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Profile of a small bank where limited growth allows the company to focus on customer service and employee morale.
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Small BusinessSecond Thoughts on Growth: For the past decade, Carl Schmitt's company has been a laboratory testing one simple idea -- that limited growth offers more opportunities than fast growth does

Eleven years ago, as investors scrambled to place their bets on a fresh-faced 25-year-old and his newly public company, Apple Computer, Carl Schmitt sat down to write a business plan of his own. Schmitt worked only a few towns away from Apple's bustling Silicon Valley headquarters, but philosophically, Schmitt and Apple founder Steve Jobs might as well have resided on different planets. "I just don't believe trees grow to heaven," declares 56-year-old Schmitt, who founded his company, University National Bank & Trust Co. (UNBT), in 1980 on the heretical notion that a company's growth has organic, almost preordained, limitations.

From the start, Schmitt heeded those limits by setting up a bank that would confine its geographical reach and top out around a 15% market share. While Apple's growth has stalled in the face of technological misfires and management shake-ups, UNBT enters the new decade much as it did its first: on steady footing, satisfied that slower growth is better growth. UNBT's return on assets is 45% higher than the average return of other U.S. banks. The bank, with assets of $287 million and 1990 net income of $3.6 million, "boasts that increasingly rare combination of a healthy 1.3% reserve ratio and virtually no nonperforming loans," according to a 1990 review of the country's banks in Barron's.

Schmitt credits keen observation rather than raw genius for his success. After 14 years with Wells Fargo, one of the largest banks in the country, he became California's superintendent of banks in 1975. Time and again he was struck by how small banks outperformed their bigger brethren. "Their profitability, measured as return on assets, was consistently better than the larger banks'," says Schmitt. "It stood out like a sore thumb." His theorem: smaller banks tend to have lower overhead and dedicate themselves exclusively to a specific market, making them more efficient. Unfortunately, too often these little jewels later stray from their focus, lured by the promise of a bigger market share and better profits.

All that gave Schmitt an idea. What if he founded a community bank but resisted growth's temptations? In 1979 he began sketching a plan for UNBT, declaring its market to be Palo Alto and four surrounding communities -- no more and no less. Undeniably, UNBT was plugging into one of the richest areas in the country, an uncommon mix of Stanford University and Silicon Valley. The wealthy client base had not gone unnoticed: all the big banks -- Wells Fargo, Bank of America, Crocker, Chase Manhattan -- had branches there.

Still, Schmitt figured he had an advantage or two. For starters, he had grown up in Palo Alto and enjoyed a high profile in the community. Then, too, Palo Alto's last small community bank had been acquired by a large bank eight years before, leaving, in Schmitt's estimation, an obvious opportunity. And finally, his years inside Wells Fargo had convinced him that the large banks were turning their backs on the age-old notion of service.

From the time UNBT opened its doors, it never lost sight of that opportunity. If nothing else, Schmitt wanted customers to know his bank was different. It was hard not to notice. The side of the bank building depicts an alien in a spaceship crashing through the wall. The strange beast also adorns the bank's credit card. The bank's courier trucks have the license plate UNBANK to spread the message of unusual, "Uncola banking," as Schmitt likes to say. Inside the building are free shoe shines. And if the bank's hours are inconvenient, simply make an appointment -- no matter what your account balance.

It was UNBT's extraordinary customer service that caught the attention of Paul Hawken and Tom Peters. But in focusing on the act of customer service, the business gurus overlooked one important point: staying small forced Schmitt to offer superior customer service -- it was the only way he could compete with big-league banks that offered multiple branches and multiple products. The linchpin of Schmitt's strategy is that limited growth offers more opportunities than full-speed growth -- opportunities for customer service, for employee satisfaction, for shareholder returns. "We could grow faster, but it would cost us everything," he insists. "In the bureaucracy of growth, you lose your distinctiveness."

What's more, Schmitt acknowledges what many managers would be embarrassed to admit. "I realize what I can and can't do," he says. "One thing I can't do is manage a much bigger company."

All this leaves Schmitt in a peculiar spot: balancing the expectations for growth -- expectations from employees, shareholders, even society -- and his own sense of limits. For the past decade UNBT has been a laboratory for this pursuit, testing out the formulas that work and those that don't.

It hasn't been an altogether easy endeavor. In a business environment built on a Bigger Is Better axiom, where investors hanker for bigger returns and competitors compete by adding more products and more locations, Schmitt is clearly bucking the trend. Perhaps more remarkable, he stuck to his strategy during a decade when big banks flooded Silicon Valley. Now, with many of those banks -- Citibank, Bank of New England -- pulling out, Schmitt has just had a record year.

