Retailers Retool Their Card Strategies

  With the big-spending season at hand, booming gift cards, reward perks and new technologies present payment challenges and chances for adroit merchants looking to grow.
  Change is constant. Just ask Sears, Roebuck and Co., General Motors Corp., and McDonald's Corp., three long-time retail top guns. All three have lessons to teach retailers and their employees toiling in card divisions.
  In 2003, the private-label card market changed irrevocably with the sale by Sears of its $28.6 billion card portfolio to Citigroup Inc.'s Citi Commerce Solutions unit. At the time of the sale, cards provided most of Sears' profits. Lesson one: Anything can happen. And probably will.
  This model year GM rolled out its last Oldsmobile, a venerable brand that attempted to appeal to changing tastes with its cornball "This is not your father's Oldsmobile" ad campaign a few years back. Lesson two: Give the consumer what she wants. And it's probably an SUV.
  Revenues at hamburger peddler McDonald's were stagnant until the chain began offering more chicken, salads and, dare we say it, payment with plastic. Lesson three: Change with the times.
  There are always intriguing ideas and profitable products catching the public's fancy in the retail and private-label card market. They just aren't the same products that many retailers have been long accustomed to.
  Some merchants, issuers and vendors are embracing the new. Others are mired in the "... your father's" mode.
  One goal, and mantra, in the card industry is being "top of wallet"-the first card your consumer reaches for. For issuers and retailers, that may soon mean creating a combination card that offers multiple uses and is essential for all their cardholders' shopping needs. Whereas retail plastic well into the 1990s typically involved charge cards good only in a particular merchant's stories, some of the most successful new retail payments programs involve debit and cobranded credit cards.
  One new leader is Starbucks Corp. Its Starbucks Card Duetto, a cobranded Visa credit and stored-value card, offers private-label features at the Seattle-based coffee merchant. A possible contender is a newly launched cobranded MasterCard from supermarket giant The Kroger Co. and the Royal Bank of Scotland Group that could prove to be the breakthrough in the grocery industry. Also in the game are vendors and issuers that are creating merchant consortium cards to grab selected consumer demographic groups.
  The biggest story in the 2000s is stored-value/gift cards, a product group that reached a consumer awareness level of 94% this year compared to 71% in 2001, according to an August survey from ValueLink, the gift card subsidiary of First Data Corp. Nearly two-thirds of consumers will purchase or receive a gift card this year, ValueLink found. Indeed, gift cards are so popular they are beating cash, with 52% of consumers preferring to give plastic rather than the 38% who prefer giving cash.
  In its 2003 annual report, First Data claimed the gift card market was worth about $45 billion, and experts are predicting $100 billion in sales in three years.
  Fresh Air
  Robert Skiba, executive vice president at stored-value and gift card provider Stored Value Systems, likens growth in the gift card market today to that seen by debit cards a decade ago. Louisville, Ky.-based SVS found in its annual gift card survey that consumers plan to spend an average of $223 on gift cards this year, up from $183 in 2003.
  Gift cards, once stuck in the birthday and holiday gift ghettos, are now being used as Mother's Day, Father's Day and even anniversary presents. "It's acceptable if you are giving a $500 gift at a spa or as part of a vacation package. You have to come into it creatively," says Skiba.
  The Duetto card brought a second major blast of fresh air to the retail market in 2004. On the one-year anniversary of its October 2003 introduction, issuer Chase Card Services bragged that 61% of Duetto cardholders call it their primary credit card and 70% use the Starbucks card account. Nearly 20% of cardholders use an automatic reload feature that puts money into their Starbucks spending account.
  Chase declines to give Duetto transaction statistics but cardholders of the original Starbucks stored-value card have loaded nearly $1 billion on their plain-vanilla plastic since its 2001 introduction. In comparison, Duetto cardholders load an average of 40% more on their Starbucks card account than that loaded by the regular cardholders.
