Richard Fairbank and Nigel Morris are passionate about applying scientific rigor to everything credit card-issuer Capital One does, from offering credit to hiring executives. And so far, at least, it pays.


Capital One Financial Corp. is hooked on tests. The fast-growing credit card company—it has 36.5 million customers and $31.6 billion in managed loans—conducted more than 46,000 product, price, marketing, distribution channel and service tests last year. It uses finely tuned statistical analysis to determine how any factor, whether a fee or a collection method, plays with different types of customers. In the past five years, the Falls Church, VA-based company has run about 140,000 such tests.Capital One doesn't just test its products; it also tests its employees. Job applicants go through a battery of exams before they're hired. And all of its 20,000 employees, from telephone representatives up through the chief executive, have their performance evaluated not just by their bosses but by their peers and by the people who report to them. Then they're graded on a curve.

"We measure everything," says chairman and CEO Richard D. Fairbank. "There's an expression we hear a lot around here: 'At Capital One, there's no way to hide.'"

All this testing plays a crucial part in what company officials call its "information-based strategy." That includes the mammoth database and sophisticated computing power Capital One is known for. And it encompasses a rigorously analytic culture. The company's top executives see that culture—which they describe with words like "entrepreneurial, creative, ingenious, non-political and fact-based"—as the weapon in their competitive arsenal.

"Testing is a way for the best ideas to rise to the top," Fairbank says. "We're not just taking huge amounts of information, but we're creating a massive scientific lab where everything can be tested. This is often underrated."

It would be hard to underrate Capital One's performance since it was spun off nearly seven years ago from Richmond, VA-based Signet Bank. That's where Fairbank, now 50, and Nigel W. Morris, 42, who had worked with him at a consulting firm and is now Capital One's president and chief operating officer, launched their rigorous strategy in the late 1980s.

The two men have an almost symbiotic relationship. They're close friends and business partners who are unafraid to use words like "love," "spirit" and "destiny" in talking about each other and their company. Yet what they share most is a fanatical belief in the power of testing, measurement, logic and analysis, what Morris calls "a tremendous passion for doing things right, and doing them based on facts."

But there's one thing Capital One can't test—at least, not with real-world experience: what would happen in a sustained economic slowdown? The company was a far different animal during the last recession. Now, with the economy teetering at the edge of the cliff, Capital One's risk management systems will have to prove their worth.

So far, on the standard tests of corporate performance, the company is pulling straight A's. Return on average equity has topped 25% since 1998, peaking at 26.2% in 2000, although it slipped a bit to 24.5% in the first three months of this year, the latest results available as this article went to press. Earnings per share grew at a compound annual rate of 31% from 1996 through 2000; the first quarter of 2001 was the fifteenth consecutive quarter of record earnings. The stock has gained about 1,000% (accounting for splits) from the beginning of 1995. For the past two years, Capital One topped U.S. Banker's ranking of the nation's best-performing large financial services companies.

To be sure, the past decade has been kind to the entire credit card industry, as American consumers went on a plastic-fuelled shopping spree. Although a few players (most notably Bank One Corp. subsidiary First USA) have stumbled, credit cards still remain one of the financial sector's most profitable businesses. And the Federal Reserve Board has given the industry a boost this year by continually cutting interest rates.

But even in a booming industry, Capital One stands out. In a recent report, Prudential Securities analyst Bradley Ball noted that its "organic" account growth (that is, not by acquisition) of more than 40% annually since 1995 far outstrips its credit card and banking peers. The same goes for Capital One's average annual loan growth of 26%, compared with 6% to 8% for its peers. Its overall revenue has been growing 41% annually, versus 8% to 10% for the peer group. And compare its annual earnings growth, 29% since 1995, with its peers' more mundane 10% to 12%. The analyst calls Capital One "the leading growth company in the financial services industry."

The company enjoys a stellar reputation not just on Wall Street but within its own niche. The universally imitated "teaser rate" was invented at Capital One. Its customer base is split about evenly among super-prime, prime and subprime borrowers. And it has managed to avoid the legal, regulatory and public relations snafus so many others have gotten into with over-aggressive sales tactics.

"I have nothing but good to say about them. They're a very smart group of folks," says Michael Auriemma, president of a credit card consulting firm in Westbury, NY. "Their approach is different than others, and their prospects are rosy."

Certainly, Capital One has big ambitions. Says Fairbank, "Our goal is to dominate the U.S. credit card industry."

