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One:
different differences
strategies between
by itself
an Information-Based Strategy
Eric K. Clemonsl Matt E. Thatcher2 One has exploited marketing, an innovabased on
use of information,
customization, time
Abstract: tive
Capital
approach
to targeted
customer profitability impressive performance issuer. It is sustaining investment through through Moreover, in infrastructure constantly a practice it is
analysis, to achieve as a leading credit card its advantage through and personnel, its as to and improving expertise this
credit
card
business
matures
and
as
competition increases, the company is prepared to diversify into a wide range of industries where it believes competitive efforts senior not to ventures remain that its IBS advantage. outside believe loyal approach will provide Indeed, marketing are committed banking, and that Their the they
key
known
attempting strategy
to other
16 banks
strengths are in IBS, and credit card industry. We will seek to address in this case study:
q
or the
for a radical
transformation
the following
questions
and after having been turned Fairbank and Nigel Morris Chairman / Chief
enjoy their positions as Executive and President Officer profitable rapid of Capital credit growth and One, card issuers.
Does
Capital
One
enjoy
competitive
advantage? How Why Signet relative under bankers? was competitive were / the advantage achieved? identified by by a bank than
its ability
profitable
opportunities
accounts, Capital One was named credit card issuer of the year in 1995 by Credit Card Management [7]. Since 1992, the dollar Capital One $12.8 billion over 500% balances the highest value of loans from growth managed by to by
Capital outsider
the guidance
sustainable?
Can other
banks
[6].
of 880% between
information-based
industrys,
chargeoffs consistently among the lowest in the industry, the stocks price soared between 1991 and 1996. Nigel Morris smiles when he adds, Sometimes I pinch myself. Ive been very lucky... helping manage this fabulous company. Sometimes I think Ill working in a woolen Wales. The lessons of Capital can Ones success to in range the of wake mill up and find myself near my family in
2.1.
A large number of industries istics that change the relative between large incumbents and
trants. We use the term newly vulnerable kets to characterize those conditions that new entrants to threaten even where market previously those incumbents, dominant structures. The following markets: Q Ease of entry entrants conditions generate incumbents
dominant superior
be extended in a wide
a large
companies
vulnerable
The company relies heavily on what it terms its h@nuztion-Based Strategy (IBS). The use of an IBS allows Capital One to develop new and
It must
for
new estab-
to enter
the market
Iished including
firms.
barriers restrictions
to and
entry, costs or to to
and that
instead do not
have reflect
charged their
prices
regulatory
Conditions markets
such attractive
as those for
described
above
make
new
entrants
with
to that That
attack
New
entrants
must
they suggest that some customers are being dramatically over-charged under average cost pricing strategies, and that they are in fact subsidizing Retail acquire many other higher provides can enter dominant firms market cost customers. a clear example an attractive incumbent of how a of In
it will be profitable for them to is, they must believe that there segments where with that the they difference those can charge to provide serving
market and
banking
and
profitable industries,
be sufficient
Difficult
There
must
be some
that account for their profits and those customers that repre-
obstacles that prevent iately duplicating entrants, sufficient their 2. 2. entry. Differing Pricing In many industries Customer and time thus to
incumbents from immedthe strategies of new that realize allow the new entrants from benefits
sent loss making accounts (i.e., kill yous ). In retail banking, for example, the best 20%0 of consumers may account for more than 100% of a banks profits, while the bottom 201X0may account for all the off-setting losses. uniform prices the
Most
retail
banks
services
despite
of significant
in customer
between the costs of providing customers: In telecommunications, with length their local of their the distance from the home
of
costs (i.e., love em and kill you accounts). This situation provides an opportunity for competitors to target the love ems, charging them less for the provision of banking services than they are charged still targeted by their marketing current for and bank the but at prices that generate profits attacker. Such cream
often
opportunistic
to the communications
skimming will leave the incumbent larger proportion of higher cost, kill will and cause profits the incumbents to fall. average In response,
in banking,
some customers
cards largely as charge cards, paying off their balances in full each month; these customers enjoy the free float, but provide only limited revenues and even smaller profits for their issuers. And nant pricing upon prices serving
q
will be tempted to raise its prices to compensate for declining profits, resulting in even more customers becoming vulnerable to the new entrants attack. As the new entrant continues to target customers to compensate continues being overcharged continues profitable by the incumbent, prices entrant as the incumbent to acquire to raise its market
yet,
historically, have
in many continued
industries prices
domibased
players
to follow customers
a uniform
strategy,
charging
average costs, rather than differential that reflect the costs associated with these individual accounts:
share at the expense of the incumbent, the defender may begin to enter death spiral [3]. That is, for the defender, the worse it gets the worse it gets! on to on
[9]).
In telecommunications, state regulators largely determine prices and typically over-charge customers in cities and suburbs in order to subsidize higher cost customers in rural communities.
