To optimize pricing in a way that preserves long-term franchise value, winning treasury management teams will learn to make precision tradeoffs within a systematic framework.
Treasury management (TM) has long been an integral and valuable component of commercial banking, providing everything from basic chequing and payments services to an increasingly sophisticated solution set that helps clients to optimize working capital. But a revenue-dilutive imbalance has crept in as the business has grown, in that the positioning and pricing of TM services has not nearly kept pace with improvements in value provided by those services.
Many players now provide comprehensive web-based payments services and liquidity options, for example. Yet most have not established a well-constructed pricing continuum that reflects the progression from basic everyday services, where aggressive promotional pricing may be more appropriate, to custom-tailored services, where premium pricing may be amply justified.
These and other significant pricing disconnects abound in treasury management across the industry. Especially given the continued profit pressure in commercial banking, fresh management attention is needed on understanding and capturing the upside potential from matching TM pricing to value.
While commercial loan growth has been on a multi-year upswing at North American banks, net interest margins have been steadily retreating, throttling spread income even as balances have climbed. Overall challenges include a flat rate climate, rising funding and compliance costs stemming from new regulation, and in energy portfolios, rising loss provisions as market prices have collapsed.
In this setting, treasury management price optimization rises to a high priority in commercial banking, one of the few available levers for incremental revenue improvement at a time when most other facets of the business are being squeezed. Blunt action, however, is not the answer. Rather, commercial bankers will need to take a more nuanced approach to strike the right balance between protecting long-term franchise value and maximizing fee income.
For methodical improvement in treasury management pricing, progressive teams will focus on three areas:
Price/value segmentation of TM services — Looking across the menu of services, offerings should be mapped by value they provide to the client versus cost-to-serve and current pricing. This framework allows for a more robust form of “pricing to value” and becomes the basis for client communication and managing field execution.
Robust benchmarking — Instead of simple averages, knowledge of full price distributions (high/low, 25th percentile, 75th percentile, etc.) is needed for precision competitive responses. The bank also needs to be able to draw correlations between pricing variations and key client traits, such as size, geography and industry sector.
Client response modeling — Corporate clients often place high value on bank treasury management services, as reflected in low price elasticity of demand, and also may face high switching costs if they relocate their accounts. These and other factors affecting likely pricing responses should be mapped across the client base.
All Over the Map
While North American banks have provided payment processing and related services to their commercial customers for over a century, treasury management has operated as a formal standalone fee-generating business at larger banks for only about 40 years. Capabilities have dramatically evolved during this time, from basic processing and reporting services to a robust solution set that helps companies to optimize their working capital. Banks, however, have not fully realized the value of their considerable TM service improvements, with unrefined pricing a main culprit.
As underscored by Novantas research, organizations primarily prepare for TM pricing decisions by reviewing sales force input and the client portfolio. In a recent survey of treasury management units at 38 U.S. banks drawn from a variety of size categories and regions, 80% of respondents said they consider sales force feedback in setting new price points, and 70% said they consider client relationship depth.
The investigation of supplemental decision factors is far less prevalent. Only 56% of respondents said they look at purchased market data, which typically consists of simple averages of posted prices. Half take the time to develop estimates of value provided to the customer (commodity services vs. value-added vs. significantly customized).
Still lower in pricing decision influence is the level of client credit commitment, which is considered by 40% of respondents. Finally, and reflecting a major oversight in our view, only 20% of respondents said they consider imputed customer switching costs, which can pose a significant barrier to exit in the event that price revisions cause some clients to considering relocating their accounts.
The disparate focus translates into what can only be described as a wild dispersion in competitive pricing. Asked about recent overall price revisions within their respective TM units, 40% of respondents reported muted increases that fell at least 45% below the survey average (Figure 1: Radical Dispersion in Price Revisions). In our experience, such revisions usually are overly modest relative to value provided to the client, often driven by a desire to avoid “rocking the boat.” Money is left on the table.
At the other end of the spectrum, a fourth of respondents reported price hikes ranging from 25% to 80% higher than the average. Another eighth of respondents reported increases that ranged from 100% to more than 200% higher.
Here the problem is client backlash. Some teams allow time to slip by and then try to implement a large “catch-up” price increase all at once. Others respond in haste to pressure from the top of the house.
Either way the result is the same: the extreme price hike becomes a visible event that can be fraught with repercussions. Suddenly the sales staff starts granting substantial discounts from the new price list generated at the corporate level. Alternatively, at the extreme, clients look elsewhere and some actually leave.
While competitive disparities in treasury management pricing revisions are far less acute in Canada, pricing is far from optimized. Overall, Canadian banks have tended toward over-caution in pursuing price increases in recent years, which is to say that a careful lid is kept on total monthly and annual billings for each client.
This posture typically is heavily influenced by traditional management approaches and sales practices — a changing blend of hand-selected posted prices and discounts — with less analytical cohesion in the pricing of specific items within the service set offered by each bank. Looking bank-by-bank at various core treasury management services in a recent Novantas multi-bank survey in Canada, for example, the highest posted price for a particular type of service often represented a 2x to 3x multiple of the lowest price.
Such wide disparities suggest a lack of market context in pricing decisions. In this sort of information vacuum, subjective concerns about client price sensitivity take precedence, leaving the bank unable to optimize pricing across the service set.
Building the Analytic Foundation
While we have used examples of pricing outliers to make a point, the goal is not “run with the herd” convergence to a narrow bandwidth that somehow seems safe. Rather, the goal is to learn how to make precision tradeoffs within a systematic framework.
