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To Have and To Hold: A Look at Relationship Pricing

February 4, 2021
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I’ve been using the same satellite TV provider for about 15 years. From that you can safely infer that I’m a loyal customer. But in this case, my loyalty isn’t why I keep my current satellite service. As a matter of fact, I have no more affinity for my current provider than I do for any other cable or streaming service. No, the only reason I stay is because my provider has a relatively exclusive relationship with the NFL, and I’ve been a football fan since I could walk. That’s it.

That’s why I stay. In order to get week-in, week-out access to my favorite NFL team, I need to subscribe to this add-on service and, frankly, it’s not cheap. But each year I get an email from my provider reminding me that my subscription is about to auto-renew. And I let it. Did I mention that I’m a football fan? Did I mention that I’m a displaced football fan? I am far, far away from my favorite team’s primary, secondary or tertiary markets, so a service that allows me to watch them every week, from the comfort of my living room, is required for someone in my situation.    

About five years into my relationship with my provider, I saw a promotion they were running for new customers: All subscribers would be given one subscription to this otherwise expensive NFL add-on FREE! Wait, what? Free? Here’s where I get a little sideways; I’ve been a loyal, pay-on-time, no-fuss customer for a long time. Why haven’t I ever been offered a free year of this subscription? Why doesn’t my provider value the long-standing relationship they have with me? And I’m certain there are a lot of other customers of this satellite provider in the same boat who probably feel the exact same way I do.

What I’m asking for is referred to as relationship pricing, and obviously the powers that be at this satellite TV provider don’t feel like a relationship pricing model would benefit the bottom line. In all fairness, they may be right. It’s not a model that fits well in all industries, but financial services is certainly one where it not only fits like a glove but has been proven to work.  

This isn’t revolutionary, and it isn’t rocket surgery.

Relationship Pricing Is Nothing New

The premise is simple: Loyalty, longevity and use lead to rewards, preferred pricing, discounts and all other manner of swag. A relationship pricing model examines the overall accountholder relationship to determine the cost of services and profitability and provides a variety of incentives to encourage cost-reducing accountholder behaviors, such as using digital and other self-serve channels. This, in turn, helps financial institutions use the relationship and activity data to define fee pricing, cash-back/bonus-interest rewards and improved interest rates.

Why didn’t I think of that! The fact is, the concept of today’s relationship pricing has been around for a long time. Anyone remember Green Stamps? Green Stamps originated in the 1930s by S&H (Sperry & Hutchinson) and were one of the first iterations of a rewards-based relationship pricing model. Each time a customer bought groceries, for instance, they would receive Green Stamps at checkout. The stamps (they were actually identical to postage stamps), were pasted into books, and customers could redeem these books of stamps through a catalog. Voila!

Airlines were another early adopter of relationship pricing and have been offering rewards miles for years. The more you fly with a particular airline, the more miles you earn. Accumulation of miles leads to “status” levels, and each status level provides travel perks such as seat upgrades and inflight discounts for products or services such as Wi-Fi. Or you can use miles in lieu of cash to purchase additional flights.

Where Data Comes Into Play

Today, these same rewards programs are alive and well. Stamps gave way to loyalty cards with barcodes that track consumer purchases and offer product discounts based on use. And we can’t have this conversation without mentioning data. A study by Economist Intelligence Unit and IBM’s Institute for Business Value suggested that 90 percent of the world’s financial services providers recognize the need for transformation in pricing processes, methodologies and use of client data. In other words, relationships need to drive pricing. 

Regardless of exactly how they’re structured, relationship pricing models have a long track record of proven success. As far as their impact in the financial services space, a 2002 study conducted by Callahan and Associates found that relationship pricing was a successful method for increasing services per accountholder, generating more profitable households and accountholder segments, and enhancing retention. Recently, Raddon did a case study on a small mid-southern credit union client that implemented a relationship pricing model. The credit union’s goal was to “encourage participation in the cooperative to cover rising operating costs and reward valuable members.” After rolling out its new plan, the credit union saw increases in assets per full-time employee by 21 percent, services per household by 11 percent and deposit balances per household by 26 percent.