So how does he do it? How does he motivate employees when he can't offer them a chance to head their own operations? How does he keep customers from walking across the street to a bigger competitor? How does he keep his shareholders happy? And on and on. Those are the questions Schmitt grapples with every day. "It's like you're rowing upstream," he says, "and you need a lot of paddles."

* * *

EMPLOYEES

If you don't grow, how are you going to attract and keep good people?
If ever there was a scene that captured the esprit de corps of Apple's early go-go years, it was the Friday afternoon beer bash -- the quintessential image of a freewheeling company having fun and making money all at the same glorious time.

Banks -- staid, conservative, bureaucratic -- can't afford such antics. Or can they? While Apple's all-company beer bashes are now a historical anecdote, UNBT has its own version that lives to this day. It has the bankerly title of Statement Day. Once a month employees from the chairman on down gather on the third floor to collate each customer's bank statement. But the mood is quite unbankerly. "We trade jokes and socialize," Schmitt says. "We eat and laugh, lick envelopes, and tell stories." It's a tradition born of customer service: UNBT promises customers their bank statements will be in the morning mail on the second business day of the month.

Statement Day is emblematic of the way Schmitt approaches what he considers the toughest part of staying small: keeping employees motivated. He does this first by being honest. "I tell new hires that there's little chance they will head a branch." Then he looks for people who know firsthand the toll of fast growth. That way, they are more apt to appreciate his strategy.

That's why his ideal employee for a limited-growth company is someone like Tormey Ward Jr.

Soft-spoken and reserved, 52-year-old Ward has a legacy in banking that stretches back to the 1930s. His father was a banking legend. Abhorring files, Tormey Ward Sr. kept the loan records of hundreds of clients stored in his head.

Both father and son earned their stripes at Wells Fargo, considered the preeminent bank in town. But as the younger Ward was midway into his second decade at Wells, the bank began shifting radically. Assets swelled from approximately $8 billion to $49 billion, as Wells gobbled up nearby banks in the battle for ever-increased growth.

"Right and left, 55-year-old guys were encouraged into retirement," Ward says. "Given a choice between two people, the bank opted for the lower-salaried younger person."

It was then that Schmitt and UNBT's president, Herb Foster, pounced. For more than six months the two courted Ward. They laid out their concept of "relationship" banking -- the Unbank's unusual customer service and commitment to staying small. Finally, Ward left Wells behind for a senior vice-president position at UNBT.

Schmitt makes a science out of such recruitment tactics. It's a policy that's paid off. In the 10-mile radius surrounding UNBT there's a large pool of bankers in their forties and fifties. Many have spent years helping their banks grow, only to fall victim to increased bureaucracy and distance from the customer. While many CEOs figure such managers are indoctrinated in big-company culture, Schmitt finds just the opposite is true. Says UNBT's chief financial officer Gayle Anderson: "We who grew up in the larger institutions appreciate how productivity slips when you work in a dreary place where long rows of desks look exactly alike. I would wager that this experience helps us better appreciate that people are most productive when they're happy and having fun."

Having fun. It's a refrain that Schmitt keeps coming back to when he explains how he confronts the challenge of keeping highly qualified people motivated when he can't offer to put their names in lights. He starts with symbols. All UNBT courier trucks, for example, depict employees doing exactly what you would expect your banker not to do. One truck shows Schmitt cheating at poker while dressed in prisoner togs behind bars. Another depicts a senior vice-president at her money-printing press while two bank officers inspect her handiwork with magnifying glasses.

Schmitt chooses symbols that almost encourage employees to break the rules. In a bank of all places.

"What will kill this company first is a bunch of people running around with their noses stuck in rule books and manuals," says Schmitt, pounding his desk righteously. More than just contributing to a starchy atmosphere, he claims, they allow people to avoid taking responsibility for their actions, sapping the challenge out of any job.

He offers the example of a typical front-line employee -- the teller -- who usually works off a mile-long list of do's and don'ts. At UNBT, tellers make their own decisions about whether or not to accept a check, based on their own subjective criteria. While teller turnover is usually about 50%, at UNBT it's zero. Add to this less time and money spent by managers supervising tellers, and you have both speedier service and money saved.

Then there's the example of senior vice-president Suzanne Powers, who saw that friction between the tellers and the customer service group -- the people who process all the tellers' transactions -- was about to boil over. "They both thought the other group didn't appreciate the challenges of their own job," she recalls. So Powers instituted a job-switching program in which tellers worked in customer service for several days and vice versa. Within weeks, Powers says, the tension was defused. What did Carl Schmitt think? He wasn't told about the program until it was well under way.

