Academic journal article The McKinsey Quarterly

What's in the Cards? the Future of the US Payment Card System

Academic journal article The McKinsey Quarterly

What's in the Cards? the Future of the US Payment Card System

Article excerpt

The future of the US payment card system

Credit cards are arguably the most successful retail financial product introduced this century. Just 40 years after their creation, they are ubiquitous among consumers, indispensable for retailers, and a major money-spinner for the banking sector. Yet the card industry has recently undergone wrenching changes. No doubt about it: though cards continue to displace cash and checks and to capture a growing share of consumer spending, the competitive environment of the future will look dramatically different from that of the past. Card issuers must reevaluate their strategies to reflect the new challenges and opportunities that lie ahead.

In 1996, the profitability of the credit card industry fell below 1.3 percent return on assets (ROA) after averaging 3.1 percent over the previous four years. Many issuers were caught unawares at a time when the US economy was booming and card revenues, charge volumes, and outstandings (the total balances unpaid by cardholders) were growing at double-digit rates. Profitability recovered marginally in 1997 to 1.5 percent ROA, but a number of issuers suffered credit problems, and several leading players (including AT&T, Advanta, and Bank of New York) exited the business. Meanwhile, the mergers of Bank One, First USA, and First Chicago NBD and of NationsBank and BankAmerica are only the most prominent episodes in a wave of consolidation that has transformed what used to be a highly fragmented industry. In 1986, the top 10 issuers controlled just 38 percent of all outstandings; today, they control a full 70 percent.

Although issuers will probably face even steeper challenges in the future, opportunities for profitable growth remain. Card companies can apply leading-edge marketing and risk management techniques to maximize the profitability of their current portfolios. Once this operational excellence is in place, they can leverage it to profit from the restructuring and consolidation of the industry. In addition, they will be able to target new financial flows outside the consumer-to-business payments that have been the credit card's traditional domain, and exploit new payment-related technologies. The biggest prize will go to the companies that combine these elements to create powerfully attractive payment propositions that offer both customers and merchants better value than do today's plastic card products.

The shakeout

Several factors suggest that the dramatic slump in profitability in 1996-97 was more than a hiccup. First, acquisition costs have soared. Penetrating consumers' wallets is becoming increasingly difficult at a time when more than 82 percent of US households have credit cards (up from only 56 percent in 1989) and the average household carries four general purpose bank cards and ten special purpose and charge cards.

Moreover, many current marketing trends have reached a plateau. Both affinity and co-branded cards (such as university affiliations and airline cards) are seeing the same response rates as non-co-branded cards. Yet direct mailings are at an all-time high: in 1997, there were upward of three billion solicitations in the United States, or 30 per household. As a result, response rates have plummeted to 1.3 percent, from almost 3 percent in 1992. The average cost of acquiring a new account via direct mail is now well over $100, up from only $40 in 1992. The "true" cost of gaining and maintaining active accounts is higher still because they constitute a declining share of the whole, having fallen from 74 percent in 1991 to only 58 percent in 1997.

Second, revenues are under pressure from increased competition. Issuers have been resorting to massive discounting in net interest margins, primarily through introductory ("teaser") rates that in some cases are now as low as 0 percent. Meanwhile, annual fees have fallen by roughly 60 percent since 1991 to less than $4. …

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