Many purchasing card issuers, flush with their early successes, are entering into a more self-evaluative phase.
In many respects, this institutional introspection reflects progress. Transaction processing businesses go through a four-stage life cycle, and the purchasing card has moved into the second phase.
The first phase is Primary Demand, during which a small number of organizations take on the pioneering work of generating primary demand, selling to the early adopters, sometimes at the expense of positive earnings. The Primary Demand phase can be quite long, lasting a decade, for example, in the case of on-line point of sale debit.
In the second phase, the Scramble for Share, a larger number of players compete with a rapidly standardizing product (and in some cases, a product rapidly commoditizing). By this time, the pioneers have validated the basic business model, and the business has begun to expand rapidly.
The third step, the Emerging Market Structure phase, is transitional. One or a series of scale players have developed cost (and technology) advantages, and those competitors lacking specialized niches either explicitly or implicitly seek to leave the business.
The credit card acquiring business has been going through this type of restructuring throughout this decade.
The final step is the Maturity phase, in which growth rates have slowed and a small number of scale players lead the market with a second tier of specialists exploiting narrow market niches. The payroll processing business, for example, has been in this phase for much of this decade.
The purchasing card issuing business has entered the Scramble phase. The key for most issuers is to determine how to drive share, while simultaneously preparing for the shakeout to come.
The purchasing card is a credit card designed to streamline corporations' procurement processes, replacing manual processes on small transactions.
Issuers can offer corporations authorization controls and information to allow the corporations a prudent level of checks and balances on their employees' card use. Both MasterCard and Visa began promoting the innovation heavily in the past five years.
Although the business is still small, its growth has been impressive. By some reports, MasterCard/Visa volume hit nearly $8 billion last year, a 140% increase over 1995. The card associations expect volume to double again this year.
Although issuers are still scrambling to sign corporations, which mostly are buying the product for the first time, 23% of corporations with sales over $500 million report a purchasing card program in pilot or roll out.
As with any product in development, adoption at many corporations has been slow. The ability to steer corporations through a pilot and into a general roll out has become a critical skill.
The trade press indicates that more than 40 issuers have implemented purchasing card programs, but according to our analysis, five issuers seem to control 50% to 60% of the business: First Bank Systems, GE Capital Corp., NationsBank, First Chicago NBD, and Citicorp.
Whereas a few years ago, each issuer's offering differed substantially from other issuers, MasterCard/Visa requirements as well as feature and functionality competition between the processors have lead to growing standardization.
The purchasing card product generates simply extraordinary unit revenues. Thus far, average tickets on the cards have been $250 per transaction-well above the consumer card average.
The primary source of revenue in purchasing cards is interchange, which accounts for 95%-plus of revenue in most programs. Interchange averages about 165 basis points on sales volume, a figure 20 basis points to 30 basis points higher than the consumer card counterpart, largely because purchasing cards include a larger number of transactions not made face to face, which reap higher-than-average interchange rates.
The combination of the high interchange rate and the large average ticket results in revenues per transaction of over $4, tremendous revenues for any transaction processing business (compared with pennies per transaction in the Automated Clearing House business, for example, or 45 cents to 55 cents per transaction in the credit card acquiring business.)
The key driver for issuers in a start-up mode has been generating sufficient volume so that strong unit revenues will cover start up and fixed costs. These factors create a market primed for price competition, which has emerged in the form of rebating, providing a percentage of interchange revenue back to the corporation.
Issuers have little control over their largest sources of revenue and expense with the purchasing card. Revenue overwhelmingly comes from interchange. Expense is mostly funding costs, representing 50% to 60% of total expenses for the average issuer.
Contracts with corporations are generally for an intermediate period, at a fixed price. We estimate an increase of 200 to 300 basis points in funding costs would wipe out the profitability of most three-year-old to five-year-old portfolios.
Issuers should consider the following five questions.
First, what can you do to grab as much share and drive as much volume as you can over the short term?
Second, are you going to be cost competitive, long term?
Relatively minimal cost disadvantages can be deadly in transaction processing. The key in signing large corporations is customization, but is your version exception processing based, or automated?
Third, have you identified potential specialties?
Only one player can be the lowest cost provider, and most organizations will eventually have to dominate one or several niches to be successful. Have you developed insight into a segment's unique needs that you can "product-ize?"
Fourth, can you compete on the basis of technology?
Technological advances in this business, thus far, have provided issuers only windows of opportunity before the competition generates similar advances. Therefore, technology strategies are really continuous innovation strategies. Can your organization commit to the steady stream of investment necessary to pursue a technology strategy?
Fifth, and finally, how do you stack up against the competition?
Have you developed technical parity with your competition? How will your relative strengths and weaknesses affect your strategic choices?
The good news is issuers have been quite successful in generating early adoption and volume growth, but there are two sides to every coin.
The skills your organization developed in building the business to this level will be made obsolete by your success and the industry's development.
Those issuers who develop the key insights early will have a better chance of guiding their organizations to a sustainable competitive position when the shakeout comes. Mr. Abbey is a principal of First Annapolis, a consulting firm based in Linthicum, Md. He focuses on the merchant acquiring, transaction processing, and card issuing business.