Enticing the Little Guys - It's No Small Business

  I'm a little old-fashioned in some ways," says Jack Amon, the proprietor of the Marx Brothers Cafe in Anchorage, Alaska. Although the use of cash and checks is declining, Amon refuses to use credit or debit cards to purchase most of the goods and services he needs to run his restaurant, a fine-dining and catering establishment that boasts an extensive wine cellar.
  Amon has several credit cards designed by their issuers for small businesses, including one from American Express, which he sometimes uses at the nearby food-wholesaler Costco. He also has a Visa card, issued by Charlotte, N.C.-based Bank of America, that his employees use to buy "odds-and-ends," such as flowers for the tables, he says.
  But those odds-and-ends do not add up to much. Amon says he racks up only a couple thousand dollars per month in credit card charges for the restaurant, or about 0.5% of the total spending.
  "We find it's easier to pay the vendors directly," whether by cash or a check, Amon says. He tracks expenses with QuickBooks, an accounting software program used by millions of small businesses, and does not want to deal with long financial statements from card issuers. Furthermore, that old-fashioned streak makes Amon recoil at the very idea of using credit cards. "To me, it's just moving debt around."
  Amon's attitude is not unusual, industry data show. According to Visa USA's annual Commercial Consumption Expenditure Index, small businesses, defined as companies with less than $25 million in annual revenue, spent $4.7 trillion in 2005, or about 29% of all commercial spending that year. And only about $225 billion, roughly 5%, was done with a small business credit or debit card, says Raghav Lal, senior vice president of Visa Small Business.
  But the market is growing. In August, Visa announced that in the previous 12 months its small-business payment cards racked up more than $100 billion in charges, up 32% from the previous year.
  Visa and MasterCard Worldwide, along with many of the nation's leading card issuers, have recently launched a series of efforts to bring small-business owners such as Amon on board. "Ten years ago, credit card companies didn't want anything to do with small businesses," says Gene Fairbrother, lead small-business consultant with the Washington, D.C.-based National Association for the Self-Employed, a nonprofit that teaches growth strategies to small businesses. "Now they're tripping over each other" to offer cards to even home-based proprietors, he adds.
  The card industry historically may have overlooked small businesses because it had other priorities. "We had so much development work to do in the marketplace just to get credit cards accepted [by merchants]," explains Alex W. "Pete" Hart, a consultant and former president and CEO of MasterCard International, now MasterCard Worldwide.
  As such, the purchasing needs of small-business owners were somewhat neglected. Now that most merchants accept credit and debit cards, however, issuers are now focused on producing a host of products and services specifically for small-business owners, Hart says.
  Indeed, as the consumer market has shown signs of saturation, the small-business niche is becoming increasingly important to the issuers' continued growth, says Brian Riley, a senior analyst with Tower-Group, the Needham, Mass.-based market research unit of MasterCard. For example, across the industry, direct mailings for consumer cards have a positive response rate of less than 1%, he says. "Back in the 1970's, it was more than 4%."
  All of the major card associations and issuers seem to have joined the rush to recruit small business.
  RECRUITMENT RUSH
  Within the past year, MasterCard began breaking the small-business market into segments and designing special cards for each one. In addition, both Visa and MasterCard recently extended zero-liability protections to small-business cardholders, meaning they will not have to pay any fraudulent charges put on their accounts, long a common feature of consumer cards. Visa limits zero liability to debit cards. MasterCard covers fraud on both credit and debit cards issued to consumers and small businesses.
  Securing experienced personnel also is important. Riverwoods, Ill.-based Discover Financial Services LLC, issuer of the Discover card, for example, last August lured away Sastry Rachakonda, the former vice president of small business for American Express Co., to develop Discover's first small-business card. He spent nearly a year helping to conduct hundreds of focus groups with small-business owners, and in June, the company began issuing the Discover Business Card. The card comes with Discover PurchaseChecks, which give users the ability to pay suppliers that do not accept credit cards, a big concern among the business owners interviewed, Rachakonda says.
