Credit Card Crisis

If you are a typical American consumer, you receive one or more credit card solicitations a month. And, if you are that typical American consumer, you don’t respond. You just throw the packages right into the trash.

In fact, credit card issuers mailed more than 3 billion pieces last year and earned a response rate of only .8%. That means over 99% of those pieces hit the circular file.

Of course, with some 80% of the population deemed credit worthy, the typical American consumer already walks around with six cards.

But a market nearing complete saturation is just one of the problems plaguing credit card issuers and cutting into their profits. Worse are the increasing numbers of competitors and decreasing numbers of prospects on the one hand, and rising bankruptcies and falling annual percentage rates (APRs) on the other. Ironically, lowering the APR was supposed to boost response rates and therefor profits.

Dick Gallagher, vice chairman, Rapp Collins Worldwide, Chicago, suggests the crisis is due to the ramifications of a free market economy. However, the remedy may be as bad.

Gallagher, who has 20 years experience with the credit card industry, points out that looking for new markets, the traditional solution, has problems of its own. If the households are not as credit worthy, the card issuers are assuming more risk.

“There are big penalties if you don’t find out for 18 months that they’re not good risks and they charge off,” Gallagher says. (It takes about 18 months to find out whether a particular customer will be good, bad or indifferent.)

And a high responder could be a high risk, says Barton Knaggs, vice president of marketing for Trajecta Inc., Austin, TX, a developer of risk assessment software for the credit card industry.

“A million and a half people filed for bankruptcy. That’s about 1.5%, which is greater than the rate of response,” Knaggs notes, adding that it usually happens in the same 12 to 15 month period when a “good” customer becomes profitable.

The question for credit card marketers, Gallagher believes, is “How do you go about looking for new new markets that may be credit worthy?”

Gallagher suggests ethnic marketing, especially to groups “just coming in.” He points out an additional advantage to this strategy. Industry research indicates the first card to grant credit is kept a lot longer than any other credit card. The first card is kept for an average of 7 years, while other cards typically are kept about one and a half years.

Geff Rapp, a senior managing partner at Group G Direct, Arminster, PA, and a former senior manager for Fleet Bank’s credit card division, estimates between 20% and 25% keep and still use their first card.

Another new market Gallagher suggest is “ratchetting down the spectrum” in terms of household income.

Metris Companies, St. Louis Park, MN, for example, chose to target the moderate income sector-households with annual incomes between $15,000 and $35,000.

Joseph Hoffman, vice president of card marketing at Metris, describes such households as “new entrants.” “They’re new to credit,” he says. “We’re their first or second card.”

Sub-segments include high school graduates who went right into the work force, the divorced, immigrants and ethnic populations. “People just getting started or have had troubles in the past or a tarnished credit history,” Hoffman notes.

With some two million cardholders, the four-year-old company is among the fastest growing issuers, reaching some $5 billion in receivables in 1998. Metris mails about 20 million pieces a year, earning what Hoffman claims to be “higher than industry average” response and conversion rates.

Credit lines are under $2,500 and APRs are high because of the higher risks. Rates range from 14.9% to 26.9%. Prospects who do not qualify for unsecured credit will be offered a secured credit card and will be traded up to an unsecured card as soon as possible.

Helping Metris manage its risk within the segment is its relationship with Fingerhut. “We leverage that database for credit history to find out who to cater to and who to avoid,” Hoffman notes. Metris also has a co-branded relationship with Bally Total Fitness, which provides the card issuer with access to payment histories as well.

While the mix of being the first card and the limited alternatives for its cardholders might seem enough to have a “higher than industry average” rate of retention, Hoffman says Metris leverages customers to fee-based businesses and add-ons. “Credit insurance, travel products, and purchase shield,” he rattles off as examples. “More than one relationship is helpful to the bottom line.”

About half of Metris’ new customers sign up for credit insurance and 44% have purchase shield, a penetration Hoffman calls “incredible” since it gives Metris three relationships with the cardholder.

A third new market is to steal customers, not just with balance transfers, but with consolidations, where one issuer buys or merges with another. In the case of balance transfers, the initial APR is usually below the cost of money and is therefore a loss leader. At some point, the APR rises to a more normal rate.

Rapp notes the inherent contradiction beyond teaser rates. Customers who are attracted by a loss-leader rate are likely to go away when the rate goes away.