There is a literature and supporting theory how to perform targeted marketing and provide differential offerings (e.g., [2] and
why differential pricing is important (e.~.,
historically analyses,
there
is very
little in
evidence
to suggest to of
targeted business
marketing of Signet
strategies
in the credit
card
and major
by of
Bank in the late 1980s. upon and uniform Nigels pricing in the
observing
of extreme
differences
among
customers impor-
the insight
developed,
information-
numerous
as consulting
and is no doubt
the most
tant reason for Capital Ones success. This strategy of mass customization represents a quantum breakthrough in marketing effectiveness and has led to tremendous banking all approach success industry to marketing. competing with [5] its against traditional
transform the credit card business by exploiting However, most banks were not their insights. interested in what became known as their information-based strategy. In fact, it was not until after the first 16 banks rejected their solicitations that they found a home at Signet Bank. By 1988, the credit ized by competition made of market had hands card industry banks the credit By was characterand
among
for scale
Advantage
Early
to consolidation increasing
In the late 1980s, Rich and Nigel developed idea, or a vision, for radically transforming credit card businesses within Idea was to enable a bank, transformation acquire competitive ed, IBS). At that profitable of their advantage time, they credit market banks. through card share and
an the
customer base, banks fixed costs associated over a large number lower prices through In addition, engaged attractive accounts during in uniform opportunities
were able to spread the high with credit card operations of accounts, enabling economies of scale. this period pricing for banks strategies, attack. with them to
information-based as follows:
strategies
the average
cost associated
acquiring
this vision
q
in this competitive
environment
(cost per
customers
are equally
profit-
who
their
most them
profitable to
accounts competitors
q
are vulnerable
solicitation divided by hit rate) was quite high. This too suggests that incumbent banks were vulnerable to an opportunistic marketing strategy that improved hit rates by selectively offering lower annual interest rates to certain potential love em customers. note, while vulnerable executing competitors to these in this is
Direct solicit
marketing many
techniques,
allowing products,
to
cost, credit or
opportunistic strategies
has turned
a local
When
using
targeted
direct
marketing,
it will
not easy, Or, as Nigel Morris has said, Anyone can find customers who want your money! Anyone can find customers who will take it and not pay you back! The trick is to find customers who will take a lot of your money fast and pay you back slowly. It was in this competitive and Nigel attempted to Rich and Nigel banks, including environment pitch The that Great Rich Lieu.
be necessary to M different targeted offerings, in order to learn the combination of characteristics that make different products for credit desirable to customers
q
and profitable
card issuers.
Since most combinations of product offerings may be unprofitable for most-customers, it will be necessary to start with small tests, but when learning is complete larger rollouts can be made.
began to shop their idea to major New York and West Coast money
center banks and super-regionals. Although many of the major banks were willing to work with Rich and Nigel in other areas, their Great Idea was rejected by five of the top six (Citibank, Chase, Bank of America, Bank of New York, and Chemical Banking) and fourteen of the top twenty banks in the U. S.. Reactions were remarkably similar across institutions:
Nigel
create
that
or
implementing
a new brand
their
that
idea to
is,
was made
improving
because
the profitability
MasterCard or Visa portfolio had far fewer entry barriers than attempting to create a new brand.
It cant be done! data that you need make the strategy able to the bank
and the to
q
they
enable
you
to
determine forward.
the
basis
of
consumers
profitable Then
not avail-
running
programs, proved
more successful
and more
And it!
we dont
need
your
help;
we already
do
like the ones that initial test stage. Unfortunately, there where
in the
expenand and of 1991
is a significant is
Finally,
Signet
Bank,
a small
bank
looking
for
opportunities to grow, accepted The Great Mea. However, Signet wanted Rich and Nigel to come into aried the company bank not as consultants with but as salbank employees long-term
In fact, by December
chargeoffs from tions had soared chargeoffs in August notes, stock 1989 We profits
Rich and Nigels 1989 solicitato 9.5~0, more than doubling the
contracts. Surprised by the offer, Rich and Nigel agreed to come into the company as heads of credit card marketing and strategy, but only under Rich and Nigel were to be certain conditions: given real bank titles, they were to have real control within over systems, and they were to be accepted Signet as line bankers. However, unlike employees of the bank Rich and profit-sharing these conditions
of the banks total portfolio from 2.6% 1989 to 5.9~0 at the end of 1991. As Rich stock price was in free fall! over early The $20.00 in late 1991 (prices to Nigel, bank card in to zero
Signet
price plummeted from to less than $5.00 in for a split bottom of $27 million profits The fall in 7/93). hit in late 1991.
adjusted
According From
main-stream
in 1988 and $25 million for 1992 had dropped in stock price
Nigel would retain significant potential. They believed that were David necessary Hunt, to allow Executive their Vice
1989, forecast by late 1991. of bad portfolio results worse; profits Rich their equally continued the number 617 in 1991. 3.3. Late
was a result
real estate loans. profits actually fortunately, the at just this time.
