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Negotiations: Why is Your Bank in the Driver's Seat?

There are as many books about negotiating as there are prescriptions for negotiating success. With titles like Bargaining Your Way to Winning, Power Negotiating Tactics, and Negotiating Techniques for Winners, these books share two characteristics. First, they all promise a “new” approach to negotiating that guarantees success. Second, each studiously ignores the structural factors that are primary drivers in determining negotiating outcomes. That these prescriptions for negotiating success don’t always deliver dust-jacket promises is not surprising.

Winning at the bargaining table doesn’t primarily depend on negotiating technique, though the capabilities of individual negotiators make a difference at the margin. Positioning through strategy selection is the key to negotiating success. Good negotiators understand how structural factors influence negotiating outcomes. They also understand that strategy selection and negotiating success are different ends of the same moustache. The better the match between negotiating strategy and negotiating circumstance, the better the negotiating prospect.

Success at negotiating banking arrangements is no exception to this rule. The first step in understanding what strategy is best suited to borrowing cost and bank fee negotiations is analysis. Only when CFO’s understand how competitive forces influence negotiating outcomes will they appreciate why strategy selection is the key to negotiating proper bank pricing.

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Five Force Model

The structural factors that shape bank negotiations are (i) intensity of price competition (ii) the bank’s bundling strategy (iii) the nature of switching costs (iv) information asymmetry and (v) negotiating intensity. These factors can be diagrammed as five force model:

Price Competition

A key measure of negotiating success is price concessions taken or given. Winners at the bargaining table either negotiate more price concessions than they grant or the concessions that they grant are less consequential. When negotiating price concessions, selling companies fare best when they can avoid peer-to-peer price comparisons. This is especially true in bank negotiations.

In banking, companies that tender are the exception, not the rule. Moreover, when banking relationships are tendered, tendering usually does not reference target pricing. The absence of competitive bidding in borrowing cost and bank fee negotiations changes their tenor. Instead of focusing on whether bank pricing is fair in relation to a market standard, negotiations fall back on a softer question, whether price increases are fair in relation to last year’s prices. From a bankers’ perspective, the current year increase question is more manageable and yields better negotiating results than nose-to-nose price competition. It comes as no surprise that banks, indeed virtually all sellers, prefer to avoid RFP’s.

CFO’s who negotiate bank pricing on the basis of the reasonableness of proposed price increases forfeit an important edge in bank negotiations. A reluctance to seek out competitive pricing sends a clear signal to bankers that (i) a company has little appetite for tough negotiations and (ii) it is prepared to opt for consistency versus market pricing as negotiating objective. By accepting last year’s prices as a starting point for current negotiations, a CFO implicitly accepts the bank’s price base as reasonable. The competitive process that underlies tendering is replaced by haggling.

When banks and corporations meet at the negotiating table, insulation from price competition is an important condition that advantages banks. Without the threat of head-to-head reviews, banks have limited exposure to direct price competition. Isolation from pricing pressures that are commonplace in other supplier relationships strengthens a bank’s negotiating position and constrains the ability of their customers to bargain effectively.

Bundling

Banks sell their products and services on a bundled basis. The credit facility is sold as a “leader” product. Ancillary fees and services are tied to it. Banks do not normally extend credit and ask a customer to take the rest of his/her business to another financial institution.

Bundling benefits banks three ways:

1. The corporate banking package bundles a critical and highly valued product, credit, with complimentary products like cash management systems, transaction processing systems, foreign exchange facilities, etc. Tying lowers overall customer sensitivity to how these complimentary products are priced. Once credit terms are set, most CFO’s are reluctant to reopen credit negotiations to leverage better bank fee pricing. Most grudgingly accept proffered pricing, vowing to revisit the issue next renewal. There’s a reason banks like to negotiate credit first and follow with interest compensation and service charge agreements

2. By including a broad range of products and services in the banking bundle, banks improve their ability to manage account profitability using “average-up” pricing strategies. A strategy of offsetting price concessions granted in one area with price increases in others is a time-tested way to ensure that returns across the banking interface meet overall bank profitability targets. It also explains the proliferation of bank fees and charges. Each new charge is another opportunity to average up. Each new charge complicates the job of keeping track of overall pricing trends.

3. In most cases, banks take the lead in banking arrangement negotiations. Term sheets and interest compensation and service charge agreements are typically offered on a pre-approved basis. This practice not only seizes the negotiating initiative. It reinforces the pricing ties that are deep-rooted in the bundled package. Credit is offered but comes with tag along obligations – a full range of products and services that come complete with explicit pricing expectations. Pre-emptive pricing lets banks leverage the credit relationship to its greatest advantage.