  (Chase Card Services itself is a combination, being born from the merged card divisions of Bank One Corp., the original Duetto issuer, and J.P. Morgan Chase & Co. The Chase takeover of Bank One was completed in July.)
  James Eckenrode, vice president of banking and payments with analyst TowerGroup, says Duetto may be the first dual-function card but the industry will soon be seeing variations on that theme. "We believe dual-product cards are on the short-term horizon," says Eckenrode. "Eventually you will see credit and debit on one card."
  Skiba calls Duetto "bleeding edge" in card creativity and successful marketing. The Duetto concept has merchants planning to team stored value with multiple retail segments to launch combination cards that appeal to a targeted demographic group.
  For example, teenagers would embrace a dinner-and-movie stored-value card that partners a large cinema group and a national restaurant chain, says Karen Larsen, ValueLink's vice president of marketing and evolution. "'Cross consortium' is the non-consumer name being used for the idea," says Larsen.
  Skiba concurs that retailers see a lot of promise in the concept but the operational details may be daunting.
  "There are lots of discussions and questions. Who pays for the processing? Is it one card, or two? Does it have two magnetic stripes?" says Skiba. Still, the notion is so promising that "by the first quarter (of 2005) you should see retailers with a joint card." Neither Larsen nor Skiba would disclose the merchants that are planning to create a cross-consortium card.
  These programs may require an open-loop system, where the card is processed through a network like those of Visa and MasterCard.
  Another vendor is offering merchants a different way to oversee a stored-value card program through their own in-house, closed-loop systems. Boca Raton, Fla.-based SmartClixx LLC installs and integrates its software with the merchant's centralized payment infrastructure, says Gary T. Dinkin, chief executive and owner.
  SmartClixx is cheaper because it doesn't charge a per-transaction fee and it gives the merchant greater authority over the program, says Dinkin. "The retailer owns the (customer) data and sets up their own accounts," he says. "That's quicker than depending on a third party" to make any changes.
  Options
  SmartClixx targets merchants with annual sales over $1 billion. Clients include The TJX Companies, Charming Shoppes, and Saks Fifth Avenue.
  This summer Boscov's Department Stores dropped ValueLink and installed the SmartClixx system at its 41 stores in five Mid-Atlantic states, citing the ability to build customized stored-value card programs without going through a vendor.
  It's these kind of options that have merchants thinking creatively to blend the old and new to jazz up or replace existing card programs.
  In the 1990s, grocery giant Kroger introduced several cobranded credit cards, including a Visa card with U.S. Bancorp. The idea of combining the ubiquitous supermarket loyalty card with a credit card makes perfect sense. Kroger has the breadth to do the job right with fiscal 2003 sales of $53.8 billion and 3,774 shops in 32 states.
  In October, Kroger and Royal Bank of Scotland (RBS) launched the 1-2-3 Rewards MasterCard that offers cardholders multiple ways to earn reward points that can be spent at Kroger stores. The cards also act as a Kroger Plus shoppers' loyalty card, offering in-store discounts. The issuer is Citizens Bank of Rhode Island, an RBS subsidiary.
  Cardholders earn one point for each dollar spent outside a Kroger store, two points for each dollar spent at Kroger, and three points for each buck spent on Kroger-branded products. The cardholder receives a $10 reward good at a Kroger's store for every 1,000 points earned. The rewards are tallied and mailed out four times a year.
  The 1-2-3 name does double duty, promoting to consumers the reward features while telling the industry the card has three functions-loyalty, credit and rewards. The grocer introduced the card with a limited rollout, marketing it in Dayton, Ohio and Cincinnati, Kroger's headquarters.
  RBS is behind a similar rewards card in the United Kingdom with Tesco Stores Ltd., a grocery chain with 2,318 outlets in Europe and fiscal 2004 revenues of $56.4 billion. The seven-year-old Tesco Clubcard counts 10 million active households, according to an RBS spokesperson.
