Pricing Banking Services

The banking services sector is one of the most profitable sectors out there.  It is not uncommon to earn an ROE of anywhere between 40%-60%.  And as we all know, a 1% increase in price can lead to an 8% increase in profits.

So how do we ensure we get the most profits out of banking services?  Are there any secrets?  I spent 28 years of my life in the banking services sector and here is what I learnt.

Find Out Which Service Component Drives Your Profits

Take a credit card transaction for example.  A credit card transaction is actually made up of two service components – a purchase and a loan.  These two service components are invisible to the average cardholder because they occur during one service process: you use the card to buy an item (purchase component), and then you pay the bill later (loan component).  Let’s look at the two components more closely.  The purchase only earns a bank about 1%.  The loan, however, could earn the bank anything from 10%-24% in interest income.  Obviously, there is a need to focus on the loan component to generate higher profits.  But you cannot get to offer the loan without first making the customer use the card for a purchase.

Strategically Price the “Enabler” Component

The purchase is the “enabling” component.  It enables the loan component. The low margin component of the purchase enables the higher margin loan.  Therefore, you will need to promote the use of the credit card for purchases first.  You may also need to price this part of the service as a loss leader, e.g. low or no annual fees, freebies upon sign up, et cetera.

Promote the Higher Return Component

The loan is the revenue-generating component.  So after you have accomplished the purchase, you need to encourage your customers to take up the loan.  How?  This may include making it easier to pay the minimum amount than settling the full outstanding.  It can also include providing rewards and frequent flyer miles for the loan outstanding.  Especially in Asian cultures, there may be a need to de-stigmatize the taking of a loan as a bad personal habit.  Marketing in all its forms is a critical component of success in this area.  Means End Theory (Reynolds & Gutman, 1988) is useful in informing the decision on how to encourage behavior that drives revenue in this part of the service component.

Alternatives and Willingness to Pay

Consumers pay for the convenience of getting a line of credit on tap whenever they make impulse or large item purchases.  Willingness to pay is a key motivator of the pricing in this component of the overall service. Keep this value driver in mind and build the pricing of this component around this in light of the alternatives available to the consumer.

Approach Competition from a Strategic Perspective

The loan component is obviously the revenue driver.  Therefore it is important that the industry does not compete on this part of the service.  You can compete on the lower margin component of the service, i.e. the purchase, but try not to disrupt the industry status quo on the loan component; otherwise the whole industry will suffer.

Summary

A banking service can be made up of several parts – it is multi-part.  Therefore pricing must also be approached from a multi-part perspective.  You need to analyze which part of the service drives revenue and the inter-dependency between the parts.  Then determine the drivers of value for each part and customer’s willingness to pay given the alternatives available.  Finally, price each part so that the overall profits for the service is maximized.