Banks are masters when it comes to bundling. They know that fee and service charge pricing is rarely a deal breaker in banking negotiations. Bundling and tying lets banks market fee and service charges as part of the overall cost of obtaining credit. This establishes ground rules that tilt the negotiating table in the banks’ favour.

Switching Costs

Banking is an industry in which corporate customers perceive switching costs as high. Few companies believe that borrowing cost and bank fee cost savings justify the effort and aggravation of a banking change. Most CFO’s regard the banking relationships as inconvenient to unravel. There are several reasons for this perception. Among them:

1. CFO’s perceive little difference between competing financial institutions. The old saying, “better the devil you know than the devil you don’t” perfectly captures their ambivalence towards competing banks. Banks themselves do little to influence this perception of sameness. Their advertising and sales programs focus on relationships, not hard identifiable features that differentiate one bank from another. When it comes to positioning, Canadian banks don’t have identifiable brand images that set their commercial operations apart. Not surprisingly, CFO’s don’t see differentiation either. Without a compelling credit reason to explore new banking options, a CFO’s natural predisposition is to stand pat.

2. CFO’s believe that the cost advantage to switching banks is nominal. This is partially a function of a lack of benchmarking data and partially a perceptual issue. Because banking costs are fragmented it’s hard to see where one bank has a clear-cut cost advantage over another. Cost savings that accrue from changing banks are incremental and are spread across the banking interface. There are usually no cost reduction homeruns that make justifying a banking change easy to rationalize.

3. In many cases, CFO’s don’t recognize borrowing cost and bank fee cost savings opportunities and even when they do, there is little incentive for them to quantify these savings. When it comes to bank pricing, the phrase “let sleeping dogs lie” is surprisingly common in industry.

4. The perceived cost of changing banks is high. Objectively, retraining costs and new systems introduction costs are not significant. The stumbling block for most CFO’s is the penalty for failure on the credit side. If the credit relationship sours at a new bank, the architect of the banking change will be subject to criticism, no matter what savings the change delivered. CFO’s are by temperament and training, conservative. They are naturally reluctant to make a change that has the potential of casting a shadow over their career.

Switching costs give banking relationships an inertia that further insulates banks from competition. This inertia favours the status quo and, in the process, favours banks at the negotiating table.

Information Asymmetry

Information asymmetry” is a term popularized by Steven Levitt in Freakonomics. It describes a negotiating situation in which one party garners competitive advantage because he or she has more or better information than the other. Information asymmetry has been widely studied by economists because it is the one source of negotiating advantage that is absolute. If one party has a monopoly of pricing information at the negotiating table, its ability to dominate those negotiations is unconditional.

In Canada, information asymmetry has been an important source of competitive advantage for the banks. Without access to borrowing cost and bank fee benchmarking data, Canadian CFO’s simply haven’t had the one tool that will tell them whether their banking arrangements are properly priced. Bank fee benchmarking studies and data have been widely available in the United States for many years and are treasury mainstays there. Phoenix-Hecht’s Blue Book of Banking Prices, for example, is in its twentieth edition. It’s not surprising that American CFO’s view the market for banking services in the United States more competitive than its Canadian counterpart.

Negotiating Intensity

Some negotiations are collegial, others bitterly contested. Along this continuum, borrowing cost and bank fee negotiations are more cordial than antagonistic. Bankers deserve credit for this state of affairs. Although they dominate negotiations, bankers are not themselves dominating. The result is a negotiating experience that, were it not for the outcome, could be described as congenial. From CFO’s there may be low grade grumbling. Acrimony, however, is the exception, not the rule.

While bankers should be given credit for not being heavy handed at the negotiating table, their job is made easier by three factors that shape the character of face-to-face negotiations.

  1. Motivation

 

Bankers and CFO’s come to the negotiating table with very different agendas.  For many CFO’s, corporate banking concerns begin and end with credit availability.  Managing bank pricing is typically a secondary concern.  This attitude contrasts sharply with bankers’ attitudes towards pricing. 

Bankers know that price is an important profit driver in their business.  They recognize that price leakage dampens bank earnings and that small price increases have a corresponding multiplier effect on bank returns. On the retail side, for example, a recent Boston Consulting Group study that reports when banks increase prices by 1%, return on equity increases 6.8%.  By contrast, a 1% increase in volume or a 1% decrease in costs would only raise return on equity by 1.8% and 2.3%, respectively.  Bankers recognize that pricing is a potent profit driver and recognize that increasing prices is a key negotiating deliverable.  They understand why McKinsey & Company calls pricing “the fastest and most effective way for companies to grow profits.”

