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A Business Case for Dynamic Pricing in Banking

Dynamic pricing is evident in almost every industry. Would this pricing strategy work in financial services? What are the benefits and challenges of a dynamic pricing model?

Subscribe TodayWe are all familiar with dynamic pricing in the hospitality, travel and entertainment industries. We may have even encountered dynamic pricing in e-commerce, probably without knowing it. At its core it is flexible pricing based on current market demands, fine tuned by data analytics where sophisticated algorithms account for time of day, supply, demand, competitive offerings and target profit margins. We have either benefited from – or taken a hit by – what we perceived were bargains or price gouging. Booking a flight or hotel room during peak travel periods, purchasing a ticket to a weekend sporting event or even Uber surge pricing are all examples.

But what about dynamic pricing applied to the financial services industry. Can the banks or credit unions apply dynamic pricing in the same manner other industries have applied it – as an intermediating algorithm, matching supply and demand? Prices of financial services take into consideration operational costs, profit margins, and demand, but at its core, financial service or product pricing is predominantly constructed around risk. A loan, an insurance product, a payment service is usually priced based on risk assumptions.

Let’s focus on a borrower who wants a loan from a bank. The bank will assess the risk of that borrower, and will come up with a rate that is directly linked to that risk and to the bank’s cost of capital, which in turn is based on market based rates. The borrower will, in turn, be very price/rate sensitive, shopping for the best available rate. The only variable in the equation is the bank’s margin embedded in the loan’s rate. The floor on that margin has to align with profitability standards and liquidity coverage requirements.

Dynamic Pricing in Lending

So the real question is … can a bank or credit union truly provide dynamic pricing on a product, like a loan, given the constraints of price elasticity? The same can be asked of an alternative lender, although an alternative lender may have more flexibility given the lower amount of regulatory oversight.

We believe the answer is more likely to be no, although a traditional bank may deliver more granular rates based on better underwriting and data analytics.  True dynamic pricing is less likely.

Does this mean that dynamic pricing is an elusive holy grail for financial services incumbents? Not quite, especially if we introduce the added dynamic of client relationships. If our borrower from the above example also has a checking account, a savings account or an insurance policy with the bank, then dynamic pricing can be viewed along two vectors: a) relationship pricing and b) pricing execution.

Note that we are not using the term “product pricing” here since the emphasis is on relationship pricing where the customer’s portfolio of products used becomes the basis for pricing. The overall relationship is taken into consideration, including the operational costs, margins and risk of the consumer’s portfolio with the institution, not just the products in isolation. This requires a shift from being product-focused to being relationship and service-focused.

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As for pricing execution, a shift also has to happen – one linked to how technology is architected, deployed and used. One where siloed systems and siloed data analysis are phased out for more holistic approaches. Imagine a system architecture that would allow for dynamically changing pricing individually or in the aggregate based on the entire product usage profile of a consumer. This pricing could be formulated based on internal goals, customer asks and/or competitive offerings, where the lifetime value (LTV) of the customer and the lifetime value to the customer are constantly weighed and optimized without one losing to the other materially. The results of this type of model can be quite powerful.

The benefits of such an approach are obvious and strategic:

  • Increased customer loyalty and stickiness
  • Enhanced customer experience
  • Increased ability to rebundle and cross sell
  • Increased contextual awareness of customer needs

The challenges are no less obvious. First, current core systems for traditional financial institutions are silo-based. Secondly, organizational structures are also silo-based. Thirdly, management incentives are also product and silo-based. Finally, and not unsurprisingly, most relationships are also viewed from a silo perspective both on a product and household structure basis (husband, wife, couple, family).

Customer Lifetime Value

Looking at the concept of consumer lifetime value (CLV) in a little more detail, the tenant that underpins the notion is that “some customers are more equal than others”, and it measures long-term value over a current quarter’s profit. Boiled down to the basics, it takes the present value of the future cash flow (profitability) attributed to a customer during the entire potential relationship with the bank. In other words, the profitability of loyalty.

