Relationship-based pricing
Thought Paper
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Relationship-based pricing
The banking scenario across geographies has
witnessed a marked evolution in the last two
decades. With a hostile economic environment
in the backdrop, the industry has seen an
unprecedented growth in competition, from
both local and international players, and an
increasingly demanding customer base. The
constant pursuit to improve the bottom-line
has seen banks cutting costs by every possible
means on the one hand, and focusing on
innovation,
product
differentiation
and
continuously evolving market strategies on
the other.
This goes to explain the increasing popularity
of ‘relationship-based pricing’ - as a service
differentiator. Relationship-based pricing, in
its simplest forms, can be understood as a
personalised pricing paradigm which has at its
core the time-tested principle of ‘each customer
is unique’ – thus, basing the price on the
relationship shared with this unique customer.
Suntec, which is a pioneer in the field of
relationship-based pricing, defines it as,
“relationship-based pricing is a customer-centric
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Thought Paper
framework that helps financial institutions to
treat each customer uniquely, based on the
overall relationship value, with innovative
pricing strategies achieved by streamlining and
automating the pricing and billing functions
across enterprise. Relationship-based pricing
ensures that customers’ benefits and rewards
are provided based on total customer value.”
Banks have historically based the incentives
offered to customers on volumes, rather than
the total profitability brought by the customer
to the table. Transactions have been viewed in
silos, without a focus on the summary of
the overall transactions with the particular
customer. The rates for lending and deposits
have been traditionally determined majorly by
the competitive forces at play in the market,
without a consideration on how an individual
customer could prove to be more profitable
to the bank in the future. Thus in a way,
when it comes to pricing, the outlook of the
banks has been more short-term than long.
Relationship-based pricing stands to change
this outlook.
Increasing share of fee based income
Fee based income for the bank implies the noninterest based income. Examples of fee based
income would include fees levied for managing
checking accounts, safe-keeping services like
security vaults, fees levied on distributing thirdparty mutual funds, commission income on
products such as demand drafts etc. The share
of such ‘fee based income’ in the overall
profitability of a bank has been on the rise, as
compared to ‘interest based income’, which in
turn calls for the ability to manage and bill
traditional charges through innovative means.
Relationship-based pricing has a vital role to
play in this arena, enabling banks to devise
pricing strategies at the enterprise level, charge
customers based on their overall relationships,
offer fee-bundling options to customers etc.
The charge calculation could be based upon
various factors ranging from volume to location
to denomination etc., and also computed in
various ways.
For example, free limits could be based upon
the funds maintained with the bank, like 10
check transactions free per month if the
Quarterly Average Balance (QAB) or fixed deposit
with the bank is above INR 25000. Another
example would be that of tiered pricing,
wherein the QAB to be maintained would
depend upon the fixed deposit with the bank –
for a deposit up to INR 50000, the QAB
required could be INR 10000, a QAB of INR
5000 for deposit ranging from INR 50000 to
INR 100000, whereas, for a deposit in excess
of INR 100000, no QAB would be required to
be maintained.
Shift from product-based pricing to customer
centric pricing
During the period before the industrial revolution
the process of ‘selling’ was very much customer
centric, wherein bargaining and negotiating
formed crucial elements of every transaction.
‘Standardization’ stepped in with the industrial
revolution, and the focus shifted to mass
production and a standardized sales procedure,
leaving little room for any kind of face-to-face
negotiation which in principle is opposed to
the concept of standardization. And banks were
no exception to this.
However what is now seen is a marked shift
from product centric pricing to customer centric
pricing. The focus is shifting from basing the
price on product features, associated costs and
product specific margin to basing it on the
value perceived by the customer. Different
customer segments would perceive value
differently. A customer centric pricing approach
looks at understanding these different segments
and the value they place upon individual
products, and accordingly pricing the product
for each of the segments. It requires a constant
assessment of the product/service attributes
with respect to the perceptions of different
customer segments.
Product bundling
The art of product bundling could be best
understood by taking the example of McDonalds.
The strategy of selling ‘package meals’ as
opposed to individual burgers, fries and drinks,
results in an increased number of takers who
see the value of the subsidized package,
resulting in increased sales for the company by
selling the same burgers, fries and drinks.
Thought Paper
03
Product bundling involves combining various
products/services into a package, the cost of
which is lower than the sum of its individual
components. Thus, essentially it is a pricing
strategy. It helps in evaluating pricing scenarios
that meet the bank’s risk as well as profitability
goals. The development of such packages and
building marketing strategies around them
plays a major role in retaining customer accounts
and maximizing revenues generated from them.
