The past decade has been a trying time for banks. In a flat interest rate environment, thin margins on loans and overall difficult economic conditions have made it difficult to drive revenue growth based on loan portfolios. As Financial Institutions have focused on other ways to grow, the average share of net revenue non-interest income has expanded to over 40 percent. Yet, a survey done by American Banker magazine reported that 15% of bank corporate clients studied were actually unprofitable. So clearly something is amiss here. Banks need profitable corporate relationships to keep growing the bottom line, but too many of those relationships are actually a drag on profits. This is a serious conundrum that banks need to address – how to keep growing profits by getting the right deals?
Before we go any further, let’s focus on the biggest factor that can increase profit for banks – pricing for services. Pricing changes fall straight to the bottom line, as shown by PwC research indicating that a mere 1% change in selling price equates to an 8% change in profit level. That impact is higher than any other profit driver, including fixed costs, variable costs, and volume changes. Banks can make more money, more easily through small, incremental pricing changes than through any other method.
The theory is easy, just raise prices as much as possible, even if that is only a small amount, and watch profits ratchet up. But practicalities complicate that nice, simple plan. Among other things, history gets in the way. Many banks have fairly generic standard pricing schemes for services that were often put together based on some notion of customer demographics and location. Since these standard pricing schedules were too generic to be useful, sales reps did what they had to do to get deals. And that meant “exception” pricing became the norm as opposed to an “exception,” while “standard” pricing became a rare event indeed.
Over time, many banks have built up huge volumes of exception pricing that are often seriously outdated. It is not uncommon for customers to keep their exception pricing arrangements for 10 years or more with little or no serious review. While inflation has occurred and markets have moved on, these customers have pricing that remains frozen in time at levels that have often become grossly unprofitable.
While most banks look to adjust pricing at least annually, these efforts are usually directed at standard pricing plans, with little or no attention focused on the exceptions. This effort often does little to move the profit needle, as so many existing customers are not using standard pricing for huge chunks of their services. Even worse, new deals are flowing in all the time with exception requests attached. So not only are banks in a hole, but they keep digging it deeper.
This may seem counter-intuitive, but to help the exception pricing situation, I often recommend that banks first tackle standard pricing. While looking at the competition may be valuable, the truth is that a bank with a lot of exception pricing already has a body of data indicating which pricing levels for which services sell to which customers and at which volumes. By exploring recent exception pricing, a bank can get an idea as to what customers are generally willing to pay for services and how their volumes perform over time for the services purchased. That information can be combined across the enterprise to form a picture of what customers in different markets and with different product interests are willing to pay for a bank’s services.
That information leads to greater refinement of standard pricing plans that align better to customer demographics and behavior. Once better standard pricing plans are in place, then it becomes time to start moving customers off exceptions, particularly if they are using very dated pricing, towards standard plans that are geared towards their products of interest, anticipated service volumes, and markets.
As older exceptions are brought to current market pricing, profits will rise. Current exceptions are reduced as targeted pricing plans reduce the need to custom-fit every deal. This enables banks to more effectively manage pricing changes in response to market conditions and available profit opportunities. Some customers benefiting from out-of-date pricing may be upset, and they may leave. But the truth is, that this may actually increase profitability as they may have been unprofitable to begin with.
Long ago, at the beginning of my career, a senior vice president at a bank once said to me, “Every deal is an exception.” I suppose that may have been okay back then, at a time when the economy was roaring and loan margins were fat. That era is definitely over. Right now, we need to design pricing packages that sales people can sell and that corporate customers will buy. And we need to be in a position to adjust that pricing over time as needed to maintain a healthy profit margin. Corporate customers should feel exceptional based on their excellent relationships with their banks, not on the basis of their pricing contracts.