In this episode of the Purposeful Banker, we revisit an oldie-but-goodie topic. Banks spend a lot of time and effort to calculate the price they want for each commercial deal. We call this process "Price Setting." But how much does your bank on "Price Getting"? In other words, once your bank has calculated the price it wants for a deal, do your bankers book, or "get" the deal at that price?
Dallas Wells explores the reasons why the answer to that question is often, "No." And he provides some suggestions on ways banks can start the process of become better at "Price Getting."
Helpful Links
- Price Setting Versus Price Getting
- What Is Price Getting?
- Is It Time to Rethink Your Pricing Strategy? (Andreas Hinterhuber and Stephan Liozu)
- Commercial Loan Pricing Market Update, July 2021
- Commercial Loan Pricing Market Updates
Questions? Comments? Email Jim Young at jim.young@q2.com
Transcript:
Jim Young: Hi, and welcome to The Purposeful Banker, the podcast brought to you by PrecisionLender. We discuss the big topics on the minds of today's best bankers. I'm your host, Jim Young, director of content at PrecisionLender, and I'm joined again today by Dallas Wells, our EVP of Strategy.
Today, we're going to take a deep dive back into the archives to talk about a topic that would probably be on a PrecisionLender greatest hits album, if we ever made one or heck, if anybody even makes albums anymore. A few weeks ago, I was talking with one of our long-time sales consultant, Scott Morgan, about some options for content he wanted to share with a group of prospect banks and he brought up price setting versus price getting. And first, I was like, "Are you sure?" Because that's the title of a blog post that Dallas wrote back in, I want to say 2016 or so as part of a blog series that made up our book, Earn It.
So I asked Scott, "Is this still relevant in 2021?" And he said, "Absolutely." So I figured if Scott thinks that this still matters, then, Dallas, maybe this is a topic we should bring back up on the podcast because it's possible, albeit not likely that folks listening in 2021 weren't around to learn about price setting versus price getting in 2016. All right. So all that intro, Dallas. Take us back to 2016. Give us a little bit of background and what was the impetus for writing that blog post, Price Setting Versus Price Giving?
Dallas Wells: Gosh, 2016, you're talking pre COVID, pre-Trump.
Jim Young: Few lifetimes ago. Yeah.
Dallas Wells: It feels really old-timey at this point, but I think Scott is right. I think this topic is one that is very much still relevant. So the impetus for that blog post was pricing is a... It's a wide ranging issue to try to solve and the struggle we've had through the years is that most banks still view it as as a math exercise solely. So how do we go about setting the correct price for our bankers to charge for our commercial customers? And that's really only half, heck maybe less than half, of the real problem to solve, because once you actually calculate a number, you have to go about actually achieving that number. You have to actually negotiate it with your client and to oversimplify it. What we see with clients is there's the number that they can calculate, that they should have charged on all their deals, and then the realization rate of that, which for most banks is way lower than they would expect.
And you actually say, "Well, what did you actually end up booking that loan for?" You calculated it should have been at 2.75 and you booked it at 2.50. That's not very good. And all your concern about calculating the number out to the four decimal points and then you lost a quarter point on the actual execution of it. I think you're missing part of the issue. So that's that blog post was about, was understanding the whole problem to be solved.
Jim Young: So just to be captain obvious on here, what you're saying essentially is that banks are about price setting, but the price getting part is the tricky part.
Dallas Wells: Yeah, I think so. And the parts that banks struggle with and the parts that they spend resources on is different depending on the size and complexity of the bank, but everyone is wrestling with both parts of that equation, and we just see way too little attention placed on the actual getting aspect of it, as opposed to the setting part. And I should also mention that this concept is not ours. We didn't invent this. We found mentions of it in lots of places and we referred to in our book an article by, I apologize upfront, I'm sure I'll butcher the pronunciation, but Stephan Liozu. We may not pronounce it correctly, but we will include links in the show notes to his work. He's written several books, lots of blog posts, and articles and videos out there. He's a pricing expert on far beyond banking, but that phraseology is really his, of price setting and price getting, and we latched onto it because it made a lot of sense and covered a lot of the issues that we're talking about.
Jim Young: You talk about it in the blog post as a balance, but also I remember in the blog post that you quoted Carl writing and was saying 90% of effective commercial pricing is about the selling part of it. Which to me sounds like... And I don't know. Maybe we don't want to get into what's more important, but it feels like getting is not just maybe neglected, but not nearly emphasized enough. Is that fair to say?