Also product bundling is a strategy to launch
new products/services wherein they could be
bundled with other successful products/services.
For instance, in retail banking there could be
products bundled around savings account, loans,
investment products, offering discounted credit
cards, discounts on loan etc.
Building upon customer loyalty
Customer loyalty can be defined as “the result
of an organisation creating a benefit for a
customer so that they will maintain or increase
their purchases from the organization” (Anderson
and Jacobson, 2000). Building customer loyalty
no longer seems to be a choice for banks, but
a means of survival for building a sustainable
competitive advantage.
In the Harvard Business Review article that
presaged their book ‘Discipline of the Market
Leaders’, Treacy and Wiersema have asserted
that “companies achieve leadership positions by
narrowing, not broadening their business focus”.
The cost of retaining an existing customer is
certainly lower than the cost of attracting newer
ones. Given the growing dependence of the
banking industry on organic growth, building
upon customer loyalty has a massive role to
play in a bank’s growth strategy to increase
penetration. It is required of the banks to
continue to deliver high value to its high-worth
customers in order to feed this self-reinforcing
system. Banks are waking up to the fact that
they can no longer afford to have a short term
view measured by number of new customers
added, but need to take into account the long
term aspect, in terms of duration of customer
retention and total value generated.
Loyalty programs offered by banks have come
to play as a differentiator with respect to
competitors. In fact, present times have seen
loyalty programs become a commodity in itself.
The industry has been witnessing a gradual
shift towards value-oriented loyalty programs,
wherein the focus is no longer on discounts
offered on a single transaction, but instead on
a bouquet of services/products being made
available as a part of product bundling. This
has led to the development of smarter pricing
mechanisms, ensuring a win-win situation for
both customer and bank. The benefits being
offered to the customer could be a mix of hard
benefits (for instance, discounts and rebates)
and soft benefits (for instance, freebies such as
discounted air travel).
Holistic view of customer relationship
A 360 degree view of the customer’s overall
relationship with the bank is crucial for it to
be able to customize its offerings accordingly.
The customer’s dealings with the bank across
different lines of business need to be taken
into consideration, so as to arrive at the overall
revenue generated, and future potential.
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Thought Paper
The demographic, transactional and wealth
information of customers, when viewed as
a whole would help build custom pricing
strategies. Efficient management of all the
historical disparate data would be the first
step when aiming to achieve the benefits of
such holistic view.
Technology as an enabler
Relationship based pricing relies upon the data
mining, analytics, simulation and CRM capabilities
of modern-day banking applications. To gain
the maximum value out of relationship-based
pricing, there needs to be a comprehensive
platform with access to real-time data instead
of individual disparate applications catering to
different lines of business/segments/channels
etc. The solution is required to be scalable, able
to plug in revenue leakage, flexible and nimble
to enable the bank to cope with the growing
challenges and be able to differentiate its
products and services.
Conclusion
Banks have been criticized in the past for
treating customers as mere account numbers.
However, in the face of a growing number of
challenges, banks have come to realize the
importance of leveraging their relationship with
customers to achieve true customer centricity. A
focus on building long term relationships with
customers is most certainly coming to become
the way forward. And personalization of services
is key for the bank to build this long term
relationship and gain an edge over its competitors.
Thus, ‘relationship-based pricing’ is poised to
become a leading strategy in the bank’s arsenal,
in its quest to gain competitive advantage.
References
1. Cross, R.G., Dixit, A., 2005, Customer-centric
pricing: The surprising secret for profitability,
Business Horizons [online], Available at: www.
revenueanalytics.com/pdf/Business%20
Horizons%20Article%20(vol%2048,%202005).
pdf> [Accessed 10 April 2012]
2. Kim, M., Kristiansen, E., Vale, B., 2001,
Endogenous Product Differentiation in Credit
Markets: What do borrowers pay for?, Available
at: www.bis.org/bcbs/events/oslo/valekimkr.
pdf> [Accessed 10 April 2012]
3. Yadav, M., Capture and communicate value
in the pricing of services, The Journal of
Professional Pricing [online] Available at:
members.pricingsociety.com/articles/Captureand-Communicate-Value-in-the-Pricing-ofServices.pdf> [Accessed 10 April 2012]
Pradnya Prakash Jadhav
Senior Associate Consultant
Thought Paper
05
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