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First Direct: Branchless Banking

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This case was prepared by Delphine Parmenter, Research Associate, under the supervision of Jean- Claude Larréché, Alfred H. Heineken Professor of Marketing, and Christopher Lovelock, Visiting Professor, at INSEAD. It is intended to be used as a basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.

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In October 1996, seven years after it first opened outside Leeds, England, First Direct was still attracting attention as an innovator that operated a bank with no branches. Intrigued by its success, financial service providers wanted to understand how unseen customers conducted business around the clock over the telephone. An article in the New York Times reported:

Representatives from banks around the world are making the pilgrimage to this industrial city in the north of England for a glimpse of what might be their stagnant industry’s equivalent of a miraculous cure. For not only is First Direct the world’s leading telephone-only bank, it is the fastest growing bank in Britain. In just six years, it has signed up 2% of Britain’s notoriously set-in-their-ways banking subjects, who call its rows of bankers 24 hours a day, seven days a week, toNot pay bills, For buy Reproduction stock, and arrange mortgages. September 3, 1996 INSPECTIONSuccess not only put First Direct COPY in the media limelight but it also helped to maintain high levels of enthusiasm, pride, and motivation internally. Fearful that complacency might hinder the bank’s ability to uphold growth and success, CEO Kevin Newman never lost sight of the bank’s challenges in an increasingly competitive and deregulated environment:

I believe that in going forward three things need to be developed. We have to be utterly low cost. We must be able to individualize the manufacturing process and recognize that all our customers are individuals. Thirdly, we must build a strong brand as people need to identify with institutions they can trust.

“Kevin”, as everyone called the chief executive, sat among the telephone sales staff in First Direct’s headquarters on the outskirts of Leeds, 190 miles (300 km) north of London. Newman had installed the information systems that were instrumental in getting the new bank off the ground in 1989. Subsequently, he was promoted to operations director in 1990 and CEO in October 1991. Newman came to the bank from the mass-market retailer, Woolworth’s, after having worked at Mars, the candy and consumer goods manufacturer. Although Kevin Newman did not start his career as a banker he was, at 35 years of age, undoubtedly the youngest banking CEO in Britain.

The Birth of the First Direct Concept

In the mid-eighties, Midland Bank, the fourth largest bank in the UK with 2,000 branches, began looking at ways of attracting more affluent and up-market customers. As Peter Simpson, subsequently First Direct’s commercial director, remarked:

If you are losing market share you can do two things: you can grow organically or inorganically. Midland Bank had limited capital, so there was nowhere to go inorganically; its reserves had been spent on the over-priced Crocker National Bank acquisition in North America and with Latin American debt. Organically, the retail banks in the United Kingdom were giving away current accounts for free, and sacrificing their profits in terms of customer value.

Consequently, in June 1988 Midland drafted a team of executives on a project code-named “Raincloud”. Mike Harris, a former Midland executive, returned as a consultant to lead the top-secret investigation. An examination of consumers’ banking habits highlighted that there was a substantial niche of people whose banking transactions were not branch-based. According to a national market research study of British bank customers by MORI in 1988:

• 20% of account holders had not visited their branch in the last month • 51% said they would rather visit their branch as little as possible • 48% had never met their branch manager • 38% said banking hours were inconvenient Not For Reproduction INSPECTION• 27% wished they were COPY able to conduct more business with the bank over the phone This was the beginning of an idea. Rather than reposition the branch network, the taskforce wondered what it would be like to have a bank with no branches. The team discovered that as early as 1981 a Dutch bank, Nederlanse Credietbank, had setup Direktbank with a small telephone staff to cater to the needs of an upscale segment. Since 1986, Bank of America offered an additional service that enabled branch customers to process transactions by pressing buttons on touch tone telephones in response to a voice-activated computer. And in France, several banks allowed customers to make account inquiries via the videotext Minitel screens linked to their home phones.

The Midland team envisioned an entirely new type of bank that would operate from one center, 24 hours a day, 365 days a year. Employing the UK's 47 million telephones as a low cost delivery system, it would use human operators rather than a machine to perform all the functions of a traditional bank. Next, Harris’ team faced the difficult task of presenting to the Midland board of directors a proposal for a new concept that might compete with its own branch network. Although Midland Bank had successfully retained its customer base with a long list of innovative banking products, it had to acquire additional business to stay afloat. Working with experts in marketing, operations, human resources, and technology, Harris was named chief executive of the proposed stand-alone telephone bank. He was given one year to design and launch it.

Developing Operational Systems and Initial Job Design

Rather than incur the delay and expense of obtaining its own bank charter, First Direct was set up as a division of Midland Bank. Short on timeMidland anticipated another bank would introduce a similar telephone servicethe team proceeded secretly, working 18-hour days. After much brainstorming, the team baptized the new bank “First Direct” to reflect its pioneering concept of working directly with customers. As far as Midland was concerned, First Direct was a completely new brand and a completely new business. A black and white corporate identity symbolized the simple, economical nature of the new bank.

The start-up staff of about 50 worked initially out of London while the operations team evaluated a variety of potential sites for First Direct’s one and only office. They were Not For Reproduction Copyright © 1997 INSEAD, Fontainebleau, France INSPECTION COPY INSEAD 3 4660

attracted to Leeds as the city offered moderate rental rates and a regional labor pool accustomed to lower salaries than in southern England. Additionally, the Yorkshire accent was recognized as easy to understand, warm, and friendly. First Direct leased a modern building in an industrial park outside Leeds that could be modified to suit the bank’s needs.

Procedures had to be built from scratch so that any traditional branch transaction could be handled in one telephone call. The planners decided that customers could obtain cash through the Midland automatic teller machines (ATM) network and make deposits electronically, while transactions would be cleared and statements processed at one of Midland’s regional processing centers. First Direct would benefit from its parent’s massive technology investments of the late eighties; otherwise Midland played no managerial role.

Next, Notthe team For turned Reproduction to new technology to deliver a portfolio of payment, savings, and INSPECTIONlending instruments over the phone.COPY A survey of the best call centers in the United States and Canada provided guidance in setting up the systems. First Direct improved upon existing technology to make all customer information accessible by any telephone operator. Furthermore, they integrated the screen and telephone systems so a call could be passed along without the customer having to repeat the entire conversation.

