British Retailers Get Serious about Banking

It is 25 years this week since Marks & Spencer (MAKSY) became the first major supermarket to make a move into personal finance. It launched the M&S Chargecard on 2 April 1985 and encouraged a million of its loyal customers to sign up in the first 12 months.

Its success encouraged rivals to follow, eventually. Financial service operations of both Tesco (TSCDY) and Sainsbury's (JSAIY) were launched in 1997. But in 2010 the retail and banking landscape has changed considerably, presenting the supermarket banks with fresh challenges and opportunities.

The supermarkets are facing a tough year. Sales growth has slumped to its lowest level since the summer of 2007, according to a report from the research firm Kantar Worldpanel published on Wednesday. It said growth in total till-roll takings across the sector slowed to 3.6 per cent year-on-year in the 12 weeks to 21 March – its worst reading since August 2007. So the focus on non-grocery activities has become more pronounced as the supermarkets look to boost returns from activities such as financial services.

At the same time they are looking to exploit the opportunity presented by wide-scale disaffection with traditional banks. A report last autumn by the business advisory firm Deloitte suggests that more people will turn to supermarkets instead of banks. Its research showed that 51 per cent of people would consider moving to a new bank.

"The concerns consumers have towards their traditional banking relationships are making them more likely to explore alternative options with non-traditional organisations," says Ian Foottit, financial services strategy partner at Deloitte.

With Tesco already rebranding its financial services arm as Tesco Bank, supermarkets' move to attack banks in their core current account business is edging closer. The supermarkets have a clear advantage in that their brands remain trusted and untarnished. They have also spent the last few years building up their financial services expertise.

M&S had more than a decade head-start on its rivals. Originally known as St Michael Financial Services at its launch in 1985, it became Marks & Spencer Financial Services in 1988 when it launched a unit trust, followed by personal loans a year later. It rebranded as M&S Money in 2003 after introducing life assurance, pensions, an ISA, home insurance and a car-buying plan.

But the most significant change in its history was in 2004 when it was taken over by HSBC (HBC). The bank paid £762m for the business and regards the brand as a key part of its distribution strategy. "M&S fits in very well within the HSBC offering," said Colin Kersley, who took over as chief executive of M&S Money last year after some 20 years with the parent bank.

"The bank has its successful online business, Direct Line, as well as the mainstream bank, and M&S Money offers something different to that. It's the most trusted retail brand and has a unique customer base with 75 per cent of them female.

"It's a business that we see growing, and over the last 12 months we've been looking to expand our product ranges and widen the relationship we have with our customers. But with this business, we don't do anything without talking to the customers first," Mr Kersley explained. "It's about building what we've got and keeping our offering unique."

But M&S's early lead in financial services has since been surpassed by the supermarket giants Sainsbury's and, in particular, Tesco. All three have over time entered into major deals with banks, but now are choosing different approaches. While M&S Money has been owned by HSBC since 2004, Sainsbury's Finance is 50 per cent owned by the Lloyds Banking Group (LYG) after HBOS bought 5 per cent of the supermarket bank for £21m in 2007. Tesco, meanwhile, reversed that strategy by buying out RBS's (RBS) 50 per cent share in Tesco Personal Finance for £950m in 2008 and promptly rebranded the business Tesco Bank last year.

The three are major players in the financial services marketplace. According to research from ICM commissioned by Sainsbury's last September, a third of people claim to have a financial services product from a supermarket, while two-thirds say they would take one out if they felt adequately rewarded for having one. "Supermarkets enjoy significant customer loyalty and respect and are well-placed in terms of marketing potential to cross-sell their financial offerings," said David Black, banking analyst at Defaqto.

The number of people that supermarkets have sold financial service products to is growing quickly. Tesco Bank claims to have more than 6 million customer accounts, with M&S admitting to 3.8 million. Sainsbury's Finance says it has around 1.5 million active customers.

