Chapter 5: The Case for a Chief Pricing Officer
Banks have chief executive officers, chief financial officers, chief investment officers, chief loan officers, chief information officers, chief marketing officers, and chief risk officers. But for some reason, there’s no chief pricing officer.
There really should be.
Pricing Is Difficult; Someone Needs To Own It
In Chapter 1, we laid out our arguments for why pricing may be the most important function that happens in a bank on a daily basis, the biggest indicator that you’re building relationships that will fuel the bank’s success. Yet in most banks, no one person really “owns” the pricing process.
Pricing is inherently a difficult task. It’s a delicate balance between controlling volume, risk, and profitability. That in itself would be problematic, but then there’s the matter of managing pricing across multiple parts of the balance sheet. And in banks, multiple parts of the balance sheet means crossing departments.
Pricing should be the front-end filter, where you can determine how many deals you get, at what level of risk, and for how much profit. It’s the one place where you can dial in those growth/risk/profit levels to match the bank’s high-level strategy.
Pricing is the one tactic we can really control, but banks rarely have any one person in charge of it. Instead, each of the various departments – lending, credit, deposits, etc. – has its own seat at the pricing table and each may have conflicting goals that aren’t in sync with the overall institutional strategy.
Take the case of deposits during the financial crisis. It was a period of time in which banks were almost drowning in liquidity; fear in the marketplace was leading people to park their money in the banking system, where banks then had to figure out what to do with it.
That was just fine for those on the deposit side, where they were customarily rewarded for growth. But on the asset side, there wasn’t enough loan demand. That led to banks putting those funds in places that had nearly a zero yield. Between acquisition costs and interest expenses, banks were often putting dollars out at a negative carry.
That sounds obviously wrong-headed, but it was a hard process to alter. It would have required someone to urge the deposit folks to stop doing what they’re rewarded to do and to turn off the deposit spigot.
Even if a bank has a solid ALCO group and can make and coordinate allocation decisions, problems can crop up at the next level – the tactical aspect of turning those decisions into real outcomes. This is where many banks break down, including our old friends from Chapter 2 and Chapter 3, Frankenstein Bank.
Frankenstein was beset by departmental turf wars when it came to pricing. The stakeholders charged with finding a way to reach Frankenstein’s balance sheet goals had different perspectives, but the same relative positions on the bank org charts. Lending and Finance continually butted heads, to the point where the person from Lending eventually left the bank in frustration. At that point Finance took over pricing and began handling it in a way that pleased Finance and no one else – focusing only on the price setting and not the price getting.
To avoid these sorts of scenarios, banks need a way to make sure all their department goals are aligned throughout the process, from coordinating the balance sheet through to setting and getting the prices. More to the point – they need a person responsible for handling that task.
What Does a CPO Do?
If you’re arguing for the creation of a Chief Pricing Officer position, you’ll need to go beyond the theoretical and into the actual job description. Here are the four main to do’s on the CPO’s list.
1. Evaluate current position – Where does the bank stand? This isn’t about individual portfolios or which group has which growth rate. This is about getting a clear picture of the bank’s overall mix: Which assets are where? What yields are we getting? What are the durations?
2. Compare current position with future aspirations – Where would the bank like to be in terms of its asset/liabilities mix and the returns it’s getting? How far does the bank have to go to get there?
3. Move the bank from No. 1 to No. 2 – Once you know where things stand, aligning the pricing will help the bank make that shift – but only if there’s commitment to the process. And that only happens if the CPO breaks down the walls between the various siloes to make sure the bank is consistent – both in the decisions it makes and in the data it bases those decisions upon.
4. Measure and adjust – This doesn’t happen if you only discuss pricing once a quarter, or in ALCO meetings. Aligning your pricing tactics to match the bank’s overall strategy is not a “set it and forget it” thing. CPOs are constantly working to make sure they get the right data in the hands of the right people, the ones who are doing the producing. So, for example, the folks on the deposit side would have direction about whether they need to slow down their intake. Or lenders would have information about which types of deals the bank needs to be pursuing and which categories are nearing saturation. And again, this information needs to be shared at the right time – not after the fact. (Remember our quarterback analogy from Chapter 3?)
