“There’s a fine line between genius and insanity. I have erased this line.” –Oscar Levant
Here at Cornerstone we spend an inordinate amount of time analyzing the different pricing for third party banking systems. The one consistent thing we see across all of the different service lines is totally irrational pricing – at times to the point where it makes absolutely no sense.
In a prior life, I negotiated large scale enterprise resource management software contracts in the retail and logistics industries (SAP, PeopleSoft, Oracle and so on). These purchases included operating systems, hardware, application software, maintenance—you name it. The pricing for these services was usually rationalized across these industries. Negotiators could expect to get a “street discount” but rare was the truly “special deal.” One might spend a week negotiating between a 27% and 30% discount on a Unix box, but the range was clear from the beginning. Once a system was purchased, upgrades were free, there was little negotiation at renewals, and the price stayed the same for the next decade—regardless of fluctuations in volumes or size. The vendor extended the functionality of the applications normally without charge to keep their customers and extend their sales.
Now, I come back to my roots in banking, and I see the pricing all over the board. It is not unusual for me to see one bank paying triple what another is even after allowing for differences in size and volume. And what blows me away is that, when dealing with banking technology vendors, everything is negotiable. I’ve seen it all. A large bank in the Southeast that has been loyal to its vendor was paying per-account fees that nearly made me choke. A small Northwestern bank badgered its vendor into a pricing structure where the vendor can’t possibly be making margin. The list goes on and on.
One could easily write this off as the vendors taking advantage of their clients and/or a case of “caveat emptor,” or buyer beware. This answer is over simplistic. The vendors I work with are good people trying to help banks find solutions. The real answer is more complicated and says something about the peculiarity of banking technology. Here are some reasons we are where we are:
The vendors have little discipline in pricing.
The key vendors in banking technology have never been known for having list or book pricing. In fact, up until the late ’90s one of the largest vendors didn’t have a list price. At the time, the IRS required this vendor to develop one to comply with GAAP accounting rules relating to booking revenue. Now it has one but I bet few banks have ever seen it.
At some vendors, deals are left to the division heads versus ratified at the mother ship. This can cause large swings in pricing variance over time. As sales in the banking technology world are commission-based, there are very large incentives to cut deals. In the ’90s and early ’00s, pricing was very much the Wild West. Today the vendors are left trying to corral their troops.
To further complicate things, consolidation in the vendor market has led to extensive turnover in the sales force. Through all this churn, one thing remains the same: vendors do not proactively go to clients to reduce fees. Vendors understand the risk of having some clients find out they are getting killed on fees, but the vendors can’t do anything about it because they have too many offsetting deals where they are losing money. Verizon may call a customer and tell her there is a better phone plan with fewer minutes available. FIS, Fiserv, Jack Henry and the like will not.
Price compression funds new services.
In most industries, the further functionality of existing business applications is funded through non-negotiable maintenance fees. In banking, if the vendor develops anything, it is usually sold as a new product. Still, vendors know customers aren’t going to keep paying more and more forever, so they negotiate with customers at renewal time to lower their existing fees to fund new services. If you don’t believe me, at your next renewal, just try to get a large amount of price compression without any offsetting revenue for new services. You will quickly learn how much leverage you don’t have.
As it turns out, with this “compress and add” approach, the banking vendors end up participating in the funding of additional functionality to banking applications. They just make their customers jump through negotiating hoops to do it.
Hurdles to entry remain high.
Because the bar to entry of new banks remains so high, vendors have developed “de novo” pricing models. . This doesn’t exist in other industries. Vendors have pricing for a start-up bank that is really very beneficial … at first. It allows the bank to “pay by the drink” for a handful of accounts, which is pretty nice for Day One bankers, who can use capital to extend loans, not buy technology. A trucking company would never be expected to operate this way. When a trucking company buys accounting and logistics software, it pays the same whether it has one truck or 1,000.
This de novo pricing has its pitfalls. It takes forever for a bank to recover from what we call a “de novo hangover” – as many as four or five terms of effective negotiations to get per-account pricing even with peers. It can be two decades for some of these systems.
Loyal followers, there’s a lot of pricing weirdness going on out there. To combat it, we offer GonzoBanker’s 10 Ways to Tame the Irrational Vendor Pricing Beast:
- Know your opponent. Hopefully our shedding some light on these subjects will help bankers be better prepared to deal with their vendors.
- Don’t accept discounts at face value. A 20% discount in banking technology could leave a banker 15% to 20% above market.
- Enlist the help of someone who can see behind the curtain. This is a very opaque market. It’s going to be that way for the foreseeable future.
- To the extent that you can, hold off on new product purchases until renewal time. Buying in bulk will give you leverage with the vendor to compress your current prices.
- Work hard on cost of living adjustment limits. Vendors are going to increase the bank’s pricing by what the agreement says it can. The bank may not get an increase in its net interest margin, but it will get an increase in its technology pricing.
- Realize this isn’t about trusting the vendor. Technology sales execs are human, too, and they are working within a system that has constraints on what can be done.
- When a vendor says you have “special pricing” or “best in class,” understand that this could be a true statement. It just may not be a good “special.” Or you could be best of a bad class.
- Nothing gets the vendor’s attention like issuing a request for proposal at renewal time. Vendors are only going to negotiate aggressively with those clients that show signs of being serious about leaving. Issuing an RFP is one of the clearest signs.
- Align your termination dates. Everything added during a term should be set up to terminate at the same time as the master agreement. Leverage only comes if you can move your services. If your termination dates are strung out, it becomes much harder to convince the vendor you could move.
- Emphasize levels of service from the start. Don’t wait until the end to talk about levels of service. As you grow and customers become more demanding, your vendor “partner” needs to share in the promise of keeping key systems available.
There are advantages to this vendor pricing weirdness. It makes our extremely dull jobs as negotiators a little more interesting. We get our jollies out of helping our GonzoBanker friends level the playing field against the vendors. And there is nothing like seeing a price that is three times above market to get our juices flowing.
Playing David to the Goliaths out there is more entertaining than having our eighth vendor call of the day. We hope we’ve pulled back the curtain surrounding vendor pricing a bit for you today.
Cheers.
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