Still, Schmitt acknowledges the value of giving his 114 employees their own sandbox. His answer is what he calls a "bank within a bank" program. Each of these minibanks is headed by a senior vice-president with three to four people on a team. Every team has its own customer list, oversees its own portfolio of loans, and sends out correspondence on its own letterhead. "It provides a sense of ownership without diluting our strategy of limiting growth," Schmitt says.

But there's a peculiar catch here, too. Schmitt refuses to judge the minibanks as separate profit centers. Instead, all compensation is tied to the performance of the entire bank. His reasoning? Small profit-center islands are "antithetical to creating a sense of team," he says, adding that often what's good for one profit center isn't good for the bank as a whole.

Thinking as a team is the glue holding Schmitt's entire strategy together. Yes, more responsibility is fine and minibanks are OK too, but as Schmitt says, "Don't forget my promise to employees -- in lieu of fancy titles I'll give people an enjoyable workplace. I'd better come through on this promise or everything falls apart."

So what makes for an enjoyable workplace? Schmitt starts with the little things -- the lavish lunchrooms, the Unbank awards, the courier trucks -- and then adds the expected things: good pay, a modified employee stock ownership plan, generous benefits. But his most important contribution is more elusive: setting boundaries for growth while ensuring his employees feel boundless in making day-to-day decisions with the customer.

* * *

CUSTOMERS
If you can't offer as many products or as many locations as bigger competitors do, how do you get and keep customers?
Most companies have never met a customer they didn't like. Schmitt meets some every day. One prominent member of the community -- in fact, a very rich one -- walked into UNBT one day to buy a certificate of deposit. He was turned down.

"We don't want one-stop customers," Schmitt says, customers who are merely looking for a good yield, a secure CD, or a quick loan. Rather than offering a little to a lot of customers, UNBT offers a lot to a few. It's a formula demanding exemplary service, rigid asset management, and limited company growth. "To grow much larger would push me to expand beyond my natural market share, and that would be the beginning of the end," Schmitt says.

The first thing a new customer might notice is that UNBT doesn't look like your typical bank. There's that alien crashing through the wall, for one thing. And a stage with a vintage vaudeville curtain behind the tellers, for another. And as at most banks, there's a safe -- only at UNBT, just inside the safe door is a glass case containing a screwdriver and a candle -- a "safe escape kit" dating from the early 1900s.

A new customer is first offered a miniseminar on UNBT's old-school banking approach, which requires every UNBT customer to open a minimum-balance checking account. "If we have your checking account, then you're not as likely to go across the street for a higher CD rate," Schmitt says. New customers are also subject to a rigorous credit check in what amounts to customer "quality control."

But it's after the account has been opened that UNBT strives for its "Uncola" banking experience. There are the prompt bank statements, of course. But how many banks "import" more than 20,000 pounds of Walla Walla sweet onions from Washington State every year as a complimentary gift to customers? How many bank chairmen pen a folksy monthly newsletter with musings on the migration patterns of the gray whale, London dining tips, and, oh yes, interest-rate trends?

All that costs money, which is why UNBT insists on the quality of its customers and the bank's importance in the customer's life. Yet if you look at the items that customers appreciate the most, they're often the least expensive, like the stamps sold at cost at the teller window.

Yes, UNBT's overhead expenses as a percentage of assets are 10% higher than its peers', according to the Federal Financial Institutions Examination Council. Schmitt compensates for this partially through employee productivity. While his older, experienced bankers command higher salaries -- about 50% higher than those at other banks UNBT's size -- Schmitt gets more for his money: UNBT's average assets per employee are 21% higher as well. Further, these seasoned employees produce a fatter profit margin: UNBT's is 17% higher than the average margin of its peer banks. Lastly, Schmitt doesn't watch this profit go down the tubes in customer turnover. Tracy Herrick, a Palo Alto banking economist, conservatively puts UNBT's customer turnover at less than a third of that of its neighbors. Herrick explains, "At UNBT customers pay more for services but know they'll be taken care of; better yet, when you make a mistake, UNBT covers for you."

Strangely enough, though, loyal, happy customers create another pressure on UNBT -- to offer more products, to expand beyond its current focus. There's no question that, at least in the short term, Schmitt could make more money if he did offer products like brokerage services and limited partnerships. But that would require abandoning -- or significantly modifying -- his strategy of limited growth.

* * *

VENDORS
How do you get good service from your vendors if you're small -- and you plan to stay that way?
Unlike its competitors, UNBT is too small to capture the attention of many vendors.

