By now, virtually every credit card institution has reviewed, or is in the process of reviewing, its portfolio for repricing. In almost all cases, the analysis will result in lower rates.

Reducing the annual percentage rate, or APR, has both positive and negative aspects.

On the plus side, a lower APR may prevent account holders from voluntarily transferring their balances to lower-rate institutions. It may also generate greater charge volume, since high rates in a weak economy substantially reduce credit card spending.

On the minus side, all other things remaining the same, lower rates mean lower profits.

A Marketing Plan

Therefore, marketers involved in repricing must develop a plan to reduce APR in a way that will minimize customer runoff and maintain profit.

But when we look at the various approaches recently used by institutions, it's apparent that this objective may not be directly met. To back up that statement, I will review two approaches I have seen and then suggest an alternative I believe can maintain profits.

The first repricing method I've observed reduces rates across the board. This is a simple, straightforward method but can have significant negative impact on profit.

Moreover, if the previous rate was very high, for example, more than 19%, reducing the rate substantially, that is, to less than 17%, can create a perception that customers were being gouged at the old rate. This is bad for the industry's image.

To Vary or Not to Vary

Another issue with this scenario is whether the lower rate should be fixed or allowed to float with the prime. A float with prime is safe and translates into an attractive figure. But adopting a variable-rate structure may be operationally difficult (and expensive).

The second approach restricts lower rates to good credit risks. To mitigate the profit impact of a rate reduction, only those accounts that have exceptionally good credit histories, lower chargeoff rates, or rarely revolve are offered the lower APR.

While offering a lot of public-relations value, this approach does little to reduce either account attrition or the APR of heavy revolvers who produce a disproportionate share of both profit and risk. This approach must be carried out carefully so that profitable revolvers don't cancel or transfer their accounts or balances.

Since neither approach is very responsive to the institution's profitability or attrition concerns, I'd like to suggest a different one. It uses account-level profitability patterns and profit to guide rate reductions. The approach requires three steps.

Segment and Target Accounts

First, account-level profitability must be developed. For purposes of this approach, revenue streams include fee, interchange, and interest incomes. Expenses include cost of funds and operational charges. There is no need to add overhead or other subjective expenses.

Next, accounts must be segmented into groups with low, medium, and high profits. The definitions of each are based on the institution's needs or goals for return on average assets or on other criteria.

Finally, targeted repricing strategies must be developed. When constructing the strategies, the dynamics of profitability should also be considered.

For instance, low-profit accounts are typically inactive and are not likely to affect profits with a rate decrease. These account holders tend to be older, keeping their cards out of inertia or as a security blanket.

High Rates for Some

As a result, they are unlikely to cancel their accounts if a rate decrease is not forthcoming. Therefore, this group can be left with the "old" rate without a significant profit or attrition risk.

High-profit convenience users don't need a rate decrease and are unlikely to start revolving after a "normal" rate decrease.

However, because they generate high profit, we don't want to take a chance on losing them because our competitive offer focuses on rate, which is not useful to them. Therefore, these account holders should be offered a different, more useful promotion, which could include a fee rebate or waiver.

High-profit revolvers would benefit from a rate decrease and because they produce "high" profits, should be given one from defensive motives. The risk of competitive offers is mitigated somewhat by the fact that many institutions would turn down these accounts because of their high credit risk.

A rate decrease for these accounts is not mandatory to limit attrition but would probably raise their outstanding balances by generating new spending. Since they're revolvers, that means more profit.

Of course, the approach outlined above is just an example; it may or may not be applicable to your portfolio. Effective pricing strategies should be custom-designed to fit the institution's profit and retention needs.

In summary, this third method avoids the pitfalls and shortfalls of some more popular approaches, which do little to affect profit or attrition.

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