MarketSim
Product/Pricing
Lecture
In Bank Training – Invest in your best
Five Key Topics
•
•
•
•
Understand the economics – Cost-based pricing
Understand the competitors – Reference rates
Understand the customers – Price elasticities
Implications on Product Design – The Importance of
‘Fences’
• The Emergence of Relationship Pricing
2
Understanding the Economics
COST-BASED PRICING
3
Profitability Calculation
less
=
less
plus
less
=
Interest Income
Interest Expense
Net Interest Income (Margin)
Provision for Loan & Lease Losses
Non-Interest Income
Non-Interest Expense
Net Income before Taxes
4
Funds Transfer Pricing
FTP
Cost of
Funds
Loan Margin
Deposit Margin
Rate
Term
5
Funds Transfer Pricing(FTP)
Provides a way to compute the
value of a loan or deposit
Allows product revenue
information
Bigger is better for the bank,
smaller is better for the
customer
HINT…In MarketSim, few get
this initially - those that do,
excel
6
Funds Transfer Pricing(FTP)
Money is a commodity, or is it? Deposit FTP Example
FTP - Promotional MMDA/
High Yield Savings
FTP - 24 month CDs
Range:
FTP on
6/30/10
(bps)
FTP on
6/30/10
(bps)
Range:
401 bps
7
110 bps
Funds Transfer Pricing
…and Loan FTP
HELOC: all-in FTP for 80% LTV, owner-occupied.
Seven respondents.
HE Loan: all-in FTP for 15-year, 80% LTV, owneroccupied. Eight respondents.
Bank / Base Rate
Bank / Base Rate
A / Swap
Curve
Average =
0.88%
A / LIBOR
B / Fed
Funds
B / Swap
Curve
Average =
3.28%
C / LIBOR
C/
FedFunds
D / LIBOR
D / LIBOR
E / Swap
Curve
E / Fed
Funds
F / Swap
curve
F / LIBOR
G / Swap
curve
G / LIBOR
H / Swap
curve
139 bps
0.0%
2.0%
4.0%
6.0%
8.0%
0.0%
8
327 bps
1.5%
3.0%
4.5%
6.0%
8
FTP – Potential Drivers
• Interest Rate Sensitivity –What happens to product
rates when interest rates move up and down
• Liquidity – What is the expected life of a product
– Stable Liquidity Life –Under normal circumstances
– Stressed Liquidity – Under stressed circumstances
• Optionality –What is the dispersion of these balances
9
9
MarketSim Funds Transfer Pricing
Loan Margin
Rate
Deposit Margin
Term
10
Profitability Calculation
less
=
less
plus
less
=
Interest Income
Interest Expense
Net Interest Income
(Margin)
Provision for Loan &
Lease Losses
Non-Interest Income
Non-Interest Expense
Net Income before Taxes
Other items considered:
• Cost of Capital
• Liquidity Impacts
• Early Termination
• Opportunity Costs
• Transactions
• Others
11
Understanding Competitors
REFERENCE RATES
12
Reference Rates
• Price that consumers believe is the market price for a
particular good or service
• Critical in determining optimal price points
• Can vary based on a number of factors and will vary by
market and channel
• Signpost Measure - Weighted Average Market Price
As a result, not all competitors necessarily matter in this
relative view—only those that enter into a customer’s
consideration set
13
Reference Rates
14
Regional gaps did not disappeared in the low-rate environment
Average Short Term (<1 Yr) CD WAMPs by State (Jan 2009)
5.00
4.00
WAMP
126 bps
3.00
2.00
72
bps
75
bps
89
bps
76
bps
1.00
0.00
Aug-07
Note: Each series represents the State Avg WAMP
Source: MRI, Novantas Analysis
Dec-07
Apr-08
Date
14
Aug-08
Dec-08
Reference Rate Differences - MMDA
Money is a commodity, or is it? Deposit Reference Rate Example
2014 Rates by State for MMDA ($10k-$25k)
1.0
0.8
National Avg: 0.66%
0.6
0.4
0.2
0.0
AR
NY
GA
PA
NJ
MA
MI
IA
MS
MD
DE
LA
AL
FL
NC
KY
OH
WI
MO
IL
VA
IN
DC
TX
NE
WV
TN
NH
SC
RI
CT
OK
MN
KS
CO
HI
CA
WA
UT
NV
NM
VT
ID
AZ
ME
AK
OR
ND
WY
SD
MT
WMAX Rate by State ($10k-$25k; as %)
1.2
Note: Weights based on concentration of large banks (top 50 banks)
Source: BranchScape, Informa, Novantas analysis.
