Dialogue: Banking on business sense

ELMAR TOIME* says NZ Post has already diversified and banking is a natural step for its branch network.

The bank that New Zealand Post opens early next year will change the banking market.It is a further component of our business diversification and is a growth plan that we have been seriously considering since 1998.

Some years ago, NZ Post realised that it could not rely on mail volumes and revenues from its core business. We adopted plans to develop our courier services and our international presence. Today we are very successful in both areas.

We already have a strong record in creating value through diversification of our business. Last week we reported a half-year result of $22.4 million net profit after tax, turning around a previous loss in the June 2000 quarter caused by a sharp downturn in mail volumes. The result was ahead of target and reaffirmed the company's business diversification plan.

Our international subsidiary, Transend Worldwide, is now one of the world's largest postal consultancies, guiding the postal services of South Africa and Trinidad and Tobago and undertaking work in 40 other countries. Transend contributed substantially to NZ Post's 8 per cent growth in revenue for the half year.

One of the reasons diversifying into banking services makes sense is the nationwide network of Post Shops that allows us to establish branch services at a lower cost than would be possible with a start-up operation.

Whereas the trading banks have sought to cut costs by withdrawing their branches from communities around the country, NZ Post has been able to increase its network - through a successful franchising programme and the Books & More joint venture - from 245 full service retail outlets in 1995 to around 320 today. We intend to provide banking services through most of these outlets, and within three months of opening the new bank will have the largest branch network of any bank in the country. The addition of retail banking services will further support the retention and expansion of that network in communities around the country.

Our retail staff already have strong experience in processing financial transactions. Last year Post Shops took around $2 billion of payments and agency banking over the counter.

The new bank will not be burdened by 20-year-old computer systems, but instead will make use of new technologies that offer a significant cost advantage, faster product development and greater flexibility over the banking systems of other banks.

The new bank will also have the advantage of NZ Post's established brand that is trusted in the community - we won't have to start from scratch as recent entrants to the banking market have had to do.

The bank will have a ready market of 500,000 to 700,000 customers who visit our Post Shop network each week. Most of those customers visit their local Post Shop to make financial transactions - paying a bill or using an agency banking service. Many of these customers have already expressed strong interest in banking services.

The banking market here is unusual. Unlike most of the countries we have investigated, New Zealand does not have a nationwide bank focusing solely on value-for-money personal banking services.

This gap in the market is reflected in the high and growing levels of customer dissatisfaction. As many as 30 per cent of customers of some trading banks are dissatisfied with the service they receive.

This dissatisfaction is cited by more than half of the 174,000 customers who changed banks last year as the main reason for switching banking provider. This is despite the well-known hassle of changing accounts and a perception of having no real choice in the market.

The question comes down to: can we provide a proposition that will encourage enough customers with sufficient value to switch to the new bank?

Our research indicates that the offer of low fees, competitive interest rates, branch access, retail trading hours (including weekend banking) and New Zealand ownership is extremely appealing when coupled with the New Zealand Post brand.

We are seeking 100,000 customers over three years to reach our targeted rate of return of 11.7 per cent. Those customers will be drawn from the 1.6 million bank customers who pay fees and a further 300,000 mortgage holders we are targeting, for a total market share of about 5 per cent. That is equivalent to two new customers a week at each Post Shop over three years.

As a start-up business, the bank is not expected to be profitable until it has completed its establishment phase in its third year. The Government's investment of $72.2 million and the $6 million of foregone dividend from NZ Post will be used to fund these establishment expenses and capital expenditure. It will also ensure sufficient capital to meet Reserve Bank requirements.

The bank is expected to return dividends from its fourth year and will be worth $400 million to $500 million within 10 years, generating returns equivalent to those of NZ Post today.

As is our practice with any business diversification, we tested our research and assumptions by commissioning an independent analysis. The report prepared by Cameron & Co clearly demonstrated the robustness of our business case and confirmed the competitive advantages that NZ Post can bring to banking.

Cameron & Co took a more cautious view of the number of customers switching to the new bank and examined a range of scenarios with even lower customer numbers, a different mix of customers and more aggressive competitor reaction than the scenarios we assumed in our business case.

In four of the five scenarios modelled by Cameron & Co, the bank reached the 11.7 per cent targeted rate of return on investment over three years. In only one scenario did the report find that the bank might not achieve that target, although it would still produce a positive return on the investment.

NZ Post has since further developed its strategies so that the new bank will be able to respond to and mitigate these risks.

For sound risk management reasons NZ Post also considered a worst-case scenario whereby the company would give up banking. Under that scenario, we expect that much of the original investment would be recovered and no customers of the bank would lose their money.

The previous performance of the Government-owned BNZ and DFC has shaped the comments of many of those questioning the establishment of the new bank. The example is irrelevant. Those organisations failed because of imprudent corporate lending. NZ Post's bank will focus solely on the retail personal banking market and its risk profile will be very much lower.

Much has changed in the past 10 years, including the introduction of the Reserve Bank's rigorous banking supervisory and disclosure regime. NZ Post has changed as well. The Government department that ran the Post Office Savings Bank and held the monopoly on post and telecommunications lost $60 million in the two years before it was corporatised and separated in 1987.

Seven years after corporatisation, in 1994, NZ Post was named business of the year for a prized management award. Since 1987, it has paid dividends of $510 million from earnings of $550 million.

The business case for diversification into personal banking services is strong. We have identified a gap in the market and have clear cost advantages over the existing banks. We have rigorously tested our strategies. With our Post Shop retail network and customer base, experience in payments and transactions and strong brand and community reputation, NZ Post is the best placed of any business to meet that market gap.

* Mr Toime is chief executive of New Zealand Post.