Teradata

The world of credit card marketing is not what it once was. No longer can issuers run propensity models against the universe, buy as many stamps as they can carry home, and then reap the benefits of a receptive audience waiting to use their product. 

In the past decade, low-rate balance transfers have gone from being a magic bullet for customer acquisition to mere table stakes. The world of loyalty programs and reward points has become so cluttered that many customers have become more proficient at gaming the system than they have at generating profits for the issuers who seek to serve them.

The cold, hard fact is that the credit card marketing game has changed over the past several years, and the old way of doing business simply cannot survive. The business model that worked when direct mail pulled a 1.50% response rate is simply not going to work when that response rate drops by eighty percent to the current industry norm of about 0.30%.

To gain a sustainable competitive advantage in the future, credit card issuers will need to create innovative new ways to drive value for the customer – changing the rules by which the industry has run for years. 

This paper discusses one such business innovation – one that should both attract and increase card usage among a highly desirable segment of the population – that is, the responsible folks that really do want to manage their money and pay back their debts. Better still, by the very nature of the information-driven value delivered to the customer, this innovation creates a competitive advantage that others in the marketplace cannot ever match, and thus, erects an enormous barrier to defection once the customer has begun receiving the value.

By changing the rules of the game, the early adopters of this approach can achieve breakthrough results in an industry that has not seen anything breakthrough in many years.

In a business world that is constantly changing, perhaps no industry has changed more in the past ten years than the credit card industry.

If we could’ve taken a credit card executive in 1996 and magically transported him forward in time to the current day, he would not even recognize his industry. Imagine his surprise when he sees the current landscape of the industry, namely:

• The market is saturated.
• Acquisition methods have become much less successful and much more expensive.
• There are no truly compelling retention tactics.
• The competition is mailing like crazy hoping to steal the best customers.

Sadly for our time-traveling executive, we cannot go back in time. However, using capabilities that did not exist ten years ago, we can create new value propositions for the customer and in so doing, create new ways of winning in the hyper-competitive credit card marketplace.

This paper examines one approach to winning in this new environment. By taking advantage of today’s active data warehousing technology and the ubiquitous internet, credit card issuers can provide customers with an altogether new way of managing their payments, while simultaneously increasing the lifetime value of those customers.

The good old days of credit card marketing are gone. No longer can you simply run a model, send out a million mailers, and reap the booty of a 1.5% response rate. Instead, average response rates have dropped by eighty percent over the past decade, and are now hovering somewhere south of 30 basis points. To achieve even these historically anemic response rates, the credit card marketers must offer up increasingly generous premiums for the new account holder. Since 2000, the percentage of direct mail offers with teaser rates has increased by twenty percent, and the average term of the teaser has doubled from six months to one year.

Paradoxically, despite these challenges for acquiring new customers, the industry does not enjoy a strong culture of customer retention. While airline miles and other rewards programs are somewhat sticky, there are no sustainable, compelling barriers to defection; if your competitor is willing to outspend you on the rewards, they can often steal away your best customers.

Given that many consumers receive multiple offers every week, the simple math dictates that without a compelling retention play, you will ultimately lose your cardholders – or perhaps even worse, you will keep them in an account that generates neither transactions nor balances, merely expenses for the issuer.

In a way, the credit card industry is suffering from a business model of its own making – despite the fact that most of the top issuers are attached to full-service banks (see Figure 1), the card sides of these banks have been reluctant to embrace the customer- centric strategies that other sides of the organization have been working on for more than a decade. While their banking brethren have long been singing the mantras of “in the customer’s best interest” and “needs-based selling,” the credit card operations have continued to operate much as if they were (still) monoline issuers.

The card industry has long been criticized for seeking to encourage its customers into evergrowing debt, regardless of whether or not this would be in the customer’s best interest. While much of this criticism is unfair – or at least, overblown – it does have some basis in truth. There have been practices, largely in the past, that pushed credit on those who could least afford or manage it, and the single-product business model of the issuers has greatly restricted the options for increasing the profitability of their portfolio. When all is said and done, there are basically three main ways for card issuers to make money on their customer base:

• Spread Income on outstanding balances

• Interchange on purchases

• Nuisance Fees such as late fees, over-limit fees, etc.

Since nuisance fees are rarely employed against those customers with whom the issuer would most like to build a relationship, we will not deal with them here. Instead, we will focus our discussion on spread income and interchange.

A wise man once said, "If your only tool is a hammer, all the world looks like a nail." Well, given these constraints, the card industry is living by a slightly modified version: "If the only tools you have are a hammer and a screwdriver, the entire world looks like either a nail or a screw."