Another group designed job descriptions to meet service standards and the use of high-tech work tools. It was obvious that the new bank’s telephone-based staff would have an assignment very different from a traditional bank teller who counted cash, filled out deposit slips, and looked for forged signatures. A visit to Federal Express’ Memphis hub provided insight as to how to recruit, train and motivate staff. Kevin Gavaghan, then marketing director of Midland Bank, remembered how the hiring criteria were determined:

In hiring, First Direct were looking for people that were fast and efficient but more importantly people with warm and engaging personalities. The first flood of applicants showed the way; the first six months proved it. The qualities required were more often than not found in the social professions - teachers, nurses, even firefighters - frequently people working difficult hours under difficult circumstances. Empathy and responsiveness under pressure marked these types out from the traditional bank clerk whose reserve and process-orientation proved at times impossible to reverse.

Initial recruitment advertising gave only sketchy details of employment opportunities in the financial services sector; there was no mention of Midland Bank. As early as May of 1989, First Direct began hiring telephone advisors who were called Banking Representatives (BRs). Training sought to improve the candidate's communication and listening skills so that they sounded friendly, mature, and well informed over the phone. By the time of launch, 200 BRs were prepared to answer inquiries and process customer transactions.

Getting Off to a Slow Start

First Direct inaugurated its service at midnight on Sunday, October 1, 1989, in a pointed reference to its seven days a week, 24-hour operation. Although for legal reasons its advertising had to mention that First Direct was a division of Midland Bank, it sought to distance itself from Midland to bring in new customers. First Direct selected a British agency known as a creative “hot shop”, Howell Henry Chaldecott Lury (HHCL), to orchestrate an aggressive £6 million advertising campaign that kicked off one hour before the bank opened for business.

Traditional banks did not see First Direct as a threat. Skeptics doubted that the concept of telephone banking would ever catch on, or that it would ever be profitable. The competitive spirit withinNot ForMidland Reproduction was such that no one anticipated a great deal of cannibalization. INSPECTIONFurthermore, as First Direct COPYtargeted individuals with relatively high disposable incomes, existing banks never feared it would gain significant market share. Although First Direct was from the outset overwhelmed with telephone inquiries, acquiring new customers proved difficult. Soon the media reported it to be a flop.

Despite its slow start, First Direct began winning a growing number of customers after its first full year of business. By December of 1992, it had almost 250,000 account holders, about 70% of whom had reportedly been attracted from competitors. A year later, Gene Lockhart, CEO of UK Banking at Midland, declared that First Direct had acquired over 350,000 customers, only 20% of whom were formerly Midland customers. The bank lost very few customers, approximately 2 to 3% per year, the majority as a result of “natural causes”. In 1996, the bank had 640,000 customers and was acquiring about 125,000 new customers a year - the equivalent of opening one new branch each week (Exhibit 1).

During the first six years of operations, First Direct’s offices adapted to accommodate this phenomenal growth. With the 75,000 square foot (7,000m2) building in the Arlington Business Center fully utilized, First Direct unveiled a second purpose-built facility three miles away at Stourton in November 1994. The Arlington location accommodated both back-office operations (foreign investments section, lending services, and mortgage underwriters) and the front-office call center (customer service and new customer department) on a single floor without walls. Besides a second call center, the 150,000 square foot (14,000m2) Stourton site housed credit and risk services, investments, new mortgage inquiries, the insurance division, and customer inquiries (Visa, direct debits, standing orders, customer relations). The operations and information technology (IT) staff occupied part of the same trading floor at the center of the business. The different teams mapped their areas by the signs that hung from the ceiling (Exhibit 2).

Telephone advisors did not have their own desks but transferred mobile units containing stationery and personal belongings to any desk available during their shift. This “hot desking” approach enabled full capacity utilization over the non-stop work shift. Kevin Newman was based in Arlington and all the directors sat with their departments at their respective sites—no one had a private office. Richard Rushton, customer services director, had a desk at each site. A mini-van made the ten-minute connection between the two sites every hour.

By early 1996, it was estimated that First Direct served a customer base equivalent to 200 branches. However, the telephone bank employed only 2,400 individuals where a branch network would require a staff of almost 4,000. Its staffing costs were about half those of a typical retail-oriented commercial branch. The construction of a third building adjacent to Stourton was scheduled for completion by June 1997.

Efficient information systems were instrumental in keeping costs down. The business required non-stop processing power to perform on-line transactions and to access the bank's mainframe computers. The hub of First Direct’s operations, the on-line customer database, used two Sequoia UNIX-based computers at Arlington and Stourton. It also supported and interfaced with the 1,800 personal computers that ran various applications across the two sites. Third parties provided IT support for transaction clearing, card service processing, and credit scoring.Not First For Direct Reproduction used an automatic call distribution (ACD) system to manage one of the INSPECTIONlargest call centers in the UK. COPY It routed calls to unoccupied operators and bounced calls back and forth between the two centers to balance work loads.

First Direct achieved break-even by the end of the 1994 financial year and in 1995 reported its first full year of profitability. In 1996, Kevin Newman commented on the bank’s financial performance:

As you know, we have been circumspect about releasing this information for commercial competitive reasons and I do not wish to change this policy. I can, however, indicate that our return on equity is extremely attractive (i.e. 25% plus). Our return on investment is equally attractive, at least as good as that currently being achieved by the UK clearing banks.

Retail Banking in the United Kingdom

Until the seventies, the so-called Big Four British clearing banks, namely Lloyds, Midland, Barclays, and National Westminster dominated retail banking in the United Kingdom while building societies controlled the mortgage market. Much like the US savings and loan institutions, building societies provided funds for the purchase of homes from a pool of members’ savings. No new bank charters had been issued by Britain’s central bank, the Bank of England, since the end of the nineteenth century.

However, in the seventies the Bank of England allowed banks to provide a more complete range of personal financial services, from share dealing and insurance broking to the provision of financial advice. Additionally, the 1979 Banking Act opened up the mortgage market to institutions other than building societies by formally dissolving the interest rate cartel. In turn, the building societies obtained the right to offer checking accounts and unsecured loans. Abbey National was one of the first institutions to take advantage of this shake-up, becoming a bank in 1989. The early eighties saw further deregulation, tax incentives, and an economic boom in the UK that greatly enhanced personal wealth for many individuals.