This equation can be a little misleading, since profitability is measured by past consumption of services (revenue minus operational costs), and value is a forecasting exercise that involves factoring in the declining value of money over time. This makes this calculationsignificantly more vague to measure than past profitability. What it boils down to, though, is how much the bank is willing to pay to acquire the customer against how much the bank is willing to pay to avoid losing the customer. Customer lifetime value (CLV) is really a dollar value of the asset, the customer.

Mathematically it looks like this:

CLV ($) = Margin ($) * (Retention Rate (%) ÷ [1 + Discount Rate (%)]) * Retention Rate (%)


When there’s a fight for increasing deposits in a low interest rate environment, and interest generated revenues are tight, cultivating CLV is a strategy that directly works to grow wallet share, especially amongst market segments where wallet share is low. There’s a direct correlation between additional marketing spend to target high potential CLV customers who currently have low wallet share with the bank.

Wallet share relates to customer loyalty and stickiness. And dynamically pricing product bundles attracts additional customer wallet share. We hinted at relationships being viewed in silos, but once those silos are broken, and the bank has a full view of the customer’s portfolio, and prices are at the portfolio level instead of the product level, forecasting the lifetime value becomes a valuable exercise.

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When Your Customer Wants a Divorce

There is one paradox in all of this, and that is a sense of customer apathy – the effort it takes to switch bank accounts. Customers may not be as apathetic as predicted.For instance, when the UK launched the initiative in 2014 to make switching current accounts easier, nearly a quarter of a million account holders switched as they looked for better offers, service, and loyalty programs. In fact, some banks launched new loyalty rewards to try to stem to leak, with some success (interestingly, when the switching surge ended, the vast majority of market shares among the primary banking organizations remained the same).

For some customers it was about service. For others, it may have been the high fees or the poor user experience. For some of those who didn’t switch, apathy may have been the most plausible reason.

Customer Experience and Satisfaction in CLV

Let’s look at the peer-to-peer alternative lending market and the growth of P2P payments, and how consumers are willing to abandon traditional bank offered products in search of a better priced, more customer-friendly option. Ernst & Young published a report in 2014 on the staggering growth of P2P lending (both for consumer and business). With nearly a 75% growth rate year over year, the P2P lending surge cannibalized a considerable chunk of the bank lending market. That growth was fueled by consumers jumping ship to set sail with alternative lenders. This growth in the P2P lending market shows no signs of slowing down.

P2P payments is another, some say better, customer service experience alternative, with nearly $90 billion worth of customer transactions leaving the traditional bank market. Both of these P2P alternatives represent potential profitability that traditional banks are losing, with the resultant negative impact on the lifetime value of the customer caused by a fractured, multi-point, conglomerate of service providers.

The obvious win-win-win is a bank – alternative provider or fintech partnership that brings these services into a one-stop-shop for the customer. Lifetime value for both bank and customer married, living under one provider roof.

Dynamic Pricing Impact on Loyalty

Since the benefits of dynamic pricing increase customer loyalty, stickiness, customer experience, as well as provide opportunities to re-bundle, cross sell and  actually meet a customers contextual needs, it’s obvious that dynamic pricing is at the root of the customer lifetime value.

It also gives the customer choices to create a portfolio of services that exactly meet their needs – the more flexible the pricing, the more flexible the bundle, the more the customer “delights” in the service provider. Choice enhances the customer experience, reaffirms institutional trust, and helps promote financial health for a valuable lifetime relationship.

It also staves off competition, since it’s the differentiator in a market of “same old, same old” bank providers.

So it begs the questions: 1) How feasible is it to achieve dynamic pricing in financial services? 2)When will that happen? and 3) Why aren’t banks responding more vigorously to the call to rebundle?

All content © 2017 by The Financial Brand and may not be reproduced by any means without permission.

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  1. Per Sjofors says:

    First a disclaimer. I founded and run America’s most trusted pricing research and advisory firm Atenga Inc. http://bit.ly/24atzQn

    Banks have three “pricing” leavers:

    1. Fixed fees for services.
    2. Interest on loans.
    3. Interest on deposits.

    The interest are already dynamic – higher interest on loans and lower on deposits from less desirable customers.