That will be no easy feat, considering the size of the many companies ahead of it. It's now the seventh-largest Visa/MasterCard issuer, and ranks third among the independent issuers—that is, those not owned by a bank. As Ball points out, the top ten credit card issuers now account for 82% of the market today, compared with 66% just five years ago.

In this rapidly consolidating market, Capital One has bulked up entirely through internal growth, not through acquisition. It spends an enormous percentage of its revenue on marketing: $906 million last year and more than $231 million in the first quarter alone. It sends out far more pieces of direct mail come-ons—some 300 million mailings each quarter—than any other company in the industry. Slow to embrace the Internet, it now gets about 3 million unique visitors to its Web site every month, 30% of whom pay their credit card bill online. And it recently launched a TV ad campaign to boost brand awareness, the first time it has done so.

The Internet and branding efforts come at a time when direct mail overall is clearly losing some of its impact. According to BAI Global Inc. of Tarrytown, NY, a consulting firm that tracks credit card marketing, the industry sent a record 3.54 billion marketing pieces through the mail last year. It should come as no surprise, then, that response rates hit rock bottom: just 0.6% of consumers receiving the pitches actually applied for a card. Nonetheless, 68% of the people who got credit cards last year did so in response to direct mail. "So it's still the most important way of reaching new customers," says Andrew Davidson, vice president of competitive tracking services at BAI Global.

Capital One is also expanding rapidly abroad, especially into Canada and the U.K., and it would like to enter the rest of Europe, as well as Latin America and Asia.

Even more importantly, it has been expanding into other financial niches, such as installment and auto loans and consumer deposits. It recently bought a medical financing company that lends money to consumers for elective surgery that isn't covered by insurance. Fairbank and Morris's ultimate goal is to apply their vision of "mass customization"—in which every customer has a unique package of products, services and delivery and collection mechanisms—not just to credit cards but to all consumer financial services.

Not that Capital One's moves into other businesses have always worked out. Last year, it abandoned a five-year attempt to build a business for selling wireless phone service, an arena its executives had felt was as ripe for the "mass-customization" ideal as credit cards. They were wrong. So far, that's been the company's biggest misstep.

The drive to learn from experience—and to create experience through testing—led Capital One to create its own data mining and customer relationship management systems. Those information technology systems are crucial to the way it operates and to how it has grown.

Take customer service, for example. Capital One's call centers route incoming phone calls in different ways, depending on a customer's account status and known preferences, and on which agents with matching skills are available. Not that the customer necessarily knows it's happening. The match is made automatically within one-one hundredth of a second, according to Marge Connelly, executive vice president of domestic card operations and IT infrastructure. Seventy percent of the time, she says, the customer gets the best route to service, but the system also determines the second-best and third-best routes for when the best one isn't available.

"The system gets information about customers and their accounts, and uses rules engines to create intelligence, if you will," Connelly says. "We have a lot of knowledge that we can apply to balancing the customer's desire for speed with the desire for a high-level experience."

She feels that the proprietary system improves the experience for customers and service representatives alike. "We developed our own customer management system because we believe that our ability to take care of our customers in a very efficient but also very caring way would be important not just to customers but to our associates. It makes this a better place to work," she says.

It also helps Capital One sell a lot more to its customers. More than half of its account holders bought at least one more product from the company last year.

It's not surprising that Connelly mentions how important it is to make front-line "associates" (as the company calls its employees) feel the company is a good place to work. For starters, though, Capital One is choosy about who it hires. Just look at what applicants for those jobs must go through:

Calling an 800-number with an automated voice response unit takes applicants through the first round of questions. Those who pass are transferred to a live call-center representative for a brief talk, then come in for an online cognitive skills (i.e. math) test and enter biographical data into the computer for real-time screening. The company also administers an online customer-service simulation, and it checks the applicant's credit history. That's just the first day. Anyone who survives (and still wants an entry-level job there) phones the HR call center in Tampa for a job-fit interview and role-playing session. Each applicant's performance is scored, then the computer determines if they've got the job or not.

All 7,500 people in Capital One's various call centers have gone through this. The company sees it as a good predictor of their job performance, that these employees have higher productivity and show more initiative than their peers at other companies.

"We think it's the hiring equivalent of what we do around here," says Dennis Liberson, executive vice president of human resources. He adds that Capital One's call centers spend less than average on each person they hire and experience less attrition during training. Indeed, attrition overall has run between 15% and 25% in the past few years, a time in which many financial services call centers have suffered employee turnover twice that high.

