The Bottom of the Frog Market

Several years back, I went to Mexico for a vacation. While there, I found a ceramic hand-painted frog-shaped planter that I wanted. My husband loves the hunt, and his quest began. Every time we saw a frog-planter, he would start negotiating with the vendor to get the lowest possible price. We searched for several days and would stop in different towns and check the markets while enjoying our vacation and exploring. When we found a frog, he would inquire about the price and negotiate for further discounts. After a few days and no success at getting the cost of the frog below a certain point, my husband declared, "we have hit the bottom of the frog market."

As credit unions grapple with how to best price their products and services, the frog-planter story could be a guide. The sellers of the planters each purchase their product from similar sources at comparable prices. The same is true for a credit union. Most of the credit union's inventory comes from their member deposits or retail funding. The overall cost of funds from one credit union to the next is similar. However, there may be some variation driven by forces such as liquidity. Another difference might be the mix of inventory purchased. Less costly inventory (regular shares and share drafts) affords more markup and possibly better profit. More costly inventory may require tighter management and asset pricing to ensure the equivalent markup and profitability.

Investment yields, loan to asset ratios, cost of funds, loan losses, compensation structures, and operating expenses are factors to consider when setting loan yields. Pricing products or loans are not a one size fits all and cannot be driven solely by what the competition is doing. Pricing becomes institution-specific when all aspects of operations are taken into consideration. Fee income also plays into the equation.

When a merchant purchases inventory, they must sell their product enough over cost to cover expenses and make a profit. If they don't make a profit, they don't stay in business. Conversely, if the inventory sits on the shelf, they will not make any money. There is a risk in pricing a product too high and problems if it is priced too low.

Luckily for credit unions, there are investment options to put unsold inventory to work and realize some revenue from the deposits they have not been able to loan. However, in this market, the investment yields are meager, and it becomes even more important not to overpay for funds that may end up in investments. In this scenario, the spreads may not cover overhead expenses and is not a sustainable business model.

After analysis, if the final loan yields needed to cover expenses ends up too high, then increasing other revenue sources, reducing expenses, and adjusting the cost of funds becomes necessary to bring loan pricing in line. Another option might be selling products and services in other markets where the competition is not as fierce, and pricing can be adjusted.

Credit union managers and boards must set loan, deposit, and other product prices correctly, or profitability and net worth could be in jeopardy. Keep in mind that the bottom might be slightly different from one credit union to the next. Back to the frog story, each shop owner had to price their product to cover the product's cost, all other expenses and have enough at the end of the day to take home and make their efforts worthwhile. It doesn't matter what business you are operating, from the frog merchants to the largest companies on wall street; there will always be a minimum price that must be maintained.

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