marketsim product/pricing lecture in bank training – invest in your best
TRANSCRIPT
MarketSimProduct/Pricing Lecture
In Bank Training – Invest in your best
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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
3
COST-BASED PRICINGUnderstanding the Economics
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Profitability Calculation
Interest Income
less Interest Expense
= Net Interest Income (Margin)
less Provision for Loan & Lease Losses
plus Non-Interest Income
less Non-Interest Expense
= Net Income before Taxes
5
Cost of Funds
Funds Transfer Pricing
Term
Rate
Loan Margin
Deposit Margin
FTP
6
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
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Money is a commodity, or is it? Deposit FTP Example
FTP - Promotional MMDA/High Yield Savings
FTP - 24 month CDs
Range:
401 bpsFTP on 6/30/10
(bps)
FTP on 6/30/10
(bps)
Range:
110 bpsFTP on 6/30/10
(bps)
FTP on 6/30/10
(bps)
Funds Transfer Pricing(FTP)
88
0.0% 1.5% 3.0% 4.5% 6.0%
H / Swapcurve
G / Swapcurve
F / Swapcurve
E / SwapCurve
D / LIBOR
C / LIBOR
B / SwapCurve
A / SwapCurve
0.0% 2.0% 4.0% 6.0% 8.0%
G / LIBOR
F / LIBOR
E / FedFunds
D / LIBOR
C /FedFunds
B / FedFunds
A / LIBOR
HE Loan: all-in FTP for 15-year, 80% LTV, owner-occupied. Eight respondents.
HELOC: all-in FTP for 80% LTV, owner-occupied. Seven respondents.
Average = 0.88% Average =
3.28%
327 bps139 bps
Bank / Base RateBank / Base Rate Bank / Base RateBank / Base Rate
…and Loan FTP
Funds Transfer Pricing
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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
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MarketSim Funds Transfer Pricing
Term
RateLoan Margin
Deposit Margin
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Interest Income
less Interest Expense
= Net Interest Income
(Margin)
less Provision for Loan &
Lease Losses
plus Non-Interest Income
less Non-Interest Expense
= Net Income before Taxes
Other items considered: • Cost of Capital• Liquidity Impacts• Early Termination• Opportunity Costs• Transactions• Others
Profitability Calculation
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REFERENCE RATESUnderstanding Competitors
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• 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
Reference Rates
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Regional gaps did not disappeared in the low-rate environment
0.00
1.00
2.00
3.00
4.00
5.00
Aug-07 Dec-07 Apr-08 Aug-08 Dec-08
Average Short Term (<1 Yr) CD WAMPs by State (Jan 2009)
WA
MP
WA
MP
126 bps
72 bps
75 bps
89 bps
76bps
Note: Each series represents the State Avg WAMP
Source: MRI, Novantas Analysis DateDate
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Reference Rates
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Reference Rate Differences - MMDA
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AR GA NJ MI
MS DE AL NC OH
MO VA DC NE TN SC CT
MN CO CA UT
NM ID ME OR
WY M
T0.0
0.2
0.4
0.6
0.8
1.0
1.2
WM
AX
Ra
te b
y S
tate
($
10
k-$
25
k;
as
%)
Note: Weights based on concentration of large banks (top 50 banks) Source: BranchScape, Informa, Novantas analysis.
National Avg: 0.66%
2014 Rates by State for MMDA ($10k-$25k)
Money is a commodity, or is it? Deposit Reference Rate Example
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Region Lien Position FICO Range CLTV Size of Loan
Market Pricing Skews by Dimension
50 - 110bp 15 - 25bp 150 - 175bp 50 - 150bp 110 - 175bp
Market 1
First
Second
0 – 679
680 – 699
10 – 69%
70 – 79%
$5 – $49K
$50 – $99K
$100 – $249K
$250K+
80 – 90%700 – 749
750+
Reference Rate Differences - HELOC12
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PRICE ELASTICITYUnderstanding Customers
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Price Elasticity
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Lower(more incentive)
More
Higher(less incentive)
Less
Price
De
ma
nd
Price Elasticity
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Demand for bank deposit
balances
Weighted average market price
Relative rate
Typically, profit- maximizing
point
Opportunities to pick up
balances; likely focused on key price-sensitive
segmentsUncompetitive
pricing – “falling off
the cliff”
“No man’s land”
Price Elasticity
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ProfitabilityProfitability
FTP RateFTP Rate
Elasticity of
Demand
Elasticity of
Demand
Rate
Balances Optimal Price
Points
Optimal Price
Points
Net Income
Price Elasticity
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How to develop the Curve?
All 6mo CDCustomers in
Region “X”
Relative Pricing at Customer decision points
(acquisition or roll)
Historic Pricing (incl
Competitors)
Balance impact at each relative “Price experiment”
Best fit against
Benchmark curves
Reliability and fit scoring
Price Elasticity
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Pricing Integration
RISKRELATIO
NSHIP
CHARACTERISTIC
S
Demand Side:Use elasticity curves to optimize
rates
Change in Share
Relative Price
BA
“Floor” price(A)
?
