by Robert D. Kugel CFA |
11/18/2008 | Article ID: V08-41 | Article Type: View
Summary
Price and revenue optimization is a business discipline that uses market segmentation techniques to achieve strategic objectives such as increased profitability and higher market share. PRO first came into wide use in the airline and hospitality industries in the 1980s as a way of maximizing returns from less flexible travelers (such as people on business trips) while minimizing the unsold inventory by selling seats on flights or hotel room nights at discounted prices to more discretionary buyers (vacationers). Today it is a well-developed part of any business strategy in the travel industry and increasingly being used in others. Ventana Research expects this application segment to continue to spread across and within industries as techniques evolve and the software necessary to support it continues to simplify its execution. We expect that over the next five years PRO will become a competitive necessity in the financial services business in particular . Nomis Solutions is a price and revenue optimization software provider financial services that companies should consider.
Assessment
Ventana Research anticipates that once the current challenging conditions in the financial services sector have eased, companies in banking and consumer finance will find themselves in an environment where managing profitability and controlling risk exposure is even more important than it was in the last cycle. In North America (especially the United States), the likely deleveraging of the balance sheets of both the financial services industry and consumers will heighten the necessity to eke out every basis point (one one-hundredth of a percent) of yield from loan portfolios while still demonstrating a consistent ability to manage risk transparently.
Nomis Solutions offers price and revenue optimization software designed specifically for the financial services industry. This software, which is built on decades-old analytical techniques, is a way for businesses to apply market segmentation techniques to maximize their positive economic outcomes (profitability or market share, for instance) while minimizing the negative ones (such as – in the case of lenders – default and other risks). This is especially important in the financial services sector because it relies heavily on custom pricing for high volume products such as mortgage and automobile loans. Since these loans are negotiated and the offer and terms are a function of factors such as income and credit history that go beyond just a customer’s willingness to pay, it is critical for finance companies to accurately segment prospective customers.
This segmentation requires that in pricing these somewhat complex products, the banker, mortgage broker or auto finance representative must make and weigh a variety of assessments. The process is all the more difficult because most sales agents don’t have sufficient first-hand historical knowledge of buyer behavior and how certain buyers respond to offers and trade-offs to do this consistently well. Even if they have some insight, the calculations are complex, to the point where most aren’t able to process them rapidly enough on their own. Consequently, companies not using these capabilities have to issue simplistic guidelines (for example, pricing based simply on risk, competitive factors or volume objectives), which agents usually interpret using gut-feel and follow-the-leader approaches. Too often, the result is hit-and-miss, with attractive borrowers put off by unfavorable terms and those that would be willing to pay more get better deals than they deserve.
Nomis enables lenders to have a better sense of their customers’ price sensitivity, segment by segment, based on historical patterns (for example, using their own “lost quote” records). Structuring this information within a framework of the financial services company’s goals (such as volume objectives or desired portfolio risk) enables it to increase profits while achieving market share and credit quality objectives. Since the software can take into account the full scope of a company’s relationship with a customer, it is able to price the offering based on his or her loyalty and lifetime profitability objectives. Other factors, such as the probability of default over time and prepayment risk, also can be modeled. Of particular importance for lenders, the software takes adverse selection into account in setting pricing structures. It also enables companies to monitor their performance to enable continuous improvement through the refinement of offerings and techniques. The software also supports compliance: By recording specific offers and the criteria behind them, it can demonstrate the absence of prohibited discriminatory lending activities.
Market Impact
The market for price and revenue optimization software has been growing rapidly and is highly fragmented. Vendors include DemandTec, JDA, Oracle, PRO Holdings, Rapt, Revenue Technologies, SAP, Symphony-Metreo, Vendavo and Zilliant, although most of these do not focus on the financial services business. In addition, many companies have developed their own solutions or have had third party consultants build them. We expect demand for this software will grow rapidly despite the temporary impact of economic conditions depressing sales in the coming year. We also believe that, following the pattern in other software categories, custom-built solutions will steadily lose ground to vendor offerings.
Recommendation
Ventana Research believes software is a necessary component of an effective price and revenue optimization strategy. We recommend that companies include Nomis Solutions as they evaluate what software will satisfy their requirements. Software, however, it is only a start. Successful PRO deployment requires the continuous implementation of increasingly refined techniques and the use of software to support the consistent application of business rules.
There are a variety of software packages on the market that handle price and revenue optimization. At this time, each aims at a certain unique industry or set of similar types of businesses. We recommend that companies considering pricing and revenue optimization software look first at each vendors’ user list, for two reasons. One is that different industries have different product and buyer characteristics and segmentation features. Since the different software packages are not yet interchangeable commodities, they will differ in their ability to handle your company’s specific requirements. The other is that at this stage in the evolution of the software, having access to a group of users that are likely to share your requirements and priorities will be helpful on an ongoing basis in guiding the direction of the software’s development and the vendor’s strategy. In other words, choosing a vendor whose focus is your market segment will ensure that the software will continue delivering value to your company over time. Whatever the details of your selection process, though, we advise all companies, especially those in the financial services sector, to consider this as a strategic option.
Related Research Notes:
The Pricing Is Right
Optimizing Revenue in Troubled Times and Beyond
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