Because of the feedback we received from an article Dallas wrote on the difference between price setting and price getting, he decided to talk through the concepts with Jessica Stone in this week’s podcast.
According to the research of Stephan Liozu, author of “The Pricing Journey“, there are two dimensions of pricing capability, Price Setting and Price Getting. In order to excel at pricing, companies must master both dimensions.
Dallas explains how price getting covers people and process issues, but it essentially boils down to one question. How good are we at actually booking that price after we set it? What many banks are now figuring out is that they can’t just “out-math” the competition. It does no good to be really great at setting prices if we end up having to discount to get deals on the books, or losing deals because we couldn’t find a creative way to make it meet our targets.
Hi, and welcome to Lender Performance, your guide to becoming a better lender. I’m your host, Jessica Stone, Director of Client Success here at PrecisionLender, and I’m joined by Dallas Wells, our Executive Vice President of Banking Strategy. Thanks for joining us. Today we’re going to talk about price setting versus price getting. This is a topic that Dallas has written about on our blog recently, so we’re going to dive a little bit deeper into that. Dallas, let’s start out with talking a little bit about what those two entail: price setting and price getting.
Sure, so where this topic comes from is as we implement our tool, our loan pricing and possibility tool in banks, we really struggle with sometimes differentiating between the things that really need to be done. On one hand we have the price setting, calculating the right number, and on the other hand, how we actually get that price on the books, to all the process stuff that goes with it. As we’ve dug into some resources for this, we found that surprise, surprise, we’re not the first ones that have dealt with this problem. In fact, this is not just a banking thing. Lots of industries and struggling with pricing, and especially as organizations get larger and more complex.
I think that that fits the bill in just about every bank over the last few years, added complexity. This goes from a small, manageable thing that you can kind of deal with by sitting around the table and hashing through it, to now we have to have all these systems and processes in place. It’s really gotten away from a lot of banks, to where they feel a little bit lost with it, and what we find is that a lot of times they’re focusing the fix and the resources on the wrong thing. That’s really kind of where this came from, is first let’s just lay out that basic concept that there are two dimensions to actually efficient, successful pricing, and the bankers tend to only focus on one of those two dimensions. That was the purpose of it was to just really dig into this.
Dallas, can you talk a little bit more about really what price setting and price getting entail for some folks that might be familiar, but it might be helpful to give a review.
Sure. The easy one is price setting. Price setting is just the math. It’s how we come up with what the number is to charge for any particular deal in the bank. Bankers are comfortable with this one. It’s quantitative, it’s math-based, and there’s some analytics to it, and bankers tend to be really comfortable digging into that stuff. It’s also where they have the most resources. If you go to a conference, you can always find something about how to set better prices and there’s lots of stuff to read on the Internet about it, so that tends to be the easy one. Now, just because it’s the easy one doesn’t mean that everybody’s good at it.
I think we’ve all run across banks that are really bad at it. Any bank you talk to, in any market, they can point to the bank that’s no good at this, where they’re the ones that are always coming at a less deal with some crazy looking price. There’s still work to be done there, but the purpose of the articles in our research on this is really to get into that second piece, which is price getting. Once you do clean up that price setting part and get that foundation right, how do you actually get that price on the books? The price getting is all the people and process stuff that’s behind getting those prices on the books in an efficient way.
That’s the part that’s really hard. That’s the part that takes some pretty big organizational change. It takes some cultural shifts sometimes. It takes some training, and it takes these big cumbersome organizations all getting pointed in the same direction. Price getting, when you get right down to it, is very much a journey. It’s not an overnight change. It’s not like price setting where you can just fix your methodology and maybe have a tool that calculates it for you.
Price getting is this constant battle of keeping that organization pointed the right way, keeping people consistently pricing how they should, and the markets always in flux. Things are changing around and your staff is changing, the organization’s strategy is changing, so we have to react to all that. The initial step of just understanding that there’s more to it than just setting the right price. That’s really what banks are starting to figure out, and the ones that are doing really well at this have started to figure out that price getting part. The ones that get good at that have a huge competitive advantage.
That’s great. Yeah. In the blog you point out that it’s so important that if you don’t really properly tackle the price getting, that any work you put into the price setting is really for nothing.
Yeah. The simple example is, and we’ve all seen banks like this and heck, probably worked for a couple of banks like this, and we see them a lot in our clients, especially when we first get them, these really sophisticated models. A lot of the times they’re built in-house. It’s a giant, elaborate spreadsheet that somebody’s poured hours and hours of their life into, and it calculates this pretty sophisticated number. The problem is is nobody ever actually gets that number. The deal’s never actually priced there.
We see this in a lot of the larger banks, where they’ve got an entire team of analysts who are coming up with capital allocation and the right funding curves, and the put-in premiums, and they spend months arguing over which interpolation method to use as they build their funding curve. Then they roll it out and the lenders see the number and then come back and say, “Well, I tried to get that, but I couldn’t. The competition was just too tight, so I priced it at LIBOR plus 200, or I priced it at prime.” They just pull a number out of thin air, and it’s because we don’t have all that organizational stuff in place.
