Wednesday, 10 February 2016

Challenges to implementing dynamic pricing in financial services

Legacy IT systems

The roadblock to real pricing execution lies in bank legacy core systems. Just a reminder, legacy systems are costly. A study by IBM suggests that rigid legacy systems cost the industry $200 billion annually, and siphons off roughly 20% of pre-tax profits. 

Let that sink in for a moment. 

One reason legacy systems are so costly: pricing resides in the core, and each product (or iteration of a product) price is hard coded. Any optimised price based on market, vertical, geography, or regulation is considered a 'new' iteration of that product, and in legacy core systems, each iteration has to be hard coded – not just in the core, but in multiple systems from the CRM all the way through to the billing system. 

Legacy systems are an impediment to real-time pricing precisely because of the hard coding requirement, and the heavy dependence on IT teams to make those changes in multiple systems. 

Dynamic pricing demands a shift from hard coded pricing and legacy systems to a real-time, business user initiated pricing that takes the price change, that single data entry point, and automates the change in all the up- and down-stream systems. 

The other impediment to relationship pricing is siloed systems, both product and business line, that obfuscates a single view of the customer. 

A true customer relationship price reflects all of the products, regardless of business line, that a customer has. Current banking silos prevent a full view of the entire portfolio across business lines. Let’s take the example of customer who has a DDA/current account, with savings and money market, who also has an SME accounts receivable/payable service. Relationship pricing would dictate that both the personal and business accounts be factored into the final bundled price. Relationship pricing can also be use to incent that customer to bring more wallet share to the bank by offering better terms or additional services like an IRA or HELOC, or payroll, term deposits or lines of credit – especially when that pricing takes both sets of accounts into consideration. 

This extends to householding relationship pricing. Take the above example, now add in a partner who has a personal account, and needs a small business account. Mix in a college age child who has an account, but also needs a car loan. If all of those additional accounts (read: revenue) aren’t being serviced by the primary bank, offering relationship pricing at the household level provides incentive to bring that wallet share to the bank. In true relationship pricing, all of those accounts ought to be considered. Siloed systems prevent that meta level view of the customer, the household, and that potential wallet share. 

Status quo mentality 

System silos are paired with profitability silos: where product and line of business profitability are seen in singularity, and customer profitability is difficult to gauge. These profitability silos are also an impediment to dynamic pricing, and any movement towards real relationship pricing requires breaching these P&L silos. 

Product lines, and product-centric offerings, make for easy accounting, but they also limit long term profitability when seen in isolation. The shift to customer-centric product bundles based on relationship pricing will take time, but it’s crucial to capturing a customer based willing to fragment their service providers to get the service they need and want. Banks who want to be the single service provider for a customer need to prioritise holistic offerings over single product profitability. With relationship pricing, that holistic offering still provides revenue streams and profitability, in aggregate. P&L needs to be customer oriented, not product oriented – and it’s this shift that will bolster banks’ reputations back into good standing. 

Clearing the hurdles

That makes sense, you say, but I’m stuck with a legacy core system – what the devil am I supposed to do about that? 

Modernise the core, I say – the case for which I have laid out before. We could discuss the merits of a full replacement, but since that solution is not always in the technology roadmap or budget, let me suggest a simpler way: remove pricing from the core. Full stop. 

Componentized functionality that sits outside a core system is the most flexible setup. Put in a rules-based pricing engine that tells the core what to do. Create a middle layer that insulates the core from all that incoming traffic, like a roundabout, where the pricing engine points the right data to the right systems and the core simply gets to keep track of debits and credits as it sits calmly, serenely on its perch in that roundabout island. 

It’s a facet of the Modernisation-in-Place approach (MIP), the virtues of which have been extolled already. MIP is like renovating a house, one room at a time. You still live in it while you fix it up. The core gets modernized in stages, each functionality componentized in turn, increasing in flexibility until it mirrors a modern, open-architected core. Let me suggest that pricing be the first component to get upgraded. 

Building on value

Dynamic pricing will become a de facto strategy in financial services, its slow embrace is merely a result of legacy systems standing in the way of a full and fruitful relationship. Legacy systems cannot be an excuse either. Considering they hemorrhage away revenue and profits, investment in fixing the plumbing is justified, obviously so. 

Fully embracing a dynamic pricing strategy comes down to planning which route to take to core modernization. It’s a simple choice, and true, the road is rocky and it can be rough going in patches, but the destination is in site, and the journey worth it, for both banks, and the customers they serve. 

This is the second part of a two-part blog about dynamic pricing in financial services. Click here to read the first part.

Director, Global Strategic Business Development & Marketing, Zaifn

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