The Dynamics of Cards

By Stefan DabMohammed BadiDeepak GoyalPedro RapalloAlenka GrealishCarl RutsteinOlivier SampieriTjun Tang, and Gero Freudenstein

The card industry has emerged from the financial crisis with many challenges to address but also numerous opportunities to capture. The challenges have been brought about by decreased consumer spending, lower receivables (both smaller and fewer), tighter regulation, and intensified competition. The opportunities include new revenue streams that leverage evolving technologies and approaches (such as those related to mobile wallets and big data), new and disruptive business models (such as those created by partnerships across the value chain), and underserved customer segments that are ripe for innovation. A key goal is lowering the cost-to-serve while at the same time improving value propositions, such as for underbanked and unprofitably banked consumers.

To be sure, the retail payments business is once again showing strong growth potential. We forecast that transaction-related revenues generated by consumer-initiated (retail) payments will increase from $249 billion worldwide to $460 billion from 2012 to 2022, a projected CAGR of 6 percent. North America and Asia-Pacific will be the strongest regions, with RDEs in the latter posting the most robust growth. (See Exhibit 1.) In addition, account-related revenues will grow from $138 billion to $321 billion, a projected CAGR of 9 percent.

In order to seize this growth potential, banks must take stock of where they are and where the industry is headed, identify their largest opportunities, and take action on a number of fronts.

Key Trends in the Issuer Space

The four key trends for card issuers revolve around macroeconomic changes, industry structure and regulation, new technology, and heightened competition in key customer segments.

Macroeconomic Changes. On the transaction side of card revenue streams, slow GDP growth and the sluggish recovery in consumer spending since the depths of the financial crisis have translated into tepid growth in interchange revenues (the fees that card issuers charge merchants). The revolving-credit side of card revenue is also facing challenges. Ongoing consumer deleveraging, regulatory pressure in many countries, a greater number of delinquencies, slow interest-revenue growth, and higher loss provisions have all taken a toll. We expect this difficult new environment to persist as the global economy continues to struggle. Issuers will need to take steps to stay on the right trajectory.

Industry Structure and Regulation. The rollout of new regulations has obviously posed big challenges for issuers. For example, there have been three sets of onerous regulations in the United States: the CARD Act, aimed at curbing excessive interest-rate hikes and hidden fees; a modification to Regulation E that requires customers to “opt in” for debit point-of-sale and ATM overdraft protection; and the Durbin Amendment (within the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010), which established limits on debit card interchange rates, eliminated network exclusivity, and created a new oversight entity called the Consumer Financial Protection Bureau.

The impact on card issuers has been significant, and will not abate. We are seeing lower revenues, changing customer-service models and higher servicing costs, higher compliance costs (particularly in terms of the number of full-time-equivalent employees), rising legal fees, tighter scrutiny, and changing power dynamics among industry stakeholders. That said, as regulation continues to be implemented across corporate and investment banks—further depressing their returns—the relatively strong performance of cards could put them back on the front lines of bank profitability.

In addition, over the past decade, we have witnessed the demise of monoline issuers as card businesses have become parts of larger banking entities. This change has allowed issuers to leverage their other assets, such as branches (for sales channels) and data sources (for improving underwriting analysis and customer targeting).

There are many implications from this consolidation. For example, current-account data will help issuers lower their underwriting cutoffs on consumer credit scores. Indeed, we have already seen cutoffs drop by up to 20 points. Brand consolidation on the merchant side coupled with well-capitalized issuers will intensify the already-fierce competition for the best cobranded portfolios.

New Technology. The proliferation of technological innovations—such as those involving digital and mobile wallets and the possibility of automated clearinghouse interfaces at the physical point of sale—has led to the introduction of new payment products and credit-card form factors. Also, the ability to leverage big data to understand and influence customer behavior has fostered more-powerful marketing tools. While experimentation is necessary to drive innovation forward, we do not believe that new products, form factors, and tools will have a significant impact on the industry in the short term. Rather, it will take several years before new value propositions are strong enough to prompt a change in consumer behavior.

Heightened Competition in Key Customer Segments. Standard business models are being disrupted as different types of players make moves to capture diverse segments such as affluent consumers, small businesses, and low-income consumers. In fact, competition in all customer segments is forcing issuers to offer more rewards, thereby eroding net interchange revenues. We estimate that just over 50 percent of total interchange revenue is returned to customers through rewards, and that card fees and spreads make up more than 75 percent of issuers’ income.

These dynamics will continue to lead to consequences such as increasing costs for rewards and high-touch service for the affluent segment, the growing importance of cash advances for small businesses, and the evolution of new point-of-sale financing models to address the subprime space. In addition, innovation in serving underbanked segments will continue to spawn new prepaid, mobile-checking, and retail-credit offerings. Finally, ongoing globalization by acquirers and payments networks will lead to a further push to explore new regions and expand card usage.

Identifying and Capturing Pockets of Growth

Given the above trends, it is becoming increasingly important to identify and capture available pockets of growth. Looking ahead, card issuers will battle over product features and pricing in their search for higher market share and the most profitable customers. By taking the following five steps, issuers can quickly put themselves on an advantaged path.

  • Segment customers in a way that reveals where the greatest growth opportunities are available.
  • Initiate customer discovery through interviews and surveys in order to understand true customer needs.
  • Deconstruct competitors’ value propositions and their appeal to consumers.
  • Design specific product features for each customer segment.
  • Clearly align marketing, servicing, risk, and fraud functions in order to ensure a consistent customer experience in the early defining days.