In this case, the nail and screw are interchange fees and balances. Clearly the industry is focused on driving up usage with all types of newly-devised, convenient ways to use cards. Similarly, there are all sorts of programs out there to drive up outstanding balances.

Of course, the main value proposition that card issuers have given to consumers revolves around these two features of the business model:

• Reward programs almost exclusively rely on increasing usage. Points are generally awarded based on transaction volume and size. Makes sense, nothing wrong here.
• Balance transfer (BT) offers focus on building balances. Essentially, the value proposition provided by the card issuer in a BT offer is this: "If you transfer gobs of debt to us now, we will hardly charge you any interest for several months. After that, of course, we’re hoping that you are either unwilling or unable to pay off the balance – at which time, we’ll happily continue to fund your lack of discipline at a modest rate of 18.99% annually (plus assorted fees, of course)."

Given the above, it’s not hard to imagine why acquisition programs are not working as well as they once did – it’s difficult to build rapport with someone who suspects that your ultimate goal is to hammer them.

Fortunately, there is a better way – a new business model that focuses on meeting the customer’s needs and sacrificing some of the here and now profits for a truly sustainable, mutually beneficial relationship with the customer. 

This new way, quaint as it may sound, entails having the card issuers work with their customers in a partnership – a partnership more mutually beneficial than that usually associated with the partnership between the hammer and the nail.

To understand the value of this approach, it’s important to first ask a very simple question. Given the mileage and points rewards associated with credit card purchases, why on earth do ANY customers EVER use any other instruments for ANY other transactions and/or borrowing? The question is both simple and enlightening. After all, given the generous rewards that cards give out, why would anyone ever willingly avoid charging anything?

Perhaps, the most appropriate analogy here is the Home Equity Line of Credit, and the reason why people don’t put all of their purchases on their credit card is precisely the same reason why they don’t use their Home Equity Line of Credit (HELOC). For many people, it’s simply a matter of not trusting themselves to maintain the financial discipline necessary to manage their debt; for many, it’s the fear that soon their debt will be managing them.

Without a doubt, a HELOC is one of the best borrowing tools on the market. However, it does require discipline. As appealing as it may be to use your HELOC to payoff your new car, and to extend the payments over 15 years, it clearly does not make good financial sense to do so. The fact is that most purchases have a definite lifetime, and to extend payments beyond the useful life of that purchase is usually asking for trouble. If you are using a HELOC to buy a new car, you should probably pay off that debt in perhaps four to five years; if you’re using the HELOC to add an addition to your home, perhaps fifteen years would be a more appropriate timeframe.

Similarly, if you’re using your credit card to pay a medical bill, you may want to stretch out your payments for six months; however, if you are using it to buy gasoline or groceries, your timeframe for repayment should be close to instantaneous. 

Of course, currently customers are not able to make these distinctions, and as a result, they generally either:

• Charge everything and lose control of their debt,
• Avoid charging many items for fear that they lose control of their debt, or
• Carry and use multiple credit cards (and possibly debit cards) with different repayment strategies for each. This can work for the customer, but requires a lot more thinking on their part and requires them to carry a wallet full of different plastics.

Clearly, none of these approaches is ideal for the customer or for the issuer. The goal should be to provide the customer with the necessary tools so that they can use their one preferred card for most transactions, yet also be able to manage their finances effectively.

The concept here is a simple one – provide the customer with the information and the tools to manage their debt in a responsible manner. Rather than forcing the customer to make transaction and payment choices based on ignorance, this approach would enable them to use their card as a payment vehicle and a financial management tool – not merely a spending and debt-accumulation instrument.

The two keys to making this happen are:

• Slightly expanding the capabilities afforded by the current online banking front-end screens for credit card transactions, and
• Changing the operating model of the credit card relationship to leverage the value of integrated customer and transaction data, combined with the analytical horsepower inherent in today’s active data warehousing engines. 

Clearly, it’s the second of these keys that will require more of a change in mindset; and clearly it’s also the second key that will be more difficult for competitors to match.

Figure 2 shows a sample of what the online banking screen might show. Most of the information shown in this screen is the same as that shown in today’s screens with a few key exceptions:

• The fifth column shows the category of spending. This is similar to the functionality available on many PC-based money management software programs.
• The sixth column shows the term over which the customer chooses to amortize this specific transaction or spending category.
• The seventh column shows the monthly payment required to amortize that specific transaction over the specified term.
• The first column that would allow
  the cardholder to select those transactions for which he would like to modify the values in columns five and six (category and term). 
  
