It doesn’t pay to be a loyal customer

Chanticleer

Laziness, inertia and lack of engagement in financial matters are not exclusive to the banking sector. It is common knowledge in the general insurance industry that loyal customers get the worst deal.

There is a marvellous anecdote about a Canadian banker who 20 years ago tried to do the right thing by loyal customers.

He wanted to close the gap between the mortgage rates offered to loyal customers and the much better rates offered to new borrowers.

Telstra’s Andy Penn and Origin’s Frank Calabria have implemented different ways of rewarding loyal customers. David Rowe

But the banker’s ‘‘fair’’ interest rate, which provided benefits to existing customers and removed most of the upfront discount for new borrowers, went down like a lead balloon. The bank suffered heavy losses in mortgage market share and the banker soon lost his job. He has gone on to have a successful career at other institutions.

The lessons learned are applicable in Australia given we have a concentrated banking market similar to Canada’s with four big players. Two obvious lessons are that new customers want the best discounts possible and there is no first-mover advantage in fairness.

In Australia, the banks enjoy a profit benefit of about $3 billion a year from exploiting the difference in mortgage rates between existing and new customers, according to analysis done by banking analyst Matthew Wilson at Evans & Partners.

He arrives at this figure by taking the impact on the big four banks’ net interest margin (NIM) of the lower revenue from making the rates charged to loyal customers (back book) and those charged to new customers (front book).

The NIM impact was estimated by the Australian Competition and Consumer Commission at 32 basis points in its 2018 mortgage price inquiry and 51 basis points in Deloitte’s annual mortgage report.

Wilson blended these to come up with an average impact of 41 basis points. He then multiplied the NIM impact by the average interest earning assets, which equals lost net interest income of about $4.45 billion. He says when you take the tax-effected amount of revenue there is an 11 per cent impact on profit.

The banks have hit back at this criticism of their exploitation of loyal customers. They claim they are working hard to offer all customers the best value proposition.

But Chanticleer has first-hand experience of how the exploitation works. Despite being a customer of Commonwealth Bank of Australia for more than 40 years, your rooster will not receive the best NetBank Saver rate of 1.5 per cent unless a request is made to roll over the deposit every three months. Without being proactive the rate will revert to 0.5 per cent.

The ACCC mortgage price inquiry said opaque discretionary pricing was a primary reason consumers failed to get better deals.

‘‘Opaque discretionary pricing inflates borrowers’ costs (including their time and effort) to discover better offers,’’ the ACCC said. ‘‘This adversely impacts their willingness to shop around, either for a new residential mortgage or when they are contemplating switching their existing mortgage to another lender.

‘‘The unnecessarily high cost of price discovery is likely a key reason why 70 per cent of recent borrowers surveyed on behalf of an inquiry bank said they had obtained just one quote before taking out their residential mortgage.

‘‘We consider that the big four banks profit from the suppression of borrower incentives to shop around and lack strong incentives to make prices more transparent.’’

One way to fix the front book/back book problem is to sell mortgage tracker products, which have a fixed margin over an official benchmark rate.

A robust campaign in favour of these products by former securities regulator Greg Medcraft fell flat.

Complacency abounds

Laziness, inertia and lack of engagement in financial matters are not exclusive to the banking sector. Customers of insurance companies, telecommunications providers and energy retailers have been equally complacent.

It is common knowledge in the general insurance industry that loyal customers get the worst deal. Insurers regard them as people with a proven inability to shop around. That makes them ideal candidates for being hit with creeping increases in premiums.

As the premiums go up, the loyal customers are inundated with information about the discounts enjoyed for having multiple policies.

The energy and telecommunications sectors are fertile ground for case studies about the mistreatment of loyal customers and the front book/back book exploitation.

In the energy sector, it took government intervention to stop the energy retailers from taking advantage of loyal and complacent customers. Clients on fixed-term, market-based offers were often defaulted into much higher-priced ‘‘standing offers’’ when their lower-priced offer expired. This gave the industry a bad name.

In telecommunications, mobile phone plans were bundled in a way that made it virtually impossible to compare prices between companies. Price discovery of the different components of a plan, including data allowances, was virtually impossible.

Origin chief executive Frank Calabria and Telstra chief executive Andy Penn are two senior executives who have been forced to confront the blatant exploitation of loyal customers.

Brutal honesty

At The Australian Financial Review National Energy Summit this week, Calabria proudly called out how Origin had abided by the federal government’s Default Market Offer. He said Origin abided by the law, which forces the implementation of lower prices, and took it a step further.

‘‘We extended that default pricing towards customers on flat plans. So that really has meant that more than half a million of our customers are paying less for energy.’’

Calabria was brutally honest at the summit when he said greater choice in consumer energy plans had resulted in greater complexity. This made it more difficult for people to navigate the market and industry practices.

Companies offered discounts priced off different base tariffs and confusing discounts, which made it difficult to be confident in choosing an energy provider.

‘‘With a lack of consistency across the industry, it’s easy to see why there has been low trust amongst customers,’’ he said.

In the energy sector it is difficult for companies to unilaterally provide lower-priced energy plans to customers because of the authorisation needed to change the price of direct debit bill payments.

Not as simple as it looks

In the telco sector, customers have benefited from the decision by companies to offer all customers the best available data offers.

Telstra’s Penn confronted this issue last year with the removal of all excess data charges for new and existing customers. This was his way of dealing with the front book/back book challenge.

Telstra explained it this way in its 2018 annual report: ‘‘By choosing to lead the market and simplifying the charging model for our customers, we are likely to eliminate up to $500 million in revenues over the next three years, with excess data charges being the first example.

‘‘However, over the longer term these changes are in the best interests of customers and will drive long-term value. They are expected to be more than offset by more services per customer and lower costs from simplicity and leadership shown by Telstra translating into new sources of growth.’’

Chris Petzoldt, the local managing director of consulting firm Simon-Kucher, says rewarding loyal customers is not as simple as it looks when seen through a purely commercial lens.

He says a customer who has been loyal for 15 years but spends very little with the company would be regarded as low value compared to a high-spending customer who had been with a company for only five years.

”Tenure is not enough, you want the customer to be engaged with your products,’’ he says.

Petzoldt said the idea of companies proactively offering all customers the best available terms was not as simple as it sounded.

He cited a study done by his firm in the telco sector in Europe. It found customers on pre-paid plans were spending far more than they would if they were on a post-paid plan. But many customers had deliberately chosen the higher-cost plan to limit the temptation of using too much data on a post-paid plan.

‘‘There may be other causes or reasons why customers choose to buy a product that looks to be worse value than another,’’ he said.

Petzoldt said the worst thing a company could do was to make an offer to an existing customer that was not as good as offers made to new customers.

Tony Boyd is The Australian Financial Review’s Chanticleer columnist. Tony has more than 35 years experience as a finance journalist. Connect with Tony on Twitter. Email Tony at tony.boyd@afr.com

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Benjamin Tucker

Benjamin Tucker

I am Benjamin Tucker and I’m passionate about business and finance news with over 4 years in the industry starting as a writer working my way up into senior positions. I am the driving force behind Block Chains Job with a vision to broaden the company’s readership throughout 2016. I am an editor and reporter of “Services” category.

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