Why Not a Committee?
You’ve sold the stakeholders on the idea of a Chief Pricing Officer and you’ve explained what the CPO will do. Chances are high you’ll then get this question:
“Why should one person have all this power? Wouldn’t it better to have a committee make this decision?”
Certainly a committee is better than nothing. Getting representation from the different areas of the bank will improve your pricing consistency. But ask yourself this: How many committees in your bank are really that effective in getting things done?
To do pricing right, you have to able to change it quickly. You need to make fast decisions, to be able to look at the current situation and make the right adjustments to keep the bank moving from where it currently stands to where you want it to be. Take too long to deliberate and the landscape will have already shifted by the time you put your tactics in motion.
Accountability is also critical. From a numbers standpoint it’s pretty easy to track – like watching a progress bar fill up on a software download. But in order to hold someone accountable it needs to be “someone” and not “some group.”
Who is Your Chief Pricing Officer?
Congrats! You’ve made it this far! You’ve gotten buy-in from the powers that be to create the Chief Pricing Officer position and on what the CPO’s job description should be.
Now the next hurdle: Figuring out who should fill this critical role.
First, you don’t necessarily have to add to headcount for this, or look outside the bank either. This is key because many banks are likely to push back at the idea of hiring another C-level exec. You can probably find the person you need within your current organization.
The person needs to have enough of a finance background to do the heavy lifting when it comes to finding the right metrics and the right data, because you’ll be doing things like measuring risk in separate systems from where you’re usually measuring production. You’ll need someone with the technical skills to align those types of things.
The CPO candidate will also need to have authority within the organization. They’re going to be coming into a lot of personal fiefdoms within the bank and moving things around to make sure everything matches up and aligns. When they make a change in pricing, the senior lenders should feel compelled to go along with the shift. That’s not going to happen if the CPO is a junior level employee. Again, pricing is probably the most important tactic you have. The CPO’s level of authority should match that.
Some of that authority comes from the CPO’s position in the bank, but some of it comes from the CPO’s personality. They need to have the power to be able to enact change across a disparate collection of groups and goals, but they also need the finesse to ensure that this feels more like a collaboration than a dictatorship.
Finally, the CPO will need friends in high places. When companies try something new, the key players always look for signals from upper management. If that group is silent and passive, then it sends the message that the change is simply the flavor of the month; just be patient and passive and things will eventually return to the way they were. But if the powers that be demonstrate strong backing for something like the CPO concept, it lets everyone know that they need to get on board with what’s happening – like it or not.
Don’t worry, we’ve got that covered.
The Dan Martin Story
Dan Martin has worked at the same Midwestern bank his entire career, working his way up from his early days as teller into a management position as a profitability analyst. He is a self-described “finance” nerd, who loves Excel and has spent years familiarizing himself with the ins and outs of pricing. Eventually Dan came to the realization that the tool the bank’s lenders were using to price loans – a funding rate sheet – simply wasn’t up to the task.
“A lender would just be tasked to say ‘Hey you need a certain spread on top of that.’ It was pretty easy,” Dan recalled. “Which is probably why the lenders also liked it. We all like simple things. But a lot of the decisions weren’t necessarily good ones.”
So Dan set about creating a better tool, an Excel spread sheet that could link with other databases and quickly crunch the numbers when a lender created a certain scenario, thus helping the bank price better deals. Once he had a base model in place, Dan made continuous improvement to it, expanding its flexibility and versatility.
Here is where we reach two of the key points in Dan’s story.
First, while Dan had the finance background that is a key part of the CPO position, he also had experience working in customer-facing jobs. Dan recognized the need for what he called “a consultative approach” to pricing deals. He believed that when a lender sat down with a borrower the lender needed to “think of five different ways to skin the cat, instead of just, ‘This is what they asked for.’”
