LAKE FOREST, Ill.—Although it seems counterintuitive, one well-respected analyst is urging credit unions to reduce fee prices, especially on overdrafts, and loan rates in order to boost profitability. It may be CUs’ only “ticket to success.”
Moreover, that same person said many CUs are being handicapped by legacy processing systems that hinder their ability to make effective pricing decisions.
Mike Moebs, the economist and CEO at Moebs $ervices and the author of five books on pricing, says credit unions need to take these steps and others to be in a strong position to compete as regulatory pressure from Dodd-Frank increases and competition from new, alternative low-cost financial services providers continue to impact banks and credit unions.
“Only the strong will survive the coming changes in regulation dealing with price and regulatory standards on capital,” said Moebs. “Volume and cost strategies using price will be the ticket to success in the next few years.”
Two Keys
Moebs believes that credit unions will accomplish two key things by lowering price. First, the move will force them to lower their operating costs and become more efficient, with streamlined approaches to lending and account opening playing important roles – both areas of numerous CFPB consumer complaints. That will position credit unions to compete effectively with new players like Walmart and Lending Club.
Credit unions will also benefit from increased volume and deeper relationships driven by the more competitive pricing.
Moebs cautioned that despite the Fed’s intent to raise rates before the end of the year, the economy is not bumping along well. “I don’t care that a lot of economists are saying that we are out of the Great Recession. GDP is still only 2%-3%, maybe 4%. When the economy was doing well GDP was 6% to 7%.”
Moebs also warned that credit unions have yet to feel the “full effect” of Dodd-Frank. Without a doubt, he said, the challenges of the Dodd-Frank Act rank number one for credit unions and all financial institutions.
“The obvious challenge is the additional cost of compliance that is built into financial service prices and impose an unnecessary financial burden on both credit unions and members,” said Moebs about Dodd-Frank. “The most concerning challenge is the potential threat of the government or its agencies to determine the price for a loan or deposit in the marketplace. While it is not impossible, it is very difficult to avoid or mitigate the complications of governmental price control in financial services.”
Alter Playing Field
To make that possible, Moebs emphasized there are two pricing approaches a credit union can consider.
“The first is to alter the playing field with different pricing measurements. In the financial services sector today the U.S. Government is trying to establish price restrictions on financial transactions with proposals by the CFPB in checking, prepaid cards and overdrafts,” explained Moebs. “Avoiding these proposed price restrictions by charging by account price, not transaction price, is an example of changing the metrics and one potential solution.”
The second way around price controls is developing a “gray market,” he said.
Michael Moebs, Moebs $ervices
“A gray market is the distribution of goods or services through channels that are legal – but unofficial, unauthorized, or unintended by government,” said Moebs. “‘Shadow banking’” is a form of gray market pricing. What Starbucks, Apple Pay, PayPal, and Walmart are doing in the payment or checking arena is a gray market – bypassing government payment systems legally. The companies operating in the gray market are taking business and accounts away from credit unions. Credit unions can compete in the gray market with Walmart and others by reducing costs, reducing price and focusing on value and relationships.”
Moebs believes that many of the operating systems credit unions use will not help them address their changing pricing needs.
“Many use legacy systems with static, one-dimensional processing structures that are dated and difficult to program to meet the needs of today’s pricing purposes,” said Moebs. “There are new, superior operating systems with open architecture that can accommodate dynamic price designs. However, this is the exception and not the rule.”
The pricing/technology problem only gets worse when confronted with more complex pricing for checking accounts and consumer loans, said Moebs.
“Now is the time to review IT and payment systems to develop a strategy to meet the pricing demand on today’s financial services,” he said.
Basic Economics
Moebs said in basic economics there are 24 formal price strategies and tactics, ranging from relationship pricing to “fractional pricing.”
“No more than a handful are employed by a credit union at any given time for a particular service such as a car loan or share deposit,” observed Moebs. “Factors such as growth, profit, marketing, costs and price management will influence these strategies and tactics. Also, economic, regulatory and local market pressures will influence and change price strategies and tactics.”
Moebs noted that in recent years relationship pricing and cost pricing strategies have dominated the financial marketplace. At the same time, many credit unions have struggled with their bottom lines in order to achieve higher capital standards, he added.
“Relationship and cost strategies work well with volume and institutional risk strategies. To ease high costs, credit unions offer price concessions by promoting one service, like free checking—which loses money—with another service, such as a vehicle loan—which is profitable—in order to have a profitable household relationship,” said Moebs. “The multiple accounts that result from this increased volume drives down cost and risk. The combination of more services to lower costs works well when done right. This is why many community and mega-banks have moved to relationship pricing and cost pricing strategies, while dropping free checking and single-service households.”
But Moebs said there are potential pitfalls with relationship pricing and cost pricing.
“Relationship pricing only works if the credit union sells. A major problem with many credit unions, and banks too, is they react to consumers, but do not sell. And, many credit unions use costs developed from quick ‘back of an envelope’ estimates,” offered Moebs. “Often these calculations consider only direct costs and risk cost, and not overhead cost and indirect cost.”
Steps To Take
Moebs outlined pricing tactics credit unions can use:
1. Fees vs. rates vs. balance: “This is a pricing tactic more and more credit unions are using. An example would be a vehicle loan. A low-priced vehicle loan can have a very low rate or yield by allowing members of different risk or budget levels to buy down the rate with a fee or provide compensating balances with a larger loan or deposit.”
2. Fractional pricing: “This is a tactic used by retail merchandisers for years. Few credit unions use this tactic. Will a loan rate sell better at 3% or 2.98%? Often the loss of a few basis points is minor in contrast to the volume which can be generated by the perceived low price.”
3. Penalty pricing: “This tactic is often used to discourage the use of the service. Many credit unions charge a high price for an overdraft above the national median of $30, pricing an overdraft like a parking ticket – high. This penalty pricing tactic is so overly used that it is now causing problems with regulators as well as consumers. An alternative is to treat the overdraft as a safety net, with lower price, and to gain revenue with more volume and more satisfied members.”
The key to action in pricing for Credit Unions in 2016, Moebs said, are “margins will be influenced by Fed changes in rates but these changes will be absorbed by credit unions very quickly, so profitability will be determined by cutting costs offset with fee and balance sheet tactics driven by volume and cost price strategies.”