Mr Black believes that Tesco is the most likely to challenge the banks. "Tesco is intending to launch a current account next year and I regard this as a potentially major threat to the established banks," he said. "It is generally a very slow process for a new entrant to pick up significant market share in the current account market, the OFT said in a report last year that only about 6 per cent of adults change their current account each year. But with Tesco's reputation, marketing potential and their popular Clubcard loyalty scheme they have a significant advantage," he said.

Tesco has been most aggressive in growing its financial services operation. When it split its partnership with RBS in 2007, it said that "only sole ownership can unlock the potential growth Tesco wants to see from the business in the future".

"Our long-term objective is to create a full-service retail bank for Tesco customers," a spokesman for the supermarket said. "But we do not underestimate the task of building a new bank. In fact it will be mid to late 2011 before we have set up the systems to allow us to trade on an independent basis."

It already has six in-store bank branches – in Glasgow, Blackpool, Long Eaton, Bristol, Coventry and Oldham – and plans to open more. It is the sixth-largest credit card provider in the country, and has more than 500,000 savings customers with balances of around £4.5bn. On top of that it has 130 Travel Money Bureaux within Tesco stores across the country. Sainsbury's plans to have 100 Travel Money Bureaux by the summer, as well as offering savings, credit cards, loans and insurance through branches.

"Sainsbury's Finance has a key role to play in growing Sainsbury's non-foods product business. A shopper spends more once they take out a finance product," said a spokesman for the supermarket. "The business will only develop new products and services that it is confident meet the needs of the Sainsbury's shopper, for example reward offers, preferential rates, tiered products to suit differing shopper needs," he said. "The business is very much aligned with Sainsbury's; we're focused on steady and sustainable growth."

The supermarket made £4m from its half share in the bank in the 2008-2009 financial year. It will publish its results for the 52 weeks to 20 March next month. The contribution from the bank is expected to be much higher after chief executive Justin King, commenting on the fourth-quarter trading figures, said that "non-food offer continues to perform well and grew at three times the rate of food".

But more eyes will be on the annual figures from Tesco, which is due to report on 20 April for the year to 27 February. Last time around it reported a £212m profit before tax from its personal finance activities, which included a £32m hit for amortisation following the acquisition of RBS's share of the business. That hit will total £130m this time around, which will depress the bank's contribution to the supermarket's profits. The underlying profit figure will prove a better indicator as to the bank's fortunes. It was £244m in 2008-2009: it should top that this time while Tesco believes its financial services could soon deliver £1bn in profits. That would certainly make it a major challenger to the high street banks.

Loyalty cards: A route into supermarket banking

Linking the different strands of grocery and finance together are the supermarket's successful loyalty programmes. In fact Sainsbury's says that the key to the success of its finance arm is the link with Nectar and the access to customer data for cross-sales and rewarding customers.

"Rewards and loyalty are central to Sainsbury's Finance's proposition," said a spokesman. "In a brand new TV advert to be aired for the first time on Monday, we'll be highlighting the fact that you can earn a week's free shopping by simply holding one product and a Nectar card and typically spending £49 or more per week for 12 months." It claims that more customers have a Nectar card than any other loyalty card, with 16.8 million cardholders.

One of the key attractions, of course, is that loyalty points can be collected elsewhere than Sainsbury's and there are more than 400 online retailers in the scheme.

Tesco Clubcard is very close behind, claiming 16 million cardholders. A £150m relaunch last year and the introduction of double points in August prompted a million new customers to sign up for the scheme.

Sainsbury's is using Nectar to drive customers to its bank. It is currently offering double Nectar reward points if customers take out a selected Sainsbury's Finance product. The supermarket acted after its research showed that additional reward incentives could be a major catalyst in getting people to consider supermarket banking.

M&S too is getting in on the act. Its rewards scheme, M&S Premium Club, launched last year, offers members triple points at stores.

Supermarkets' reward schemes could be their trump card in attracting bank customers, says David Black, banking analyst at Defaqto. "The loyalty point reward schemes can be harnessed to attract and encourage new current account customers," he said.

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