The Lexford Notebook. Product Governance. Identifying the customer target market.
A fundamental part of product governance is to ensure that a product is designed to meet the needs of an identified target customer market.
This sounds obvious. But product design and development can often be in response to the competitive market, as increments to existing products, limited by system technology or with regard to inflexible distribution channels.
If these factors become the primary influencers of product design and development, with customer needs being post-rationalised to explain the inclusion of product features, then the process should be reviewed. Product governance is the mechanism to monitor this and ensure that customer needs are brought to the forefront of product activity.
In practice this could mean:
A customer target market is identified and their needs are understood, to then inform product design and development. Product features are clearly mapped to the needs they are addressing.
More broadly than product, the wider proposition can be designed considering customer needs, to include areas such as customer experience strategy and any relevant value add services.
An assessment can be made of appropriate distribution channels to reach that customer target market, with monitoring mechanisms in place to ensure this happens.
An ongoing assessment is maintained that the product continues to meet the needs of its target customers and any subsequent product changes are designed around those needs.
Defining the target market is clearly then an important step in the product lifecycle. The concept of proportionality is important here. This informs a scale for the required specificity of definition of the target market, based on factors such as the risk to customer detriment and product complexity. From simpler mass retail products at one end to specialist investment products at the other.
The European Securities and Market Authority (“ESMA”) have outlined five categories for MiFID II firms which provide useful guidance, although are broad enough (particularly the category “Clients Objectives and Needs”) to require further consideration of how they might be applied in practice and whether they are sufficient for the product under consideration.
To provide further definition within these ESMA categories and for insurance firms for whom the ESMA categories might not be relevant, other approaches to defining target markets might be considered. Whether internally developed segmentation modelling or using third party methodologies, there are a range of options. For example, Experian FSS segments provide good insight into customer needs across a detailed segmentation model and could be of value in defining a target market to address.
The approach you take to defining your target market should be rationalised and set out in a document that explains why you have applied certain criteria and not others. This supporting document comes back to one of the key principles of product governance, namely to set out your methodology and the rationale for your decision making. This will be of value if you are challenged on your approach either internally or by the regulator.
Importantly when defining your target market is assessing how you are then going to monitor whether sales are being made to this market. If relevant, also to monitor sales being made to your determined negative target market. This monitoring can be a particular challenge when using third party distributors and access to customer information is more limited.
There are a few potential approaches here, summarised in the table below:
1. Utilise the data and information you receive via your systems as part of the sales process.
Will provide a timely, automated and accurate view of target market sales.
Dependent on the data that you collect and whether it provides sufficient information on your target market.
2. Surveying a sample of distributors to assess whether they are clear on your target market and can evidence they are distributing to it.
Useful to get direct feedback from distributors and might be the only source of information.
Surveying can take time for the manufacturer and the distributor. Potentially only a relatively small sample can be used.
3. Distributors have some obligations to provide information back to product manufacturers to support their product governance and if a negative target market has been defined, whether any sales have been made to that market.
Useful to get direct feedback from distributors and will be a valuable source of information.
Depends on the proactivity of the distributor who may work with several product manufacturers so creating an onerous process for them.
4. A product manufacturer could consider surveying a sample of their own customers to assess.
Direct customer insight could be a useful source of information and an engagement opportunity.
Response rates can often be low. May confuse customers why they are being asked questions. Ideally agree approach with distributors in advance.
Importantly the product manufacturer must be able to demonstrate it is monitoring sales to the target market to an extent in proportion to the specificity of the target market defined (so the more specific the target market, the onus to monitor distribution is higher).
Defining a target customer market, understanding those customer needs, designing a product around those needs and ensuring the product is then distributed to those customers, is likely to be a standard approach for many financial product manufacturers already. The regulatory rules bring a greater need for firms to evidence this process and set out the methodology and rationale for their approach. This process formalisation should ultimately only enhance its quality and so be considered a value adding exercise.
Approach for financial product manufacturers:
Identify your product customer target market and understand the target market customer needs to inform your product design and development.
Ensure your distribution strategy is appropriate to deliver to the selected target market.
If using third party distributors make sure they understand the target market and if relevant, the negative target market.
Determine how you will measure whether the product is being distributed to that market and when relevant the negative target market.
Work with your distributors to agree how you will gather information on a regular basis to inform target market / negative target market sales if required.
Write out your methodology for this, setting out the rationale for your approach and why that is proportional for that product.
Lexford provides specialist advisory and solutions to financial services firms, with a particular focus on the insurance sector. Our Product Governance solutions include:
Our free product governance self-assessment framework for financial product manufacturers.
A full suite of product lifecycle governance frameworks (new product approval, product risk assessment, product governance review, product closure and value for money),
Consultancy support to enhance your product governance approach.
We are also developing a digital product governance platform, Product GovX, to empower the governance process.
Contact firstname.lastname@example.org for further information.