The Art and Science of Pricing Financial Services

This paper suggests that pricing financial services is both an art and a science. It argues that the “art” of pricing is in choosing a combination of fees and charges acceptable to customers, that are fair and transparent, and in determining if the product has any unique attributes that deserve premium pricing. The “art” of pricing is in careful and considered communication to and feedback from customers and staff to ensure that pricing messages are appropriately and correctly delivered. The “science” of pricing is in ensuring that the product is profitable and is competitive in the market, that aside from very few specific and chosen loss leaders, that each product returns a profit.

This short paper briefly examines pricing from the customer perspective to examine how important price is as a determinant of customers’ choices and why prices of financial services are so difficult for users to understand. It considers the pricing implications of the evolution of “traditional” microfinance to a more “market led” approach – looking at competition efficiency and product diversification.

The paper then reflects on theory and practice, with an emphasis on the later, in particular the significance of transparency and mechanisms and policies to improve transparency of pricing – more specifically it discusses pricing objectives, pricing as a marketing strategy and using price as a differentiator. A simple, but effective pricing methodology is also introduced that considers the cost of provision, the charges of competing products and the value of the product to customers.

The paper ends with consideration of factors relevant for pricing different types of financial services, including savings, loans and e-banking products. It concludes that in concept product pricing is simple, firstly, establish cost, secondly examine the fees charged by the competition and finally determine whether the product or service has sufficient customer value to deserve a premium price. In practice, pricing is complex, customers and institutions alike find it difficult to track prices regularly and to understand the nuances of pricing calculations. There is a role for regulators in promoting transparency, but a less clear role in setting interest rate ceilings as these can act to restrict the supply of credit. Finally, where possible, pricing should reflect levels of risk and not be an avenue for excessive returns or to cover for inefficiencies in delivery of services.

Related Resources