  These combination cards have found greater success in Europe, possibly because big merchants don't have the market dominance they do in the U.S., says Anand Ramakrishnan, vice president of card services at Kanbay Inc. Rosemont, Ill.-based Kanbay provides technology outsourcing to multinational firms. In the payments arena, it targets the 10 largest issuers and the top four private-label card providers, says Ramakrishnan.
  Kanbay went public this year. U.K.-based HSBC's U.S. unit, formerly known as Household International, owns about 17.5% of the company, and Morgan Stanley, parent of Discover Financial Services, holds another 4.8%.
  Merchants in the United Kingdom are joining the Aura program, where consumers can earn and spend points at a cross-section of product and service providers, he says. Aura is administered by Cetelem Ltd. Issuers include Paris-based BNP Paribas and England's Halifax Bank. Cardholders earn points at the corner merchant, major chains, utilities, financial institutions and other segments. The program is marketed as Aurora in France.
  Ramakrishnan predicts consumers worldwide will see card programs that combine features like credit and installment-style loans at the point of sale.
  "You will see products with a merchant offering a six-month promotion with an installment plan on the card," he says.
  Issuers will be able to tailor programs to individual cardholders. That might mean a card's total credit limit could include a separate limit for larger loans that carry a separate interest rate. Or an issuer may offer a special deal on a big-ticket item with an enticing interest rate and attractive payment options.
  Cross-Brand Cards
  In the here and now is the newly launched GapCard from specialty apparel retailer Gap Inc. The private-label card allows cardholders to earn and redeem points not just at The Gap stores, but also the parent company's two other chains, Banana Republic and Old Navy stores.
  The card was launched in October and is issued by General Electric Co.'s GE Consumer Finance unit. San Francisco-based Gap Inc. in fiscal 2003 operated 3,038 stores worldwide and saw sales of $15.9 billion.
  GE launched the Banana Republic card in 1998, and the Gap and Old Navy private-label cards in 2000. A Gap survey found that current cardholders spend twice as much as other shoppers at their three stores. About two-thirds of Gap shoppers also shop at Old Navy and Banana Republic.
  GapCard holders will earn one point for every dollar spent at the three stores, their Web sites and factory outlets. The card offers a 5% reward with cardholders earning a $10 coupon for every 200 points they accumulate. The card also offers smart simplification, sending cardholders a single monthly statement that consolidates their spending at the three retailers.
  A GE spokesperson says that the Gap's cross-brand card is the only program for a specialty retailer that allows the cardholder to accumulate and spend reward points at all the retailers under their parent's umbrella. GE presented the cross-brand concept to the Gap's executives in 2003, according to the spokesperson.
  A Super-Exclusive Approach
  Of course, some merchants still prefer to run their own card programs despite the sales of many large private-label card programs to processors in recent years. The argument remains that private-label cardholders shop more at the store, buy more expensive items, and are more likely to be impulse buyers. What's not to like?
  Neiman Marcus Group Inc., parent of the high-end retailer, continues to run its own card program and, at a time when most retailers' portfolios are slowing shrinking, saw receivables rise 12.3% to $525.7 million in fiscal 2004. Like a haughty princess, Neiman Marcus declines to accept the decidedly down-market cards with, ugh, Visa and MasterCard logos. (Neiman does take American Express Co. cards in a resigned nod to market realities.)
  Roughly 60% of sales at Neiman Marcus stores are made with the Neiman card, says Stacie Shirley, vice president of finance and treasurer at the Dallas-based merchant. Few cardholders revolve on the card and delinquencies and bad debts are very low, says Shirley. The retailer has about one million active cardholders.
  Cardholders earn one point for every $1 in spending though there are several double-point periods during a year. Consumers may opt to pay a $50 annual fee to become an NM Gold Card member and receive Neiman newsletters and magazines. Cardholders who spend $5,000 in a calendar year may join the InCircle Rewards program, which offers specials at various merchants, complimentary gift packaging for purchases over $25, subscriptions to in-house magazines and newsletters, and other deals.