By 1993, four of the top ten building societies had obtained bank charters and were competing directly with the Big Four banks in the provision of a broad range of consumer banking services. Consequently, by the early nineties Britain had an excessive number of banks and branches, difficult to sustain in the face of economic recession and increased automation. Inevitably, several much-publicized mergers followed. The Hongkong & Shanghai Banking Corporation (HSBC) bought Midland Bank in July 1992. Three years later, Britain’s biggest building society, Halifax, planned a merger with Leeds Permanent, the country’s fifth biggest. The consolidation process accelerated markedly in 1995 (Exhibit 3).

Parallel to this industry-wide reshaping, individual banks and building societies embarked on their own downsizing programs by closing branches and centralizing transaction processing. The total number of branches fell by 15% between 1980 and 1992, with a loss of over 100,000 jobs. MoreNot qualified For Reproduction or senior staff were often replaced by lower-paid, less-qualified workers. INSPECTIONThe banks and building societies COPY soon attracted unfavorable media attention and criticism for their long queues, high level of errors, and exorbitant customer charges. In response to these attacks, Midland Bank was the first to introduce charge-free banking and personal loans. In the late eighties, the Henley Center for Forecasting found that customer dissatisfaction remained higher in banking than in any other retail sector in Britain. However, only one in thirty British consumers switched banks in a given year. Despite increased competition, only one person in five could distinguish between the services offered by the various banks.

Many financial institutions saw automation and new technology as ways to replace some expensive branch transactions. Customers responded enthusiastically and automated teller machines proliferated. Banks made ATM network share agreements and also installed cash machines in non-branch locations like supermarkets. With new technology, telephone-based banking now offered person-to-person, person-to-computer, or even computer-to-computer based transactions at an estimated cost as low as one-sixth that of conventional branch-based transactions (Exhibit 4).

As early as 1983, the Nottingham Building Society offered Britain’s first subscription telephone banking service, known as Homelink. However, the service attracted only 5,000 subscribers. Another pioneer, The Royal Bank of Scotland launched its Home and Office Banking System in 1984 and Direct Line insurance in 1985. By 1996, the use of telephone banking in one form or another was widespread throughout the industry (Exhibit 5).

The introduction of debit cards and smart cards also favored the advent of electronic banking. As an alternative to cash, NatWest and Midland Bank piloted the Mondex smart card in July 1995. Positioned as an electronic wallet, it allowed customers to store cash, debit purchases electronically, and replenish the card from their accounts at an ATM or through specially equipped telephones. In 1995, Barclays, the largest retail bank in the UK, launched a home banking service accessed through the customer’s personal computer.

Acquiring New Customers at First Direct

The majority of First Direct’s new prospects called the bank on a toll-free line. Direct mail activity produced high call volume and brought in nearly one-half of new customers. More importantly, word-of-mouth recommendations generated about one-third of customer acquisitions. Customer polls showed that 87% of the customer base was either extremely or very satisfied with First Direct, compared with an average of 51% for conventional banks; 85% of its consumers actively recommended the bank to friends, relatives, or colleagues (Exhibit 6). In both 1994 and 1995, First Direct achieved the largest net gain of all UK banks and building societies in customers transferring their checking account.

The new customer team answered inquiries, opened accounts, explained the mechanics of telephoneNot banking, For andReproduction carried out the initial processing and assessing of the 17,000 prospects INSPECTIONthat applied every month. They COPY obtained basic customer details (name, address, date of birth) before taking the caller through the application process over the telephone. Then, the computer system automatically generated a preprinted application form for customers to sign and return. Next, First Direct formally processed the application and made various fraud and credit checks. Credit scoring requirements were strict because new customers were instantly issued 25 checks and a £100 check guarantee card that potentially gave access to £2,500 credit. The bank rejected about 50% of applicants.

New customers received a “Welcome” pack and established security procedures to ensure proper identification and confidentiality. Ninety-seven percent of new customers opened a checking account; about 70% also transferred their direct salary deposits, 60% opened a savings account, and 40% a credit card account. Although First Direct did not require a minimum balance, the average checking account balance was about £1,000. After the first three months of activity, First Direct made several mailings and telephone calls to take customers through the "Education" phase in order to build awareness of the range of investment and lending services provided.

Customer Service

The heart of First Direct was the call center. Regular customers could call at any time of the day or night on a special Lo-call telephone number charged at local rates, regardless of where the call originated in the UK, or contact the bank from overseas via a special number. First Direct received over half of all calls outside traditional banking hours, many on public holidays. The average customer called First Direct once a month. During peak hours, from 10 a.m. to 12 noon and 6 p.m. to 9 p.m., nearly 800 people worked the phones. That number dropped in the middle of the night to about 40 operators.

Banking Reps verified the customer’s identity and retrieved the account information on the computer screen. The Customer Information System recorded each customer contact and gave BRs access to all the customer’s accounts and business history. Day-to-day transactions such as balance inquiries, electronic payment of bills, or a transfer of funds between accounts could all be completed by the same representative, without the customer being transferred. In

fact, BRs could handle 85% of the inquiries. Some BRs were accredited to deal with more complicated Visa card or foreign currency requests.

For more specialized information regarding loans, personal insurance, mortgages, or investments, BRs transferred customers to telephone advisors within the respective business units. For example, mortgage counselors were available from 7 a.m. to 12 midnight, seven days a week, for advice on a new mortgage, remortgage, or a home improvement loan. A mortgage application could be completed over the phone. Additionally, an experienced group of BRs manned what was called an overnight “mushroom squad” to answer any type of customer inquiry in any business area.

Telecaster screens suspended from the ceilings in each department signaled the number of calls waiting,Not For the average Reproduction length of the wait, and the current service level expressed as a INSPECTIONpercentage. To meet minimum COPY service objectives, 75% of all calls had to be answered within 20 seconds or less. If callers were put on hold for more than two minutes, BRs apologized and arranged a call-back. The bank recorded customer calls to safeguard against transaction errors. As much as possible was done via the phone, but for legal reasons it was sometimes necessary to complete written documents after the phone had been put down.

