How to Ease Profit Losses from Regulatory Interventions with Intelligent Pricing

February 11, 2021

price increase reaction

Although central bank moves are sometimes sudden, financial service providers can prepare well in advance for regulatory intervention. In this article, we shed light on opportunities for financial service providers to react to price regulations and proactively mitigate the impact of potential measures.

When the Central Bank of Kenya enforced lower transaction charges for mobile money services in March last year, effects were immediately visible. Transaction volume soared by 80 percent and almost three million new users registered. But the measure also blew a hole in the financial statements of financial service providers. M-Pesa, the incumbent player, announced a sharp decline in revenues by more than 10 percent.

The banking and financial services industry has always been prone to regulatory intervention. Nowadays, financial service providers are experts in dealing with an abundance of rules and requirements. Whereas such regulations have traditionally targeted capital requirements, credit ratings, or corporate governance, more recent interventions in several African countries concern the setting of prices and price levels. For instance, governments and central banks now target single price points for services such as ATM withdrawals, inter-bank transfers, card maintenance fees, POS transaction fees, and FX transfers to be lowered significantly. Such directives are usually backed by severe penalties and leave banks with little room to manoeuver or time to achieve compliance. Therefore, banks have few options other than to meet their newly stated obligations swiftly.

The suspension of mobile money transaction charges by the Central Bank of Kenya at the start of the COVID-19 pandemic serves as one example. Another was set by the Central Bank of Nigeria which reduced fees for selected banking services by more than 50 percent in 2019. The move by the Kenyan institute was well reasoned with the spurious economic outlook at the start of the pandemic. However, the ensuing conversation on transaction prices in general shows the dangerous impact these interventions have on businesses. After all, customers will think they heavily overpaid if providers suddenly slash prices to a fraction. They may see the lower prices as more appropriate and, once firms try to raise prices to the original level, they will think they are being overcharged. Not only do firms immediately experience the effects in their balance sheets, they also face serious backlash from consumers when later increasing prices.

Serious consequences for banks

Regardless of the origin and motivation of price interventions, financial service providers face serious consequences. Whereas some institutions with solid earnings can afford to swallow the pill and tolerate reduced earnings, those with higher costs may suddenly find themselves with partly loss-making operations.

What’s more, the African banking market is becoming more sophisticated in the digital age, leading to increasingly demanding clients. Therefore, banks rely heavily on surplus revenues to finance innovative solutions to meet these growing customer needs. The obvious reaction is to lower revenues, postpone investments, reduce service levels and shut operations, however this is an unsuitable remedy to the problem.

Lower levels of service that go hand in hand with cost reductions can lead to two drastic consequences. First, they significantly reduce customer satisfaction and can encourage clients to switch providers, leading to even lower revenues. Second, lower service levels can nudge clients to adjust their habits and use alternative services. If a transaction service reduces charges yet simultaneously becomes less reliable in delivering transactions, clients will happily switch to other means of wiring money. Providers cannot fully control whether these are their own services or those of a third party.

Both reduced satisfaction and habit shifts encourage customer churn. Customers are more willing to find alternative service providers which either charge nothing for the particular service in question or do not respond to reduced prices with service reductions. Usually, these alternative service providers are global BigTechs or non-African enterprises that focus on increasing their reach in Africa before starting to charge prices in the future. By the time these alternative service providers introduce charges, the clients are already hooked by their products, which makes it harder for them to switch back to their known African bank.

How banks can balance price and value

Financial service providers that exercise a high degree of commercial excellence balance the value of a service with the prices charged. Therefore, these firms know which aspects of their service customers are willing to pay for. Once this balance is unsettled by forced price decreases, it seems natural to reduce value by a similar level. But instead of mastering the art of penny pinching, financial players should explore ways to compensate losses through intelligent pricing and packaging approaches. Moreover, instead of responding to price reductions with less value delivered or cost reductions, they need to find ways to actively compensate losses. After all, price remains the number one profit driver.

Strategies for banks to respond to forced price setting

Over time, we have developed and observed multiple successful approaches for financial service providers to ease regulatory intervention in price setting. We demonstrate three of these below.