Relationships Lead to Longevity

So why relationship pricing and, specifically, why now? Consumers want it. According the Bank Administration Institute, 52 percent of consumers feel as though their financial provider should reward them for longevity.

Let’s stay with the longevity theme for a second, but let’s refer to it as retention.  

Most financial institutions spend considerable time and expense on acquisition of new accountholders, and when we at Raddon query our clients, growth through new customers or members is usually one of the top concerns. But in this new financial world of online banks, neobanks, online lenders, big tech and the list of usual suspects, keeping existing accountholders and increasing their share of wallet – both loan and deposit – is becoming increasingly predicated on relationships and value to the consumer.

Now, I’m not suggesting that acquisition efforts should be curtailed, but maybe financial institutions should start paying a little more attention to what’s currently in their bucket and, more specifically, what flows out.

Let’s stay with the bucket analogy for a minute. You have a bucket, and as you are filling your bucket with water (customers/members), you notice a leak near the bottom. But you need a full bucket, and regardless of how hard you try, it just won’t stay full. In your attempt to keep your bucket full, you can either: 1) boost the rate and volume of water you are adding to the bucket (acquire), or 2) somehow decrease the amount of water that is flowing out of the hole in the bottom of the bucket (retain).

Decreasing the outflow, first off, heightens the impact of a static inflow while at the same time decreasing the need for more of it. In other words, if you aren’t super successful at generating new accountholders, retaining those you do have makes that less detrimental. Secondly, the cost associated with slowing the outflow (retention) is five to six times less than the cost of filling the bucket (acquisition).  

So, yes, financial institutions need to spend more effort on retention, and relationship pricing is one way to do that.

Relationships Help With Stickiness

In addition to the retention piece, relationship pricing also increases cross-sales. Cross-selling and getting more products and/or services in accountholder households makes the relationship “stickier” and less likely to leave. Stickier? What the heck does that mean? Let’s put it this way; according to research by Khalid Saleh, existing customers are 50 percent more likely to purchase additional products and spend 31 percent more, compared to new customers.  

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Furthermore, more products per household equals more profitable households and less overall subsidization across the accountholder base.

The chart below illustrates how profitability and accountholder efficiency are impacted by depth of relationship.

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And now is the perfect time to implement a relationship pricing model in an attempt to retain some of the dollars that have been parked in liquid accounts. Over the past two Performance Analytics cycles (June 2020 and September 2020), Raddon has seen a sizable jump in the average deposit share of wallet as many consumers have attempted to safeguard their money in these uncertain and volatile economic times.

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While we’re on the topic of profitability, a well-formed relationship pricing model identifies nonprofitable accountholders and serves to either engage them or start the process of attrition, thus reducing overall subsidization.

What’s the Catch?

If there is so much potential value in a relationship pricing model, then why isn’t it more widely used? What’s the catch?

A true relationship-based pricing model is complex with many moving parts, so let’s start there; it’s hard to implement and presents challenges in tracking adopters. Again, it involves rewarding accountholders, in some way, for having certain products and services, balance thresholds, or number of transactions. These activities cross the entire expanse of a financial institution’s departments. Coordinating and exchanging information necessary to identify accountholder activity, particularly in a siloed environment, is difficult. In that same vein, ownership of the program becomes an issue, and without a true champion behind the effort, the model will undoubtedly fall short.

Speaking of which, unrealistic expectations have probably been a big hurdle with many institutions. Relationship pricing is not a marketing campaign. It is, or should be, a culture, so to speak. As with any cultural shift in an organization, it’s a long-term prospect that requires buy-in at all levels. As well, implementation carries some expense that many simply can’t stomach. Depending on the depth and breadth of the model, these expenses could include new technology and systems, training, new processes, and promotional costs.

Of course, there must be a cost/benefit analysis performed to see if a relationship pricing model fits, but we know it works. We know consumers feel it’s important, and we know financial institutions have data you should be using to deepen your relationships with customers or members.  

After all, you’re in the relationship business.