Although no one at First Direct dealt with customers face-to-face, the employees elected to wear business dress to convey a sense of professionalism. The 1,200 Banking Representatives (50% of the total staff) formed the customer's overall impression of the company. Bringing with them their own experience as bank customers, BRs strove to be flexible enough to accommodate those customers who complained that the bank’s rigid systems did not always meet their needs. When things went wrong, BRs tried to go overboard to recover customers.

At First Direct there was no such thing as a normal workday. Workweeks varied between 16 and 36 hours and there was no premium paid for night or weekend shifts. Full-time BRs worked a 36-hour week with a 10-minute break every two hours and a half-hour lunch break. The 1996 television advertising campaign put pressure on the call center not only from increased inquiries but also by increasing the average call length of existing customers from three to three and a half minutes. Some telephone advisors were more than willing to work overtime, often putting in 14-hour shifts and taking over 200 calls in a day. (Overtime was paid at one and a quarter times the hourly rate.) Although the staffing was based on sophisticated forecasts, an additional 30 seconds spent with each of First Direct’s 26,000 daily callers was likely to jam the call center. Newman recognized that working in the call center was a tough job:

Calls come in incessantly, one after another. So, after having answered 150 calls it is difficult to keep the momentum going and to be sincerely friendly on the phone especially when handling tedious transactions. But our business is built on how the next call is answered. The biggest part of my leadership role is to enable a culture which allows people to feel very positive about their contribution to our business so that they may deliver genuine smiles over the phone. This cannot be obtained by telling people to do so; they can only do it because they believe it.

The commercial department’s principal function was data management geared at building a one-to-one customer relationship. Database specialists fed information to the new product development team and the communications team to jointly determine and optimize marketing strategies. The Management Information Database (MIND) software combined transactional information with behavioral data to predict the next product a customer was likely to purchase. This database prompted BRs to cross-sell other financial services when clients called with routine requests and also helped personalize their conversations with customers:

Sylvia (BR): Hello, First Direct. How may I help you? Mr. Scott (Customer): Good evening, I would like to order some US dollars please. Sylvia:Not For Your Reproduction account number please? INSPECTIONMr. Scott: 58-395-123 COPY Sylvia: Thank you. Please bear with me while I verify some information for security reasons. Could you please give me the third digit of your password? Mr. Scott: Five. Sylvia: And the date of your wedding anniversary? Mr. Scott: February 14th Sylvia: Thank you, Mr. Scott. How many US dollars would you like to order? Mr. Scott: It depends, I’m going skiing in the States. Can you tell me if there is a cash machine in Vail, Colorado please? Sylvia: I’ll need to ask you to hold the line for a minute while I find that information for you sir. Mr. Scott: Thank you. Sylvia: Hello, yes in fact there is a Cirrus ATM machine at the First Interstate Bank at 38 Redbird Drive in Vail. Mr. Scott: In that case, I’ll only take $500 in cash with me and use the cash machine at the resort. Sylvia: Right. I’ll put in an order for $500. Shall I debit your checking account and have the currency delivered by registered mail to your home address? Mr. Scott: Yes, please. Sylvia: Thank you sir. You should receive it within three days. We’ll include a confirmation of the amount deducted. Have a nice trip! A few weeks later: Peter (BR): Hello, First Direct. How may I help you? Mr. Scott: Good evening, I would like to make a payment to British Gas please. My account number with First Direct is 58-395-123. Peter: Thank you. Please bear with me while I verify some information for security reasons. Could you please give me the first digit of your password please? Mr. Scott: Three. Peter: And your mother’s maiden name? Mr. Scott: Bradford Peter: Thank you Mr. Scott. I’ll be glad to arrange your payment to British Gas. By the way, were you able to find the First Interstate cash machine in Vail when you were on your skiing holiday in Colorado? I hope everything went well.

People and Development

First Direct was the largest private employer in Leeds with over 2,400 employees by early 1996; it projected to add an extra 550 by year-end. On average the staff were between 20 and 40 years of age; nearly 69% were women and 24% part-timers (Exhibit 7). Recruitment was

carried out continually via a 24-hour phone answering service that provided application information. Two meeting rooms adjacent to the lobby in Arlington were reserved exclusively for interviewing. It was becoming more difficult to recruit telephone advisors because Leeds had become a hub for call centers. (By 1996, there were over 350 24-hour call centers within the United Kingdom in the retailing, banking, and utility sectors.) The team leaders who interviewed the 60 BRs hired each month looked for people with a positive attitude who were enthusiastic about joining a first-class organization. First Direct also had a reputation for providing comprehensive training and a benefits package that included a mortgage subsidy, a pension scheme, and 27 vacation days (Exhibit 8).

Recruited from a non-banking background, BRs did not come into contact with customers until theyNot had For successfully Reproduction completed a seven-week training course conducted by twenty in- INSPECTIONhouse trainers. Four weeks COPY were devoted to understanding the bank’s products and communication systems. They also practiced telephone techniques such as voice projection skills to regulate the pitch and volume vital to create trust and confidence. The last three weeks concentrated on role-playing to build excellent listening skills and the ability to access and input data accurately and efficiently. Only a small part of the customer interaction was scripted for the beginning and end of conversations. Banking Representatives were encouraged to use what they thought were the right phrases, given the nature of the rapport. To become a full-fledged BR required passing a total of 54 internal accreditation tests over the first nine months of employment (Exhibit 9).

All the BRs were assigned to teams of individuals working the same shift pattern. A team leader acted as a coach and watched the customer service screens to make sure that everything ran smoothly and to identify any members who might need assistance. A lengthy call was a clear signal of a customer problem or complaint. There were over 100 teams in the two call centers with names like "Vernon's Vikings", "JJ and the Dinos", and "Hard Time Lovers". Sales competitions, product awareness sessions, and theme days were organized regularly between the teams to bond people together.

The level of basic pay related to the market and to individual acquisition and development of skills rather than to the pay and grading structures of traditional banks. Annual appraisal ratings determined the level of performance bonuses that could go as high as 5% of annual salary. Each year, nearly 30% of the BR staff moved to other departments such as lending services or mortgages. It took about 18 months to learn the job and to get to know the company before applying for other jobs. Such career opportunities helped keep turnover low at 11%. In 1996, 40% of the employees had been with the firm for at least three years.