Knaggs cites one approach to stopping rate surfing: a fixed rate and an annual fee. The effect, however, might be that the customer is paying more.

Knaggs also points out that for some issuers, paying a premium for names beyond the value of the balance transfer might be cheaper than acquiring new names through the open market. (On average it costs $100 to acquire a new customer, including everything from mailing to the plastic itself.) What is being acquired is information about the consumer based on specific buying habits that are believed to be more accurate and detailed than credit bureau scores.

“Behavior traits of consumers through such acquisitions are more predictive than open market acquisitions,” Knaggs says.

Max Coats, executive creative director, RMG, Glen Allen, VA, provides several examples. It is, he says, no longer enough for credit card marketers to know that a bureau score is 720, the issuers must know what adds up to that score. For example, if two or more cards are carrying balance of 50% or over, the prospect might be a poor credit risk. National issuers might also look at the economic trends of an area. Boom areas like Charlotte, NC, are better and safer to target than depressed areas.

A more important issue for credit card marketers, Rapp Collins’ Gallagher says, is how to insure that the card keeps the customers it has acquired, and more important, gets them to continue to charge.

Coats points out that activation rates are low, ranging between 70% and 80%. “The companies have to do something habit forming to build use of the card,” he says.

Mastercard launched its “Priceless” campaign to make it the “first card out of the wallet,” says Larry Flanagan, Mastercard’s vice president of advertising, who credits the campaign with closing the gap between Mastercard and Visa.

Using television for the most part, with some support in print and on the Internet (www.mastercard.com), the typical ad lists the cost of several items and finishes off asserting the value of the experience is priceless.

Flanagan adds the campaign is based in a paradigm shift in consumers’ values from the 1980s and 1990s. “Consumption no longer holds up as a sign of success,” he says. “The nineties are about quality of life values.”

“It’s not that they’re not consuming stuff,” Flanagan adds. “They’re living life and buying things they need to live life, but things don’t begin and end with a purchase.”

Knaggs notes that the prettiest card is often the one that’s used. It may have the cardholder’s picture on it or it may a different color. “Platinum looks good and makes the cardholder look like a big shot,” Knaggs says. “It’s no better. It’s all about image and keeping up with the Joneses.”

Chris Batenhorst, vice president of competitive tracking services at BAI Global, Tarrytown, NY, says platinum products and fixed rates were big in 1998. “Everyone has started to do it,” he says.

Over the past five quarters, Batenhorst says, regular cards solicitations went from 221 million a quarter to 196 million a quarter, while Platinum cards went from 335 million to 612 million. Gold and platinum cards are pretty much the same product, he explains, the prestige is different. (Gold card solicitations went from 262 million a quarter to 73 million a quarter over the same period.)

And, according to Batenhorst, the immediate future will be much the same. Secure cards will always have their niche. He sees affinity cards as strong at best and not going away at worst. Reward programs will continue to be important.

“We’re seeing a proliferation of loyalty programs and affinity programs,” Gallagher adds, citing such examples as Advantage One and United Miles Plus. Rapp points to the GM Card and Discover’s cash-back program as other examples. Knaggs offers such affinity and co-branding strategies as payback to favorite charities or one’s school. He cites MBNA as specializing in organization affinities, like the American Institute of Architects.

Gallagher suggests the next generation of loyalty programs will be much more specific than variations of frequent flyer miles, not just in terms of offer, but also in terms of whom the credit card issuer wants to keep-and how much can they afford to spend to keep a customer. He predicts more growth in cross-selling other financial products and services.

Knaggs speculates on further mixing and matching credit line, APR, annual fee, late fee, and product class to create profitable acquisition packages and retention programs.

Rapp cites $4 to $10 has being a typical range of what a company might spend on relationship management. More, if the customer is particularly profitable.

“It’s not necessarily a pretty trend, or consumer friendly,” Rapp says. Since the bank has the right to change terms at any time, it can raise or lower interest rates depending upon how the risk model predicts the customer is or is not likely to go delinquent or worse, bankrupt. Not only can credit lines change, but also late fees and over the limit fees can be charged.

Knaggs points out that annual fees account for about a third of the market and range from $40 to $50, while cash advances are typically set a 2% of the advance.

Interestingly, direct mail remains the favorite way to acquire new customers. Knaggs suggests between 80% and 90% of a total budget might go to direct mail.