Bank Technology News, Profitability: When is the Price Right

BB&T's new price optimization strategy bodes well for optimizing profits

Bank Technology News, December 2006, by John Adams - When it comes to setting prices for financial products, you can never have too much data to help make your decision.

"You bring as many variables into place as possible," says Dan Rozelle, vp and product manager for the sales finance division of BB&T. "We're not operating in a vacuum. We want to know who in a specific market is dominant, or has success at a certain level, and what their rates are and what their volume is."

Rozelle's unit, which handles mostly auto finance, is in the midst of deploying new price optimization technology. The goal is to vastly expand the variables taken into account, ranging from credit risk to demographics to the competitive and regulatory landscape. The goal is to determine the best (highest) price possible-a little more and people get turned off, a little less and you're leaving profits on the table. The strategy may be called "price" optimization, but that's not really what it's about. "When you're talking about price optimization, it's a resource mainly for profit optimization," says Rozelle.

With margins thinning as competition broadens among financial services firms, charging the right price is more important, and more complex, than in the past. Simply looking at what competitors are charging and trying to boost business by shaving a couple of basis points may not be enough anymore; that's because the story behind a competitor's prices is another piece of intelligence that can go into your own pricing strategy. "When we see competitors that are suddenly dropping prices when they've been mostly raising prices, that means they are losing business, and they're trying to come back with lower rates," Rozelle says. "We try to analyze all of our competition and market share elements as well as the composition of the book of business that we're buying."

At the heart of BB&T's new pricing strategy, which is currently in pilot phase, is the concept of elasticity, or that magic tipping point where a price becomes too much for a consumer. For the institution, that point is arrived at via a rate sheet that it shares with its dealer clients. The rate sheet includes about 80 different data points ranging from credit scores to the age of the vehicle to the make and model of the car.

"Elasticity can be based on the term of the loan, its elements such as size, the borrower's economic situation, the channel they're using to apply for the loan, among other factors," says Robert Phillips, CTO and vp of services for Nomis Solutions, which sold its pricing platform to BB&T's auto finance unit. Phillips says the combination of individual metrics with broader demographics create a multi- dimensional view of a customer.

"We also leverage lost loan data; people who applied for a loan and didn't get one, and the impact of customer attrition and rates of default on pricing," Phillips says. The product also offers a dashboard for pricing that managers can use for "what-if" scenarios.

Rozelle says that by moving beyond old-school pricing strategies and adding a multi-dimensional view of what customers will do as prices are increased or decreased, a better view of the overall marketplace emerges. "You can start to focus on a particular component of the pricing matrix, so that a small move in a certain area may have a greater impact than a large move in another area."

Price optimization has ramifications for almost all financial products, from auto loans to credit card rates to mortgage products, though it's still in the early stage of adoption for most firms. It's starting to catch on, since research is emerging that points to room for improvement in pricing across financial products.

In August, BenchMark interviewed executives responsible for setting prices at the largest North American banks, with 15 of the banks representing 81 percent of the home equity loans that are booked in the United States.

Of the 22 total banks that were surveyed, 100 percent of home equity lenders believe there is room for improvement in their current pricing practices, 73 percent plan to improve pricing practices in the next two years and 50 percent are in the process of evaluating price optimization products.

The survey also revealed the shortcomings of pricing strategies most often deployed by home equity lenders at the present time-a mix of competitors' prices and customer risk. In most cases, BenchMark says, lenders are not considering the price-responsiveness of different customer segments to different products when they are setting prices.

Ignoring the different preferences of different customer groups is often where current pricing strategies go astray, market researchers say. Financial firms often act as if everyone responds to changes in price the same way, which most researchers say is a mistake.

During a recent Webcast, TowerGroup research director Kathleen Khirallah outlined how existing pricing processes are "broken." Among the problems is the "one-size-fits-all" approach, in which pricing recommendations are made at the product level and are based on intuition.

Khirallah also points to the manual gathering of competitive rates, inaccurate cash flow projections, pricing decisions that are rarely audited, and the manual dissemination of rates as all troublesome to pricing strategies.