First Direct’s facilities reflected the needs of a 24-hour workforce. A private security firm manned the entrance to the car parks and reception areas throughout the night. The company restaurant served breakfast, lunch, and dinner from 7 a.m. to 9 p.m. seven days a week while vending machines made hot and cold drinks available free of charge around the clock. Day- care centers at both Arlington and Stourton looked after 150 small children.

Marketing Strategy

Management did not foresee telephone-only banking as having universal appeal. In fact, First Direct estimated that telephone banking would ultimately attract up to 10 million of the UK’s 36 million bank customers. Most First Direct customers were between 25 and 44 years of age, living in metropolitan areas and working as professionals, managers, or in high-grade clerical positions. Research also showed that about 50% of its customers owned personal computers - twice the market average (Exhibit 10). These busy professionals were attracted by the offer of speed and convenience; their extensive use of the bank’s services also generated higher profitability. A New York Times journalist estimated:

The average balance is ten times higher at First Direct than at Midland, while the overallNot Forcosts areReproduction 61% less. Overall, First Direct makes money on 60% of its INSPECTIONcustomers, compared to COPY40% at the average British bank. September 3, 1995

First Direct rated several times among the “Best Buys” of Which? magazine’s consumer reports on retail banking (Exhibit 11). It also won the 1995 Unisys/Sunday Times “Customer Champion Awards” for outstanding customer service in financial services and as overall winner. The First Direct brand seemed to create a service halo; research showed that First Direct customers had a satisfaction level with the ATM system double that of Midland Bank customers, even though they shared the identical network.

Among its full range of traditional banking services (Exhibit 12), First Direct featured its interest bearing checking account that offered an automatic fee-free overdraft facility of £250 and daily cash withdrawals of £500 a day subject to sufficient funds. However, fees accumulated rapidly if customers exceeded the agreed overdraft. First Direct encouraged customers to maximize short-term returns by frequently transferring money between their checking accounts and multiple savings accounts. There were no transaction charges for any of First Direct's basic services. Advertising claimed that the lack of branches enabled it to pass on savings to customers. Even the Visa card was free of annual charges, offering up to 56 days interest-free credit as well as free travel accident insurance. First Direct was also known to offer better interest rates on mortgages, personal loans, and Visa cards (Exhibit 13).

While most UK banks marketed mortgages in the spring or car loans in July, First Direct's approach was to mail customers information only when they needed it. When First Direct added car insurance in March 1995 to complement the life and household insurance products already offered, it adopted a soft-sell approach. BRs were prompted to collect car insurance renewal dates from customers and to record this information on the customer database. As renewal dates approached, customers either received a quotation in the mail or by phone.

Communications Strategy

The First Direct brand tried to communicate a no-frills, hassle-free approach to banking more in tune with customers’ lifestyles. Matthew Higgins, market planning manager, explained:

People do not see banks as a fundamental part of their lives. We are trying to market First Direct as a background activity. No bank should be at the top of customer’s minds. The whole idea with First Direct is that it is efficient, easy, and available when you want it. You simply tap into it and then you go away and do something more interesting.

The purpose of First Direct's initial offbeat ad campaign was to break into a sluggish market by getting people to switch banks. This was a challenging task as it was an industry joke that the British were more likely to change their partners than their bankers. The launch advertising helped First Direct stand out in the crowded financial services market. In 1991, First Direct entrusted Chiat Day, a creative American agency, to invest £3 million in television commercials underlining its customers’ extraordinary satisfaction with the new telephoneNot bank. For Unfortunately, Reproduction the resulting campaign did not build the brand and First INSPECTIONDirect stayed off the air for COPYthree years in search of new solutions. The 1995 television campaign also failed to develop the theme of banking and living in harmony.

Between 1991 and 1995, the press was used almost continuously to attract new customers through offers of high-quality service and no fees. As competition intensified, Chiat Day came out in 1993 with a press campaign to differentiate the pioneer from the new players. Simultaneously, First Direct mailed out brochures explaining the mechanics of telephone banking to a broad upscale audience. The mailing combined with the press ads generated an overwhelming number of customer inquiries. Unable to keep up with the demand, First Direct cut short the campaign so as not to compromise service quality.

Finally, in 1996, First Direct turned to WCRS, a major international advertising network, part of the EURO-RSCG group. Their brief revolved around the necessity of developing a more disciplined approach to building the First Direct brand. WCRS had a solid reputation for image development with clients like BMW cars and Orange mobile phones. Not until 1996 did television advertising demonstrate what it meant to bank with First Direct. Back on the air with two six-week bursts between January and April of 1996, the "Tell me one good thing about your bank" campaign underlined the advantages of First Direct to attract dissatisfied customers from competitors. The £7 million television, radio, press, and direct mail campaign raised meaningful brand awareness among the target audience from 30% to 45% (Exhibit 14).

Management Style, Organization, and Culture

In February 1996, Newman restructured the business into five units that operated as profit centers: banking, savings and investments, lending, insurance, and mortgages. Product management moved out of the commercial department into integrated operational units at the heart of the business. With this structure each business could eventually acquire customers directly. All the business unit heads reported to Richard Rushton who also managed the banking unit directly - including the call center, the new customer team, customer service relations and inquiries, customer service support, and business planning. All the central support functions such as IT, finance, operations, commercial, credit services, and personnel and training were outside this structure.

