DN: Thanks for agreeing to the interview Neil. I know our readers will be very interested to hear your view on how banks can deliver more value to their customers through customer centric initiatives while increasing profitability. Let's start with relationship pricing.  

NS: Relationship pricing is not a new concept in general – to a varying degree we see this tactic deployed in industries such as the telecom and hospitality sectors. Is it new to banking? Or what is different these days?

To bankers relationship pricing may mean:

·       Volume-tiered pricing

·       Global analysis of a customer

·       Consideration of households or related customers

·       Price differentiation

We should keep in mind that some aspects of bank pricing are thoroughly public.  Others are generally non-disclosed outside the parties involved.  There are degrees of publicity and ramifications/consequences to potential disclosure. The more extreme the pricing differentiation, the more potential for disclosure and consequences.

The business of banking is to provide trusted commitments of liquidity.  Banks are financial intermediaries who borrow from and lend to the consumers, businesses, and governments in the community.  Banks source their raw material and sell their finished goods in the same market.  In the past the risks and logistics of managing money presented enough challenges for consumers, businesses, and government entities in the community that they would generally allow bankers to create and sustain an adequate financial return for the “lubrication” bankers provided to the flow of money in the community.

Today, our technology and society give us access to an enormous number of viable choices in regards to accessing money.  The intensity of this competition diminishes profit potential as bank customers consider the value proposition of alternatives and substitutes.  To be sure, this phenomenon is not unique to banking.  However, banks deal with what many would define as the ultimate commodity - money.  To the extent bankers allow their service to be commoditized they are in a race to the lowest cost provider status.  If they are not in position as the lowest cost provider, they must be able to extract price based on de-commoditizing or differentiating their value.   An effective business case for a bank’s claim of a differentiated value proposition in the marketplace can only be rewarded if associated with a differentiated pricing strategy. 

Relationship pricing is an approach to differentiated pricing that appeals to most community bankers intuitively. The vision and mission of community banks focuses on building relationships; it seems a natural progression to quantifying the value of these efforts through price.

DN: What are some product areas or lines of business where banks can easily adopt relationship pricing?

NS: As consumers we tend to think about pricing at the product or transaction level.  We expect to discover and compare a discrete cost for a service or product.  The product or transaction level is the simplest level to think about pricing.  A more robust or holistic approach would consider the broader context of the business case.  This occurs anytime that the cost structure is more complicated as it expands beyond purely variable cost businesses.  Any product line where the product or serviced is supported by fixed costs and capital investment creates pressure on pricing strategy.  If the only cost is variable, it is simple to conclude that selling below cost is unsustainable.  However, if the variable cost is only a small portion of the total cost of doing business, then you will find that a viable case can sometimes be made for pricing that covers only variable costs.

DN: You wrote an article called ‘The Relationship Pricing Trap’. We’ll share a link to it, but I’m wondering if you can share a high-level synopsis or theme for our readers.

NS: Well-intentioned bankers in pursuit of enhanced performance in their bank may realize detrimental impacts from pricing adjustments that embed naïve assumptions about the likely responses of their customers.  Customers today have an enormous number of viable choices.  Bankers who cannot compete as the lowest-cost provider of a commodity must be able to demonstrate a differentiated value proposition and have an effective rationale for their differentiated price.  Respecting the unique value of each relationship can be a good foundation for price differentiation, but it must be done properly.

DN: So partially you are arguing that relationship pricing as a theory is sound but in practice it is difficult to use profitably? Relationship managers sometimes adopt a compromise/compensate strategy? Can you elaborate on that?

NS: Our intuition as bankers needs to be supported by a thorough understanding of all the required variables to this situation.  Sometimes the expansion of a process to include a new set of variables is less stable than the original version because of bias that is introduced in the changes.  It aligns with the old saying that sometimes it is better to be generally right than precisely wrong.  If the underling purpose of enhancing our pricing strategy is to enhance profitability of the bank, we should assess our pricing process in light of the realizable profitability the system is intended to create.  I expect few bankers will be amused when they discover that their new, fundamentally flawed pricing initiative was effective in diminishing profitability rather than enhancing it.

Simplistic inclusion of one additional variable in pricing (the current estimated fully-loaded economic profitability of the relationship) should not be expected to give a banker enhanced pricing of the next opportunity.  What action should a high performance banker take when they know that the customer to-date has generated a +/- $xx,xxx economic profit considering the allocation of all fixed costs and capital charges?  By itself that information can often diminish the banker’s effectiveness in pricing.

DN: How can banks avoid ‘The Relationship Pricing Trap?’

NS: Bankers need to develop a robust understanding of the drivers of profit and measure the profit impacts expected from all activities.  A clear estimate of the gross profit, net profit, and economic profit for each product and service should guide pricing aggressiveness as we estimate the unique responses of each of our customers in regards to volume and breadth of relationship.

DN: What are some other areas that you think we will see a lot of innovation around in banking? Are they region specific (i.e. North America) or more global in nature?

NS: As bankers provide trusted commitments to liquidity (access to money) we help people.  We help people who need money they don’t yet have.   We help people who have money they don’t yet need.  We help people who want payments made simply as they expect.  We help people by providing accounting and documentation for all of these services.  Banking is evolving rapidly via technology and societal changes that transcend geography.  We have observed bankers adopt technology applications to the back-room execution of banking – payments, credit analysis, electronic access to money and delivery channels. 

Meanwhile, bankers have often retained the notion that banking is a personal business built on relationships.  The emphasis on establishing and sustaining trust and confidence through interaction with people is being challenged in this era.  So, I see the next generation of innovation coming to the front-line of banking, where technology empowers the front-line banker to be viewed as a financial professional who delivers real consultative financial solutions.  This model serves the customer with a de-commoditized offering that is worthy of a differentiated priced due to the perceived value created for the bank customer.

DN: Thanks for your time Neil - that was very useful.

Neil Stanley is the president of Bank Performance Strategies and is based in Omaha, Nebraska. He is an expert in relationship pricing in banking and has created the Stanley Retail Deposit System including Limited Edition Savings, CDtwo (Registered Trademark and Patent Pending) and CD Revolution (Registered Trademark and Patented). He also teaches and coaches bank executives on competitive strategy and the integration and economic principles of marginal pricing into optimal loan and deposit pricing. He can be reached at neil@bank-ps.com.