Do Issuers Need A Strategy Review?

  Issuers for years have systematically delivered signature-based, or offline, cards deeper into their overall base of debit card customers to drive greater revenue from their portfolios. Similarly, issuers have established policies designed both to encourage signature use and to discourage PIN use.
  With market forces shifting in favor of PIN debit, however, they may want to rethink that strategy, experts say.
  A Cards&Payments analysis found that banks may be reaching as far as they can go in issuing offline debit cards to their existing customers. Among a sampling of top-10 issuers, the average percent of debit cards they issue that support signature functionality was 80.4% at the end of 2004, up from an average of 77.5% in 2002 (see chart, page 13). The average penetration rate among five smaller institutions nearer the bottom of the top 50 offline-debit issuers reached a similar plateau in 2004, 80.6%, but the rate gain was somewhat higher, from a 65% average in 2002.
  Whether these gains prove financially beneficial in the long run, though, is murky, as several factors are emerging that could quell issuers' preference for offline debit in the coming years, experts say. These include escalating legal and market pressures that could force Visa USA and MasterCard International to lower offline debit interchange rates. Such moves could prompt issuers to shift their preferences to PIN debit, which some experts view as being technically superior to its offline cousin.
  "With the push on the legal side, it will help the market move in that direction," says Norm Patrick, vice president and product manager for debit card at Cleveland-based National City Corp., which issues some 2.5 million Visa check cards. "I don't know where that's going to end up. The when and how remains to be seen."
  In the United States, offline debit cards are supported by either the Visa or MasterCard brands and go by the respective Visa check card or debit MasterCard names. Top PIN-based point-of-sale debit networks include Interlink, Star, Pulse and NYCE.
  From a historical perspective, the focus among institutions to add more offline debit cards to their portfolios came with some apprehension. Issuers once feared fraudsters could open accounts and use offline-debit cards to spend more than the funds deposited because the transactions typically take two or three days to settle.
  To ease such concerns, issuers would give new customers PIN-only "ATM cards," which deduct funds from accounts almost instantly when used to make purchases and cannot be used to withdraw more than what is in the customer's account. Once issuers became comfortable with customers' ability to manage their accounts, they would reissue them offline debit cards.
  But today, with nearly all U.S. merchants securing real-time transaction authorizations from issuers for signature-based transactions, and with most banks putting holds on account funds until transactions settle, institutions are less concerned about giving offline debit cards to new customers. Many issuers, in fact, may be nearing saturation in terms of how far they internally can grow their offline debit programs, and their strategic focus is shifting to finding ways to increase card activity, observers say.
  "Eighty percent is pretty high up there," says Ali Raza, executive vice president at Speer & Associates, an Atlanta-based consultancy. "We probably will never hit 100%.... The focus now is more on usage than on growing the card base."
  There is still plenty of room, however, for issuers to boost card activity. Richard Lyons, MasterCard International global product group executive, says recent research conducted by the American Bankers Association and Dove Consulting suggests that, of the 83% of checking-account holders that have an ATM or debit card, just 68% are regular card users.
  National City is among the institutions that has de-emphasized the need to increase the number of offline debit cards issued to customers and has begun to focus more on increasing card usage. With 86.9% of cards issued supporting offline debit functionality, the bank "has squeezed the towel dry," says Patrick.
  Many of the bank's customers have only savings accounts and are not entitled to receive offline debit cards. Moreover, some checking-account customers still view Visa as a credit card brand and do not want the logo appearing on their debit cards, Patrick says, citing customer feedback.
  One recent method National City used to activate more cardholders was through a three-month cash-back promotion, in which customers received a quarter-up to $2.50 per month-each time they conducted a signature-based purchase. While Patrick did not have specific data, he says the promotion generated double-digit activation rates among targeted customers. Though the increase was small, he says, the cardholders' transaction volumes "were better than they were before."
  Issuers' success in growing their offline debit card bases has helped boost issuers' transaction volumes as well. In the third quarter ended Sept. 30, 2005, the total number of Visa check card transactions grew 18.4%, to 2.7 billion, compared with the same period a year earlier, while debit MasterCard purchase volume grew 26.5%, to 705.7 million during the same period, according to the card associations.
  Patrick, in fact, acknowledges that not every bank may be as satisfied as National City is with the status of its offline debit base. Indeed, at least one leading issuer appears intent on trying to get more customers offline debit cards.
  "We still think customers opening new accounts are not always getting a check card when they might benefit from it," says Chris Roberts, vice president and card product manager at Charlotte, N.C.-based Wachovia Bank N.A., which at the end of 2004 issued 6.4 million Visa check cards and was the nation's fifth-largest offline-debit issuer. "It's really a matter of getting focus within the sales force and making sure they understand the importance of selling the additional function versus the ATM card."