Sales representatives will still provide important input and exercise their discretion in the field. Clients certainly will have their sway. But ultimately the central team needs an analytic foundation — a basis to evaluate all of the key influences on pricing; make decisions according to a consistent logic; and communicate and manage implementation for best effect and with minimal repercussion.
In building this foundation, management teams have three main priorities:
Price/value segmentation of TM services — Pricing at many units is either monolithic across the portfolio or differentiates only by product line. Providers often give short shrift to the extra value embedded in their
Basic commodities — chequing accounts, cheque deposits and ACH payments — can be found on every street corner, so to speak, and should be price competitively to market. The situation is quite different with custom services, such as cash flow management applications for specific industries and/or clients. They rightfully should be priced more aggressively to reflect the unique value the bank provides to its clients.
While the rationale is crystal clear, in practice it often fails miserably, as reflected in a Novantas analysis of discounting practices across 11 national and regional U.S. banks. Most of the banks discounted customized services at the same levels as core services — or higher. And across all value tiers, discounts soared above reasonable norms (Figure 2: Discounting — Target Caps vs. Actual).
The upshot is that significant fee revenues are being left on the table. Discounts of up to 53% were seen on core services, for example, far above a reasonable outer limit of 30%. Discounts on value-added services ranged up to 47%, and the peak discount on custom services reach an eye-popping 70% — basically a giveaway.
Such anomalies are seen in Canada as well. In our pricing survey of 24 basic treasury management services, for example, scattered instances of zero discounts from the posted price were seen — but myriad instances of chunky price concessions, some ranging above 40%. Worse, in some instances, the provider that came to market with the lowest posted price on a particular item also was found to be extending the largest discounts, raising questions about sales governance.
These are revenue-consequential disparities. To address them, treasury management teams should apply a price/value segmentation to their own service sets. The idea is to sort offerings by the level of distinctive value provided and then adjust both market pricing and maximum allowable discounts accordingly. The more valuable the service, the higher the list price and the smaller the window for sales discounts. Portfolio-level or product-line pricing approaches do not fully capture these dynamics.
Robust benchmarking — While benchmarks are widely available, often the data does not provide enough detail to support nuanced pricing strategies. Instead of a full distribution, most third party sources of external data focus on “standard” prices, presented as averages or medians. This benchmark data is often sourced via mystery shopping and only represents list prices, not the actual negotiated market rates.
For fuller competitive context and a window into price elasticity of customer demand, banks need to understand the full distribution of actual prices in the market — not only the average and median, but the 20th percentile, 80th percentile, etc. A variation of 5 percentage points above the mean in a 50-point dispersion is something quite different from being 5 points above the average in a 15-point dispersion.
Even richer context can be had by correlating various market price points with client attributes, such as sales volume and relationship size. Absent this context, banks often wind up discounting more aggressively than is warranted.
Client response modeling — Finally, banks do not sufficiently consider likely client responses when making pricing decisions. All too often, treasury management teams fall into practices and assumptions that take on a life of their own:
- Large, valuable clients are automatically considered to be price sensitive, reflexively offered the most competitive pricing via deep discounts.
- Pricing is tamped down over fears of attrition, overlooking the fact that the costs and complexities of switching often give clients strong reason to stay.
- Pressured by tightening competition, teams lose sight of the high value of services provided to clients and settle for a dovish posture on pricing.
In each of these examples, a reasonable concern got out of hand because it went untested against actual client response. In fact, there are specific and measurable variables that can be used to model potential client responses to price changes (Figure 3: Client Response Modeling). Many of these variables are based on data that already resides in many treasury management units.
A prime example is modeling potential switching costs. Some clients try to strengthen their hand in price negotiation by raising the possibility of switching their business elsewhere, but often that is not even necessary — scars from past experiences with lost accounts are enough to keep the TM sales team on edge.
But there is another side to the story. The bank has leverage in negotiations as well, in the form of switching costs. Relocating a treasury management relationship to another bank is a complex and expensive effort for most enterprises, with transitions costing up to $100,000 for a large commercial client and taking from six months to a year to complete. In the Novantas U.S. survey, it was surprising to hear 80% of respondents say they do not model client switching costs as one of their pricing decision factors.
While competitive pricing and deep discounts are warranted for specific services and clients, the lack of precision in treasury management pricing has limited the ability to capitalize on situations where banks do have
We have seen many instances where key clients are outright exempted from periodic price increases or even pricing reviews, largely on the basis of traditional business practices and spoken and unspoken concerns. These are not arguments to be won or lost. Rather, they are situations to be modeled, with data and analytics helping to inform management judgment and sales practices.
As commercial banks lean more heavily on their treasury management units for fee revenue lift, winning teams will be sure to review their pricing skills and strategies. In many cases there is much more analytic context to be had, including expanded market context; price elasticity of customer demand; models of client switching costs; and perspective on the extra value that advanced services provide.
As an advanced pricing framework comes into view, it provides further benefits in orienting the sales force, communicating and negotiating with clients, and managing overall field implementation, including discounts. For example, estimating the value of the bank’s services to the client — essentially putting a dollar value on the extra value represent in unique service capabilities, premium deposit rates and advisory support — can be helpful to sales officers in conveying the context for price increases to their clients.
To be sure, moving to a more robust pricing framework entails some level of effort and expense. But even net of transition outlays, precision pricing is still a top avenue for revenue improvement in commercial banking, providing both a lever for short-term lift and a long-term tool for managing competitive position and field execution.
Ultimately it is about maximizing pricing power relative to the valuable array of treasury management services already being delivered to clients.
Scott Musial is a Principal and Dave Robertson is a Managing Director in the Chicago office of Novantas. They can be reached at email@example.com and firstname.lastname@example.org.