    Fee for service then remaining. The authors makes a huge mistake in comparing customer acceptance of dynamic prices in hotels and airlines with the fees of a bank. We rarely use the same hotel over and over again and we rarely fly the same stretch again and again. But we use bank services over and over again. If those service fees are starting to change, customers will be confused and upset. Confused customers always take their business somewhere else.

    So, in short, there is no business case for dynamic prices in banks. Those who try will be badly burned.

    If you are interested to read about other pricing mistakes, here is white paper called the Top 10 Pricing Mistakes: http://bit.ly/1LpCSR8

  2. Ron Shevlin says:

    I have a question for the authors: Have either of you seen any banks truly use CLV calculations at an operational level?

    Personally, I have yet to find one. The concept is great at the theoretical level, but seems impossible to use on a day-to-day basis.

    Personally, I think CLV should be used as a backwards-looking measure, as I argued here.

  3. I find it a bit amusing that even the simplest formula for CLV is silo based! For example, if I have a credit card with Bank A and mortgage with Bank B, Bank A’s assessment my CLV is only related to my CC spends and duration with bank. How will Bank A know about potential CLV from my mortgage held with another bank? How will Bank A figure out how much marketing $ it should spend on me to make me switch my mortgage from Bank B to A?

    On a side note, the UK current account switching program is considered to be a flop. https://www.finextra.com/news/fullstory.aspx?newsitemid=28363

  4. Daniel Smith says:

    I have to agree with the authors that in the case of banking we should be looking at dynamic relationship pricing, and not dynamic pricing that is driven by other macro like factors such as supply and demand as seen in other marketplaces.

    That still leaves another variable that in my mind needs to be resolved, and that is closely related to the discussion around CLV.

    In the specific case of deposits, as a bank we may be comfortable giving up a few extra basis points based on the customers existing product portfolio and relationship… BUT… that is normally a static measure taken at a specific point in time that does not auto-adjust through the life of the deposit.

    In this sense, it is not truly “dynamic” and is instead just “relationship pricing”.

    What we should be looking for and applying is a relationship based pricing at the point of sale, where additionally any deposit payouts through the life of the deposit are themselves automatically adjusted to the then current relationship that the client continues to maintain with the bank.

    Obviously this requires a different type of deposit processing system that is able to automatically handle dynamically adjusted payouts without any processing overhead for the bank.

    Upside: this approach protects the bank while creating an additional incentive for customer stickiness as well as share of wallet.

    (Disclaimer: We have a system that does this)

  5. Perhaps I’m just gunshy about the whole issue, but I’m wondering why there has been no consideration about the regulatory impacts of this type of pricing? I can only imagine the raised eyebrows at the CFPB when a bank announces their intent to use dynamic pricing. I can only imagine the countless exams that will occur, delving into reams of statistics and looking for any inference of discrimination or unfairness. Perhaps someday dynamic pricing will occur, but not under the current regulatory scrutiny.

  6. Hi,

    I agree with Daniel, especially in the point of applying Relationship Pricing at the point of sale. But also being able to change the Pricing along the way – e.g. I have seen in one of the Retail-Consumer Finance client ability to Dynamically Price Loans based on both Risk related as well as Relationship related metrics and both at the point of Opening the Account as well as changing the Price during lifetime of that customer based on the changing situation with (both changes in Risk as well as in Relationship/Wallet Share).

    I wonder what are you real experiences with Dynamic Pricing in Banks? I have been quite disappointed as a customer, trying to re-finance my mortgage as I was not really satisfied with my incumbent bank and I was literally asking what other banks can offer to me if I bring my whole financial services portfolio to that Bank, listing all my products in various banks. I expressed willingness as a customer, as well as wish, to consolidate all my banking relationship under one roof, but interestingly I have not been offered anything interesting. Non of the bank and bank employees were empowered to actually reflect my potential revenues (CLV) to offer me interesting Mortgage rates. Do you know about any real example where the Bank is capable to react more appropriately to this obvious opportunity to get a new customer with high wallet share?

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