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Relationship-based pricing

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Relationship-based pricingThe banking scenario across geographies has witnessed a marked evolution in the last two decades. With a hostile economic environment in the backdrop, the industry has seen an unprecedented growth in competition, from both local and international players, and an increasingly demanding customer base. The constant pursuit to improve the bottom-line has seen banks cutting costs by every possible means on the one hand, and focusing on innovation, product differentiation and continuously evolving market strategies on the other.

This goes to explain the increasing popularity of ‘relationship-based pricing’ - as a service differentiator. Relationship-based pricing, in its simplest forms, can be understood as a personalised pricing paradigm which has at its core the time-tested principle of ‘each customer is unique’ – thus, basing the price on the relationship shared with this unique customer. Suntec, which is a pioneer in the field of relationship-based pricing, defines it as, “relationship-based pricing is a customer-centric

framework that helps financial institutions to treat each customer uniquely, based on the overall relationship value, with innovative pricing strategies achieved by streamlining and automating the pricing and billing functions across enterprise. Relationship-based pricing ensures that customers’ benefits and rewards are provided based on total customer value.”

Banks have historically based the incentives offered to customers on volumes, rather than the total profitability brought by the customer to the table. Transactions have been viewed in silos, without a focus on the summary of the overall transactions with the particular customer. The rates for lending and deposits have been traditionally determined majorly by the competitive forces at play in the market, without a consideration on how an individual customer could prove to be more profitable to the bank in the future. Thus in a way, when it comes to pricing, the outlook of the banks has been more short-term than long. Relationship-based pricing stands to change this outlook.

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Fee based income for the bank implies the non-interest based income. Examples of fee based income would include fees levied for managing checking accounts, safe-keeping services like security vaults, fees levied on distributing third-party mutual funds, commission income on products such as demand drafts etc. The share of such ‘fee based income’ in the overall profitability of a bank has been on the rise, as compared to ‘interest based income’, which in turn calls for the ability to manage and bill traditional charges through innovative means. Relationship-based pricing has a vital role to play in this arena, enabling banks to devise pricing strategies at the enterprise level, charge customers based on their overall relationships, offer fee-bundling options to customers etc. The charge calculation could be based upon

During the period before the industrial revolution the process of ‘selling’ was very much customer centric, wherein bargaining and negotiating formed crucial elements of every transaction. ‘Standardization’ stepped in with the industrial revolution, and the focus shifted to mass production and a standardized sales procedure, leaving little room for any kind of face-to-face negotiation which in principle is opposed to the concept of standardization. And banks were no exception to this.

However what is now seen is a marked shift from product centric pricing to customer centric

Increasing share of fee based income

Shift from product-based pricing to customer centric pricing

various factors ranging from volume to location to denomination etc., and also computed in various ways.

For example, free limits could be based upon the funds maintained with the bank, like 10 check transactions free per month if the Quarterly Average Balance (QAB) or fixed deposit with the bank is above INR 25000. Another example would be that of tiered pricing, wherein the QAB to be maintained would depend upon the fixed deposit with the bank – for a deposit up to INR 50000, the QAB required could be INR 10000, a QAB of INR 5000 for deposit ranging from INR 50000 to INR 100000, whereas, for a deposit in excess of INR 100000, no QAB would be required to be maintained.

pricing. The focus is shifting from basing the price on product features, associated costs and product specific margin to basing it on the value perceived by the customer. Different customer segments would perceive value differently. A customer centric pricing approach looks at understanding these different segments and the value they place upon individual products, and accordingly pricing the product for each of the segments. It requires a constant assessment of the product/service attributes with respect to the perceptions of different customer segments.

The art of product bundling could be best understood by taking the example of McDonalds. The strategy of selling ‘package meals’ as opposed to individual burgers, fries and drinks,

Product bundlingresults in an increased number of takers who see the value of the subsidized package, resulting in increased sales for the company by selling the same burgers, fries and drinks.

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A 360 degree view of the customer’s overall relationship with the bank is crucial for it to be able to customize its offerings accordingly. The customer’s dealings with the bank across different lines of business need to be taken into consideration, so as to arrive at the overall revenue generated, and future potential.