Known for its leading edge management practices, First Direct attracted top quality managers. Only 50% came from a banking background. Six directors reported to Newman: commercial, customer and financial services, information technology, personnel, finance, and credit services (Exhibit 15). Their principal task was to develop strategy and people through coaching, while Newman dealt directly with their subordinates on business issues. Thirty distinct roles were key within the organization, where individual accountability and competence were far more important than titles or functions. Although First Direct ran a business around the clock, most managers kept traditional 8 a.m. to 6 p.m. schedules, spending a great deal of time on the floor where they could get first-hand feedback from employees and a feel for service levels. Unlike traditional British banks, everyone was on a first name basis and ate in the same cafeteria. Newman firmly believed in leading by example;Not the onlyFor perk Reproduction he enjoyed was a company car. INSPECTIONThe corporate mission statement COPY greeted all employees as they entered the lobby at each site:

Our mission: to be the best in the world of personal banking

Pioneering: the first 24-hour person-to-person telephone bank

Successful: UK’s fastest growing bank with 640,000 customers

Responsive: the most satisfied bank customers in the UK

First Direct had earlier identified five core business values - responsiveness, openness, right first time, respect, and contribution - which were a fundamental part of the training program and widely shared by employees. This mindset made employees feel part of something special and it was reflected in the image projected to customers over the phone. In 1996 a sixth core value, “kaizen”, or continuous improvement, was added following the suggestion of a new management hire. To get the entire organization focused on continuous innovation, the internal communications specialist launched a theme day during which the building was decorated in “kaizen yellow” and everyone wore T-shirts that they had decorated with colored pens to express their own creativity.

The Challenges Ahead

In only seven years, First Direct had made a significant impact on the industry and had become a worldwide reference for telephone banking. By 1996, most banks and building societies offered their customers some form of direct access. Direct Line insurance had broadened its offering to include lending, mortgages, and savings products to its two million policy holders. Furthermore, competition was now by no means restricted to banks, building societies, or insurance companies. Richard Branson’s Virgin Direct, launched in March 1995, subsequently introduced savings plans and low-cost life insurance via the telephone. Even the retailing chain Marks & Spencer offered life insurance from early 1995 (Exhibit 16).

First Direct was constantly faced with the predicament of not compromising on service and price so as not to lose those customers who complained that it had grown too quickly. Yet to meet the objective of one million customers by the year 2000, First Direct needed to sign on another 400,000 people. Furthermore, First Direct recognized that its management methods might not necessarily be appropriate in the future. Management wondered how to keep all the strengths of the business and its innovative culture as, over the next five years, it grew to 10,000 employees located at four or five sites.

Critics charged that First Direct had not kept up with banking technology as it did not offer an on-line home banking service. This additional channel would provide increased convenience to customers while further reducing transaction costs. A significant minority of First Direct customers had spontaneously requested PC access to their accounts. Although the HSBC Group Notsigned Fora deal Reproductionwith Microsoft in late 1995, First Direct did not expect to offer an on-line INSPECTIONbanking service until 1997. NewmanCOPY explained his perspective:

The mode of distribution is changing - at the moment we definitely see it as person-to-person over the telephone. Do we believe that people will bank electronically over the next ten years? We are not fussed about how quickly or by which means our customers choose to access all or part of their banking electronically. The elements for us are: when they do so what is the role of a bank, and how do we deliver competitive advantage in this environment? We must always remember that our "moments of truth" are the telephone contacts with the Banking Representatives. With PC access this disappears, thus limiting our opportunities. Creating value in an electronic world will be a key issue for First Direct. We like to think that we are not really in banking but distribution. We just happen to supply financial products.

List of Exhibits

• Exhibit 1: First Direct: Estimated Account Data

• Exhibit 2: Simplified Floor Plan Arlington and Stourton

• Exhibit 3: UK Retail Banks - Statistics 1989 & 1995

• Exhibit 4: Alternative Home Banking Technology Not For Reproduction INSPECTION• Exhibit 5: Sample of Direct COPY Financial Services in the United Kingdom • Exhibit 6: Customer Satisfaction Survey for UK Retail Bank Customers Year-end 1995

• Exhibit 7: First Direct Workforce Profile

• Exhibit 8: Banking Representative Recruitment Advertising

• Exhibit 9: First Direct Training Programs

• Exhibit 10: Comparative Customer Profiles: First Direct vs All British Banks

• Exhibit 11: Home Banking Systems Compared by Which Consumers Association

• Exhibit 12: First Direct Products and Services

• Exhibit 13: Comparative Interest Rates: First Direct and Other British Banks

• Exhibit 14: First Direct Television Advertising Slogans 1996 Campaign

• Exhibit 15: First Direct Organization Chart

• Exhibit 16: Sample of Direct Financial Services Across the Globe

Exhibit 1 First Direct: Estimated Account Data

Date Total Total Calls/day Staff number of number of customers accounts

April 1996 641,000 1,100,000 32,000 2,400

December 1995 586,000 800,000 26,000 2,300 INSPECTIONNotDecember For Reproduction 1994 COPY 476,000 700,000 21,000 1,900 December 1993 361,000 500,000 16,000 1,500

December 1992 241,000 350,000 11,000 1,000

December 1991 136,000 200,000 7,000 500

December 1990 66,000 105,000 3,000 300

December 1989 11,000 N/A N/A 250

Source: Estimates based on Midland Bank Annual Reports and Internal Sources First Direct, 1996

Exhibit 2 Simplified Floor Plan Arlington and Stourton

Staff Arlington Main Floor Entrance

Mortgages Call Center Computer Room Creche INSPECTIONNot For Reproduction COPY Finance

Storage Computer Room

Commercial

New Customer Team

Mail room Restaurant Reception

Staff Entrance

Stourton Trading Floor

Plant Plant Plant Room Room Room

Call Center Customer Services Inquiries Customer Services Support

Operations Creche Credit Services Information Technology

Creche Entrance Staff Interview Rooms Reception Entrance Kitchen Staff Entrance

Exhibit 3 UK Retail Banks - Statistics 1989 & 1995

Retail Banks Assets Pre-tax profits Number of Number of (£ millions) (% of total assets) branches employees 1989 1995 1989 1995 1989 1995 1989 1995 National Westminster 116,189 166,347 0.3 1.1 2,997 2,215 86,600 61,000 Bank Barclays Bank 127,616 164,184 0.5 1.3 2,645 2,050 85,900 61,200 Lloyds Bank TSB1 83,023 131,750 -0.7 1.3 3,722 2,858 87,500 66,400 Abbey National2Not For Reproduction37,201 97,614 1.3 1.1 678 678 13,600 16,300 MidlandINSPECTION Bank3 62,619 COPY 92,093 -0.4 1.1 2,042 1,701 47,500 43,400 Royal Bank of Scotland 27,436 50,497 0.8 1.2 842 687 20,500 19,500 Bank of Scotland 14,073 34,104 1.3 1.3 527 411 12,100 11,300 Source: Annual Abstract of Banking Statistics, British Bankers Association, 1996, volume 13

1 Lloyds Bank merged with TSB in October 1995 and acquired Cheltenham & Gloucester in 1995.

2 Abbey National acquired National & Provincial in 1995.

Exhibit 4 Alternative Home Banking Technology

• Automatic Call Distribution - ACD Systems that manage a high volume of incoming calls by routing and placing each call in a queue to the next available operator so that the caller never hears a busy signal.