  About 10% of Neiman Marcus customers are InCircle members and they accounted for $1.2 billion in spending at the stores, says Shirley. The InCircle cr?me de la creme join the Chairman's Circle after accumulating 1.5 million points. The Chairman's "simply spectacular" rewards include an 11-night private-jet tour of the casinos of Europe, a 13-night safari in Africa, and a custom kitchen by Italian designer Arclinea. Cardholders who accumulate five million points can choose among Silversea Cruises, Maserati sports cars, and private-jet flights to New York, Chicago and Los Angeles for shopping extravaganzas.
  That super-exclusive approach seems to be working as revenues at the 35 Neiman outlets, its sister Bergdorf Goodman and company-owned beauty lines totaled $3.54 billion in fiscal 2004, up from $3.09 billion in 2003.
  Mass Market
  Sounds simply fabulous. But most merchants with card portfolios work in less rarified air and must face the long-term trend of consolidation and intense competition for the mass market. Hit the hardest are the traditional department stores that are being challenged by the big-box discount retailers. To raise cash and sharpen their focus on retailing, many have sold their portfolios to processors in recent years, most notably Sears, sponsor of the single largest retail card program by far.
  The top four retail card issuers in 2004 aren't retailers, with Citi Commerce Solutions in the lead, followed by GE Consumer Finance, HSBC Retail Services, formerly Household Retail Services, and Alliance Data Systems. The four held combined receivables of nearly $80 billion at the beginning of the year, according to Thomson Media's Card Industry Directory, 16th Edition.
  The biggest retailer now running its own card program directly is St. Louis-based The May Department Stores Co. May's is the fifth-largest retail card portfolio, with $2.38 billion in outstandings. The $2.25 billion portfolio of Federated Department Stores Inc. follows May closely.
  May jumped a few slots after paying $3.24 billion in June to Target Corp. for its Marshall Field's department-store chain and its $672 million card portfolio.
  A month later Target unloaded its Mervyn's chain, selling the affiliated private-label card portfolio to GE Consumer Finance for $475 million and the 257 stores for $1.65 billion to an investment group. Mervyn's card receivables totaled about $481 million at the end of the retailer's fiscal first quarter in May.
  Target's Retailers National Bank unit had been the issuer for its two former subsidiaries. Retailers National Bank's portfolio is now down to Target's Guest card and the Minneapolis-based merchant's fast rising cobranded Visa card. The portfolio was valued at $4.72 billion at the end of Target's fiscal second quarter.
  Struggling department-store chain Dillard's Inc. closed in November on the sale of its $1.25 billion card portfolio to GE Consumer Finance for $1.1 billion, including the assumption of $400 million in securitization liabilities. The deal includes ongoing revenue sharing and calls for GE to issue and service the card for 10 years. Dillard's operates 329 stores in 29 states.
  The consolidation pace is quickening, following similar trends among banks, says portfolio broker Robert K. Hammer, president and chief executive of R.K. Hammer Investment Bankers in Thousand Oaks, Calif. Merchants are tempted because the processors offer very good service to retailers' customers, and accept the credit and interest-rate risk, says Hammer. In addition, competition for portfolios is on the rise.
  "Private-label (portfolios) are going at higher prices. A lot of firms are looking to buy and there's not a lot for sale," says Hammer, whose firm has sold one million cardholder accounts this year.
  Prices paid for a private-label portfolio can range from a 10% discount to receivables to a 30% premium, says Hammer.
  A New Tangent
  In October, GE Consumer Finance announced it would actively court smaller merchants, a new tangent from its long-term focus on major merchants like Wal-Mart Stores Inc. GE created the Specialty Retail Group to target merchants with card portfolios under $200 million. Paula Clayton, vice president and general manager, leads the 230-employee unit and reports to Margaret Keane, president and chief executive of GE's Retail Consumer Finance Group. Specialty Retail will deliver such services as loyalty programs and had two unnamed clients in the pipeline within a month of its formation, according to a spokesperson.