Take the case of credit-card services. Eager to offer UNBT credit cards, UNBT arranged for a $20-billion correspondent bank to issue the cards and handle the back-office work. Problems began immediately. One UNBT customer was rejected because his income was more than $1 million and the correspondent's computer accommodated only a six-digit number.

For the correspondent bank, UNBT was too small an account to be noticed by anyone of much importance. So Schmitt was left to fume. "Where we think in terms of individuals, these vendors have a herd mentality," he says. It doesn't help that his bank can't offer the enticement of ever-increasing volume in the years ahead.

UNBT is now on its third correspondent bank. And while it still isn't completely happy with all its vendors, it keeps looking for ways to make its relationship with them work. UNBT has a senior manager on the user board at a computer-service supplier, for example. "This gives us some control, some understanding of the company, the players, the politics," Schmitt says.

UNBT also looks for vendors that share its philosophy. The current correspondent bank for credit cards is a small regional bank not unlike UNBT, and UNBT was able to help design the whole credit-card-processing system. "You have to be choosier about whom you do business with," Schmitt says. "Not every company understands what we're trying to do."

* * *

SHAREHOLDERS
Will anyone buy stock in a company that doesn't at least pretend the sky's the limit?
If anybody is unforgiving about the necessity of growth, it's shareholders. They are the ones, after all, who take the risk; shouldn't they be rewarded by a company that never puts the brake on growth?

Not according to UNBT's shareholders. "I think the '80s proved to us all that growth by itself is not necessarily in the interest of the owners," observes George G. Parker, professor of management for Stanford's Graduate School of Business, member of UNBT's board, and stockholder. "Senior management became more concerned with size than with profitability -- pushing right past optimal size to megasize, making the company less valuable to the owners than it had been before."

Optimal size. It's the cornerstone of UNBT's promise to its investors, and it's a promise reaping them hefty returns. Since the bank's founding, UNBT's stock price has risen fivefold, return on equity has consistently been above 14% for the past seven years, and the dividend payout has been 30% -- five percentage points higher than the average payout of other banks its size. "Remember, this stock is about consistency," says one stockholder. "Consistently good returns born of solid profitability."

But that's only the first chapter in the UNBT pledge. The second kicks in around 1995, when Schmitt thinks the bank will reach full market share of 15% and will begin pumping earnings not into growth but back to its bankrollers. Servicing his limited market ever more efficiently, Schmitt expects the bank's payout ratio to jump to 40%. Why so high? Again, it comes back to his admitted limits: "I don't pretend to know how to use their capital for expansion beyond my market."

His shareholders are believers. More than 63% of the outstanding shares have been in the hands of people who first bought stock at the bank's initial public offering, 11 years ago. And 65% of the shareholders are also bank customers.

Schmitt's IPO was typical of the way he approaches a decision. He carefully scrutinized his potential stockholders. Those looking for a quick sell he turned away. From the start he sought a large, diversified shareholder base of more than 500 (more than most banks his size go after). What better marketers for his new bank than hundreds of happy investors? he reasoned. Moreover, he needed a large enough pool so he could offer UNBT over the counter and create a secondary market. "It was a way to provide my shareholders with a means of exit in case they tired of the bank or its strategy," he says.

Investor fatigue was no small worry to Schmitt. He stipulated that no investor could purchase more than $150,000 worth of stock at the IPO, and he continues to hold the largest chunk of shares himself. "If people have too much of their net worth tied up in this investment, it's hard to be patient.

"I'm not trying to push investors away as much as herd the right ones in," Schmitt adds. Once shareholders come on board, though, he doesn't stop communicating with them, reminding them in an annual report he writes himself of the year's triumphs. His annual report has become another symbol of the bank's style: one year's report converts into a model of the bank, complete with the staff waving from atop a roof deck. "Carl is a nut," says Parker. "He's fun to work with. . . . He's colorful, buoyant, a real freethinker, which you don't see too much of in this business."

Yet, for all the good news, Schmitt walks a tightrope with his stockholders. "If there's anything that can give me a good case of insomnia, it's the fear of slipping below a 15% return on equity." Once the bank's return falls below that mark, Schmitt figures, his shareholders would willingly entertain a lucrative buyout from a bigger bank. To escape such a scenario, many banks grow their way out of trouble -- by boosting their loan base through the purchase of brokered deposits, for example. Schmitt doesn't have that choice, however, owing to his extremely conservative portfolio approach. A healthy ROE at UNBT depends largely on constant innovation to increase productivity and efficiency. "It's a real juggling act," says Schmitt. "Let's put it this way, I don't get bored."