• Computer Integrated Telephony - CIT Computer databases are linked to the incoming call, allowing call handlers to quickly access customer files.

• Calling Line Identification AnNot additional For CIT Reproduction service which shows the number at the source of the call. INSPECTION• Interactive Voice Recognition COPY and Response CIT systems can react to the tones entered by telephone, or even recognize certain predetermined voice inputs.

• Teletext and Videotext-based Access Videotext terminals, with screens and keyboards, provide an interactive access to a bank’s computer. The national French Minitel system is the most developed network in Europe, British Telecom offers a similar Prestel network.

• Multi-Media Kiosks Stand-alone multi-media kiosks may communicate with the customer using powerful interactive digital text, audio, video and animation.

• PC-based Access A personal computer may access a bank’s computer via a modem and telephone network.

• Internet World Wide Web Site Home banking customers may connect to their bank’s proprietary web site via private dial-up networks and tap into their personal accounts.

Source: Data gathered from various publications

Exhibit 5 Sample of Direct Financial Services in the United Kingdom

Institution Service Launched Description Bank of Scotland CardCall October 1993 add-on telephone inquiry service using interactive voice response HOBS 1985 add-on teletext banking service Phoneline add-on operator-based home banking Royal Bank of Direct Line 1985 direct insurance services via Scotland telephone operators Not For ReproductionDirect Banking April 1994 full service 24-hr telephone banking INSPECTION COPY by touch tone phone or operator TSB Speedlink 1987 add-on mass-market telephone banking service via voice recognition PhoneBank October 1994 operator-based home banking National Westminster Actionline September 1988 add-on automated 24-hr touch-tone Bank inquiry service later with operators Primeline September 1991 up-market fee-based telephone service via personal account managers with Thomas Cook Touch 1995 add-on banking and travel services via stand-alone videotext kiosks Nottingham Building Homelink 1983 add-on home banking service Society offered via BT Prestel videotext network Midland Bank Customer May 1993 add-on customer service inquiry via Service Center operators Co-operative Bank Armchair 1992 add-on telephone banking service Banking with operator Barclays Bank Barclaycall July 1993 add-on mass-market telephone banking service via operators 1995 electronic computer to computer banking Alliance & Leicester Telecare 1995 integrated telephone banking via Giro operator Swiftcheck automated telephone inquiry Nationwide Home Banking 1995 computer-based home banking Clydesdale Telebank 1995 computer-based home banking Lloyds Bank Lloydsline 1994 add-on up-market telephone banking service manned by operators Marks & Spencer April 1995 insurance services by telephone Virgin Group Virgin Direct March 1995 financial services via telephone Source: Data gathered from various publications

Exhibit 6 Customer Satisfaction Survey for UK Retail Bank Customers Year-end 1995

Very or Extremely Have recommended at least Satisfied once in last 12 months Bank Q4 1995 Q4 1994 Q4 1995 First Direct 87% 86% 85% Big 5 Main Banks (avg.) 51% 44% 16% Building Societies 66% 65% 27% Other Banks (avg.) 69% 65% 42% Not For Reproduction INSPECTIONMidland COPY 54% 46% 14% Lloyds 55% 46% 18% NatWest 44% 41% 16% Barclays 47% 37% 15% TSB 59% 56% 15%

% who have recommended

90 First Direct 80

70 building societies 60 50 40 other banks 30 Lloyds 20 NatWest TSB 10 Barclays Midland 0 0 20 40 60 80 100 % very satisfied

Source: First Direct Survey conducted between November 20, 1995 and January 21, 1996

Exhibit 7 First Direct Workforce Profile

Sex % Status % Age % Service % length Male 31% Full-time 76% <20 1% <1 yr 22% Female 69% Part-time 24% 20-25 29% 1 yr 22% 26-30 26% 2 yr 16% 31-35 20% 3 yr 14% 36-40 14% 4 yr 7% 41-45 6% >5 yr 19% Not For Reproduction 46-50 3% INSPECTION COPY >50 1% Source: First Direct Workforce Profile, May 1996

Exhibit 8 Banking Representative Recruitment Advertising

INSPECTIONNot For Reproduction COPY

Exhibit 9 First Direct Training Programs

Customer Service Duration Account Operating 7 weeks Back Office 1 day Customer Development 1 day

Team Leader Development Program Duration CoachingNot & Feedback For Reproduction 2 days INSPECTIONMotivation COPY 2 days Effective Team Leading 3 days Time and Priority Management 2 days

Formal Training for Managers Duration Counseling Skills 2 days Developing Your Team 2 days Influencing & Assertion 2 days

Miscellaneous Formal Training Courses Duration Presentation Skills 1 day Written Communication Skills 1 day Interview Skills 2 days Appraisal Skills 2 days

Source: First Direct, Training & Development Guide, May 1996

Exhibit 10 Comparative Customer Profiles: First Direct vs All British Banks

First Direct British Bank Customers Customers Age: 15-19 1% 9% 20-24 3% 6% 25-34 33% 20% 35-44 32% 17% 45-54 22% 16% 55-64 9% 13% INSPECTIONNot For Reproduction COPY65+ 0% 19% Sex: male 50% 49% female 50% 51%

Socio-economic group: AB 46% 19% C1 36% 29% C2 12% 23% DE 6% 29%

British Socio-economic group definitions

Grade Social status Occupation A Upper middle class Higher managerial, administrative or professional B Middle class Intermediate managerial, administrative or professional C1 Lower middle class Supervisory or clerical, and junior managerial administrative or professional C2 Skilled working class Skilled manual workers D Working class Semi and unskilled manual workers E Lowest level of subsistence State pensioners or widows, casual or lowest-grade workers