  RULING OPENED THE DOOR
  In 2004, the U.S. Supreme Court refused to review a lower-court ruling that allowed Visa and MasterCard member financial institutions to issue AmEx and Discover cards. And AmEx, which issued its first small-business card in 1987, has taken advantage, allowing both Dallas-based Guaranty Bank, a subsidiary of Temple-Inland Inc., and Reading, Penn.-based Sovereign Bank to offer an AmEx-branded small-business card, a spokesperson says. GE Money uses the Discover network to issue the Sam's Club Discover Business Card, a Discover spokesperson says.
  Issuers already have their foot in the door, experts say. A 2005 survey of owners of hundreds of businesses with annual sales of less than $10 million by Atlanta-based Synergistics Research Corp. found that roughly two-thirds already use cards for at least some purchasing needs. And more than two-thirds of those reported purchasing raw materials or office equipment with a card.
  "That shows a lot has changed in the past 10 or 15 years," says Bill McCracken, Synergistics president and CEO. Back then, most small companies used cards only for the occasional car rental or hotel room. That many now bring out a card to pay for something other than travel "tells you that the card issuers have done a pretty fair job" popularizing their use, McCracken says.
  Still, the Synergistics study found that business owners typically use their payment cards for small purchases. Even businesses with annual revenues between $5 million and $10 million reported purchasing on average slightly less than $10,000 per month. Those earning $100,000 to $5 million annually averaged $2,790 per month in card spending, and businesses earning less than $100,000 bought only $350 a month with cards.
  While more small-business card users than consumer cardholders tend to pay their full card balances each month, many businesses use their business credit cards to manage their cash flow, according to Discover.
  Industry officials recognize that they have a long way to go. "[The small business effort] is in its infancy," Rachakonda says.
  Vendors might present the largest obstacle. "If we have a very large client, I don't want them to pay with a credit card," says Mike Van Horn, president of San Rafael, Calif.-based The Business Group, a consultancy for small businesses. Ironically, although The Business Group advises its clients to use credit and debit cards, it sometimes balks when asked to accept them. Van Horn says he accepts American Express, but for payments over $5,000, the fees are too steep. "I'd just rather get a check for that," he says.
  Discover officials contend PurchaseChecks addresses that concern. Cardholders can write a check, embossed with the Discover logo, to pay suppliers that will not accept a card for payment. "It's something unique to break through this habit," says Rachakonda. To the vendors, the payment works like any other check, and it keeps them from having to pay high fees.
  GRACE PERIOD CUSHION
  But for cardholders, Discover still waits 25 days before putting the check expenditure on their account. That grace period might give small businesses without large cash reserves sufficient time to collect enough money from their customers, Rachakonda adds.
  Focus-group participants also wanted to make sure they could control spending. Therefore, Discover gives cardholders the ability to change the credit limit by either accessing their account online or by calling a toll-free number. "The day I send [an employee] to the paint store, I can increase [the limit] to $500" and put it back to zero when he returns, Rachakonda says.
  Discover plans to focus on the country's 22 million businesses that have fewer than five employees, Rachakonda adds. "It is a segment which is hugely underserved," he says.
  Rachakonda hopes Discover can get the word out to business owners through online and direct mail appeals. Also, "there's a huge word-of-mouth potential," he says.
  Banks may have an advantage over Discover when it comes to recruiting more-established businesses, says Ken Paterson, director of credit advisory services for the Waltham, Mass.-based Mercator Advisory Group. Credit card issuers such as Bank of America, for example, have a "significant small business [lending] program, and that gives them a huge opportunity to solicit within their customer base," Paterson says.
  Still, Discover's strategy to sign up microbusiness owners might have promise, says Dan Schatt, a senior analyst with Boston-based Celent LLC, an industry research firm. "Historically, that's [a] very hard [market] to tap into because it's so fragmented. But they don't get a lot of attention from their banks even though they have the same needs," he says.
  CLUTTER REDUCTION
  All of the issuers say payment cards can reduce the paper clutter created by invoices and checks. Discover users, for example, can download a record of their business card transactions into QuickBooks, the popular accounting program.
  Rachakonda says Discover has a licensing agreement with Mountain View, Calif.-based Intuit Inc., the software firm that sells QuickBooks. AmEx has a similar agreement, and Visa and MasterCard issuers also provide online tools that allow small-business users to track payments.
