Irresponsible banking practices were the leading cause of the credit crunch in 2008. This is undisputed. Four years on, we are living in an era where customers despise banks yet cannot exist without their services.
The impending return to a soft economy will only exacerbate this crisis: profit optimization becomes ever more important to the banks, while at the same time their customers are in need of their services and advice more than ever.
There are a number of actions that banks can and need to take in order to ameliorate their reputational low while at the same time profitably growing their business.
Pricing is still an unsolved issue in the industry. Recent regulatory actions, designed to increase transparency and thus improve the industry's public image in the long run, have nevertheless triggered the exact opposite result. Brute-force price adjustments on the part of a few big banks seeking to plug the fee-revenue holes unleashed a tsunami of renewed consumer distrust. After Bank of America reneged on its planned monthly debit card fee, most other banks followed suit and quickly tossed their own fee-adjustment plans. Retail banking products are effectively stuck with compressed margins, as customer-acquisition volumes stagnate under climbing costs.
By recognizing that banks are entitled to a profit and customers should expect good value, there is a responsible way to approach pricing, which we call Fair Value Exchange, where customer needs and bank needs are in equilibrium. The result is a fair return on savings and investments, a fair interest rate on a mortgage or other loan, and fair fees for checking. Fair Value Exchange needs to be the guiding principle in product development and pricing if the industry finally wants to get out of its ongoing image crisis. It is about designing products and services the way customers want them, identifying the optimal price points to meet corporate profitability targets and customer expectations, and communicating very transparently how much is charged and why. Here is how it works in five simple steps:
1. Develop needs-oriented value propositions. In many of our interactions with banking customers, it was clear that banking for them was not about individual products, but rather solutions to everyday financial needs, e.g., making a payment, taking out a short term loan, or financing a home. The answer thus lies in developing simple, integrated solutions that help customers manage their finances and stay in control, as opposed to being forced into a back seat and told what to do by an industry that they hardly trust today.
2. Leverage modern technologies such as mobile devices. They open completely new opportunities to deliver value to your customers and improve the interaction with and among them. These new technologies can help your customers navigate through your offering, make better choices, and not fear that they are going to be cheated if they should make a wrong decision.
3. Align price levels with customers' willingness to pay. If banks are pricing products or services too high, few people will buy them and revenue and profits will be suboptimal. If they are pricing too low, customer demand will be high, but the low per-unit margin will again lead to a suboptimal performance.
The trick is to find a set of prices where banks sell just the right volume of products to the right number of customers to maximize overall revenues or profits. This is the best measure of fair price-setting and therefore the best way to bring Fair Value Exchange to market.
Keep in mind that "one size fits all" pricing is neither optimal for the banks, nor for the customers. You don't want some customers to get a free ride by using a product that was designed for another segment. So banks must establish what we call "fences" to differentiate customer segments.
The typical way of introducing fences is by easily observable socio-demographic or regional markers: You can offer a cut-rate checking account, for instance, but you might make it available only to students or seniors; deposit rates vary by region, since some local markets are more competitive than others.
More innovative approaches directly leverage differences in customer needs, attitudes and behaviors; banks design and price out different versions of products such that each of them appeals to a specific customer segment's needs. Customers then can choose freely among different product alternatives and pick the version that best fits their needs – and their willingness to pay for it (a process referred to as "customer self-selection"). From our experience, this needs-based approach generates an even better fit between customer demand and bank offering, and thus stronger financial returns, than the type of fences that are based on obvious variables and lump together customers with different needs. For example, one college student might be concerned about security, and another might be keen on earning rewards. Wouldn't it make more sense to offer an account with an identity theft prevention feature to the former, and a one with attractive rewards to the other, than to pitch a "student account" to both?
4. At the same time, simplify the product portfolio. Doing so reduces the effort for customers to find the right product for them and it makes the primary interaction simpler and more effective. You don't want to end up with seven or eight different checking accounts on offer; try to keep it closer to three.
5. Transparently communicate pricing. This may sound simple, but it removes the fear of the unknown and helps build trust. Specifically, banks should proactively communicate the way that price structures (penalties, bonuses, tiers, etc.) work, and illustrate this clearly before a customer makes a commitment. Fifty-page documents outlining the terms and conditions of a checking account are ineffective. Transparent communication of interest rates and fees needs to be much more engaging and illustrative.
Examples of successful transitions to Fair Value Exchange are plenty in other consumer-facing industries like telecom, hospitality, travel, media, and banking in other parts of the world. Banks have to get on top of this now, before continued consumer mistrust sparks a new wave of regulatory tightening and customer activism. It is time to win back customers' hearts and minds.
Jens Baumgarten is managing partner at Simon-Kucher & Partners, a consulting firm, and leads its financial services team in North America. Ben Snowman and Wei Ke are directors on his team.