* * *

For all the work Schmitt has put into making his strategy work, the real test is yet to come. His alternative growth model has required him to spend the first 10 years building UNBT's market share, now at 11%, while laying in place the slow-growth foundation that will ensure his success once the bank reaches its "natural" limit of 15%. After that UNBT will grow with its market. "We don't intend to be dead in the water," emphasizes Schmitt. "It's really a matter of focus; our focus isn't growth: it's efficiency and greater ROE."

You don't have to look far to find critics of the strategy. No further, in fact, than down the hall. "I don't particularly agree with Carl," says president Herb Foster. "We go back and forth about this, but I think we always need new ideas, and that might include more growth." Adds senior vice-president Tormey Ward Jr.: "The risk of limited growth is complacency, and we may need to get more aggressive, particularly in appealing to commercial customers."

And down the road a ways, Roger V. Smith, president, CEO, and founder of Silicon Valley Bancshares, voices the feeling of many CEOs. "Growth helps build the corporate culture," he insists. "It provides a mission, a sense of purpose."

Schmitt understands that and says he's preparing by actively pursuing non-capital-intensive ways to expand. Still, there's every reason to believe that as the bank's market share begins to level off in the next four years, the challenges will get trickier. Some would even argue that Schmitt already deviated from his strategy in late 1989, when he opened up his first branch.

He had long declared UNBT a one-location bank. "Branches," he liked to say, "connoted shoddy service." But his need to penetrate the Menlo Park market, one of the four communities he originally targeted, pushed him toward a decision he had hoped he'd never have to face: opening the bank's first branch there. After nine years a measly 10% of UNBT's deposits came from Menlo Park, and no one thought that figure would go much higher if the bank didn't establish a local presence. Separated from Menlo Park by a wide boulevard, UNBT in Palo Alto learned that, like it or not, Menlo Park residents kept their banking on their side of the street.

"It wasn't a step we took lightly," recalls one board member, "but there wasn't a choice." Schmitt did his best to fold the move into his strategy, calling the new operation a banking floor rather than a branch, insisting that it use the same letterhead as the main bank, and finally, refusing to let customers transfer from the main bank to Menlo Park.

Clearly, this was a moment when strategy and goal were at cross-purposes. On one side was the goal: UNBT's unparalleled customer service. On the other, the strategy: the ungrowth approach. Shouldn't the measure of a strategy be how close it gets to the goal? For Schmitt, the answer was yes, and he opted to reinterpret the strategy. "Call it a compromise," he says. "The world changes. The environment shifts. Any strategy has to bend."

Underlying that clash was a more subtle struggle between ego and conscience. After Schmitt starred on Tom Peters's nationwide television series, his phone lighted up. From Peoria to Pittsburgh, people called, desperate to bank with UNBT -- by mail if necessary. H. Ross Perot's lawyer phoned to hash out possible bank acquisitions along with the economics of small banks. And today Schmitt still receives half a dozen offers a year to expand. All that ego gratification "makes it hard not to start believing your own press clips," he says. "You think, Geez, if I'm really so good, why not make this bigger -- try a move to San Francisco or Los Angeles?"

So far Schmitt swings away from these personal temptations, cleaving instead to what he knows is right for the bank. But what keeps his ego in line is the tension this notoriety creates. "All this limelight on me ruffles feathers around here." Managers secretly wonder why they're working for "Carl's bank" when they thought they were toiling for "our bank." That thinking threatens a critical link in Schmitt's strategy: employee motivation. "I have to pay people well both monetarily and psychically."

Experts often dismiss such ungrowth alternatives on the theory that if you're not growing, you're dying. Schmitt wonders if such thinking isn't a tad extreme. Put him in any other service business and, he says, he'd apply the same approach. "It's like you're sailing down a river with many tributaries running off. Yes, you pause to consider each tributary and whether it is part of your voyage, but keeping you on course is the knowledge of where you want to be at the end of the trip."

Less a story about an unusual bank, Schmitt's tale revolves around a critical business lesson -- all but forgotten in the '80s. What this founder is talking about is the ability to discern between good business and bad business. During a period of robust economic growth, bad business can appear profitable, while over time it exacts a hefty price in people, capital, and business focus. In the past that price was obscured by fast growth. But no more. The '90s augur a new discipline. Faced with a declining work force and tighter credit, business owners will have to define anew what constitutes good business and bad business. Tributaries once seen as profitable will become marginal. And even if profitable, they may undermine the core business. In such a climate, the business byword will be less and less "growth at any price," and more and more "growth at what price."

Last updated: Mar 1, 1991




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