Supermarket giant will be a financial minnow

Sainsbury's will compete head on with other telephone banks on service and cost competitiveness as well as brand name. It is throwing its hat into a very crowded ring
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Is Sainsbury's likely to revolutionise the banking industry with its plan to set up a bank? Or is this just another marketing gimmick in the store wars, which will be here today and forgotten tomorrow?

On the face of it, the supermarket chain's plan certainly has a lot going for it, and the big clearing banks have been given much food for thought.

With millions of customers and a strong brand name, Sainsbury's has access already to a customer base comparable with the biggest of the clearers.

The fact that the company has decided to set up a proper bank, in conjunction with Bank of Scotland, is another plus point, since it could allow Sainsbury's to offer a full banking service, not a pale imitation.

This distinguishes it from Tesco's Club Card Plus account, which is like a savings account with an overdraft facility and amounts to no more than a custom-designed service from NatWest with Tesco's badge stuck on it.

With the precedent of the supermarkets' entry into petrol retailing, which set off a price war and indirectly led to the closure of a lot of smaller garages, the traditional high street banks and building societies could be in for a rough ride if Sainsbury's version of supermarket banking works.

There is, however, one supermarket chain that has long had a bank as an integral part of the organisation. It is, of course, the Co-op, which has had miniature banks in its stores since the early 1970s. Indeed, the Co-op movement can boast that it invented the cash-back service in the late 19th century, by offering to cash customers' cheques in its stores.

The Co-op's supermarket chain may not have the reputation in the food retailing business of Sainsbury's or Tesco. But it is certainly big enough to give some useful clues to the relationship between financial services and supermarkets.

The Co-op has 5,000 stores of all sizes, including 1,800 supermarkets and 94 superstores. About 1,000 stores have some form of banking outlet, including 250 with counters operated by professional bank staff and many more with cash dispensers.

The in-store banks were set up in the 1970s because the Co-op Bank wanted to expand but could not afford the enormous expense of building a national branch network.

It was not alone in doing this. Giro Bank, now owned by Alliance & Leicester, used the Post Office, which was once its parent, in much the same way.

Harrods also has an in-store bank to tap its upmarket customers, while across the Atlantic, the Bank One group has long specialised successfully in supermarket banking.

Nowadays, the Co-op Bank is much less reliant on its in-store branches. It has become a full-scale telephone bank with 1.5 million customers, fighting in the same marketplace as First Direct, the Midland subsidiary that put telephone banking on the national map, and a host of similar services now being bolted on to other clearing banks.

That is exactly the battleground Sainsbury's has chosen. With Bank of Scotland, it is setting up a centralised telephone banking operation. The role of the stores appears to be to promote the telephone banking service. That means Sainsbury's will be competing head-on with other telephone banks on service and cost competitiveness, as well as brand name. It is throwing its hat into a very crowded ring.

The Co-op experience shows that the synergy between retailing and banking is decidedly patchy. No detailed figures are available, but the Co-op says the overlap between banking and retailing customers is not particularly large.

There appears to be no magic recipe for converting the queues at the checkout into banking customers. Perfectly good retail customers may not necessarily be the ones to whom a bank would wish to lend money or sell other financial services.

The customers may take the same view. It is not a foregone conclusion that they will be prepared to trust a retailer with their money, no matter how good its name as a supplier of food. They may prove rather sceptical.

Indeed, owning a bank could become positively embarrassing if Sainsbury's tries to offer its services to all its retail customers. Imagine customers' reactions if they were refused credit because of a history of getting behind on payments, or because their earnings were too low to qualify.

Supermarkets have a rather good public image, which they promote at vast expense, while banks have always had a poor one. It could be rather risky to mix the two businesses.

As Tim Sykes, a banking analyst at BZW, says, Sainsbury's will have some important competitive advantages. The strength of the brand name is one. Another advantage is that it should be able to offer a very cheap banking service.

This is because the Bank of Scotland subsidiary that will be doing the processing work for the new Sainsbury's bank has exceptionally low operating costs, so should be able to compete on customer charges with the big clearers - though the advantage will not be so marked against building societies.

There are, however, good reasons for thinking that after the initial rapid expansion which is characteristic of start-ups, Sainsbury's may not find its new bank growing into another high street financial services giant, at least within the next decade. One is the Co-op experience. Another is that banking ties up substantial amounts of expensive capital, which under Bank of England rules must be topped up as the deposit base increases.

There is no point in fighting for market share in intensely competitive financial services if all it brings is a price war and an unprofitable business that does not justify the capital devoted to it.

Sainsbury's may have 12 million customers. But among the established banks, Barclays, NatWest and Lloyds TSB already have 40 million and they are not going to let go of them easily.

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