Supply Side:Calculate segment-level floor rateP
RO
DU
CT
A
TT
RIB
UT
ES
“Optimal” price(B)
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THE IMPORTANCE OF FENCESImplications of Product Design
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Higher
HigherLower
Lower
Product Design and ‘Fences’
Pricing Product Design
RealizedPrice
ValueProposition
Pricing is always a trade-off with product design.
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Less
Pri
ce
Product Value (Features)
Higher
Lower
More
More Feature Value, Higher Price
Chevy
Product Design and ‘Fences’
Buick
Caddy
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For example access vs. price
Access
Rate of Return
Non InterestChecking
InterestChecking
Zero
Unlimited
Savings/MMAs
3-12 Month CD
>1 year CD
Product Design and ‘Fences’
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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.
First Class:Includes Assigned Seats, Glass
Windows, and Fans
Second Class:Bench Seating
SecondClass
SecondClass
Feature Value
PriceFirstClassFirstClass
Product Design and ‘Fences’
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SecondClass
SecondClass
First Class:Includes Assigned Seats, Glass
Windows, and Fans
Second Class:Bench Seating
Their solution was to create a “third class” by removing the roof of a car and placing it directly
behind the smoking engine.
Third Class:
Bench Seating, no Roof
Feature Value
Price
FirstClassFirstClass
ThirdClassThirdClass
Feature Value
Price
Higher prices without better “relative value” without increased
features
New, lower value product near previous pricing
Product Design and ‘Fences’
FirstClassFirstClass
SecondClass
SecondClass
SecondClass
SecondClass
FirstClassFirstClass
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Cannibalization is a huge issue.
61%
57%
38%
66%
66%
49%
75%
39%
43%
62%
34%
34%
51%
25%
0% 25% 50% 75% 100%
Bank 1
Bank 2
Bank 3
Bank 4
Bank 5
Bank 6
Bank 7
New Customers Switched Customers
Switched & Augmented Balances as % of Acquisition over First 6 Months
Product Design and ‘Fences’
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RELATIONSHIP PRICINGFuture State of Pricing
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Relationship Pricing
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Product Level
Tiers, Terms
Geography
Customer
Level
Single Product
Multi Product
End-State in a Virtualized
World
‘Price off the Loan Book’
FTP-based Pricing
Elasticity-based
Optimization
Relationship Optimization
Increasing Sophistication of Analytics
Gra
nula
rityo
f Acti
ons
Current State
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Examples
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Relationship Pricing 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
Opaque
• Discretionary pricing and pricing grids based on relationship balances
• Example: A number of North American Banks Static
• Static packages combining multiple products with associated price and non-price benefits
• Example: Scotia Bank Complete Small Business, CitiGold
Transparent
• Promoted single-product price breaks based on relationship balances
• Example: HSBC Premier, Nordea Customer Program, BofA Platinum Privileges
Dynamic
• Flexible packages offering opportunities to add different combinations of products at the customer-level
• Example: PNC Bank More Get More, Westpac DIY Super
Modes of Relationship Pricing
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Option 1 – Online Only
One-year subscription to Economist.com. Includes online access to all articles from The Economist since 1997
Price: US $59.00
16% chose Option 1
Behavioural Economics
Source: Predictably Irrational by Dan Ariely
Option 3 – Print Only
One-year subscription to the print edition of The Economist.
Price: US $125.00
Option 2 – Online + Print
One-year subscription to the print edition of The Economist and online access to all articles from The Economist since 1997
Price: US $125.00
84% chose Option 2
0% chose Option 3
68% chose Option 1
32% chose Option 2
When only 2 options were offered, the majority of the group selected the Online Only option
When an “irrelevant alternative” Option 3 is added, the majority of the group chose the Online + Print option over the Online Only option
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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
Hotel $2,058
Park Tickets$1,616
Dining -- 3 Meals Daily, Snack $1,460
-- 2 Character Dinings $800$2,260
Entertainment -- Water Sports Unlimited -- 9 Special Disney Tours Unlimited -- Cirque du Soleil + Golf Unlimited
Unlimited
Services (“Babysitting”) Unlimited
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.
À La Carte Replica – 15% Savings
with Premium Package
À La Carte Realistic – 33% Higher Expenditure
with Premium Package
$8,629 $9,884
$6,503
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• 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
Summary
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Next Steps
Break into
teams
Discuss current product features & prices
Make product feature
decisions
Make product
price decisions
Be prepared to answer the question, “What do you expect to happen?
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Next Steps
Break into
teams
Discuss current product features & prices
Make product feature
decisions
Make product
price decisions
Be prepared to answer the question, “What do you expect to happen?