Pricing is as important to bankers as it is unimportant to their customers.  This being the case, it’s not surprising that bankers have a motivational edge at the bargaining table.

  1. Training & Experience 

Bankers and CFO’s differ in the training and experience they bring to borrowing cost and bank fee negotiations. 

Bankers are well trained.  Borrowing cost and service fee pricing is an important component in bank profit models and managing accounts profitably is a key skill that must be mastered by any banker that expects to climb the corporate ladder.  Mentoring, on-the-job training, job rotation, and formal courses are all part of bank training regimes and managing the pricing side of customer relationships is an important part of the bank training curriculum. 

Their corporate counterparts are not as well trained. Managing the banking relationship is a subject that only gets passing mention in business administration or professional accounting programs. Until TMAC’s Managing Bank Pricing courses, professional development courses in this area were most notable by their absence.  Most CFO’s openly acknowledge that, in this particular area, they are anything but experts. It’s a field where you learn by doing. 

The “doing” side of the training and experience equation is also an area where bankers have an edge. 

For treasury personnel quality negotiating experience is also hard to come by.  Most CFO’s apprentice their trade in smaller companies.  In these companies the CFO’s priority is implementing financial discipline and operational controls.  Bank pricing is neither an area of expertise nor a major concern.  Moreover, in many small companies, the CFO often isn’t even the lead negotiator in bank negotiations.  The CEO or owner frequently handles this responsibility directly.  More often than not, the apprentice is better equipped to handle negotiations than the master. 

For CFO’s working in multinationals, the opportunity to gain bank negotiating experience is even more limited.  In these companies, the treasury function is usually a head office responsibility.  For treasury personnel working in a multinational branch operation, bank negotiations are, at best, experienced second hand.

Bankers negotiate many banking arrangements each year.  Over a working career, they negotiate more agreements with more variety than the average CFO.  Banks, as institutions, give bankers greater opportunity to “learn from experience” compared to their counterparts across the negotiating table.

In summary, bankers are well equipped from both training and experience viewpoint to succeed in bank negotiations.  The disparity between the training and experience they receive and a typical CFO’s training and experience is noticeable.

  1. Measurement 

 

The final factor influencing negotiating intensity is how success is measured.

For CFO’s in most companies a successful banking negotiation is one that delivers a required credit line.  Hard nosed bargaining, to the extent that it occurs, tends to focus on lending covenants and security arrangements. 

Few CFO’s aggregate the cost of price increases they face.  Fewer still recognize that banking cost increases have an annuity effect.  Current year increases in bank pricing establish a base line for future increases.  Bank-cost savings are generally assumed to have a five-time multiplier value.  When reporting the result of bank fee negotiations, it’s easier to rationalize a $25,000 price increase than a $125,000 erosion in corporate value.

For CFO’s the yardstick used to measure success or failure at the bargaining table is forgiving.  Not so for bankers.

Borrowing costs and service fees are an important component in the banks’ profit model.  They have no choice but to take the pricing aspect of bank negotiations seriously.  Bankers that can’t manage customer relationships profitably have a short shelf life.

Banks today are beholden to investors that demand better financial results every quarter.  As businesses they are driven to increase shareholder value.  Their cultures are pushed by demanding Boards and senior executives and pulled by lucrative bonus and stock option plans.  The pressure to improve bottom line results is as relentless in banks as it is in any public company. 
When it comes to banking negotiations this culture creates pressures to deliver price increases that are omnipresent for bankers.  Fortunately for them, most of their customers are either predisposed to acquiesce to banks demands or don’t they know how to counter them.  In either case, the asymmetry of expectations works in the banks’ favour.

 

1. Motivation Bankers and CFO’s come to the negotiating table with very different agendas. For many CFO’s, corporate banking concerns begin and end with credit availability. Managing bank pricing is typically a secondary concern. This attitude contrasts sharply with bankers’ attitudes towards pricing.

Bankers know that price is an important profit driver in their business. They recognize that price leakage dampens bank earnings and that small price increases have a corresponding multiplier effect on bank returns. On the retail side, for example, a recent Boston Consulting Group study that reports when banks increase prices by 1%, return on equity increases 6.8%. By contrast, a 1% increase in volume or a 1% decrease in costs would only raise return on equity by 1.8% and 2.3%, respectively. Bankers recognize that pricing is a potent profit driver and recognize that increasing prices is a key negotiating deliverable. They understand why McKinsey & Company calls pricing “the fastest and most effective way for companies to grow profits.”