15
8
Reference Rate Differences - HELOC
12
Region
Lien Position
FICO Range
CLTV
Size of Loan
$5 – $49K
0 – 679
10 – 69%
$50 – $99K
First
680 – 699
Market 1
70 – 79%
$100 – $249K
Second
700 – 749
80 – 90%
$250K+
750+
Market Pricing Skews by Dimension
50 - 110bp
15 - 25bp
150 - 175bp
16
50 - 150bp
110 - 175bp
Understanding Customers
PRICE ELASTICITY
17
Price Elasticity
18
Price Elasticity
Demand
More
Less
Lower
(more incentive)
Price
19
Higher
(less incentive)
Price Elasticity
Typically, profitmaximizing
point
“No man’s land”
Demand
for bank
deposit
balances
Opportunities to
pick up
balances; likely
focused on key
price-sensitive
segments
Uncompetitive
pricing –
“falling off
the cliff”
Weighted average
market price
20
Relative rate
Price Elasticity
Balances
Optimal
Price
Points
Net Income
Elasticity
of
Demand
FTP
Rate
Profitability
Rate
21
Price Elasticity
How to develop the Curve?
Historic
Pricing (incl
Competitors)
All 6mo CD
Customers in
Region “X”
Best fit
against
Benchmark
curves
Relative
Pricing at
Customer
decision
points
(acquisition
or roll)
Balance
impact at each
relative “Price
experiment”
22
Reliability
and fit
scoring
Pricing Integration
Demand Side:
Use elasticity curves to optimize rates
Change in
Share
A
B
PRODUCT
ATTRIBUTES
“Optimal”
price
(B)
Relative
Price
?
Supply Side:
Calculate segment-level floor rate
RISK
“Floor”
price
(A)
23
Implications of Product Design
THE IMPORTANCE OF FENCES
24
Product Design and ‘Fences’
Pricing is always a trade-off with product design.
Higher
Lower
Realized
Price
Value
Proposition
Pricing
Product Design
Lower
Higher
25
Product Design and ‘Fences’
More Feature Value,
Higher Price
Price
Higher
Caddy
Buick
Chevy
Lower
Less
Product Value (Features)
26
More
Product Design and ‘Fences’
Non Interest
Checking
For example access vs. price
Unlimited
Interest
Checking
Savings/MMAs
Access
3-12 Month CD
Zero
>1 year CD
Rate of Return
27
Product Design and ‘Fences’
In the late 1800’s, French trains had two classes. The French railroad company
sought to raise prices for most customers without losing their most price
sensitive customers; they needed to create option that was unappealing enough
to keep all but the most price-sensitive customers out of the lowest price class.
Second Class:
Bench Seating
First Class:
Includes Assigned Seats, Glass
Windows, and Fans
Price
First
Class
Second
Class
Feature Value
28
Product Design and ‘Fences’
Their solution was to create a “third class” by
removing the roof of a car and placing it directly
behind the smoking engine.
Second Class:
Bench Seating
First Class:
Includes Assigned Seats, Glass
Windows, and Fans
Third Class:
Bench Seating, no
Roof
Higher prices without better
“relative value” without increased
features
Price
Second
Class
Price
First
Class
Second
Class
Third
Class
Feature Value
New, lower value product
near previous pricing
29
Second
Class
First
Class
First
Class
Feature Value
Product Design and ‘Fences’
Cannibalization is a huge issue.
