"Profit" is not a four-letter word, and tracking product profitability isn't just for banks-it's something every credit union should be doing and for good reason, one financial consultant is stressing.
The increasing availability of data, combined with technology improvements, puts calculating product profitability within the reach of most credit unions, said Ken Allen, manager of Kansas City, Mo.-based consultancy Tshibanda & Associates during an education session at the Credit Union Association of Colorado's annual meeting here. Yet only a small percentage of credit unions currently examine product profitability.
"There are many ad hoc analyses of the cost characteristics of goods and services, but not many systematic ones," he said. "Historically, most credit unions look at organizational profitability, but product profitability is an underused financial management tool. Value-added products generate revenue, and management must know which members are buying them."
To determine the "right" price for any given product, management must have access to account level information, accurate average balances, historical interest rates, product characteristics and the risk profile of each product, Allen said. When calculating credit risk, Allen noted CUs can use either actual net charge-offs or make an allocation for losses. "The key is to be consistent," he advised.
Allocation of costs can be tricky, he observed, because operating expenses are difficult to correlate with individual products, since, for example, "credit union do not have a person who does JUST checking accounts," Allen observed. But CUs must allocate expenses and overhead when pricing product or "run the risk of coming up short."
With numerous technology options on the market, credit unions today can build a "pretty robust" accounting system, Allen said. The key is combining the data from the general ledger, transaction systems, asset liability management systems and vendors.
To get started, Allen suggested building a pilot pricing system for one or two products. He recommended asking the "hard questions" up front, and not avoiding accounting for costs.
"The benefits far outweigh the costs, I think," he said. "Product pricing gives an advantage to a credit union its competitors don't have."
Once a CU has a product pricing system in place, reporting becomes increasingly important. Allen said it is not necessary to have a report on every product every month, because most products at credit unions do not change monthly. He advises preparing reports on a quarterly basis, and spreading them over each month of the quarter.
Also, while accuracy is important, Allen said credit unions do not have to worry about being precise. "Hit the target, but it is not necessary to hit the bulls eye. We don't really need to know a product has a return of 15.1% as opposed to 16.2%"
"I don't know how a credit union prices a product without a product profitability report," he declared. "It is a big project, but definitely worth a credit union's while. If a credit union can meet its expenses, yet still price a product below a competitor, that is a huge advantage."
