Processors Take Control of Retail Credit

  It's been a year of huge news for retail credit.
  Certainly the biggest story of 2003 was the decision by Sears, Roebuck and Co. to sell its two big card portfolios to Citigroup Inc. for a $3 billion premium and ongoing marketing revenue. Citi will obtain Sears's $12.4 billion Gold MasterCard program and its $18.4 billion store card portfolio ("A Meeting of Giants," October).
  The purchase makes Citi the clear leader among the processors, or outsourcers, that have been gobbling up retail card portfolios like hungry Pacmen over the last few years. The two other leading outsourcers are GE Consumer Finance, the retail card arm of General Electric Co., and Household International's Retail Services unit.
  Citi's retail card division, CitiCommerce Solutions, will have about $34 billion in receivables when the Sears deal is completed (chart, page 34). But GE remains powerful with its "A" list of retailers, including J.C. Penney.
  Household is about half GE's size with $13.5 billion in outstandings. However, Household was purchased this year by London-based, global banking giant HSBC Holdings plc, which claims assets of $983 billion.
  Citi has momentum on its side that began in June 2002 when it announced that it had bagged the Home Depot Inc. portfolio from GE. Citi puts the home-improvement retailer's card outstandings at $7 billion today.
  Meanwhile, there are some interesting rivals to the big dogs, offering the "we try harder" approach. Alliance Data Systems Inc. prides itself on its loyalty programs and creative mindset. On the one hand is its middle-market to upscale department-store clients. On the other is the unbanked market that Alliance is attempting to reach with new technology like multi-use kiosks and stored-value cards.
  In addition, the private-label space has regional processors that emphasize their handholding and service, especially for new and small merchants.
  Still, the Big Three have a lot to recommend them. They offer ready capital for qualified merchants. Their staffs are experienced. And they bring a treasure trove of products and services that clients crave. Bottom line, Citi, GE and Household bring tremendous scale to their relationships with merchants.
  "Our size allows us to bring talent, functional expertise and a breadth of resources that individual retailers can't duplicate," says Bill Johnson, executive vice president and general manager of Citi's retail sector.
  A card program is expensive and the analysis and marketing run at headquarters is only one part of what's needed, says Johnson. The retailer also must oversee operational centers for processing, calling centers with help desks and collection operations, in addition to mailing needs. Don't forget the basic plastic and embossing.
  That's why retailers should focus on retailing, says Richard C. Klesse, Household's national director of business development. His firm will take care of systems, risk management, credit approval, marketing analysis, and customer relationship management. Retailers "can maximize the sales and limit the losses" by outsourcing, says Klesse.
  That argument proved enticing to California retailer Gottschalks Inc., which decided to sell its card program for $103 million to Household last February.
  This year, the Big Three and their scrappy contenders came to dominate the private-label card market as merchants faced bad news and changing times. Those factors have merchants rethinking their proprietary credit programs.
  One aspect of retailers' recent hardships comes gratis with every economic downturn. Margins contract as consumers shop for bargains and, all too frequently, file for bankruptcy. Regulators start sniffing around when losses pile up.
  But the millennium seems to have brought new challenges for retailers.
  One trend is evolutionary. Store plastic used to be the starter card for Baby Boomers. Now, Generation Xers and Yers have convenient bank cards with point programs before they leave college.
  Then, there's the tsunami known as Wal-Mart Stores Inc. with net sales of $244.5 billion in fiscal 2003. The big box, low-budget behemoth out of Bentonville, Ark., has competitors squeezing every drop of waste out of their operations.
  That means scrapping low-volume goods, and slashing seemingly extraneous spending. If something isn't generating an immediate, identifiable return, drop it or find a partner to share the cost. The phrase du jour is core competency. And in the last 12 months, several sizable retailers have decided that running their own card program isn't core.
  The eye-popper was Sears, owner of by far the nation's largest store-operated credit program that for decades was-and remains-a reliable profit generator. Sears, outflanked by nimbler competitors, cited a need to focus on retailing as the primary reason for its deal with Citi.
  To be sure, the card portfolio had been giving Sears trouble of late. Credit quality deteriorated as The Big Store aggressively grew its Gold MasterCard program that it launched in 2000. Sears gave store card holders with less-than-stellar credit scores the opportunity to get the gold card and transfer their balances. Sears also did mass mailings to non-customers.
  The economic slowdown made that strategy a mistake. As chargeoffs grew, Sears increased loan-loss reserves by $189 million in last year's third quarter and cashiered card chief Kevin Keleghan.
  Running a program is getting more costly as tougher regulatory scrutiny forces retailers to closely monitor their cardholders. The Office of the Comptroller of the Currency in May slapped Saks Inc. and its credit card bank with a cease-and-desist order, saying the Jackson, Miss.-based retailer was late in reporting large cash payments by its cardholders. Saks was required to put in place written policies that ensured compliance with the Bank Secrecy Act.
