The Pros and Cons of Relationship Pricing

What are potential high value customers looking for when choosing a financial institution that will best suit their needs? Or what promotes customer loyalty? Offers, Rewards and Perks. In other words, relationship pricing, which is a pricing and billing framework that is determined by the level or longevity of business a customer does with their financial institution. These pricing models have a big impact on new customer development and customer retention. Each pricing model is different, and it is important to understand the pros and cons. In this blog, I’m going to discuss the pros and cons of relationship pricing models.

Pros:

• Gives customers benefits for growing with an institution.
• Encourages high balance accounts.
• Allows the bank or credit union to easily cross sell the customer more services, resulting in a more in-depth customer relationship, with customers holding multiple accounts at one FI, such as loans, checking and savings accounts, money market accounts, certificates of deposit (CDs), and individual retirement accounts (IRAs). An ingrained customer maintains a multitude of products or services, which makes it difficult for the customer to move to another FI.
• Expands an institution’s customer base with competitive pricing.

Cons:

• Poorly executed discounts and perks negatively impact a financial institution’s overall profitability by giving too much away to customers who have the greatest ability to pay and/or the highest demand for those products and services. Here are some examples:
  • Smaller rates on short and long term loans result in less overall revenue for the bank or credit union.
  • Perks, such as waived fees on deposits, and other services add up over time and are an important non-interest income generator.
• Software to manage reward program is an expense.
  • If the relationship pricing model is not making enough to pay for the software, it can negatively impact the institution.
  • Due to the cost of software, many banks and credit unions choose to manually manage and track, which is tedious, time consuming, and leaves room for human error.

Relationship pricing is an important tool for banks and credit unions. Having long-term, loyal customers is important for any business to thrive, and offering benefits for simply continuing to bank with an institution or for maintaining a certain account balance, increases the likelihood of ongoing business. Yet an important consideration is understanding that relationship pricing models are not a one-size-fits-all solution for everyone. Relationship pricing models need to be built around the customer needs and competition in the market, and it is vital that an institution doesn’t disregard potential income for a customer relationship. What’s the point of having a customer if they only cost the institution money?

If you’re unsure if your institution’s relationship pricing model impacts revenue negatively, look for these three signs:

1. Abnormal activity/exploitation of certain products

If your institution is seeing an increase in people using a reward or perk from your relationship pricing model that typically does not have a large demand, then it is possible customers are taking advantage of a pricing flaw. As an example: safety deposit boxes are a reward of your relationship pricing model, and there is a significant increase of safety deposit box usage; there’s a chance it’s being exploited. If there’s high utilization of a reward product or service, you should compare the usage of the same product at its regular price, these comparisons may alert your institution to a potential product exploitation.

2. Your institution’s return on assets (ROA) is decreasing after relationship pricing was implemented

Another sign that your pricing model is costing the institution is when you evaluate your ROA. ROA is a great indicator for how your institution uses its assets to increase overall profits. A decreasing ROA in conjunction with a new relationship pricing roll out shows that the institution is not making enough profit on each dollar spent.

3. You see a lot of waived fees                   

It’s common to see the occasional waived fee, but when every service or product fee is waived, it may be a sign that there is a problem in your relationship pricing model. Fee income is an important source of revenue, and it shouldn’t consistently be given away for free in relationship pricing models.

In my experience, it’s important to continually evaluate your institution’s relationship pricing models on both the loan and deposit side to ensure you’re staying competitive with the market. As I previously mentioned, no model is exactly alike and not every model is going to work for your institution. If you have any questions about how to balance profitability while nurturing healthy and long-lasting relationships, please reach out and I’ll be in touch!