Leveraging pricing excellence in the new era

Regulatory changes and a shifting competitive landscape make it increasingly important to adopt a customer-centric pricing strategy. Frank Rohde explains how Nomis’ pricing solutions anchor profits in dynamic markets.

“The Nomis Price Sensitivity Index is at its lowest level since 2005. Banks need the tools to anticipate and respond to rising consumer price sensitivity.”
-Frank Rohde

How will changing regulatory frameworks impact pricing and profitability?

Frank Rohde: With recent changes in the regulatory environment, there is increasing pressure on financial institutions to leverage pricing optimization solutions to shore up profits. Banks are finding that traditional sources of profit with no clear value to the consumer are being scrutinized by regulators. In certain cases, these avenues of profit are being tightly controlled through new regulation. Recent examples include the CARD Act and Reg E in the US, and Credit Insurance in the UK. These regulations will make it more difficult for banks to generate profits. In the case of the CARD Act, banks have limited flexibility in changing the APR of an account after origination. Reg E regulation in the US mandates that banks notify consumers about the Not Sufficient Funds overdraft fees they charge, so that consumers can opt-out of this lucrative source of profit. This will eliminate several billion dollars of NSF fee revenue for the banks and force them to rethink how to price checking accounts.

Similarly, in the UK, the recent move to ban banks from selling credit insurance at the time of credit sale will curb a highly profitable revenue source for financial institutions. It is imperative that banks respond to these growing regulatory pressures by protecting and growing profits through smarter pricing decisions in a customer-friendly and fair way. Understanding what customers value (price, brand, features, access, advice) and how much they are willing to pay for each of these components is the first step.

How will pricing strategies and tactics have to adjust as interest rates rise in key economies over the next 18-24 months?

FR: Canada just raised its base rate, and US and UK interest rates are expected to climb in the near future. With interest spreads getting squeezed, banks will need to change lending rates more frequently to maintain margins. As rates rise, banks will also need to contend with changing consumer preferences, particularly as households are still deleveraging. Pricing strategies will need to take into account the underlying price sensitivity of the consumer and cater to price-shoppers differently than to consumers who are shopping for service, product features, and access. On the deposit side, rising interest rates potentially pose a threat to balance and customer retention. Banks again need to develop a better understanding of the inherent price sensitivity of the customers they are attracting and attempting to retain. In order to do so, they need to understand the value customers place on price relative to other features such as brand, service, or product features. The ability to tailor prices to micro segments based on a variety of non-traditional factors such as consumer demographics, price sensitivity and the value they place on price vs. other features will be essential to help banks succeed in an environment of changing rates and permanently changed consumer preferences.

Will pricing dynamics change as competitors re-enter the lending markets?

FR: As credit markets have slowly opened up, consumer loans, which had all but shut down during the credit crisis, have seen a modest rebound. This rebound is forecast to continue as consumer sentiment and expectations about the future continue to become more positive. At the same time, banks and lenders have by and large repaired their balance sheets and are re-entering the lending markets. The increased competition is sure to put downward pressure on rates for financial products. In conjunction with rising base rates, it is going to be increasingly difficult for institutions to maintain profitability and grow their portfolio. Price optimization technology can help banks understand how specific customer segments value lending products and the optimal rate and price that should be offered to maintain profitability without surrendering market share or revenue. For example, the Nomis Score - which provides an understanding of the customer's level of price sensitivity - will enable marketers to measure the impact of pricing decisions on consumers and target the right offer to the right segment.

Have consumer attitudes, price sensitivity, and willingness to borrow/save at different price levels changed as a result of the global financial crisis?

FR:The Nomis Price Sensitivity Index for Consumer Loans (PSI) is presently at the lowest level since the index was established in 2005. The Nomis Price Sensitivity Index, which measures segment-level trends in consumer price-sensitivity is computed monthly and available to Nomis customers. The PSI saw a dramatic drop in price sensitivity since 2008 from a high of 38 to its present value of six. The way to interpret this is as follows: at a PSI of 38, a 100 basis points rate increase will result in a drop in demand of 38 percent, while at a PSI of six, a 100 basis point rate increase will result in a drop in demand of just six percent. We can clearly see that price sensitivity peaked in late 2007 at the same time as the over-heated lending markets. As credit availability dried up over 2008-2009, consumer price sensitivity plummeted to historical lows in 2009 and 2010. If we overlay milestone market events such as the failures of Bear Stearns, Lehman Brothers, and the lowest level of banks' willingness to lend, we can see the effects of the destabilization of the credit markets impacting consumers' price-sensitivity. The real question now is: "How will consumer price-sensitivity change as interest rates rise, regulation changes, and banks return to lending?"  Based on our most recent data, we are forecasting a slow but persistent increase of the Price Sensitivity Index through the rest of 2010 and into 2011 in North America.

What are the most important capabilities that banks will need to possess in order to be successful in this new era?

FR: Banks need an efficient closed-loop pricing process that incorporates data, advanced analytics, innovative technology and tailored business processes to make more intelligent, data-driven decisions that align their pricing practices with customer needs and business goals. Understanding consumer's preferences and price sensitivity will enable banks to approach the goal of personalized pricing for each customer. This will provide the ability to unlock the profit and volume potential of their consumer lending and deposits portfolios while satisfying risk, funding and regulatory constraints.

Biography

Frank Rohde is President and CEO of Nomis Solutions. Nomis Solutions provides pricing and profitability management solutions to leading banks and finance companies in North America, Europe, and South Africa, including the Nomis Price Optimizer^TM, the Customer Portfolio Optimizer^TM, and the Nomis Score^TM.