The numbers are out there, and they’re well thought out numbers, but it’s all theoretical, and that’s where you start to get the clash between, we term it as the front of the bank and the back of the bank, the front of the bank being the customer facing, producing folks and the back of the bank usually being the financing, credit staff that have put those numbers together. If you don’t bridge that gap, and fix that disconnect between those two sides, you’re really always going to be at odds with this and really struggling to get real performance out of it.
Dallas, in your blog post you talk about some categories that banks might fall into based on how good or bad they are at the setting versus getting. We’re going to walk through a couple of those. Let’s start with the reckless gunslingers. These are quite the names, and that’s who fall, who aren’t really great at the setting or the getting. Can you explain that a little bit more?
Yeah, so these are the banks that they take pricing really just off the cuff, and they kind of make it up as they go, so they’re a dwindling breed quite frankly, because they fail a lot. There is a lot of things around that, they raised money in ’03, ’04, ’05, and put together a bank and then their goal is just let’s just grow the heck out of it. The way they priced was they just figured out what somebody else was charging and they charged a rate less than that. That was the strategy, and so they weren’t very good at setting the price. They didn’t incorporate the risk.
They ended up with a whole lot of high concentrations, development deals and speculative CRE projects and things that just ended up getting really ugly. They got a lot of that on their books because it was developed through everybody else, so they’re the ones that are guessing at the price, and then if the customer leans on them, they just discount it from there anyway. These are the dangerous ones. They’re dangerous to themselves and they’re dangerous to the other competitors in their market, because even if they are coming out of left field, it’s still a number that’s sitting in front of your borrowers.
You still have to recognize it and do something about it. That can be tricky, especially for those really strong credits that know they can shop around. They might get a really crazy deal that you really can’t compete with and you’re kind of stuck with it. The good news is if you’ve got some borrowers you aren’t thrilled about, point them their direction because they may be glad to take that off your hands for you. But they’re the dangerous ones and the ones that we have to watch out for, but I also think that most of them won’t be around much longer. A lot of them failed and then a lot of them are going to be picked off through acquisitions over the next few years.
Then the next section is, we call them the stubborn old mules, so these are folks that aren’t great at setting but are better at the price getting. Can you talk about that?
Yeah, and a lot of these you’ll find are family owned banks or more [inaudible 00:09:26] banks that have just been around for a long time. In a lot of cases their numbers look pretty good. They’ve been profitable for a long time, they don’t have a lot of credit issues and they just kind of chug along doing what they’re doing. What you see a lot of times is that they’ve drawn their line in the sand and they’re not going to bend no matter what. I’ve worked for one of these banks at one point along the way. They just felt like if they thought a loan should be at whatever, prime plus two, and everybody else was willing to do it at prime, it wasn’t them that was wrong, it was the market that was wrong.
They were willing to just pass on those and say, “Sorry. We’re not going to budge. We’re going to make sure that we always get the price that we set out there.” Now, the problem is is that there’s not always a lot of sophistication in that pricing. A lot of times they’ll say things like, “Well, we’re never going to do a loan if we have to charge less than 4%. We’re never going to put a three hand [one alone 00:10:34].” I just talked to a bank last week that said that exact same thing. “It’s got a three on it, we’re not doing it.”
What that tends to do is there’s lots of banks that are saying, “Hey, overnight money is … Even with the change in the fed fund rate, it’s still basically free. The overnight rate is 0.5, so we can put money out at prime, at 3 1/2 floating. There’s no interest rate risk, and a spread of three on a really good credit, that’s pretty good. We’ll take that.” When you say you’re not going to do those, what that means is that you’re selecting towards some of the weaker credits or you’re pushing yourself out on the yield curve, and saying, “Well, if you only take fours, that means you’re only going to be doing deals that are three or five or seven years, whatever it is in your market,” and so you end up taking on more risk that you haven’t properly calculated in that setting part.
You’ll get what you ask for, because you’re really disciplined about it, but you’re asking for the wrong thing. These banks will stick around, but we’re seeing more and more of them realize that they can’t compete, because they’re not growing anymore. They’ve still got kind of solid deposit bases, but more and more of it’s landing in the bottom portfolio, those margins are shrinking, so then they have great spreads on their loans. There’s just not as many to be had anymore, because other more aggressive, sophisticated players are taking those away. These are the banks that are most likely to be picked off by acquisitions, just because there’s a good starting point, and somebody can come in and fix the easy part, the price setting, and really have a great asset based on that.
Okay, and next these are the folks that are really good at the setting, but not as great at the getting and we call those the push-overs.
Yeah, so these are the ones that I touched on a little bit earlier. A lot of these are the big banks where they spend a lot of time and effort calculating that number, but they’re just not very good at getting it. A lot of the times the problem is the silo effect, where you’ve got the so-called nerds in the finance area that are calculating the number, and the lenders know that they can ignore him because their boss doesn’t care. It’s not someone that they answer to and those two groups are rarely in the same room to hash it out. These are the ones that have the most work to do, but rarely recognize it.