  
  

As shown in this mock-up, the Payment Term would default to one month – though this could conceivably be set by the customer. As the customer views his transactions on the web, he sees that the new kitchen counters are not yet identified as being a “Home Improvement” purchase, and thus, are amortized over the default period (one month). 

By simply checking the box in column one, the customer would bring up a “Payment Duration Selection” screen as shown in Figure 3. Here, the customer can change the “Payment Category” of the purchase to “Home Improvement” and thus, automatically reset the amortization period to 36 months.

Of course, if the customer chooses to add, delete, or modify the choices for “Expense Category”, he would be able to do so using a simple screen such as that shown in Figure 4.

Once the customer has chosen the appropriate Expense Category for each purchase, or simply let the transactions default to the “Miscellaneous” category, it’s a simple matter to calculate the payment necessary to meet the customer’s self-defined “Personal Repayment Plan” (this would basically require using the Excel PMT() function). If desired, the issuer could also present the standard “Minimum Payment” required using the same logic as applied today. The customer would then be empowered to exercise financial discipline, while still being able to enjoy the benefits of a credit card.

Clearly, this type of data-enabled service offering would create tremendous value for the customer and for the issuing institution.

The customer would receive a heretofore unavailable capability to manage his finances – combining the convenience of the credit card with the discipline of a budgeting tool. For a minimal time investment to categorize those transactions that should not be paid back immediately, the customer can avoid the death spiral associated with increasing debt, without having to swear off credit cards completely.

For all the benefit this type of service would provide to the customer, it would provide even more to the issuer:

• For the early adopters, this would be a tremendous differentiator for acquiring new accounts. Not only would this be an extremely attractive feature for a highly desirable customer segment, but it would not require a special premium. Instead of trading cash or goodies for customers, issuers adopting this type of acquisition tool would be trading the relatively less-expensive perks of information and empowerment. In general, it’s always a better idea to trade something that has high value to the customer and low cost to the issuer (e.g., information, airline seats, etc.) than something that has exactly the same cost to the issuer as it does to the customer (e.g., cash, reduced interest rates, etc.). This service would provide just such a cost-value arbitrage opportunity
• Once the customer begins using this type of service with Issuer A, it would be nearly impossible to disentangle his finances to move to Issuer B. Since many of the transactions still being amortized this month would go back years, there would be no way for Issuer B to recreate the Personal Repayment Plan for charges already incurred. Currently, there is nothing within the credit card industry that is even close to this level of stickiness.
• Having the customer enter their Personal Repayment Plan would provide a tremendous amount of valuable insight to the issuer. Among other things, it would show the issuer which customers are growing balances in a responsible manner versus which ones are growing balances due to fiscally irresponsible behavior. This type of customer insight would be invaluable in determining which customers to cross sell, up sell, or retain. And it would be insight that the competition will never be able to harness.
• All types of customer treatments could be devised to better serve and better entrench the customer. Depending on the profitability associated with the moves, offers could be made to refinance certain expense types into Home Equity Loans or other financial products. If desired, the issuer could even offer different interest rates based on the Expense Category and Payoff Duration.
  
  
  

Insanity is often defined as continuing to do the same things you’ve done before and expecting different results. This is especially relevant to the credit card marketing world. The silver bullets of balance transfers and loyalty points have clearly lost their once-significant power to attract and retain customers. Thus, the industry is faced with the choice of either continuing to up the ante on the promotional premiums or to fundamentally change the rules under which marketing is executed.

A capability such as that described above is both revolutionary and sustainable. From a technical perspective, this vision is achievable for those possessing an integrated data environment and an active data warehousing engine. 

The greater challenge lies in changing the business model and, indeed, the mindset of the credit card business community. It can be done, and once it’s launched by one issuer it will be demanded by many of the most desirable customers. 

In this case, as in most, the future belongs not to those who merely play the game, but rather to those who leverage their technology and customer insight to fundamentally change the rules of that game.

Bob Brady is a Senior Industry Consultant within the Financial Services group of Teradata Corporation. In this role, he works with clients and prospects to identify, develop, and implement innovative ways to drive business value from integrated data. 

Prior to joining Teradata in 2000, Mr. Brady led Pricing and Profitability, Product Management and Customer Relationship Management initiatives at NationsBank and First Union National Bank (now, Bank of America and Wachovia Bank, respectively). He earned a BS in Electrical Engineering from Virginia Polytechnic Institute and State University in 1984, and an MBA from Duke University’s Fuqua School of Business in 1991.