Market Pressures Challenge Rewards-Program Profitability

  Rewards programs have become so prevalent that consumers now look for the added value when choosing credit cards. However, the programs, which started as a way to increase activation and usage and to differentiate one brand's card from others in consumers' wallets, now represent the biggest expense consuming issuers' interchange revenue.
  Indeed, the challenge for rewards programs no longer is how to block consumer attrition. A growing number of issuers instead are adjusting their rewards programs to meet specific needs. As such, there is little consistency in how the industry is working to make rewards initiatives more efficient.
  Diamond Management & Technology Consultants Inc. of Chicago estimates that 44% of interchange fees paid by merchant banks finance rewards programs. With merchants, who ultimately pay interchange to issuers, putting legal pressures on Visa USA and MasterCard Worldwide to reduce interchange rates, pressures similarly are mounting on issuers to find ways to absorb more of the cost.
  Issuers rely on rewards programs for their marketing, and the competition for transactions is fierce. "The battle for share of wallet is more intense than ever, and strong rewards and recognition programs drive customers to pull their preferred cards out of their wallet more frequently," says Kelly Hlavinka, director of Colloquy, a loyalty marketing publisher and consultancy in Milford, Ohio.
  Merrill Lynch attempts to do this on its Merrill + credit and debit cards by delivering benefits that increase in number with cardholder spend. Cardholders who spend up to $20,000 annually on the card receive standard perks that include double points on Merrill Cruises, 24-hour concierge service, a transatlantic companion ticket on British Airways, and complimentary spa services and special room rates at hotels and resorts worldwide.
  Cardholders whose transactions total from $20,000 to $50,000 per year receive these reward features plus seven others, including an international business-class companion ticket on Delta Air Lines, free nights at leading luxury properties with the purchase of a stay and three free months of Wine.com membership with the purchase of nine additional months. Cardholders spending in excess of $50,000 annually on either the Merrill + credit or debit card receive instant membership in American Airlines or Delta frequent-flyer airport lounge clubs and additional benefits such as a personal 24-hour concierge, free upgrades on British Airways and a free flight hour with a purchase of a Marquis Jet prepaid card.
  Steve Georgeou, president of Geocom Inc., a New York-based consultancy, lauds Merrill's strategy of differentiation. "The biggest violator of the profitability rule is the credit card that gives the same benefits, service and communication to customers whether they are profitable or unprofitable," he says. "Card issuers should spend their loyalty dollars against their profitable customers rather than spread equal amounts across all cardholders, including unprofitable ones."
  Georgeou says Merrill + accomplishes this because the spend levels bring in more revenue, thereby allowing for more loyalty program expenditures.
  EXPENSE CUTTING
  Even American Express Co. is cutting down on rewards expenses, or is at least shifting their emphasis. This past summer, AmEx eliminated double points for everyday purchases on its green, gold and platinum products. The issuer replaced these rich rewards with the Bonus Points Mall, which includes more than 100 online merchants that present double points-earning opportunities.
  While the initiative is significantly slimmer on stickiness than the previous double-points scheme, Georgeou says, AmEx says the intent of the change is to drive activity in a new area rather than to save the issuer Membership Rewards-related money.
  When AmEx launched the double-everyday-spend benefits for some charge cards, the goal was to promote spending in everyday locations and help take share of wallet away from debit and cash, says Ralph Andretta, AmEx senior vice president and general manager of Membership Rewards.
  "The change in behavior was successful," he says. "And instead of continuing to increase rewards cost for incenting behavior already exhibited by customers, we wanted to put our dollars into a new bonus program to help incent behavior around online spending."
  AmEx's loyal base of rewards members likely will not balk, Andretta contends. "Rewards are key to our business and drive results," he says. "Our cardmembers in rewards programs spend five times more than those not enrolled."
  The issuer has achieved success on the business side with Membership Rewards in large part because it has built a partner network of aspirational brands and preferred providers of AmEx's elite core customer, Andretta says.
