More than ever before, banks are interested in figuring out how "elastic" their customers are. It's a question that, if answered correctly, can be a boon to the bottom line.
In the expanding game of price optimization, "elasticity" refers to how price-sensitive consumers are when choosing to do business with a bank. To accomplish this, many financial institutions are kicking the tires on new offerings from firms like SAP, Earnix and Nomis.
After being off the radar as recently as 2005, banks are starting to wake up to the idea of advanced pricing strategies. So interested is the banking industry that a recent conference in Chicago focusing on profit-based pricing drew nearly 100 executives from the likes of Bank of America, CitiGroup, Barclay's, Washington Mutual, Wachovia, JPMorgan Chase, Wells Fargo, HSBC and RBC.
As banks find margins becoming tighter as many services become more commoditized, getting to know where a customer's "breaking point" is in terms of pricing can be the difference between maximum profitability, or losing that customer to a competitor. "One of the challenges is there's not an understanding of elasticity of pricing," says Kathleen Khirallah, research director for retail Banking at TowerGroup, which has published a report on profit-based pricing penned by senior analyst Bobbie Britting.
The new generation of pricing technology aims to break down the wide net that banks cast to price lending and deposit product offerings. The goal is to use the software to figure out which groups of customers are willing to pay a bit more for certain advantages, and which groups shop for banking relationships based entirely on factors such as rates and fees. Other factors, such as credit risk, are also thrown in for good measure. "Some consumers are sensitive about pricing for deposit or lending products and aren't interested in convenience," she says. "Others are very convenience-oriented and they don't mind giving up a few basis points for the convenience."
Khirallah says banks have traditionally assumed that all customers are price sensitive. "So they gave the best possible pricing deals to every consumer. That's not the best way to go about it."
Financial institutions are growing to understand that their customers don't all reside in the same tent when it comes to pricing. Now the trick is to divide those customers into their proper tents. "Institutions are groping their way to a better understanding of pricing. There's more progress being made on the lending side, but there's a long way to go on the deposit side. As solutions some in, there's more opportunity for banks to stop leaving money on the table," Khirallah says.
Cindy von Hollen, industry principal for the financial services industry for SAP, says the strategic change for institutions is to make pricing driven by consumer demand. "You want to know the price at which a customer is willing to buy," she says.
SAP ramped up its price optimization efforts via its acquisition of Khimetrics in the first quarter of this year. The firm wouldn't name any users, but said a few clients were looking at SAP's application product.
Its product collects data through a variety of sources. It then utilizes modeling techniques to determine a customer's elasticity. An optimization engine determines the best price for each product and service. A Web-based user interface works to manage rules and does additional analysis. "For example, customers with higher FICO scores tend to be sensitive to the price you are offering because they have more choices," von Hollen says. "Customers with lower FICO scores don't have choice, so they are less sensitive."
TowerGroup says the price optimization vendor field for institutions also includes Earnix, which uses data-driven customer segmentation and demand prediction tools to enable its price optimization suite. Its customers include Zurich Financial Services and Budget Financial Services.
Another firm, Nomis, has a roster of clients that includes BB&T, Barclay's and Halifax Bank of Scotland. It's suite tracks the performance of pricing to get a sense of the impact of different pricing strategy on business results.