  The industry is pondering whether the Herculean GE, with receivables of about $26 billion, can offer customized care to comparatively small programs. "If they can treat them as an individual, they can be very successful," says Hammer. "If not, they will get out in two or three years."
  Edward Fechner, senior vice president at Shoppers Charge Accounts Co., says that GE and other titans recently have been dipping their toes in the mid-size merchant arena, a market that SCA has served for 67 years.
  That's meant higher prices for card portfolios. But a merchant seeking to outsource its cards won't get lost at a smaller firm like SCA, with $338 million in receivables at year-end 2003, argues Fechner.
  "We accommodate (clients) more and dictate less," compared to the likes of GE, he claims. "Many merchants prefer to deal with a hands-on firm that provides highly customized programs."
  Mahwah, N.J.-based SCA stresses customer care, refusing to sell cardholder lists to third parties or affiliated parties. SCA prides itself on its in-house collections group that takes an individual approach to slow payment problems. And while SCA may be smaller than GE or Citi, it is a division of $8-billion-asset Hudson United Bank, giving it some heft when bidding on portfolios.
  Technology's Role
  As the service providers battle over middle-ground clients, merchants will be busy keeping up with new technology offerings. McDonald's broke the mold and began accepting cards, thus making plastic standard fare at quick-service restaurants. This August it announced it soon would be accepting payments from the PayPass radio-frequency (RFID) wand from MasterCard and several of its largest members. Five hundred McDonald's in the New York area and 200 around Dallas will be the first to roll out the program. The PayPass card, or wand, includes a contactless smart chip that sends a signal to specially equipped point-of-sale terminals.
  A test in Orlando, Fla., in 2003 found payment transactions with the wand could be faster than those conducted with a standard magnetic-stripe card, according to MasterCard. Citibank, Chase and MBNA Corp. participated in the test, and rumors abound over which of the three will issue PayPass on a larger scale.
  Radio technology is also being used at sports venues where fans wave their wand to buy hot dogs, beer and programs. Smart System Technologies Inc. is implementing its PowerPay wand with the National Football League's Philadelphia Eagles and Seattle Seahawks. Consumers link the wand to their debit or credit card account. PowerPay marketing highlights transaction speed, playing on fans' desire to get back to the game after standing in line for snacks. The industry truism that consumers buy more when paying with plastic should play well at arenas where a beer costs over $5 and no one pays peanuts for peanuts.
  Micropayments
  Smaller payments-that is, even smaller than the cost of a burger and fries-are intriguing to many merchants. Micropayments vendor Peppercoin Inc. is signing distribution-style deals with merchant acquirers SunTrust BankCard and Moneris Solutions. Peppercoin has signed parking lot provider Reino Parking Systems of St. Leonard, Australia, and is working with online providers of games, music and personal services. The Reino deal will allow for payment with cards at the 10,000 parking spaces it operates in San Francisco, Houston, and other U.S. cities. Reino also is developing technology that will allow payment by cell phone.
  Interchange, the part of a bank card transaction ultimately paid by the merchant that goes to the card issuer, makes these micropayment programs problematic. Interchange can account for such a large percentage of card transactions valued under a $1, that merchants have long opted not to accept cards.
  Peppercoin's solution is to aggregate many small card transactions into one larger one, thus reducing interchange fees. Peppercoin's decision to work through merchant acquirers to sign merchants suggests that the Waltham, Mass.-based vendor may craft a realistic, and profitable, solution to the problem.
  Some may look at the consolidation of the retail market and see little hope for shrinking, traditional credit programs. And while prepaid cards and related new ideas are the subject of much hype, it's guaranteed that some of this year's promising products and concepts will fizzle. There's no question, however, that fresh ideas and technology are bringing a silver lining to the retail payments segment.