By: Amanda Roth
Doesn’t that sound strange: Pricing WITH competition? We are familiar with the sayings of pricing for competition and pricing to be competitive, but did you ever think you would need to price with competition? When developing a risk-based pricing program, it is important to make sure you do not price against the competition in any extreme. Some clients decide they want to price lower than the competition regardless of how it impacts their profitability. However, others price only for profitability without any respect to their competition. As we discussed last week, risk-based pricing is 80 percent statistics, but 20 percent art — and competition is part of the artistic portion.
Once you complete your profitability analysis (refer to 12/28/2009 posting), you will often need to massage the final interest rate to be applied to loan applications. If the results of the analysis are that your interest rate needs to be 8.0 percent in your “A” tier to guarantee profitability, but your competition is only charging 6.0 percent, there could be a problem if you go to market with that pricing strategy. You will probably experience most of your application volume coming to an end, especially those customers with low risk that can obtain the best rates of a lender. Creativity is the approach you must take to become more competitive while still maintaining profitability. It may be an approach of offering the 6.0 percent rate to the best 10 percent of your applicant base only, while charging slightly higher rates in your “D” and “E” tiers.
Another option may be that you need to look internally at processing efficiencies to determine if there is a way to decrease the overall cost associated with the decision process. Are there decision strategies in place that are creating a manual decision when more could be automated? Pricing higher than the market rate can be detrimental to any organization, therefore it is imperative to apply an artistic approach while maintaining the integrity of the statistical analysis.
Join us next week to continue this topic of pricing with competition which is, again, an important consideration when developing a risk-based pricing program.