We have developed a “cube” model for segmenting consumers that examines “off-us” card behavior (activity on competitors’ cards) and “on-us” card behavior (activity on a bank’s own cards) to determine which customer segments will yield the greatest growth opportunities. (See Exhibit 2.) In mature markets with little greenfield opportunity, such as North America, Western Europe, and parts of Asia-Pacific (including Japan, South Korea, and Australia), an issuer has two primary growth routes: win share from competitors and increase business from current cardholders. Understanding the cube model is critical to these initiatives. If “off-us” spending is more active, the issuer must develop a value proposition that will trigger a migration to its own credit card. For example, an airline-branded card issuer could find growth opportunities in the airline’s hub city by targeting competitors’ cardholders who have no-rewards credit cards—and who could therefore earn more miles and other perks with the branded card.

More specifically, in order to benefit from the cube model, banks need to analyze three types of data:

  • Internal data for “on-us” transactions, although these data alone are not sufficient to achieve full customer understanding
  • Credit-bureau data for “off-us” transactions, which are an important addition—providing insight into cardholders’ credit lines, risk profiles, and balances—but which do not indicate payment behavior regarding, for example, whether the cardholder typically pays the minimum balance, revolves a small portion, or pays the full balance every month
  • Third-party data based on card-issuer data sets, which help provide a more complete picture on not only the payment history but also the type of interest being paid (such as promotional or indexed rates) and the type of card being used (such as cash-back, generic reward points, or branded reward points)

Analyzing and leveraging the cube model constitutes the critical first step in the journey toward effectively expanding a credit card portfolio. Once this step has been completed, the issuer is well positioned to undertake the next step—customer discovery—which delves into the functional, technical, and emotional dimensions of target client segments. The offerings that are eventually developed can include a single product (such as a new card) or a multiproduct, commingled value proposition, such as making mortgage payments from an issuer-provided current account in return for credit card reward points.

Customer-Relationship University

As banks explore the optimal value propositions for their new product offerings, it is worth taking a quick refresher course at what we call Customer-Relationship University. There are a number of different levels of value to consider—starting with mastering the task of cross-selling credit cards to current-account customers, and ending with determining which customer needs are best served when different products are combined to forge new value propositions.

Level One: Mastering the Standard Cross-Sell. Banks obviously wish to sell multiple products to their customers. Level-one initiatives can include not only direct mail credit-card offerings to current-account customers but also sales efforts in bank branches to leverage multiproduct interactions. For example, a bank could use current-account transaction data to underwrite higher-risk credit-card applicants. The pitch to customers might be that by linking their credit card to their current account and automatically paying at least the minimum balance on their card bill, they will never again pay a late fee.

In addition, card issuers can capture incremental growth by actively converting their telephone-service interactions into sales occasions. Having just resolved a customer problem, service reps have earned a measure of trust and are well positioned to suggest new or better products—ideally aided by a powerful analytics engine to enable real-time customer segmentation so that customers are offered appropriate products.

Level Two: Leveraging Transaction and Demographic Data to Generate Thoughtful Offerings. A bank should know its own customers better than its competitors do because of copious internal-transaction data that provide insight into its customers’ behavior. For example, a bank can readily determine who is using revolving credit, who is paying balances in full every month, and who typically spends how much on different types of products and services. Credit-bureau and third-party data on competitors’ customers also provide visibility into customers’ credit usage and their preferred providers for products such as mortgages, personal loans, and credit cards. Level-two initiatives involve developing better, more innovative offerings in order to encourage customer migration.

Level Three: Creating Product Bundles Targeted at Specific Segments. By level three, banks have moved beyond customer lists and leveraging basic data to providing suites of products aimed at specific customer segments—on the basis of a segment’s wealth, wallet size, and current product portfolio. One example might be a “student pack” involving price discounts tied to a student’s product usage.

Level Four: Collecting Data on “Trigger” Events and Offering Relevant Products as Customer Needs Change. Banks at level four pay close attention to what each one of its customers is doing and make highly targeted offers. Changes in select customer data can signal a “trigger” event—such as a job change, a marriage or divorce, the birth of a child, or a young adult heading off to college—and provide an opportunity to keep up with the customer’s evolving needs. The bank knows when a customer is in the market for additional products and reaches out in a timely manner.

Card issuers can also harness their understanding of customer spending patterns and life events to build a highly targeted advertising and promotion program along the lines of merchant-funded rewards. These programs can be developed in-house or in partnership with a growing number of rewards platforms. Designing a differentiated customer experience is critical so that customers receive the right offers at the right time and are not inundated with spam.

Level Five: Combining Products, Linking Rewards, and Using Special Tools to Forge New Value Propositions. Although it is the most challenging stage, level five—which might be thought of as graduate school at Customer-Relationship University—reaps the greatest customer value. Leading retail banks have moved beyond creating basic product bundles coupled with price discounts to developing integrated product-reward bundles. By linking products and offering flexible reward options, these banks generate a value proposition that is greater than the sum of its parts. For example, one bank has developed a special program that combines current and savings accounts with debit and credit cards—along with tools to help the customer save, and incentives and rewards for customers who achieve their savings goals. The customer maximizes the value proposition by having all four products.

In the “new new normal” climate, banks need to become more innovative across the value chain of retail payments—from data analysis, customer segmentation, and product development all the way to product and rewards bundling. The reality is that banks can no longer merely sell products. Rather, they must offer workable and cost-effective solutions to meet customers’ needs with regard to all types of payments—and, more broadly, all types of financial management.