From 2006 through 2007, for the first time in U.S. history, credit unions experienced average net interest margins on loans running below operating expenses. In 2008, a poll of over 100 credit unions found their top concern was decreasing profit margins, partially due to their tendency to asymmetrically lower loan rates more rapidly than raise them in response to market changes.
Central to the recent difficulties experienced by credit unions is their inability to use a professional, noninterest pricing strategy to compensate for the ongoing decline in interest margins. Although credit unions often offer superior financial security–a key customer decision criterion in today's turbulent times–they still overlook opportunities to professionally manage their noninterest income.
We strongly advise credit union managers to professionalize the way they determine rates and fees. In today's highly competitive markets, pricing is by far the most important profit driver, much more efficient than efforts to reduce cost or increase market share. The key to benefiting from pricing is diligent adherence to a structured pricing process that can be broken down into three steps: transparency, intelligence and execution. Combined, these steps will help credit unions fully exploit their income potential by determining a clear pricing strategy, optimizing rate and fee levels and structures, and properly enforcing fees in the market.
Transparency is first a matter of clearly defining pricing objectives: surplus growth versus membership or asset growth with clear distinction across segments and products. Once these goals have been defined, managers should determine where they want their price positioning to be relative to the market while considering members' perceived value of their products. Currently, many credit unions offer a better value (in terms of product offering, member service or accessibility) than their banking competitors, but their pricing is inconsistent with this superior value delivery. Once target positioning and strategic goals are defined, management must develop pricing guidelines that explicitly communicate the union's pricing philosophy and objectives to product and relationship managers.
Secondly, it is essential for credit unions to develop clear visibility on how profitable their portfolio is on a product-by-product and member-by-member basis. A thorough categorization and analysis of product and member data is required. It is often found that a substantial number of member relationships have an overall negative effect on income. Furthermore, often there is not even a positive correlation between a member's assets or product usage and his or her impact on the health of the union. This can be due to inappropriate pricing structures or levels or poor enforcement of fees by relationship managers.
Creating intelligent pricing first requires designing rate and fee structures that mirror members' needs and psychology about prices. A prerequisite is to segment members using both quantitative (assets, product usage, deposit balance, etc.) and qualitative (life stage, focus on relationship versus. focus on transaction, etc.) criteria. After having mapped the different segments and their specific needs, the most powerful pricing structures to be created are those which set incentives for increased product usage and thus ultimately improve both member satisfaction and the credit union's income. We have successfully introduced such pricing schemes in many projects for credit unions, often using a combination of nonlinear pricing, bundling and/or multiperson pricing. In one typical case, implementing a new pricing structure, which consisted mainly of offering a new set of needs-based payment bundles for retail and commercial clients, led to a 60% lower churn rate, a 10% improvement in client satisfaction and a 25% increase in revenue for those members who selected one of the new bundles
Determining optimal price levels is the next step and requires credit union executives to precisely understand members' price elasticity, a measure of the sensitivity of volumes to rate or fee changes. Elasticity can be determined using a variety of methods, including historical data analysis, price experiments and expert judgment. For example using the knowledge of front-office teams to anticipate members' reaction to different price levels. However, the most powerful approach is conducting member surveys: members of credit unions are usually very open to such surveys as they have a relatively close relationship with their credit union.
Finally, a professional pricing process accounts for nothing if it is not implemented properly. Credit unions must ensure that pricing goals are achieved and price levels are enforced. Very few of them currently have a compensation system that rewards pricing performance, that is, the ability of their sales staff to enforce target rates and fees (and possibly outperform their pricing objectives). To more easily track pricing achievements and set new measures when needed, price monitoring tools are also required. We often observe that credit unions do not monitor prices with the same diligence as costs (as is the case with many other financial services institutions).
The current market crisis is giving credit unions even more reasons to be concerned about their financial footing. Times like this show how important it is to ensure consistent and profitable streams of revenue; smart pricing is the most reliable way to do that. Taking an analytical, data driven approach to pricing and developing member-centric strategies that are enforced and monitored will pay marked dividends and help to ensure continued financial health for the members' benefit.
Jens Baumgarten is the man-
aging partner of Simon-Kucher
& Partner's New York office and head of Financial Services
North America. He can be
reached at 646-512-5723 or [email protected]
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