  AmEx's most popular rewards redemptions continue to be travel rewards, although retail and experiential rewards-such as an hour-long spin as guest DJ at a New York City lounge and zero-gravity flight programs that replicate astronaut training-are growing in popularity. "For the experiential rewards, we work very closely with our partners, ... and the loyalty we gain from giving a cardmember a once-in-a-lifetime experience more than pays for itself," Andretta says.
  While some issuers contend cardholder segmentation can be a viable strategy to keep card portfolios profitable, some observers say issuers should broaden their views to include the institution's overall profitability plans.
  "The deeper the product relationship can be in the household, the more unlikely it is that the consumer will attrite," says Dennis Moroney, senior research analyst at Tower Group, a Needham, Mass.-based advisory, research and consulting firm owned by MasterCard Worldwide. "Rewards across products also drive [bank] usage."
  Citibank is the purported leader in using this type of strategy. With ThankYou Network rewards, Citi doles out points across its retail banking products, presumably spreading funding responsibility for rewards across its lines of business.
  Through the ThankYou Network, Citi rewards customers each month for having Citi checking, money market or savings accounts; making Citi debit card purchases; investing in Citi certificates of deposit; and choosing Citi for home equity lines of credit, home equity or personal loans, or mortgages.
  "Citi is investing in the loyalty and relationships with our customers," says Terry O'Neil, Citi Cards executive vice president. "We know that consumers have a vast choice when it comes to selecting a credit card or bank, and we want them to select, engage and stay with Citi."
  To that end, Citi also offers accelerated point-earning opportunities. Citi Premier Pass distributes points in three ways for flights purchased with Citi's cards. Cardholders receive points for miles flown, the dollar value of the ticket purchase and frequent-flyer miles from the airline carrier. Citi issues a cobranded card with American Airlines.
  The bank also continues to expand the ThankYou Network, which now includes earning rewards when purchasing travel on Expedia. This relationship is the first non-Citi property in the network, but it may signal a new coalition of popular consumer brands.
  Ten million consumers already combine ThankYou points through their banking needs. Now they will be able to garner points through Expedia transactions and spend them on Expedia-booked trips, too.
  Citi introduced another new wrinkle to rewards in October when the issuer expanded the American Airlines co-brand program to include Private Pass. The new offering grants cardholders access to exclusive concerts and events.
  Dave Matthews Band kicked off the Travels through Life concert series that launched Private Pass. By mid-December, Citi AAdvantage cardholders who use their cards to pay through the program could also see Mary J. Blige, Aerosmith and Tony Bennett, receiving VIP parking at the shows and private entrances to the theaters where the artists performed.
  CONSUMER DEMAND
  "Bringing unique, once-in-a-lifetime experiences to Citi AAdvantage cardmembers was a natural progression to the program," O'Neil says.
  There are costs involved in creating Private Pass program events, but O'Neil contends that profits are not put at risk. "Citi has the scale and business relationships to manage the costs of experiential rewards offerings," he says.
  Credit card issuers continue rewards and loyalty strategies in part because consumers demand them, says Colloquy's Hlavinka. "With the considerable presence of rewards-based credit card options, consumers have been trained to look for cards that provide extra value. Additionally, consumers are surrounded with mass advertising messages that emphasize rewards and recognition benefits."
  But weakening returns on equity and assets, dismal response to customer-acquisition campaigns and the rising number of inactive accounts signal trouble ahead for the bankcard industry, says Tower Group's Moroney.
  Even Citi has had recent reward troubles. In last year's fourth quarter, the issuer reported a $545 million pretax reduction in revenue because of an accounting change to account for rewards still outstanding. And in May, Citi announced the closing of its AT&T Universal Cash Rewards credit card. The no-annual-fee card paid rewards of 5% of the sale on everyday purchases and a lower rate for other transactions.
  "The card industry is still very, very profitable, but it is struggling with [returns on assets], [returns on equity], declining revolving balances and profitable transaction volume," Moroney says.
  Rewards programs remain important offerings for card programs. The challenge is to make them preferable but also profitable.
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