit, represented by the bond issues of national, state, and municipal governments;
      7) international credit, which is extended to particular governments by other governments,
by the nationals of foreign countries, or by international banking institutions, such as the
International Bank for Reconstruction and Development.
       The principal function of credit is to transfer property from those who own it to those
who wish to use it, as in the granting of loans by banks to individuals who plan to initiate or
expand a business venture. The transfer is temporary and is made for a price, known as interest,
which varies with the risk involved and also with the demand for, and supply of, credit.
       Credit transactions have been indispensable to the economic development of the modern
world. Credit puts to use property that would otherwise lie idle, thus enabling a country to more
fully employ its resources. The presence of credit institutions rests on the readiness of people to
trust one another and of courts to enforce business contracts. The lack of adequate credit
facilities makes it natural and necessary for inhabitants of developing countries to hoard their
savings instead of putting them to productive and profitable use. Without credit, the tremendous
investments required for the development of the large-scale enterprise on which the high living
standards would have been impossible.
       The use of credit also makes feasible the performance of the complex operations involved
in modern business without the constant handling of money. Credit operations are carried out by
means of documents known as credit instruments, which include bills of exchange, money
orders, checks, drafts, promissory notes, and bonds. These instruments are usually negotiable;
they may legally be transferred in the same way as money. When the party issuing the instrument
desires to prevent its use by anyone other than the party to whom it is issued, he or she may do
so by inscribing the words ―not negotiable‖ on the instrument.
      Creditors sometimes require no other assurance of repayment than the debtor’s credit
standing, that is, one’s record of honesty in fulfilling financial obligations and one’s current
ability to fulfill similar obligations. Sometimes more tangible security, such as the guarantee of a
third party, is required. Also, the debtor may be obliged to assign the rights to some other
property, which is at least equal in value to the loan, as collateral security for payment. Bonds
placed on sale by a corporation are often secured by a mortgage on the corporation’s property or
some part of it. Public borrowing, as by the issuance of bonds of a government, is usually
unsecured, resting on the purchaser’s confidence in the good faith, taxing power, and political
stability of the government. When goods are sold on a deferred-payment plan, the seller may
either retain legal ownership of the goods or hold a chattel mortgage until the final payment is
made. The depositing of funds in a bank for safekeeping may also be regarded as a form of credit
to the bank, as such funds are used for loan and investment purposes, and the bank is legally
bound to repay them as an ordinary debtor.
      Cash Management and Other Services
      Although deposits and loans are the basic banking services provided by banks and thrifts,
these institutions provide a wide variety of other services to customers. For consumers, these
include check cashing, foreign currency exchange, safety deposit boxes in which consumers can
store valuables, electronic wire transfer through which consumers can transfer money and
securities from one financial institution to another, and credit life insurance which automatically
pays off loans in the event of the borrower’s death or disability.
         In recent years, banks have made their services increasingly convenient through electronic
banking. Electronic banking uses computers to carry out transfers of money. For example,
automated teller machines (ATMs) enable bank customers to withdraw money from their
checking or savings accounts by inserting an ATM card and a private electronic code into an
ATM. The ATMs enable bank customers to access their money 24 hours a day and seven days a
week wherever ATMs are located, including in foreign countries. Banks also offer debit cards
that directly withdraw funds from a customer’s account for the amount of a purchase, much like
writing a check. Banks also use electronic transfers to deposit payroll checks directly into a
customer’s account and to automatically pay a customer’s bills when they are due. Many banks
also use the Internet to enable customers to pay bills, move money between accounts, and
perform other banking functions.
         For businesses, commercial banks also provide specialized cash management and credit
enhancement services. Cash management services are designed to allow businesses to make
efficient use of their cash. For example, under normal circumstances a business would sell its
product to a customer and send the customer a bill. The customer would then send a check to the
business, and the business would then deposit the check in the bank. The time between the date
the business receives the check and deposits the check in the bank could be several days or a
week. To eliminate this delay and allow the business to earn interest on its money sooner,
commercial banks offer services to businesses whereby customers send checks directly to the
bank, not the business. This practice is referred to as ―lock box‖ services because the payments
are mailed to a secure post office box where they are picked up by bank couriers for immediate
deposit. 3
         Another important business service performed by banks is a credit enhancement.
Commercial banks back up the performance of businesses by promising to pay the debts of the
business if the business itself cannot pay. This service substitutes the credit of the bank for the
credit of the business. This is valuable, for example, in international trade where the exporting
firm is unfamiliar with the importing firm in another country and is, therefore, reluctant to ship
goods without knowing for certain that the importer will pay for them. By substituting the credit
of a foreign bank known to the exporter’s bank, the exporter knows payment will be made and
will ship the goods. Credit enhancements are frequently called standby letters of credit or
commercial letters of credit.

    Palfreman David – Banking: The legal environment, Pitman Publishing, London, 1994, p.102

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