CREDIT CARDS - MAINTAINING PROFITABILITY BY ATTRACTING MORE PROFITABLE USERS, PROVIDING MORE USES FOR THE CARD AND GENERATING THE RIGHT TYPE OF USAGE. James Cranfield, Insight Consultancy UK Limited James Cranfield is a Director of Insight Consultancy and is a specialist in Credit Card Profitability and Financial Modelling. James has worked closely with Bluerock Consulting at Marks & Spencer Money. In everything but their shape and their core function, credit cards have changed more dramatically than any other financial service offering over the past four decades. Technology and competition have driven card issuers to change the product from a generic functional piece of plastic that was founded when Frank McNamara forgot his cash in a restaurant in the USA and started Diners Club all those years ago to a highly sophisticated globally accepted access device. Today the credit card product has been forced to differentiate itself in almost every conceivable way: functionality, features, price, user segment, delivery channel, security, etc. In fact, until recently the shape of the card has been the only constant - but even this is now becoming a marketing differentiation tool for some issuers, from the smaller key-ring sized cards to the new curved corner card recently introduced by RBS Advanta. Increase in competition and ever more sophisticated marketing strategies have driven issuers to pursue more aggressive and targeted campaigns aimed at finding the profitable segment and encouraging profitable behaviour. It is no longer possible to recruit anyone but the most credit hungry cardholders on the promise of a credit line. Issuers in today's environment need to create innovative products that attract and keep cardholders. In the 1990's issuers were already starting to market to individuals rather than the masses. The advent of co-branded and affinity cards gave issuers a unique opportunity to market to sub-segments with a common interest/behaviour. Information based marketing has further enhanced issuers' ability not only to target new cardholders but to offer different products to different micro-segments of their own portfolio using risk based pricing. The "Segment of One" was born. Sustained profitability in today's issuing environment can only be achieved through continual redesign of the product offering. Some issuers have already achieved this by allowing cardholders to design their own card. This has matured from the relatively unsuccessful photo cards launched in the 1990's to the fully flexible pricing and rewards packages offered by some issuers today. Part of the reason that issuers need to be able to adapt their offering at relatively short notice is the fast changing nature of profitability. Attracting and keeping profitable cardholders in a competitive market place is an expensive business. Needless to say the ability of issuers to offer expensive features depends on their ability to manage their costs and revenues carefully (see overleaf). Bearing in mind that a typical revolving credit card operation would generate approximately one quarter of its income from interchange (fee payable by merchant acquirers to card issuers for point of sale transactions), many issuers need to revisit their loyalty offerings with the current downward pressure on this revenue source. Blended interchange rates are likely to drop from over 1% to approximately 0.70% in the next few years. With many issuers basing their loyalty offers on this revenue stream, the most obvious being cash back rewards of up to 1%, we can expect to see a weakening of some of these offers in the coming years. Of course, issuers who are able to generate increased revenues from other sources such as interest bearing balances may still be able to afford such rewards, but there has always been a tendency for loyalty programmes and cash back rewards to attract transacting rather than revolving behaviour. Managing costs as an issuer has recently become a more interesting area with many more options available to issuers than existed in the early days of credit card issuance. Today, issuers can choose a multitude of entry strategies from co-branding to full issuer status. Once they have decided on an entry strategy they need to decide which services to operate in-house and which to outsource. Outsourcing to specialists is no longer limited to processing of transactions but also to all other areas of the cards business now including customer service. There are several technological advances which are aimed at cost reduction for both issuers and acquirers, examples of which include chip & PIN initiatives. However, these initiatives require substantial investment by the card issuers and acquirers, without immediate payback. In fact, many observers have commented that investments of this nature will not be justifiable even in the long run unless organisations actively promote the benefits to cardholders and truly leverage the capabilities of the new technology. Chip card technology offers issuers an unprecedented opportunity to create loyalty in a competitive market place, yet very few issuers have launched chip based loyalty programmes. This reluctance may stem from a belief that the cardholder is not yet ready for this technology, but developments in other industries such as telecoms tend to suggest otherwise. Being "front of wallet" is the ambition of all credit card issuers. The issuer wants its card to be the first card of choice for the cardholder, who will typically have 2-3 cards to choose from at the point of sale. The introduction of both PIN and chip will give issuers the opportunity to move to "front of wallet". When PIN replaces signature as the default verification method in the UK, cardholders will want to change their credit card PIN number to match their existing debit card or ATM PIN number. The credit card that offers the easiest and most convenient PIN change facility will tend to move to the front of the wallet. Conversely, those issuers who cannot offer convenient PIN change facilities could be facing a dormancy issue. Cardholders no longer want or need 6 or 7 cards in their wallet, but would rather have 1 or 2 cards that can do everything. With the introduction of chip and its multi-application capabilities issuers will have the opportunity of not only moving their cards to the front of wallet but requiring the cardholder to use the card more often and for different purposes. If your credit card was also your library card, debit card, ID card, video rental card, golf club card and mobile phone card, you could scarcely leave home without it. Once issues over data protection have been resolved, medical records could also one day be stored on your credit card. If one card could do all this, the cardholder would not have a need for a secondary card and rather than move to front of wallet, the issuer's card would "be the wallet". Clearly we are still a long way away from this scenario. However, economic, competitive and regulatory pressures are colluding to motivate issuers into creating more relevant and useful products for their cardholders, and card profitability can be maintained and enhanced in the future for those issuers who are prepared to take advantage of these changes.