Sources: (1) First Direct NOP Survey January 1996 Fieldwork Nov 95-Jan 96 (2) The Financial Research Survey NOP April-Sept 1996

Exhibit 11 Home Banking Systems Compared by Which Consumers Association

INSPECTIONNot For Reproduction COPY

Source: Which?, (May 1996, p. 53) an independent monthly consumer magazine published by Consumers’ Association, 2 Marylebone Road, London NW1 4DF Not For Reproduction Copyright © 1997 INSEAD, Fontainebleau, France INSPECTION COPY INSEAD 27 4660

Exhibit 12 First Direct Products and Services

Type Product Features Checking interest bearing checking account -interest bearing, no fees -£250 automatic fee-free overdraft -automatic bill payment Debit/Credit First Direct Debit Card -£100 check guarantee card Cards -£500 daily cash withdrawals from 7,000 ATMs -access to Switch* network Not For Reproduction -access to Cirrus and Maestro ATM network INSPECTION COPYVISA Card -no annual fee -56 day interest free credit -£500 daily cash withdrawals -membership Visa points program Savings & High Interest Savings Account (HISA) -unlimited withdrawals Investments 60-day accounts -minimum deposit £2,500 -60 day notice for withdrawals Fixed Interest Savings Account - Money Market Account -£5,000 minimum deposit Tax Exempt Savings Account (TESSA) - Personal Equity Plan (PEP) -medium to long term tax-free investment Share Dealing -buying or selling on London stock exchange Direct Interest Savings Account -high interest rates paid on balances over £1,000 -one free withdrawal or transfer per quarter Financial Planning -personal financial planning advice Mortgages Variable Rate Mortgages -25 year financing of 80% of purchase price Home Improvement Loans - Equity Release Loan -financing from £3,000 of 95% of home value Loans Flexiloan -rolling loan plan between £500-£10,000 -variable interest rate Personal Loan - Insurance Car Insurance - Life Insurance - Home Insurance - Travel Foreign Currency/Travelers Checks -home delivery within 24 hours Services Travel Insurance -12 month individual coverage Source: First Direct Brochures March 1996

* Switch electronic debit card was launched in October 1988 by a consortium of three banks: Midland Bank, National Westminster Bank, and Royal Bank of Scotland. It enabled purchases to be paid in supermarkets, gas stations, and shops using the Switch network in the UK. Not For Reproduction Copyright © 1997 INSEAD, Fontainebleau, France INSPECTION COPY INSEAD 28 4660

Exhibit 13 Comparative Interest Rates: First Direct and Other British Banks

VISA Card

NatWest Lloyds Royal Bank Barclays First Direct of Scotland

Card Access/Visa Access Visa Barclaycard Visa

APR* 22.9% 22% 21.7% 21.6% 19.5%

AnnualNot Fee For Reproduction£12 £12 £10 £10 none INSPECTIONSource: First Direct February 1996 COPY *APR = Annual Percentage Rate

Variable Rate Mortgages

NatWest Alliance & Halifax Abbey Barclays First Direct Leicester National

Interest Rate 6.99% 6.99% 6.99% 7.04% 6.99% 6.69%

APR* 7.20% 7.20% 7.20% 7.30% 7.20% 6.90%

Source: First Direct March 1996 *APR = Annual Percentage Rate

Exhibit 14 First Direct Television Advertising Slogans 1996 Campaign

Tell me one good thing about your bank:

You don’t get passed around from person-to- person when you want to open a new account.

I like the way they are on call 24 hours a day.

Not For ReproductionI was their first customer, they’ve got a half a INSPECTION COPYmillion now.

I can settle my bills over the phone.

They always treat you like a grown up.

There's no standing in queues.

I can get cash wherever I go.

There are no walls.

I don’t have to get dressed to go to my bank.

It’s easy.

They never sleep.

Freedom.

Source: First Direct 1996 Television Campaign - Each spot (from 10 to 20 seconds) featured one of the above slogans as a response to “Tell me one good thing about your bank”.

Exhibit 15 First Direct Organization Chart

Graham Picken Chairman

Kevin Newman INSPECTIONNot For Reproduction COPYChief Executive

David Mead Peter Simpson Andrew Armishaw Brian Carney Guy Davis Richard Rushton Richard Rushton Personnel Director Commercial Director IT Director Finance & Credit Services Director Financial Services Director Customer Services Director Operations Director

Savings & Lending Banking Investments

Mortgages Insurance

Source: First Direct, May 1996

Exhibit 16 Sample of Direct Financial Services Across the Globe

Country Bank Service Launched Description France Paribas Banque Directe March full service telephone 1994 banking with 30 operators Credit Commercial de Videocompte 1983 originally add-on Videotext France service, eventually offered phone-based vocal access, customer advisors, and PCs Compagnie Bancaire Cortal 1984 stand-alone home banking Not For Reproduction offering videotext access, INSPECTION COPY phone-based vocal system, and customer advisors Credit Mutuel Bretagne Citelis 1995 web site home banking Germany Commerzbank Comdirect February add-on full service telephone 1995 banking via operators and interactive voice response Citibank CitiDirect September add-on full service telephone 1995 banking via 100 operators Holland Nederlanse Credietbank DirektBank 1981 stand-alone telephone bank with small telemarketing staff Portugal Banco Commercial Banco 7 1994 stand-alone full service Portugues telephone banking via telephone operators Spain Banco Santander Open Bank April 1995 Spain’s first stand-alone telephone bank Argenteria Group Bex Banco Directo Sweden Skandia Skandia Bank October stand-alone telephone bank 1994 using an interactive voice recognition system and a few agents Middle National Bank of Kuwait Watani National Phone August add-on telephone service via East Bank 1990 interactive voice response system Brazil Banco 1 Unibanco stand-alone full service telephone banking service answered by managers USA Wells Fargo Person-to-Person 1988 add-on 24-hour customer service with operators Chase Manhattan Chase Direct add-on service First Chicago Bank First Direct add-on service Huntington Bancshares Huntington Direct stand-alone full service telephone banking via operators and interactive video kiosks Source: data gathered from various publications