Liberson admits that it's much harder to apply these sorts of automated techniques to people who are applying for executive-level jobs, but even those hopefuls must submit to several rounds of interviews, business case-study and behavioral tests and other highly standardized procedures before they're hired. "You can never take 'chemistry' or 'fit' out [of the hiring process], particularly at the executive level," he says. "But you can influence people with data here."

Even people the company wants very much to hire find themselves under the microscope. Noting that top executives have to go through as many as 15 interviews when they're recruited, CEO Fairbank says, "They're so worn out by the time they're done, they can't say no to us."

The intense assessment continues all the way through everyone's career at Capital One, at every level of the organization. At each level, employees know what skills they're expected to have to start, and what skills they're expected to develop to keep advancing up the ladder, or even to move to different parts of the company.

Pay is based on such development, too, and managers must rate everyone who reports to them in relative terms, so no one can afford to stagnate. And it's not just the boss's opinion that counts: Capital One uses so-called 360-degree feedback, meaning that you're scrutinized from all sides. Even Fairbank gets the treatment; he hired a former Pepsi executive as a coach to help him set development goals and to talk to everyone around him to see how well he's doing at meeting them.

All of this "keeps people challenged and stretches their abilities," Liberson says. Of course, some people might run screaming right out of a corporate environment like that. But Capital One doesn't want those people anyway. And the company plays up its high ranking on many national magazines' "Best Places to Work" surveys.

It also uses compensation to keep executives' eyes on the company's trajectory for the long haul. Senior executives can forego all or part of their salaries and bonuses in favor of long-term stock incentives that pay off only if the share price rises significantly over the course of years. In fact, neither Fairbank nor Morris have drawn a salary or received a cash bonus since 1997. (They have sold vested stock for income, though.)

Both the CEO and the president say that retaining Capital One's unique culture as it continues to grow is one of their toughest challenges. "As we become bigger, we have to make sure we preserve the spirit and the magic of Capital One," Fairbank says. "When we had 1,000 employees, I was afraid that when we got to 5,000, it would be too bureaucratic. Then when we got to 5,000, I worried about 10,000. Now we're at 20,000, and it still has that entrepreneurial spirit. But it won't be easy."

Given that international expansion is one of the company's top goals, it's hard to guess how successful it will be at translating its corporate culture to other markets. So far, it has overseas operations only in Nottingham, England, and foreign sales account for only about 10% of Capital One's total.

But forget growth. The more immediate challenge is the likelihood of a recession—if we're not in it already.

As unsecured lenders, credit card issuers have the most to lose in bad times. In anticipation, many stock analysts have cut their ratings throughout the industry. Many of Capital One's fans among the analysts—and it has plenty—have downgraded its stock from "buy" to "hold" in recent months.

Nonetheless, Capital One's executives sound confident that they'll weather any economic storm. "I'd be disappointed if we're not able to push right through a recession," Fairbank says.

He insists that the company's risk management systems and business projections include scenarios for a severe recession, "and we still show earnings growing." In every projection—including the marketing and credit decision process—Capital One includes the assumption "that a recession is starting tomorrow," Fairbank says. "Every day we remind ourselves that we're living through the best economy in history."

Morris calls credit quality one of the two issues that "keep me awake at night." And he wants credit risk "to keep me awake until the end of time," he says.

Conservatism has been Capital One's standard operating procedure for years. "We have by a wide margin the lowest credit lines in the industry, something like a quarter of the industry average, because of the assumptions we've built into our decision-making process," says Fairbank.

That can annoy prospective customers with stellar credit ratings, who are used to card companies offering them the moon to switch.

"During good times, it makes marketing more of a challenge," the CEO acknowledges. "But when things go bad, they don't go as bad."

The vigilance has paid off so far. Capital One's charge-off rate was 3.9% in 2000. According to Prudential analyst Ball, that was 200 basis points better than the industry as a whole. And Ball calculates that the company's risk-adjusted margin (which measures revenues minus charge-offs as a percentage of managed receivables) was 16.79% last year, more than twice its margin in 1996. The analyst expects Capital One's credit quality to continue to outperform the industry. Still, in April, he whacked back his rating on the company to "hold" from "strong buy."

Both Fairbank and Morris believe adamantly that their competitors, no matter how good their computer systems, will never be able to replicate wha's been built at Capital One.

"You can't turn a regular company into this. It's not about bolting a few smart people to the side of an existing bank," Fairbank says. "From the very beginning, we've had this beacon of information-based strategy, and everything we've done has worked backward from there. The hills we've taken on the way to that vision may have evolved, but the vision itself hasn't changed."

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