Switched & Augmented Balances as % of Acquisition over First 6 Months
Bank 7
75%
Bank 6
25%
49%
51%
Bank 5
66%
34%
Bank 4
66%
34%
Bank 3
Bank 2
38%
62%
57%
Bank 1
0%
43%
61%
39%
25%
50%
New Customers
Switched Customers
30
75%
100%
Future State of Pricing
RELATIONSHIP PRICING
31
Relationship Pricing
Increasing Sophistication of Analytics
Product Level
Customer Level
Granularityof Actions
‘Price off the
Loan Book’
FTP-based
Pricing
Elasticitybased
Optimization
Relationship
Optimization
Tiers,
Terms
Current
State
Geograp
hy
Single
Product
End-State in
a Virtualized
World
Multi
Product
32
3
2
Examples
Product Packages/Bundles
Preferential pricing on existing
products to existing customers,
based on defined behavioral criteria
Wrapping individual products into a
single offering that is priced
preferentially to sum of all products
•
Discretionary pricing and pricing
grids based on relationship
balances
•
Example: A number of North
American Banks
•
Promoted single-product price
breaks based on relationship
balances
•
Example: HSBC Premier, Nordea
Customer Program, BofA Platinum
Privileges
Static
Relationship Pricing
Dynamic
Transparent
Opaque
Modes of Relationship Pricing
33
•
Static packages combining multiple
products with associated price and
non-price benefits
•
Example: Scotia Bank Complete
Small Business, CitiGold
•
Flexible packages offering
opportunities to add different
combinations of products at the
customer-level
•
Example: PNC Bank More Get
More, Westpac DIY Super
3
3
Behavioural Economics
an “irrelevant
alternative”
3 is added,
the
majority of the group chose the
When only
2 options were
offered,Option
the majority
of the
group
Online
Print option
over the Online Only option
selected
the +Online
Only option
Option 1 – Online Only
One-year subscription to
Economist.com. Includes
online access to all articles
from The Economist since
1997
Option 2 – Online + Print 32%
84% chose
68% chose
16%
Option 1
One-year subscription to the Option 2
print edition of The
Economist and online access
to all articles from The
Economist since 1997
Price: US $59.00
Price: US $125.00
Option 3 – Print Only
0% chose
One-year subscription to the Option 3
print edition of The
Economist.
Source: Predictably Irrational by Dan Ariely
Price: US $125.00
34
Where It Could Go
Typical Family: 2 Adults, 2 Children (ages 5 and 7)
Itinerary: 7 Nights Disney Hotel + 4 Theme Parks + 2 Water Parks + Dining + Entertainment
Premium Package – $8,629
Hotel
$2,058
Park Tickets
$1,616
À La Carte Replica – $9,884
15% Savings
with Premium
Package
Dining
-- 3 Meals Daily, Snack
-- 2 Character Dinings
$1,460
$800
$2,260
Entertainment
-- Water Sports
-- 9 Special Disney Tours
-- Cirque du Soleil + Golf
Unlimited
Unlimited
Unlimited
À La Carte Realistic – $6,503
Unlimited
Services (“Babysitting”)
Unlimited
33% Higher
Expenditure
with Premium
Package
All prices before tax. Park tickets refer to 4-Day Tickets + Park Hopper + Water Parks / DisneyQuest / ESPN Access.
Hotel refers to Animal Kingdom Lodge Resort during the timeframe of July 20-July 27, 2014. Water Sports refers to 1 hour each of four activities.
35
Summary
• Need to understand true economics (risk-adjusted for
loans)
• Importance of ‘reference rates’
• Need to understand the ‘demand-side’ – customers’
price elasticity
• Product design and fences are critical, in particular to
minimize cannibalization
• The next frontier is relationship pricing
36
Next Steps
Break
into
teams
Discuss
current
product
features
& prices
Make
product
feature
decisions
Be prepared to answer the question,
“What do you expect to happen?
37
Make
product
price
decisions
38
39
40
41
42
43
Next Steps
Break
into
teams
Discuss
current
product
features
& prices
Make
product
feature
decisions
Be prepared to answer the question,
“What do you expect to happen?
44
Make
product
price
decisions