Dallas Wells: Yeah, I think it's actually the hard part. For all the complexity that the capital allocations and loss expectations and all the nuance of the math, that's actually really easy. The math is not super complicated. The hard part is actually realizing that in the market, using that number as you're out there competing and for live deals and with lots of those variables that go into that math being unknown at the time that you're negotiating it. There's this massive human element to it and I think that's what causes a lot of bankers to ignore it, is it's hard to control. So the math is neat and tidy and you can control it. So there's all this focus placed on it. And Carl has this great way of describing how banks do this, where they measure with a micrometer, they mark it with chalk, and they cut it with an ax. That's actually a really apt way of describing what's happening. These banks, in their ivory tower, they have this team of folks. For a community bank, it's probably one person. For the larger banks, it literally is an entire team, maybe a floor at the world headquarters.
There's a group of people whose job is to go into the lab and in the cold, sterile environment of a spreadsheet somewhere, come up with a modeling exercise, but they come up with what the calculated numbers should be. And out in the wild, when you actually try to put that number in front of a customer and actually charge it and get it booked on a live deal, you rarely achieve it. That's the human element. And that's where it becomes so important to understand the math so that you know what the right trade-offs are because you're not going to get the deal just as the spreadsheet dictates. You're going to have to move parts around, you're going to have to trade pieces back and forth to try to win things, and you need to know what each piece is worth so that you can make net positive economic trades for the bank that also end up being at least acceptable to the customer, maybe even beneficial to them.
But that's the power of the math. It's not coming to this optimal solution that is the right answer because in the messy human nature of people on two sides negotiating a deal, you're rarely going to land exactly right there.
Jim Young: Well, so you mentioned the human aspect of it. So is it simply a matter of saying, "All right. Yeah, I hear what you're saying, Dallas. We got that price setting part, we've got people dedicated to that. So we just need to hire better people at getting that price." Is it just like just good salespeople, basically?
Dallas Wells: That's relevant. It's part of it, but I think also it's just... The way we view it and the way we describe it with clients is putting clear boundaries or clearly marking the out of bounds portion of a deal. So you may have calculated the number out to four decimal places, but in reality, there's a range that's acceptable. So you want your bankers, your well paid, highly experienced technical professionals to be able to trade within that range, and you want to incent them to do well within that. And then once they cross that out-of-bounds line in any of the directions that you've outlined there, that's when your acception and approval process has to kick in. It's a dynamic process. It's not something that you can create and then it's good for 20 years.
It's something you have to actively manage of what is the bank's risk tolerance? What's the bank's return expectations? What's the high level balance sheet strategy that's in place? And that's what should dictate what you're allowing your bankers to negotiate and what you're going to expect some input from senior management on. But it really is about process and none of this stuff is exciting or sexy, but it's really where bank returns come from, is being really disciplined about this kind of stuff and being really clear with your bankers about what the expectations are.
Jim Young: Yeah. I was going to ask that in terms of... You mentioned a little bit about incentive. We're talking about this as an issue for banks, but I'm wondering how much of it is it a disincentive if you don't get the price that's set? If that makes sense.
Dallas Wells: Yeah. Still, there's so many banks. Even really sophisticated banks, they go through all this trouble and all this pain and heartache on this exercise, and then they incent their bankers to just book deals. They pay them based on volume. And when you say it out loud like that, it seems silly, but that is still the most common incentive plan that we see, is if you book deals, you get paid. And there just has to be some nuance to that of the returns have to be met and it's on the bank management team to figure out what the right trade-off is between profitability and growth. And again, heck, that's a boardroom strategy that needs to be set.
And then you need to have all those processes and logistics in place for your frontline bankers to actually then be able to execute that strategy, to have the tactics in place, to be able to make the right trade-offs that reflect what that board level strategy is. But connecting those dots, it's one of the things that's easy to say and hard to do, but incentive and expectations and accountability, those are all the key ingredients there that are still way over simplified at most of the banks we deal with.
Jim Young: Yeah. I think we talked about this in the last podcast. We were going through some of the weird pricing data we were seeing. And one of those was that Anna-Fay Lohn and her market update basically noted that 10-year fixed rates were being priced lower than five-year deals. I can't imagine that somebody in the back room said, "Hey, let's do this," when they set the price, but I am but a marketer on a podcast, but it seems a little weird to do that. So it seems to me like that's exhibit A, again, on why this is relevant. Well, we've got literally banks out there getting prices that don't really make any fundamental sense on those fixed year deals.
Dallas Wells: Yeah. That price was not set that way, right? The model didn't yield that result. That is the market dynamics coming into play. This is another interesting aspect of it. We've dealt with some larger banks globally. It seems to be more common outside of the United States so far than in the U.S. They're trying to incorporate that market dynamics into the equation, right? They want to make that part of the price setting is to understand what the competition looks like. Well, you can do that for mortgages and you can do that for auto loans. We haven't yet seen anybody actually be able to pull it off at scale for commercial loans. And even with our dataset, which is the deepest in the world on bilateral commercial loan transactions, we can provide lots of context about, "Here's what market pricing looks like for that deal," but again, it's going to be a range.
