MarketSim Product/Pricing Lecture In Bank Training – Invest in your best.

MarketSimProduct/Pricing Lecture

In Bank Training – Invest in your best

2

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

4

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

7

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

99

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

10

MarketSim Funds Transfer Pricing

Term

RateLoan Margin

Deposit Margin

11

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

12

REFERENCE RATESUnderstanding Competitors

13

• 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

14

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

14

Reference Rates

15

Reference Rate Differences - MMDA

8

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

16

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

17

PRICE ELASTICITYUnderstanding Customers

18

Price Elasticity

19

Lower(more incentive)

More

Higher(less incentive)

Less

Price

De

ma

nd

Price Elasticity

20

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

21

ProfitabilityProfitability

FTP RateFTP Rate

Elasticity of

Demand

Elasticity of

Demand

Rate

Balances Optimal Price

Points

Optimal Price

Points

Net Income

Price Elasticity

22

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

23

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)

24

THE IMPORTANCE OF FENCESImplications of Product Design

25

Higher

HigherLower

Lower

Product Design and ‘Fences’

Pricing Product Design

RealizedPrice

ValueProposition

Pricing is always a trade-off with product design.

26

Less

Pri

ce

Product Value (Features)

Higher

Lower

More

More Feature Value, Higher Price

Chevy


Buick

Caddy

27

For example access vs. price

Access

Rate of Return

Non InterestChecking

InterestChecking

Zero

Unlimited

Savings/MMAs

3-12 Month CD

>1 year CD


28

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


29

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



SecondClass

SecondClass

SecondClass

SecondClass


30

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


31

RELATIONSHIP PRICINGFuture State of Pricing

32

Relationship Pricing

32

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

33

Examples

33

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

34

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

35

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

36

• 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

37

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?

44

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?

MarketSim Product/Pricing Lecture In Bank Training – Invest in your best.

Documents

Transcript of MarketSim Product/Pricing Lecture In Bank Training – Invest in your best.