When you say, “Hey, you need to fix your pricing,” their answer is usually, “Yeah, I know we really need to work on that capital allocation model. It’s not quite right,” even though they’ve been at it for three years. They’re trying to out-math the competition and that’s really not what it’s about. It’s not about calculating a better number. It’s not about your assumptions being more accurate out to four decimal places instead of three. If you can’t have your lenders actually negotiating and getting that price that you’re calculating, being slightly more accurate is not going to fix the problem, and so they spent a lot of time and money focused on the wrong thing, fixing the strength, the easy part, instead of that really painful, organizational stuff that has to shift.
Okay, and then last is the group we call the champs. These are very good at both the setting and the getting. Can you talk a little about that?
Yeah, these are the rare ones, and again, just because it is hard to do both very well. They’re rare because they’re really easy to spot. There are several that are clients of ours, that I could point out that we’re proud of what they’ve done. But I’ll point out one that’s not a client, just so that it doesn’t come off as a sales pitch, but someone like Bank of the Ozarks. It’s a bank that’s grown a ton. They’re always in the top five or ten list for total returns, whatever time frame you want to look at.
Every market that they’re in they’re known as being very aggressive, but very smart about how they’re aggressive. They go after the exact kind of deals they want. They win a bunch of them, and everything else they get paid really well for. When you see one of those banks, it sticks out like a sore thumb. The other thing about it is when they’re asked about that, when they’re asked about that performance, you’ll notice they don’t talk about a pricing model. They don’t talk about the methodology they use.
What they talk about is relationships and people. We make the numbers, the math part really easy. We put that in front of the lenders in a clean, easy way, so that then they can focus on that relationship stuff, and making sure that they’re providing some actual value so that they can get paid and realize those rates that are put out there. That’s kind of what you’re aiming for, and if you look at the numbers on a bank like that, you’ll see it’s worth the time to work on both those dimensions, because the results are pretty impressive.
Dallas, if a bank thinks that … They’re trying to be objective and evaluate themselves, and they think they might fall into the reckless gunslingers or the pushovers, who aren’t as great on the getting side of things, what are some ways that a bank can get better at the price getting?
Price getting is going to come between really a better connection between those tools, where we’re calculating the number and the front of the bank staff that’s actually having to be out there negotiating it. The key is to give them some flexibility. Where the process really breaks down is lenders are usually okay with quoting the [inaudible 00:16:07]. They’ll start there, but what they need to know how to do is how to react once a customer says, “I’m not going to do that rate. I’ve got a better deal somewhere else.”
If the only option you’ve given them is that or nothing, then what they’re going to do is say, “Well, I’ll take that same structure, that same deal, and I’ll just do it at a lesser rate, and I’ll tell the guy at the back of the bank that it just wasn’t possible. I tried, but it’s not my fault that their number wasn’t realistic.” You have to give them a framework and an ability to negotiate so they have type of a better understanding of what’s driving those numbers and where the out of bounds lines are.
“How far can I move the maturity, or the end schedule, or can I rearrange fees or collateral or guarantees or whatever it may be so that I can get to that number the customer’s looking for in a way that still works for the bank instead of just saying, ‘Oh well, I tried.'” That’s the key. Again, that’s not an easy thing to do, but that has to be the objective. It’s not about a better number. It’s about better tools and communication between the front and the back of the bank, and making sure that those lenders are well trained in what that means and the types of conversations they should really be having with their customers.
Great. Okay, Dallas, anything else on price getting before we end our podcast today?
Yeah, I’ll mention one other thing that … Just because it’s come up a lot lately, and that’s about lender incentives. Okay, if that’s the behavior that we’re after, how do we get the lenders to follow along and to actually get those numbers we’re putting out there? Obviously there’s some accountability there. You actually have to stick to that, and a lot of people are trying to do it with some incentives. I think that’s helpful. I don’t know that it’s necessary. I think at it’s core, it’s really just about sticking to your guns and kind of walking the walk, meaning a lot of lenders know that they’ll be complained at about their pricing.
People will show them reports at the end of the month that show that they didn’t quite hit the targets, or they’re short of the rate sheet numbers or whatever. But if they get to the end of the year and they grew your portfolio and they beat their budget number, they’re going to be just fine. Their boss will be happy. They’ll get the raise. They’ll get the promotion. We preach about the profitability, but the actions always come back to just plain growth. You have to hold them accountable to both pieces.
It’s not just putting volume on the books, but it’s also putting volume at a possibility of x, and you have to stick to both. Just because somebody made their volume number, if they did it by giving it away on pricing, then probably that doesn’t count. It’s closing that loop for the lenders, not just with words, but truly with the actions too. That, whether it be through incentive dollars or just through the … How the end of year review goes. Just close that loop in a meaningful way.
Great. Okay, well thank you for talking through this, Dallas. This is really helpful, so I think that will do it for us today. Thank you everyone for listening. You can always find more information about today’s episode at precisionlender.com/podcast. If you like what you’ve been hearing, make sure to subscribe to our feed in iTunes, SoundCloud or Stitcher, and we’d love to get ratings and feedback from this platform. Thanks for listening until next time. I’m Jessica Stone.
And I’m Dallas Wells.
And this is Lender Performance.