We're going to show you where you are relative to other deals that look similar. That's different than saying, "All 15-year mortgages are being booked at 2.50 and you're at 2.55. You're not going to win this." It is not that commoditized of a product and there's too many moving parts to these deals and there's still frankly, too much relationship involved in these for those levels of price elasticity assumptions to go into the modeling of it. So I think it's worthwhile to incorporate market data. We spent a ton of money and resources doing that into our pricing platform, but again, it's context and there's still enough complexity to these deals that you want the educated human experts that are in the middle of the deal to see that as one more piece of context, not as the deciding factor or as another variable in a formula that just tells them what to charge.
It's something they need to be aware of as they're negotiating. So that's an interesting aspect that we'll see where that goes over time. There's market data available now that there wasn't five and 10 years ago, but we're a long ways from this being a commodity product where you can actually incorporate that into some algorithm that's going to spit out the magic price.
Jim Young: Right. All right. So finally, and you've touched on aspects of this, but I wonder if you can bring it together here in this last answer, this last question. If I'm a bank and I go, "Okay." I listen to this and say, "Yeah, that's a good point. We're not getting the price that we're setting and we feel pretty good about what we've been setting." What's at least the starting process to resolving that disconnect?
Dallas Wells: Well, the starting place is the two magic ingredients of transparency and accountability. So we take the math and our secret sauce is to take that math and make it very visible to everyone. We measure all deals on the same mechanics, and these don't sit in siloed spreadsheets on somebody's desktop. It's where you can actually manage deal flow as it comes across the bank. So you see where the portfolio sits, you see where the pipeline is sitting, and you see live deals as they're being negotiated, and you can see what the trends are and returns and then risk factors, and then you have to be able to take that crucial next step, which is really the last mile problem that banks struggle with here, which is to be able to communicate the nuanced feedback to your bankers in the moment of, "We need more deals like this one, less deals like that one. This is an acceptable risk trade off and that's not." That's the part we're just simply calculating. The number isn't enough.
You have to actually translate that math into negotiating points and deal exchanges, trading deal terms, which is really what commercial banking is about, is making those fair trades on terms to come to an acceptable point. You have to be able to communicate that and understand the worth of each one of those things in the moment. So again, to go back to the discipline aspect, it's about measuring all things the same way, about bankers being clear on what they're allowed to trade and what they're not, and then when necessary, you have ways for them to escalate those deals so that we have consistent ways of making decisions. If you don't do that, then what happens is you're paying bankers for volume and they see the number calculated pop up on a screen somewhere and they say, "Yeah, but to get this deal done, I've got to do something different."
So I think that's okay. You haven't given them that context, you haven't explained to them what's the appropriate trade off, and you haven't given them a path to say, "Is this one okay to make that exception for?" So what you end up with is you're realizing 80% of that calculated number, which is what most banks see. They calculate an expected return and then they don't actually end up booking that. Over and over, month by month, consistently through all the ups and downs of the cycle, that's what happens is they don't achieve the returns that the models tells them they should.
Jim Young: Got you. Yeah. I got to admit, I started off as a little bit of a skeptic at the beginning of this, for that reason of like, "Hey man, that's a blog post we talked about a long time ago," but you converted me. I mean, yeah, everything we're talking about here is still very relevant to-
Dallas Wells: Well, it's a core issue. Yeah. It's fundamental and in that old blog post, we laid out there are banks who are really good at one aspect or the other. And we made this little quadrant where you can... I mean, heck, you can look at a bank's performance and you can tell where they fall here by seeing the makeup of their balance sheet and the spreads they actually generate on their commercial loans. You can tell are they really good at price setting, but bad at getting it? Or is it vice versa? The negotiating versus the calculating trade-off, you can, you can see it in action. So it's from 2016, but I think it's relevant, and again, we'll share the link to that and I think it's applicable if you are a $200 million community bank, or if you're a $200 billion super regional bank. The core elements are the same, how you go about executing it will be slightly different, but understanding those trade offs is important.
Jim Young: Yeah. I mentioned we'll have a link to that post. As well as within that post, there's a link and I'll separate that one out to the Stephan Liozu or the original piece that inspired it, and as well as a link to a piece in which we really get into bit more of well, exactly about price getting, and again, the processes involved in that. So will be links on the show notes. So definitely encourage everybody to do a little reading in addition to their listening on this podcast. And that'll do it for this week show. Dallas, thanks again for coming on.
Dallas Wells: You bet. Thanks, Jim.
Jim Young: And thanks so much for listening. Now for a few friendly reminders, if you want to listen to more podcasts, check out more of our content, visit the resource page at precisionlender.com or head over to our homepage to learn more about the company behind the content. If you like what you've been hearing, make sure to subscribe to the feed in Apple Podcasts, Google Play, or Stitcher. We love to get ratings and feedback on any of those platforms. Until next time, this is Jim Young for Dallas Wells, and you've been listening to Purposeful Banker.
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