  Suppliers can also benefit. Although Business Group's Van Horn dislikes accepting credit cards for large bills, he says many small businesses pay his company regular monthly dues. And if they set up an automated card payment, it eliminates the need for him to send out invoices or make bank deposits.
  The ability to automate the management of financial information should drive small-business use, industry officials say. "The technology enables small businesses to do things that, until recently, only large companies could do," says Bruno Perreault, MasterCard group head of global small business.
  MasterCard issuers offer the Smart Data Online program, a service that allows users to not only download payment information into accounting software but also to generate reports on such topics as how much their company spent on airline tickets or office supplies in a given period, Perreault adds. That technology "was not available three or four years ago," he says.
  Furthermore, like Discover, MasterCard has conducted numerous focus groups recently with small-business owners to help develop new products. "The small-business [market] is getting the kind of attention that the consumer debit [and credit] market was getting five years ago," says Perreault.
  This year, MasterCard began offering cards with features designed for specific types of businesses such as construction and professional services like real estate and accounting. Construction companies, for example, told MasterCard officials that they typically have to buy large amounts of raw materials, such as lumber, upfront. But their customers sometimes do not reimburse them for 60 days. The MasterCard Construction Card allows the builders to delay settlement of their expenses until customers pay them, Perreault says.
  Perreault admits that giving users a "float" period is not unusual. Still, the information gleaned from the focus groups should help MasterCard's member banks market the cards. "[Construction firms believe] the more traditional business card programs won't work for them," Perreault says. "You need to speak to them in their language."
  Visa's Lal says many small operators, especially start-ups and home-based businesses, use their personal credit cards for business purposes. Visa estimates that in 2005 small businesses bought $80 billion of goods and services with personal consumer cards. Converting that spending to business cards is the industry's "short-term challenge," Lal believes.
  Card companies hope to rope in small-business owners the same way they brought in consumers: with rewards. Lal says the best enticements to switch from checks to Visa cards are the rewards, which include cash-back bonuses, travel discounts and, as part of an agreement with Google, discounts in online advertising. Amon of the Marx Brothers Cafe says one of the chief reasons he uses his Visa small-business card is to get discounts on air travel.
  DETERMINING CREDIT
  One of the biggest concerns, experts say, is how issuers will decide to extend credit to small businesses. Although banks can judge start-ups with a sole proprietor by looking at the owner's credit score, and companies with dozens of employees most likely have well-established records, small businesses with few employees fall into a gray area, says Mercator's Paterson.
  Dan Meder, the senior director for commercial credit risk solutions at Experian Inc., a Costa Mesa, Calif.-based credit bureau, says most banks simply look at the personal credit scores. Experian, however, recently completed a study that found many small businesses run into trouble, letting bills go unpaid, for example, even though the owners' personal credit ratings remain stable, Meder says.
  Experian examined thousands of small-business failures and looked back in time to pinpoint when evidence of financial problems emerged. Although the first warning sign in a troubled microbusiness - one with fewer than five employees - was more likely to be the deterioration of the owner's credit rating, operators of businesses with five to 20 employees were more likely to keep their personal credit unblemished.
  "[Microbusiness owners] probably use their personal cards to pay a lot of the bills," Meder explains, noting, though, that others can pay themselves a sufficient salary to sustain their own credit rating.
  Of course, Meder agrees that when dealing with start-up efforts banks usually will have little data to rely on other than the owners' consumer scores. But, he says, Experian has begun to push its banking clients to use a blended score that examines both personal and business records as much as possible.
  "A lot of [bankers] grew up using consumer scoring," Meder says. "We're looking to open a few eyes."
  Fairbrother, the small-business consultant, believes card issuers will find small-business owners a better risk than average consumers.
  "[Owners] know they're going to live and die based on how they do in business, so they have to be more attuned to what they spend," he says. "[Success] means a roof over their heads and an education for their children."
  The small-business market provides issuers with considerable potential for growth. Small businesses, however, still need to be sold on the advantages cards offer over the traditional use of checks and cash.
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