But even though Dan tried to put himself in the shoes of the lenders, it took quite a while before he got widespread buy-in for his pricing model. He experienced plenty of pushback from lenders who wanted to keep doing things the way they already knew.
“I remember banging my head against the wall so many days of those years, saying to myself, ‘This is so much easier.’”
That brings us to the second important point: It wasn’t enough that Dan’s model was an improvement. He needed backing from the executive level.
The breakthrough came when the Chief Lending Officer in Dan’s region mandated that information from Dan’s pricing model had to be included in every packet.
“Once he gave that blessing, that’s when they had to use it,” Dan recalled.
The tool produced results at the regional level, and when Dan was moved to the bank’s central headquarters, his model became the subject of intense interest.
“Within a few weeks I was in a room with execs I’d only heard of but had never met,” he said. “They looked at the model and said, ‘Man, that’s good. That’s way better than what we’re doing right now.’”
Within three months of arriving at headquarters, Dan was moved from a job in which he dealt with budgeting and forecasting into one in which his focus was purely pricing.
“They were able to change my job into something I was really more passionate about,” he said. “Kudos to them.”
The bank was essentially checking off each box in the “Who should be your Chief Pricing Officer?” checklist. In Dan they had someone with a finance background, but who understood the importance of the lender/borrower relationship. They’d backed his ideas and put him in a position of authority to ensure his tactics would be carried out. And, by putting Dan in charge of a pricing overhaul for the entire bank, they also put the accountability squarely on his shoulders.
Dan did not disappoint. He quickly realized that his homegrown tool would not scale beyond the regional level and went shopping for something that could be managed across multiple regions and would integrate with the bank’s CRM and other software systems. When he found the right software, he told his bosses, “If I could build anything, it would be this.”
It was another point at which Dan’s CPO story could have been derailed. The bank could have looked at the price tag and opted to spend less money on a project that was – to borrow from the Stephen Covey example in Chapter 1 – basically “sand.” Thankfully, the president of Dan’s bank knew full well what a huge rock pricing was.
“Pricing pressures right now are incredible,” the president said then. “Over the next few years it will only intensify. The ability to effectively manage pricing will determine the survivors.”
Dan’s bank purchased the pricing software he had requested, and they made him the Director of Pricing Strategy and Performance. In the past two years, the bank has not only survived – it’s thrived.
Before implementing the pricing software companywide in the second quarter of 2013, the bank’s NIM had underperformed its peer group (as defined by SNL) by 23 basis points. During the two years after implementation, the pendulum swung completely in the opposite direction, and Dan’s bank produced a NIM that outperformed its peer groups by 11 basis points. For a bank of Dan’s size, those 11 basis points translated to more than $17.2 million per year. Overall, the 34 basis point turnaround (from underperforming by 23 basis points to outperforming by 11 basis points) translated to more than $53.3 million per year.
Dan’s pricing strategy has played a central role in his bank’s success, but when he talks about it now, he stresses the relationship aspect of his job over the math.
“I call myself a chief customer officer, just because that’s what I’m focused on. I’m always looking at what’s best for the customer – and the bank, obviously – and incorporating that into their experience.”
And the process of doing that brings Dan into contact with stakeholders across the full range of the bank.
“I’m constantly in front of these executives and cross-functional lines,” Dan said. “I’m telling them about –and selling them on – the experience we now have for the bank, which for the first time is a consistent one across all our footprints. We don’t step on each other’s toes.”
Dan is the hero of our story, but he’ll be the first to tell you that he’s had plenty of help along the way. A Chief Pricing Officer can align the bank’s pricing tactics with its strategy, but there’s still the critical matter of the people who actually “get” those prices – the lenders.
To compete in this age of rising customer expectations, banks must take steps to shorten their lending timelines and be more creative with the options they offer borrowers. To do that, they must move the pricing process from the back of the bank to the front.
Chapter 6: What Makes a Great Lender?
Great lenders can have a tremendous impact on a bank’s performance. What if great lenders are made? What if we can train and develop the next generation of stars from within our own ranks?