Setting Prices: Different Paths Seen as Leading to Same Goal

Determining the contribution of small business banking to overall bank profitability continues to be a pressing problem.

"Without a customer profitability model, there's no way to know if the business customer relationship is profitable," Sergio S. Ora Jr., a senior vice president at Mellon Bank, said at a recent gathering of the Consumer Bankers Association. "The model is not difficult, but you must know all the pieces."

Mr. Ora challenged bankers to become more familiar with the costs and the value of servicing the small business market. The biggest problem, he said, is totaling the right statistics.

"It is only by determining the aggregate business that you can do an analysis to show small business' contribution to the bank," he said.

At Mellon Bank (Delaware), net deposit revenues contribute 70% to 80% of the small business division's total operating revenue and nearly 20% of its operating funds, he said. Service revenues account for another 20% of total earnings.

"You cannot be in this business without credit products," Mr. Ora said. "If the bank that services the account won't help them with loan needs, the business won't bank with them."

He also recommended new attention to pricing methodology.

"Establish a strong correlation between your institution's marketing strategy and the profit contribution of the market segment and profit lines," he said. "Too many of us are driven by pricing against the competition rather than money-market sensitivity to pricing strategies."

Cash-Flow Analysis

Some analysts believe banks can best monitor this in small business lines by using cash-flow analysis rather than traditional net income or internal rate of return criteria.

Using traditional net income as a standard sends the wrong message, said Dennis Uyemura, chief financial officer of First Interstate of Washington, Seattle. "The management that sends the signal to accept any transaction that has any profitability ignores the risk impact of those deals."

A focus on internal rates of return, meanwhile, may send a signal to shrink bank assets, resulting in the purging of good customer relationships.

Peter B. Deakins, an actuary at Milliman & Robertson Inc., Radnor, Pa., said that bankers may resist net present value analysis because they commonly show a negative cash flow in the first year. What bankers forget, he said, is that positive cash flow follows in future years. Net present value analysis evaluates products and customer relationships based on expected cash flow.

Ms. Franzoni, a freelance banking reporter, is based in Springfield, Mo.

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