  Saks earlier had decided to sell the assets of its National Bank of the Great Lakes to Household for $300 million and the assumption of $1.1 billion in securitization liabilities. At the time, the bank claimed $1.4 billion in card receivables and 4.6 million active holders of Saks' proprietary cards.
  The regulators also came down on Spiegel Inc. and its card bank, First Consumers National Bank. The bank had been manipulating the books going back to 2000, according to an independent examiner's report for the Securities and Exchange Commission. The examiner found that FCNB had falsely reported the value of its card bonds by pumping up sales reports from Spiegel's merchant units, Eddie Bauer, Newport News and Spiegel Catalog.
  In March, Spiegel filed for bankruptcy. In April, it chose Alliance Data Systems to administer programs for new cardholders. Woodbury, N.Y.-based CardWorks L.P. took on Spiegel's old portfolio of four million accounts with a face value of about $2 billion in receivables ("Subprime Cards: Act II," page 46).
  In a variation on the hardship theme, struggling electronics retailer Circuit City Stores Inc. decided it would keep its proprietary cards but sell its cobranded cards issued by a subsidiary, First North American National Bank. Each portfolio has outstandings of about $1.5 billion. The bank card program had a pre-tax loss of $142.3 million in the second quarter while the proprietary portfolio had pre-tax income of $9 million. Richmond, Va.-based Circuit City expected a sale by the end of the year.
  Despite all these hardships, many retailers are standing fast with their proprietary programs. Federated Department Stores Inc., parent of Bloomingdales and Macy's, is holding on. So are Kohl's Corp. and May Department Stores Co.
  Many experts agree that private label, or at least a cobranded operation, is still important. But you have to carefully control credit granting and be creative in marketing and developing new products.
  "It is still a profitable venture, especially when you consider (retailers) get the margin on goods sold" on their cards, says John M. Bresnahan, a director with consultant Edgar, Dunn & Co. Bresnahan, who works closely with retailers with card programs, notes that the customer intelligence that a program generates can be invaluable for marketing.
  Retailers have a strong advantage in customer relationships and marketing over a third-party outsourcer, adds John C. Grund, principal at Linthicum, Md.-based First Annapolis Consulting Inc. "There's still a lot of runway left for retailers to run their program," he says.
  The financial giants have a clear advantage in access to capital, Grund acknowledges. But if a retailer has a sound credit strategy and solid connections to financing, it should stick with its program, says Grund.
  Card programs bring in shoppers and generate profits, he says. For all its problems, Sears' credit division brought in $1.5 billion in operating income in 2002, beating the $1.2 billion from retailing.
  As for Wal-Mart, everyone agrees it's a bruising competitor. Its private-label card is issued by GE. It also has a cobranded MasterCard from J.P. Morgan Chase & Co.
  But that doesn't mean retailers should fold their card programs, says Ed Fechner, senior vice president, Shoppers Charge Accounts, a processor with $330 million in receivables and 1.5 million accounts. Instead, emphasize cards to build sales, he says.
  "Wal-Mart affects everybody. Private-label credit is one way you differentiate yourself," says Fechner.
  Back to the Basics
  Mahway, N.J.-based Shoppers Charge serves small and mid-sized retailers and prides itself on its personal touch, sensitivity to the customer and flexibility. One Shoppers Charge tactic calls for the sales associate to offer consumers at the point of sale a card brochure and a 10% discount for a first purchase. It's an old fashioned idea, but some of the largest retailers seem to forgotten it. Observers note that one reason Sears got into trouble was its overly aggressive direct-mail campaign promoting the Gold MasterCard.
  Check out Target Corp., which built its cobranded Visa smart card without direct mail, convenience checks or balance transfers, says Grund. The chip card, launched only in 2001 and issued through Target's Retailers National Bank, reported $3.9 billion in receivables in the second quarter, up 56% compared with $2.5 billion from 2002. Much of the growth came through upgrades from the Target Guest store card. Revenues on the Visa card were $211 million in the quarter, up 55% compared with $136 million a year earlier.
  Target this summer began its SmartCoupons campaign with product discounts for card use. Smart cards haven't done well in the U.S. and the campaign isn't a sure thing. But the retailer has put this card above the crowd, says Grund.
  The market power of the Big Three processors has competitors testing new technology. Alliance Data Systems is attempting to push the envelope with client 7-Eleven Stores Inc. and the Vcom kiosk, a check-cashing machine that looks like an ATM on steroids. ADS provides stored-value and loyalty services for the Vcom. The market is the unbanked fellow stopping by 7-Eleven on the way home. The Vcom also offers Western Union money transfers and Internet sales for select merchants.
  "We're looking for ways to use technology to lift, shift and retain customers," says Kimberli Hull, vice president.
