Whew! Credit card executives across the land are breathing a sigh of relief as industry economics continue to improve. (See table below.) Bankruptcies and loan chargeoff rates are significantly down, and several leading indicators are encouraging, including reductions in delinquency rates and in direct mail solicitations, which tend to siphon off credit card issuers' most profitable and least risky customers.
While credit card executives guardedly celebrate, potential new players - including insurance, brokerage, and Internet companies - may be licking their chops. One likely scenario is as follows: Because the Glass-Steagall Act is effectively dismantled, newly formed financial holding companies (under Gramm-Leach-Bliley) will reassess their strategies to identify the right combination of products and services to attract and keep customers. What could be better than a financial product that is versatile, personal, portable, convenient, tangible, ubiquitous, and e-nabled?
Here's another scenario: Having witnessed the success of NextCard, an Internet start-up enters the credit card business with little more than a novel, executable, and defensible business plan, because it can outsource all resource-intensive account processing and cardholder-servicing functions.
These two scenarios are at opposite ends of the spectrum. In one, a large, well-established financial services company seeks depth of relationship and share; in the other a start-up executes a niche strategy. Perhaps these will be the entrants in an industry that feigned maturation in the late 1990s, but which is headed for another growth phase because of the acceptance of the Internet as a channel, as well as product innovations such as the American Express Blue Card.
Many potential entrants perceive the development of a credit card program as daunting, and indeed, working through the details can be arduous. But entering the business can be expressed in five steps:
1. Accessing association brand membership. Entrants will want to offer credit card products that are broadly accepted at merchants, to ensure optimum utility. To do this, entrants have typically applied for membership in Visa and MasterCard and have issued cards under both brands.
Today's entrants may also want to consider the following alternative entry strategies:
- Choosing to offer either Visa or MasterCard.
- Issuing American Express cards (since American Express has identified growth as an alternative credit card network as one of its long-term strategies).
- Renting a bank identification number, or BIN, to become part of the Visa Network, or renting an ICA authorization for MasterCard. Under this arrangement, issuance is technically performed by another bank, but branding, program management, funding, processing, and servicing is conducted by the entrant. An example would be NextCard, an emerging Internet-focused credit card company, which had such an arrangement with Heritage Bank of Commerce until it established NextBank, under which it issues credit cards on its own behalf.
- Establishing an affinity arrangement, in which the company offers its customers branded credit card accounts that are supplied by an existing credit card issuer.
2. Developing a business plan. After choosing an entry strategy, entrants should address three fundamental questions. Why should they enter the credit card business? How will they offer the card? What results should they expect?Understanding why to enter the business typically involves identifying linkages into a company's overall strategy and the perceived need for a credit card product to strengthen customer relationship potential. Entrants can gauge the size of their market, assess the competition from issuers and from other rivals with affinity card offerings, and identify the benchmarks that should be used in evaluating program results, such as growth, revenue, risk, and profitability. In structuring the program, entrants also need to consider the products they will offer, their pricing strategy, and the channels through which they will market.
After identifying the proposed mix of products, pricing, and channels in the context of marketing investment, anticipated response rates by channel, and underwriting guidelines, new entrants can then estimate growth and performance. Predicting financial performance is important for setting expectations within the company, but the quest for attractive financial results should not always dictate strategy. For example, an entrant may choose to offer competitively priced card products that by themselves do not produce spectacular returns, because the increase in loyalty and is use of other financial products more than offsets the lost credit card profits.
3. Choosing an account processing platform. In selecting a processing platform, an entrant will first decide whether to process in-house or to outsource. Though in-house platforms are available, the vast majority of the industry lacks the requisite scale and resources to support in-house data processing systems. Most entrants will choose to outsource, at least in the interim. The two largest credit card processors, First Data Resources, a unit of First Data Corp., and Total System Services Inc., a unit of Synovus Financial Corp., offer leading platform solutions.
Running a credit card program also requires numerous account-servicing tasks that must be performed on behalf of cardholders. Fortunately, entrants can choose to "in-source" or outsource each of these functions as they see fit. For example, an entrant may choose to outsource all cardholder-servicing functions except for 9-to-5 call center support.
4. Funding the cardholder balances outstanding. Once an issuer begins to originate credit card accounts, it will generate cardholder balances, an asset on the balance sheet that must be funded with debt (90-95%) and equity (5-10%). Debt funding can be accessed through revolving lines of credit with other financial institutions, deposit taking, and credit card asset securitization.
5. Hiring management and staff. Developing an effective organization ensures that the investment of resources directed toward the first four areas pays off. The optimal structure of a credit card issuing organization will vary for each entrant and will depend on its financial services strategy and its degree of outsourcing.
As companies seek to enter the credit card issuing business, they will undoubtedly pass through each of these five steps. Perhaps the most interesting question is who will be first to do it. Frank Martien is a senior consultant at First Annapolis Consulting