Pricing is as important to bankers as it is unimportant to their customers. This being the case, it’s not surprising that bankers have a motivational edge at the bargaining table.

2. Training & Experience Bankers and CFO’s differ in the training and experience they bring to borrowing cost and bank fee negotiations.

Bankers are well trained. Borrowing cost and service fee pricing is an important component in bank profit models and managing accounts profitably is a key skill that must be mastered by any banker that expects to climb the corporate ladder. Mentoring, on-the-job training, job rotation, and formal courses are all part of bank training regimes and managing the pricing side of customer relationships is an important part of the bank training curriculum.

Their corporate counterparts are not as well trained. Managing the banking relationship is a subject that only gets passing mention in business administration or professional accounting programs. Until TMAC’s Managing Bank Pricing courses, professional development courses in this area were most notable by their absence. Most CFO’s openly acknowledge that, in this particular area, they are anything but experts. It’s a field where you learn by doing.

The “doing” side of the training and experience equation is also an area where bankers have an edge.

For treasury personnel quality negotiating experience is also hard to come by. Most CFO’s apprentice their trade in smaller companies. In these companies the CFO’s priority is implementing financial discipline and operational controls. Bank pricing is neither an area of expertise nor a major concern. Moreover, in many small companies, the CFO often isn’t even the lead negotiator in bank negotiations. The CEO or owner frequently handles this responsibility directly. More often than not, the apprentice is better equipped to handle negotiations than the master.

For CFO’s working in multinationals, the opportunity to gain bank negotiating experience is even more limited. In these companies, the treasury function is usually a head office responsibility. For treasury personnel working in a multinational branch operation, bank negotiations are, at best, experienced second hand.

Bankers negotiate many banking arrangements each year. Over a working career, they negotiate more agreements with more variety than the average CFO. Banks, as institutions, give bankers greater opportunity to “learn from experience” compared to their counterparts across the negotiating table.

In summary, bankers are well equipped from both training and experience viewpoint to succeed in bank negotiations. The disparity between the training and experience they receive and a typical CFO’s training and experience is noticeable.

3. Measurement The final factor influencing negotiating intensity is how success is measured.

For CFO’s in most companies a successful banking negotiation is one that delivers a required credit line. Hard nosed bargaining, to the extent that it occurs, tends to focus on lending covenants and security arrangements.

Few CFO’s aggregate the cost of price increases they face. Fewer still recognize that banking cost increases have an annuity effect. Current year increases in bank pricing establish a base line for future increases. Bank-cost savings are generally assumed to have a five-time multiplier value. When reporting the result of bank fee negotiations, it’s easier to rationalize a $25,000 price increase than a $125,000 erosion in corporate value.

For CFO’s the yardstick used to measure success or failure at the bargaining table is forgiving. Not so for bankers.

Borrowing costs and service fees are an important component in the banks’ profit model. They have no choice but to take the pricing aspect of bank negotiations seriously. Bankers that can’t manage customer relationships profitably have a short shelf life.

Banks today are beholden to investors that demand better financial results every quarter. As businesses they are driven to increase shareholder value. Their cultures are pushed by demanding Boards and senior executives and pulled by lucrative bonus and stock option plans. The pressure to improve bottom line results is as relentless in banks as it is in any public company.

When it comes to banking negotiations this culture creates pressures to deliver price increases that are omnipresent for bankers. Fortunately for them, most of their customers are either predisposed to acquiesce to banks demands or don’t they know how to counter them. In either case, the asymmetry of expectations works in the banks’ favour.

In spite of these disadvantages, some companies routinely pay far less then their competitors for bank services. What’s their secret?

To begin with, these companies know that the payback for managing borrowing costs and service fees isn’t a one time cost time saving. It’s an annuity with a five-time value multiplier effect. The value creation yardstick gives bank fees much needed visibility. It highlights the real cost of letting fee negotiations slide.

Second, these companies want the best banking deal that’s available. Nothing more. Nothing less. They also know that when it comes time to negotiate banking arrangements, you get what you deserve, and you deserve what you negotiate. They take borrowing cost and bank fee negotiations seriously.

Finally, financial executives in these companies are pragmatists. In their world, bankers are smart business people who make the most of their negotiating opportunities. To level the playing field these companies rely on a process called principled negotiating and an aid that’s fundamental to the principled negotiating process – benchmarking.

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Jack Ostroff, performed the review quickly and efficiently, and delivered a comprehensive report shortly after completing his field of work. Jack was able to find a couple of areas that in the long term will net us significant dollars as well as areas for future improvement.

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George Harman
VP Finance