  Hull is working on stored-value cards and electronic coupons that are triggered at the point of sale. Alliance also has pilot projects using biometrics and smart cards, and a cellular-telephone test with gas retailer Fina in the Southwest. Not all new technologies will find consumer favor, but "if it takes off, we'll be positioned," says Hull.
  Alliance had private-label receivables of $2.6 billion at the end of the second quarter. It has partnerships with over 50 middle-tier to upscale retailers including The Limited, Victoria's Secret and J. Crew. In May, it announced a 10-year deal with Stage Stores, a program with 2.2 million accounts and $241 million in outstandings.
  Dallas-based Alliance Data doesn't pretend to compete in financial offerings with Citi, GE or Household, says David Kratoville, vice president of business development. Instead, the focus is on using customer information to build sales.
  "Private label is a customer-relationship tool," says Kratoville. "Our skill is gathering and sharing information with our retail partner." He adds that analyzing customer sales patterns is a different approach from reviewing the loans made or finance charges generated by an account.
  Customer knowledge helps stores make themselves unique, he says. "There's a lot of sameness to a lot of retailers. You need to differentiate, create a new customer relationship," says Kratoville.
  That outlook strongly opposes the cobranded route for merchants. However, many consumers prefer a card with Visa or MasterCard brand because it can be used anywhere and reduces the amount of plastic in wallet. Merchants have decided they would rather join than fight the cobranding trend. The problem remains-how do you set yourself apart?
  Bank One Corp., the largest Visa card issuer, has taken a fresh approach through recent issuing agreements with two well-known merchants. The Disney Visa credit card from The Walt Disney Co. turns the rewards concept on its head. Disney's retail shops have had a mixed track record. So Bank One's acquisition materials tell prospects they can earn points for spending at other retailers, then redeem the points for a Disney resort vacation package.
  Meanwhile, Bank One has teamed with Seattle-based Starbucks Coffee Co. and in October rolled out a combined stored-value/Visa credit card called Duetto. Starbucks customers will be able to load funds on to the magnetic-stripe card for in-store purchases and use the credit function at any Visa-accepting merchant location ("A New Addition to Cobranding's Menu," page 40).
  That's similar to a card from Boscov's Department Stores, a retailer based in Reading, Pa., with 40 stores in five states. The cobranded card offers both Visa and private-label lines of credit. Cardholders receive separate billing statements and separate reward points for each credit line. The First National Bank of Omaha handles the Visa side of the card, says Robert W. Fisher, Boscov's vice president of credit operations. Boscov's Receivables Finance Corp. handles the private-label side. Boscov's also operates a travel club where the points can be redeemed.
  Cardholders appreciate the fact that they only have to carry one card, says Fisher. For Boscov's, the cardholder intelligence is improved.
  "We get a better view of our customer," says Fisher. "Before this we could see only cardholder purchase behavior at Boscov's. Now we see purchase behavior on Visa."
  Fisher says Boscov's Receivables Finance Corp. had proprietary outstandings near $200 million at the end of 2002, with a 4% monthly growth rate.
  American Express Co. has been aligned with membership merchant CostCo Wholesale Corp. since 1998. Consumers who pay the annual Costco fee get the card and don't have to pay an annual AmEx card fee. Consumers supply their own photo for the card, which doubles as the ID for store access. AmEx also includes a 2% rebate for spending at the store.
  And there's always a good old merger to grow the business. York, Pa.-based Bon-Ton Stores Inc., with 72 stores in nine Mid-Atlantic states, is paying $93 million to buy Dayton, Ohio-based Elder-Beerman Stores Corp., operator of 68 stores in the Midwest. Analysts applauded the deal, saying there was a similar customer base but little geographic overlap.
  The deal will combine Bon-Ton's 3.6 million card accounts and $183 million in receivables with Elder-Beerman's 900,000 active accounts and $120 million in receivables. The lights may not have burned into the wee hours at GE's or Citi's executive suites at the announcement. But Bon-Ton and Beerman gained some of that scale the management consultants love to stress.
  These efforts indicate there are alternatives for the mid-sized and smaller players in the retail credit market. But the challenge is huge. The processors are powerful. Still, they have to prove they can market as well as they provide financing, according Grund.
  "There's a lot of parity with programs. Everyone offers (the cardholder) a discount or online access to their account," says Grund. "Will the new partner just keep on keeping on or will the program be retooled to better support the retailer?"
  Observers say that 2004 probably will be more of the same for retail card programs. Consolidation seems a given, with executives at Citi, Household, and Alliance all saying they are on the trail of store portfolios. Wal-Mart plans to open another 300 U.S. stores in fiscal 2004. The technology gurus will keep searching for the killer app. And the creatives might find that certain something that catches the consumer's eye.
  For many retailers and their card executives, next year could be decision time-should I stay or should I go?