  Wachovia saw its offline-debit penetration rate rise to 85.9% in 2004 from 72.1% in 2002. In 2004, Wachovia had to reissue cards because of a switch in PIN-debit networks, to Visa's Interlink from First Data Corp.'s Star, and it used the opportunity to issue more offline debit cards to customers. Wachovia sent Visa check cards to thousands of customers who previously had ATM cards.
  "It wasn't all that sophisticated," Roberts says. "We just upgraded ATM cards to check cards."
  Roberts says the market today still provides issuers with more incentive to promote offline debit card use. Wachovia, for example, participates in Visa Extras, which provides debit cardholders reward points when they use their signatures to initiate payment. Roberts says PIN-debit interchange does not generate enough revenue to include it in the program.
  "If we could make it work economically, we certainly would" include PIN debit, he says.
  For the most common type of nonsupermarket $40 purchase, Wachovia and other Visa check card issuers receive about 52 cents in acquirer-paid interchange. That compares with 38 cents to 45 cents for an Interlink purchase. Interlink interchange is capped at 50 cents, so the difference in interchange revenue between the two debit types grows as the transaction amount gets bigger.
  Wachovia has eliminated one deterrent to PIN-debit use, however. The issuer once charged ATM cardholders 50 cents per PIN-debit purchase but would not assess the PIN-debit fee if it was done with a check card. The goal was to encourage customers to get a check card to increase the chance they would sign for the transaction instead. Virtually all offline debit cards also can be used to initiate PIN-based purchases.
  To Steve Mott, CEO of BetterBuyDesign, a Stamford, Conn.-based payments consultancy, the "most egregious example of unenlightened marketing strategies" began with surcharges on PIN use. "But it doesn't stop there," says Mott, who was MasterCard senior vice president of electronic commerce and new ventures from 1995 to 1998. "The genius who thought up the "Skip the PIN and win!" program will come to live in infamy as the truth about the superiority of PIN-debit ultimately manifests itself through the transactional economy."
  Mott says many bank executives he has spoken with are expecting somebody to "stick a pin in the signature-debit balloon" any day now. "But they can't wean themselves from taking profits from this 'artificial' or 'temporary' product while they can," he says.
  Whether, or when, the debit card market supports mostly PIN-based purchases remains unknown. A report released in December by Financial Insights notes that payment cards that cost merchants less to accept, particularly PIN-debit cards, will be the leading drivers of card-spending growth through 2009. The Framingham, Mass.-based research and consulting company predicts in the report "U.S. General Purpose Card 2005-2009 Spending Forecast and Analysis" that PIN-debit volume will overtake signature-debit volume by 2009.
  Mounting Pressure
  The report suggests that mounting legal pressures on Visa and MasterCard could force down signature-debit interchange, making PIN debit more attractive to issuers. Merchants have filed more than three-dozen lawsuits challenging the means by which Visa and MasterCard set credit card interchange rates. Many of those lawsuits, plus one filed by a merchant challenging a Visa rule that prohibits surcharging check card transactions, have been combined ("Merchants Tackle Credit Card Fee Policies," January). Some attorneys have said off the record that it may be just a matter of time before merchants file similar suits challenging the card associations' policies for setting offline debit interchange rates.
  Aaron McPherson, Financial Insights research director, says his company no longer is projecting reductions in signature-debit volume within the next two or three years but instead is anticipating a slowdown in volume growth. More issuers than anticipated adding rewards to their signature-debit programs prompted the forecast change, he said. "If signature-debit interchange declines, banks won't be doing that as much," McPherson says.
  Moreover, McPherson adds, "Visa's response to any reduction in signature debit would be to increase PIN-debit promotion, and that would accelerate the shift" from signature to PIN debit. Visa does little today to promote its Interlink brand to consumers.
  Other market factors also are putting pressure on the card associations to reduce interchange rates. Advances in check imaging at the point of sale, for example, are reducing merchants' cost to accept checks, notes David W. Lott, a director at Collective Dynamics LLC, an Atlanta-based consultancy.
  "The problem is competition in that a merchant wants to offer as many payment alternatives to the customer and let the customer make a selection," he says. "But should the merchant community win the right to impose surcharges for signature-debit transactions, this could have a major negative impact on usage."
  For now, Wachovia's Roberts says it is difficult to say how the legal climate and other issues could affect Wachovia's debit strategy. "We're just focusing on building the portfolio as much as we can," he says. "There's no specific strategy related to legal actions or potential legal actions at this point."
  More issuers are starting to realize they have gone as far as they can to issue offline cards to customers, and many now are implementing card-usage strategies to turn up the signature-debit volume. However, a market push in support of PIN-debit at the point of sale may limit their hopes for significant revenue gains.
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