Customer loyalty can be defined as “the result of an organisation creating a benefit for a customer so that they will maintain or increase their purchases from the organization” (Anderson and Jacobson, 2000). Building customer loyalty no longer seems to be a choice for banks, but a means of survival for building a sustainable competitive advantage.

In the Harvard Business Review article that presaged their book ‘Discipline of the Market Leaders’, Treacy and Wiersema have asserted that “companies achieve leadership positions by narrowing, not broadening their business focus”. The cost of retaining an existing customer is certainly lower than the cost of attracting newer ones. Given the growing dependence of the banking industry on organic growth, building upon customer loyalty has a massive role to play in a bank’s growth strategy to increase penetration. It is required of the banks to continue to deliver high value to its high-worth customers in order to feed this self-reinforcing system. Banks are waking up to the fact that

Holistic view of customer relationship

Building upon customer loyalty

The demographic, transactional and wealth information of customers, when viewed as a whole would help build custom pricing strategies. Efficient management of all the historical disparate data would be the first step when aiming to achieve the benefits of such holistic view.

they can no longer afford to have a short term view measured by number of new customers added, but need to take into account the long term aspect, in terms of duration of customer retention and total value generated.

Loyalty programs offered by banks have come to play as a differentiator with respect to competitors. In fact, present times have seen loyalty programs become a commodity in itself. The industry has been witnessing a gradual shift towards value-oriented loyalty programs, wherein the focus is no longer on discounts offered on a single transaction, but instead on a bouquet of services/products being made available as a part of product bundling. This has led to the development of smarter pricing mechanisms, ensuring a win-win situation for both customer and bank. The benefits being offered to the customer could be a mix of hard benefits (for instance, discounts and rebates) and soft benefits (for instance, freebies such as discounted air travel).

Product bundling involves combining various products/services into a package, the cost of which is lower than the sum of its individual components. Thus, essentially it is a pricing strategy. It helps in evaluating pricing scenarios that meet the bank’s risk as well as profitability goals. The development of such packages and building marketing strategies around them plays a major role in retaining customer accounts

and maximizing revenues generated from them. Also product bundling is a strategy to launch new products/services wherein they could be bundled with other successful products/services.

For instance, in retail banking there could be products bundled around savings account, loans, investment products, offering discounted credit cards, discounts on loan etc.

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Relationship based pricing relies upon the data mining, analytics, simulation and CRM capabilities of modern-day banking applications. To gain the maximum value out of relationship-based pricing, there needs to be a comprehensive platform with access to real-time data instead of individual disparate applications catering to

Technology as an enablerdifferent lines of business/segments/channels etc. The solution is required to be scalable, able to plug in revenue leakage, flexible and nimble to enable the bank to cope with the growing challenges and be able to differentiate its products and services.

Conclusion

References

Banks have been criticized in the past for treating customers as mere account numbers. However, in the face of a growing number of challenges, banks have come to realize the importance of leveraging their relationship with customers to achieve true customer centricity. A focus on building long term relationships with

1. Cross, R.G., Dixit, A., 2005, Customer-centric pricing: The surprising secret for profitability, Business Horizons [online], Available at: www.revenueanalytics.com/pdf/Business%20Horizons%20Article%20(vol%2048,%202005).pdf> [Accessed 10 April 2012]

2. Kim, M., Kristiansen, E., Vale, B., 2001, Endogenous Product Differentiation in Credit Markets: What do borrowers pay for?, Available

customers is most certainly coming to become the way forward. And personalization of services is key for the bank to build this long term relationship and gain an edge over its competitors. Thus, ‘relationship-based pricing’ is poised to become a leading strategy in the bank’s arsenal, in its quest to gain competitive advantage.

Pradnya Prakash Jadhav Senior Associate Consultant

at: www.bis.org/bcbs/events/oslo/valekimkr.pdf> [Accessed 10 April 2012]

3. Yadav, M., Capture and communicate value in the pricing of services, The Journal of Professional Pricing [online] Available at: members.pricingsociety.com/articles/Capture-and-Communicate-Value-in-the-Pricing-of-Services.pdf> [Accessed 10 April 2012]

Finacle from Infosys partners with banks to transform process, product and customer experience, arming them with ‘accelerated innovation’ that is key to building tomorrow’s bank.

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