By John J. Coffey, C.P.A. and Gene Palm, www.profitres.com, originally published February 2004, ABA Bank Marketing

Most banks cannot answer these basic questions:

§         How profitable are our products?

§         How profitable are our customers’ accounts?

§         What can we do to make our products and customers’ accounts more profitable?

Without knowing these answers, a bank can take on considerable risk when making pricing decisions.  How you price your products can make all the difference in how profitable your bank becomes.

Fortunately, marketing database software companies as well as consulting firms have developed a wide variety of profitability solutions to help bankers answer these questions.  However, some of these solutions are better than others.  If you’re not reasonably careful, it’s possible that a solution could actually give you the wrong answer because it contains one or more fatal flaws.  So, before you spend anything on additional software or consulting services to help you answers these initial questions, you need to ask a few more questions of your own in order to receive the best value for your money.

Basic Answers

The very first question you should ask is “How costly is this solution?  Like anything else in life, there are two extremes – lavishly expensive and ridiculously cheap!  The sky is the limit on the expensive solutions.  If you want, you can have a consulting firm construct an elaborate profitability relational database for you and pay over a $1,000,000 for it – but will you ever be able to justify this expense in the long run?  You can also pay more than $100,000 for a cost-accounting system, but again, you need to justify the expense of the software, associated hardware, and someone to run the system!

On the other hand, it’s just as much of a mistake to spend too little by using outdated publicly available national cost averages and having someone inside the bank who is not a financial expert work on this project.  In other words, you won’t receive a whole lot of value going this route.

To find the “happy median,” let’s suggest that for most community banks under $1 billion in assets, a good profitability software and consulting solution should cost less than $50,000.

The next question is similar to the first one, “How long will it take to implement this solution?  Again, there are two extremes – a really long time and too little time.  Some custom cost-accounting solutions can take up to two years to implement because of the complexity of their structure and the steep learning curve needed to master their features.  Other, more automated solutions, take very little time to implement; however, they can be too simplistic and may not provide adequate information.

Again, to find the “happy median,” let’s suggest that the ideal implementation time for a good solution should be measured in weeks, not years or seconds.  For most community banks, a good profitability software and consulting solution should take no longer than 12 weeks to implement.

It seems obvious to ask, “What should the profitability solution do?”  The answer to this “obvious” question is as varied as the opinions of all the CFOs in the banking industry!  Still, most CFOs would agree that the solution should:

§         Reconcile the profitability within your relational marketing database to the bank’s operating results

§         Be customized to reflect the bank’s detailed financial information, instead relying solely on national averages

§         Accommodate actual account-level transactions (fees and costs)

§         Calculate income based on historical data, and

§         Have adequate quality controls built into the profitability modeling

At the same time, there are some things that the profitability solution should not do.  It should not:

§         Force balance the profit without any user-override

§         Become unstable when new account-level data is loaded

§         Distort the allocation of the product profitability assumptions thus resulting in erroneous conclusions, or

§         Be a “one-size-fits-all” profitability model that results in the use of large “allocation buckets”

Finally, a good profitability solution should be one that pays for itself many times over.  It should contain some user-friendly tools such as “What-If” analyses that allow the user to change profitability assumptions for various products and see what the impact will be at the account level.

Ultimately, the solution should help you increase the bank’s net interest income and non-interest income or decrease the bank’s non-interest expenses and provision for loan losses in order to increase the profitability of the entire bank.  After all, if you’re going to the trouble to get good answers to your questions about profitability, the solution should be profit done right!

John J. Coffey, C.P.A. and Gene Palm are the principals of Profit Resources, a consulting company that specializes in MCIF technologies.  © Profit Resources, Inc. 2006