1. Optimize non-headline fees

While some price points are often the focus of concern for customers and regulators alike, others slip the public eye, even though they have a comparable impact on profits. Whereas customers display a low willingness to pay for some services, they may feel the opposite for others, e.g., those involving manual labor or specific expertise.

This means that oftentimes, financial service providers do not charge for such services accordingly. They need to know customers’ preferences in order to identify which product features and services clients would be willing to pay more for. This can be done by analyzing existing usage and sales data on clients. Moreover, by examining actual product and service demand and by studying how customers make use of products, banks can identify additional willingness to pay. Once providers know which features and services are valued more than currently charged for, they need to capture this. After setting new prices, providers need to estimate the impact of price changes and carefully balance potential churn with potential profit. Following this approach, a large national retail bank was able to reduce losses from capped card transaction charges by optimizing its fees for electronic transactions.

Another path for providers is introducing new price points and monetization logics. Oftentimes, the specific regulations leave room to price features and services adjacent to the ones mandated. When regulators cap base fees, providers can introduce new logics such as percentage fees for additional services to regain lost revenues. In another example, a payment service provider was able to mitigate the revenue impact of the capped interest rate by introducing commission charges.

Regardless of the approach chosen, providers need to ensure these new price points and raised fees are acceptable and perceived as fair to customers. Intelligent communication strategies usually accompany the introduction of such charges.

2. Introduce value-added services

Some providers may have exhausted the pricing potential of their current offer or have a very narrow set of services to start with. They turn to enriching their portfolio with value added services (VAS). These expand use cases of the actual service or make it more accessible, e.g., by integrating accounting software more closely into transaction services. When VAS increase the perceived value of the underlying service, clients will show a higher willingness to pay.

In order to introduce and price VAS, firms need to know how clients utilize products and services and search for unmet needs. Providers can do so by following user journeys and by observing everyday usage. However, potential VAS do not need to be ground-breaking or unparalleled. We repeatedly observe that users place high notions of value on integrations and shortcuts that ease administrative workload and, ultimately, reduce costs.

An African payment provider for instance, was able to turn around its loss-making POS business profitable by adding business service applications to their payment proposition. The resulting bundle generated far higher margins on the market than both parts would by themselves. By deeply integrating payment services into business applications and reducing administrative workload for its clients, the firm created a novel value driver which it was able to charge for accordingly.

3. Develop a differentiated offer structure

Instead of reacting to novel regulations with knee-jerk measures, companies that display a high degree of commercial excellence take preventive measures. They adjust their offering so that it is not severely impacted by sudden pricing interventions. However if necessary, they can still react quickly. These firms offer differentiated options of their products and services, with each option corresponding to the requirements of a specific customer group.

In order to do so, financial service providers segment their customers and identify what brings value to the different groups. They re-package their goods and services in a way that encourages customers to naturally go for the bank’s preferred option. Techniques include varying price levels and differing sets of features, components, volume, and VAS.

Introducing multiple offer packages tailored to specific client needs helps customers to select a preferred option and to reduce comparison with competitors. Customers who are unsatisfied with specific prices have the option to switch to different packages. For instance, a client who deems charges for specific transactions too high can be incentivized to select another product option with lower transaction charges at the cost of a higher base fee instead of switching to competitors. Such emergency exits have repeatedly proven to retain a high share of customers while simultaneously securing margins. Furthermore, they offer clients the flexibility to upgrade their package in the future without searching for a competitor’s product.

Such package optimization gives companies the flexibility to change price points more granularly. Packages with reasonable base prices and low fees for individual services often escape regulatory scrutiny. Otherwise, financial service providers can swiftly regain lost revenues from diminished returns of a single price point by optimizing other fees in specific packages.

In order to retain their competitive position, banks need to act deliberately to counter regulatory price interventions. All three approaches, optimizing non-headline fees, value-added services, and offering differentiation yield specific benefits. They vary in scope, in workload, as well as in lead time to implement. Selecting the right approach is often a question of economic pressure to react and the bank’s organizational capabilities to rapidly introduce changes, which means: preparation pays off. Banks with clear commercial strategies can easily mitigate the impact of regulatory price interventions and gain an advantage over their competitors.