A necessary starting point for getting beyond the pricing mistakes of the past is to unbundle the full range of products and services offered by each business into their component parts.
Automated teller machine services, for example, might be broken down into withdrawals, deposits, balance and account inquiries, fund transfers/payments, and "off-us" transactions that generate surcharges.
Then, the revenues associated with each business area's product or subproduct components can be determined, establishing a starting point for evaluating repricing potential.
Bankers often do not price products at the subproduct level. Even when they do, there is usually little data available for quantifying the associated total revenues of each.
Therefore, total revenues for a product are disaggregated to each subproduct based on transaction volumes, allowing the bank to observe the overall demand for products and services at the component level and to examine the "reasonableness" of current pricing.
The bank's direct cost of offering subproducts establishes the absolute minimum price it can charge without losing money. Since many banks have no true understanding of their costs, however, scores of products and services are offered at low prices, below what is needed to cover variable costs, let alone contribute to fixed costs.
The following analyses are designed to enable the bank to approach repricing armed with the cost information necessary for evaluating options:
* Product work flow. To identify all of the costs associated with the delivery of specific products and services, a work-flow chart that details the major tasks involved with each process is prepared.
Just as unbundling allows banks to view products and services in terms of their component parts, the work-flow chart illustrates the various activities associated with providing each subproduct.
* Unit cost and the cost/price comparison. This involves deriving the total cost associated with the subproduct's activities, then comparing the unit cost of the product as a whole to the price per unit currently charged.
Using ATM services as an example, one bank found that the total controllable annual cost of the processing component was $2.9 million. With five million transactions per year, this translated into a processing cost per unit of 57 cents.
When the costs of other components were added to processing, the cost per transaction equaled $1.40. A comparison of this unit cost with the current price per unit of 25 cents on a bundled basis helped set future ATM fees at the subproduct level.
* Customer relationship analysis. This requires the identification of those customers who contribute the most of cost and profit, first by estimating the revenues associated with specific customer segments and then by comparing those revenues with the associated transaction volumes and costs they generate by subproduct.
The goal is to detect any imbalance between the level of tailored services provided to specific customer groups and the revenues obtained from them.
Analyzing the economies of its corporate trust employee benefit plan customers, one bank discovered that less than 8% of customers, representing over 77% of total assets for the product, produced 43% of total revenues and just 8% of the costs.
At the same time, 71% of customers, holding 7% of total assets, produced only 27% of total revenues and 80% of costs.
Perceived Value
Understanding the "perceived customer value" of product components is the crucial link between cost, current revenues, and repricing potential.
To achieve a broader understanding of perceived value, it is necessary to measure how much importance customers attach to each of a product's main attributes, compare the bank's ability to meet the needs of its customers with that of its main competitors, and examine the relationship between price and value for each product.
This analysis provides a foundation for assessing the "price band positioning" of the bank's products and services (that is, the bank's prices relative to competitors for the respective value they provide), and allows the identification of situations where the value of specific products exceeds the price charge.
The following steps are taken to achieve this objective:
* Identifying and ranking product attributes. From a customer's perspective, attributes are defined as the specific needs fulfilled by each product. Once the attributes of a product or service have been identified, the next step is to rank each attribute in terms of its relative importance to the bank's customers.
To provide a basis for comparison, the same ranking is carried out for each of the bank's main competitors using available market and product information.
* Determining surplus value potential. The bank is now prepared to compare its ability to meet customer needs with its competitors' ability to do so, and thereby to examine the relationship between the value that customers attach to products and the prices that are currently charged.
Thus, the potential for repricing specific products, services, and transactions can be identified.
For example, one bank discovered that it was offering an estate planning product at a substantially lower price than its key competitors. Raising prices to realign charges for its product's relative value increased revenues by more than $700,000.
The last step in preparing for the evaluation of repricing options is to review the bank's relative market share over time, versus historical price changes and competitor responses.
Bankers are often concerned that a variety of price increases will have a severe impact on their current account balance and transaction levels.
To allay this fear and help establish the available latitude for price increases, customer price sensitivity is analyzed. Data are gathered showing the precise amount of each price change by product in the past, competitor responses, and the resulting impact on the number of accounts and net revenues.
Historical Pattern Emerges
This establishes any historical patterns of runoff and, in most cases, illustrates the rarity with which historical price changes have affected revenues--typically less than 1% for price increases of even 20%.
Thus, revenue contribution analysis at the subproduct level creates the context for examining the reasonableness of current pricing; a careful review of products and services based on perceived customer value and surplus value potential sets the stage for generating repricing opportunities; and market analysis provides the competitive parameters within which repricing can occur.
The preparatory steps described above involve painstaking, detailed analyses of the bank's current patterns of pricing.
Laying a Foundation
Understanding current pricing, however, simply forms the backdrop for the generation of repricing options that specifically link price to value and focus explicitly on customer price elasticity at the transactional level.
Such analyses need discipline and structure if they are to be carried out effectively, but they are an indispensable foundation for the comprehensive and creative approach to bank transaction pricing that will be discussed in the final article of this series.
