By Neil StanleyDespite dramatic declines in net interest margin—76 basis points from early 2010 to late 2015—not all banks are not accepting lower profitability as inevitable. They demonstrate that the pricing processes can be greatly enhanced to make them the exceptions to this industry trend.
Pricing is not most bankers’ favorite topic. Developing a robust, clearly defined pricing culture is not likely to be found on the primary agenda of an average bank executive. But it’s a critically important differentiator, and mastering price offers stands to set banks that do it apart. For example, according to a recent SageWorks survey, only 35 percent of bankers believe they are pricing loans correctly. By contrast, 37 percent aren’t sure, 23 percent think they are underpricing loans and 6 percent say they are overpricing their loans. Pricing provides an opportunity to be different than average in a very important and powerful way.
In the pricing pressure cooker
Customers always expect the professional to initiate price offers. For customer-facing bankers, initiating the price discussion feels uncomfortable, and handling pushback from customers can be frustrating. Pushback arises frequently because virtually everyone—regardless of their competencies—possesses reference prices. Banking is not alone in this regard. Most people can tell you fairly accurately the cost of things ranging from a home to a gallon of milk or gasoline. Competitors don’t advertise their average prices. They advertise their best promotional rates and these are the prices that become valid reference points in the mind of your customers.
The pricing spectrum for viable buyers and sellers has some explicitly stated, as well as unspoken, points. These price points include aspiration (the price they hope for), expectations (the price they believe is reasonable) and abandonment (the price they are unwilling or unable to go to or beyond). Of course, the order of these price points on the scale is flipped when you compare the buyers and the sellers. The buyers want to buy low and the sellers want to sell high.
In a mature industry like banking, it can be challenging to differentiate the offerings of one financial institution from another. Buyers inevitably focus on the competitive offerings they can find in the marketplace to discover the most favorable prices. Buyers use the Internet to shop globally and then seek to buy locally with their fresh online pricing research clearly in hand. Who doesn’t like to buy with the conveniences and service expected from retail at wholesale prices? This clearly produces pricing pressure in financial services.
In a successful business, the largest line item on the income statement is revenue. This means that a percentage change in the pricing of revenue has a bigger impact on the bottom-line profit than the same percentage change in fixed or variable costs. Pricing is a critical driver of profitability and profitability is a critical driver of capital formation.
These pressures add motivations for today’s high-performance bankers to establish substance and robustness to their pricing processes. Properly addressing pricing pressure is a multi-dimensional issue. Bank leaders need to:
- Consider perspectives of customers and competitors
- Hire and prepare representatives capable of actively engaging pricing
- Collect detailed information about marketplace pricing variations
- Embrace and design variations within products and services
- Offer variations in price to align with offering variations
- Empower representatives to respond on a timely basis
- Create accountability for results
- Report impacts of new and renewed business results
- Commit to continual enhancement through learning
Offering variations in price
At the center of these initiatives is the ability to offer variations in price. Recognizing the pricing spectrum of aspiration, expectation and abandonment, price negotiation seems appropriate. However, without a good product design—which creates variations and viable systems for calculating the appropriate pricing so that the sales representative clearly knows the impact of variations of pricing on the portfolio performance—the discussion can result in unnecessary price concession. Without adjusting what’s being offered, a price concession leads the buyer to wonder, “Is there more?”
Sales representatives equipped with a well-designed pricing system can quickly, easily and accurately calibrate pricing to consistently achieve profitability goals as offerings are negotiated. Structural negotiation allows representatives to provide greater customization to the needs of the buyer while maintaining the potential for optimum profitability. Structuring products to have numerous variations to fit the needs of the buyer enhances the application to the buyer’s purposes and preferences and provides greater opportunity to de-commoditize offerings.
Commercial lending is an ideal situation for structural negotiation because of the numerous natural considerations producing opportunities for variations, including fixed, variable or adjustable interest rates; rate caps and floors; term; amortization; collateral; and guarantees. Structural negotiation showcases the professionalism of the organization, as offering variations are welcomed and comfortably addressed. It becomes obvious to buyers that deviations are not nuisances to the financial institution that has designed pricing systems to expect and handle customization.
When the relevant variables are few—as with time deposits—structural negotiation opportunities are limited. For these situations, offer differentiation gives the sales representative a sequence of offers that are designed to best achieve profitability results. Offer differentiation recognizes that buyers differ in their valuations of non-price attributes. Not all buyers will move through a negotiation or deliberate on options at the same pace and intensity.
Thus, a robust pricing and sales process takes into consideration these differentials and sequentially makes offers that begin close to profitability aspirations, and, when needed, move closer to expectations and finally to abandonment. Each offer needs to be supported by a differential in the product offering so that the justification of each offer is not seen as merely a concession in price. For example, time deposits can be offered in a sequence of standard offers, promotional specials, customized maturities and special purpose savings. At each stage an offer is made and an acceptance provides mutually beneficial outcomes. While it is hard to predict the stage at which any individual sale will occur, the aggregate sales results will be simultaneously larger and more profitable. This can be done with any well-designed bank offering.
With a thorough understanding of the pressures on pricing in banking, high-performance leaders actively engage this function of their business. They establish a set of processes that support pricing competencies and culture. The resulting systems enable sales representatives to know how variations in offerings should be priced and to assemble offerings and appropriately customize pricing to enhance buyer confidence.
Neil Stanley is founder and CEO of the CorePoint, an Omaha, Neb.-based firm offering a web-based retail deposit pricing and sales platform and performance analytics, and president of community banking at TS Banking Group, headquartered in Treynor, Iowa.