Had the credit card dropped to zero the of course been far to produce IBS began
Bank, played a major role in the transition. Rich and Nigel also received support from Bob Freeman, then CEO of Signet. Perhaps most importantly, the firm. ideas, David to listened recognize You to Rich the think and buy-in Nigel, of within had their the vision potential
and basic
however, neither
faith
in
conception focus
of strategy on testing,
to generate
nearly
Then go do it! Performance for Rich and Nigel at Signet 1988 when they entered Signet Nigel stresses that to the first infrathe out commitment
of tests conducted
335 in 1989 to
1991.
a large
Nigel, and those associated with The Great Lieu, which continued spin-off of Signets credit One in 1994.
building databases, management, and this very difficult out their scale. of
learning figuring
card business
their
IBS
was
based on a test and learn methodology. test and learn consists of the following
q
In brief,
During this period (1992-1994), growth in receivables and in number of accounts soared [see Table 1], especially when compared to its competitors. At the same time, percentage chargeoffs improved and were consistently better than industry averages [see Figure 1]. Not surprisingly, the stock price of Signet Bank surged, allowing the bank to grow faster than 996 of the Fortune 1000! In fact, Signets stock appreciated January 1991 and the end of 1994. 5377. between
some
test
marketing
activities
(e.g.,
Determining
which ones do not; this takes some time, and most of the tests will be unprofitable. However, unprofitable tests are not unsuccessful, if
The credit card operation at Signet was doomed by its own success it could not continue as part of the bank. The credit card business came to account
2/3 the
This governew
as
The result
success of the
of Capital proprietary
the direct
of young
when
relatively
of the
accounting
profits.
strategy strategy
Rich
and
business, was clear of action structure Freeman the credit company, 3.4.
scientific testing and a highly flexible operating infrastructure to deliver the right product, to the right customer, at the right time and at the right price. The [5] core of this and strategy that is based differ widely information upon from to exploit the a
of Signet. As a solution, Signet CEO Bob made the audacious decision to spin off card business not associated Period as a wholly with Signet. independent
that
customers
in their
of sources
can be synthesized
The Current
The current period can be considered the time from the spin-off in 1994 through the present. During enjoy this period, considerable Capital success. in terms One has continued They have of growth to achieved in number
this customer profitability gradient. IBS represents the commitment to exploit this customer profitability gradient, and test and learn is the mechanism for doing so.
4.1.
success as measured
Rich when
of accounts and total outstandings well as in low loan losses when competitors performance [see Figure 1]. In has been strong.
were
scoring
to determine
Clearly, Capital One has experienced tremendous success. By any measure, Capital One has more than tripled in the past three years. [5] Capital Based One continues Strategies to to rely acquire upon Informationmarket
account to an applicant. were usually procured sealed neither meters allowing designed ably and Nigel
These black box models from a vendor, and were could paracould not profitRich credit
in the sense that the algorithms be examined nor altered. While could be updated based the models to learn thus to be tuned, which algorithms were definitely could rates. the
on experience,
profitable
share and continues to rely upon Test and Learn methodology for developing and implementing Indeed, testing continues at those strategies. Capital growth
3.5.
One, as demonstrated by the exponential of its R&D efforts [see table 2].
advocated
Assessment
is clear that
of Capital Capital
Ones
It
scoring models off for test offerings, and developing and tuning their own models to determine which combination of product, price, and credit limit could be profitably offered to customers who could be characterized credit incubation which by a wide period, range of publicAfter and to to be possible ly available a lengthy rollout these to determine smaller and demographic it would tests were offerings tests. data.
has more
profitable,
corresponding
Achieving
Competitive
There Capital
about
either or the
the source
extent
of
The structure of this process explains the initial period of extremely unprofitable operations after the introduction of test and learn. The degree of trust needed to turn off the banks credit scoring models likewise probably explains a great deal of the resistance when
IBS 4.2.
advantage
of this
encountered in their
The entire management team bethe organizations success comes from Strategy and its reliance of IBS via Test and Learn.
they
approach.
attempted
interest
Transfer
The
breakthrough
this
process
of test
and This
learn product
was
the who
5.
Sustaining did
Competitive powerful
offers credit
Why Nigel?
so many Why
balances
card. It turns out that this transfer of balances by customers ftom higher APR credit cards to a lower one provides the card issuer with an important signal. Customers that do not carry balances find no value in a lower APR and will not take the time and effort to switch cards. More importantly, the customers that the balance transfer product have which Therefore, Clearly, will they they these attract they will are cannot eventually those customers payoff APR. Morriss payoff who but slowly. a balance presently the lower meet
and
of
strategies,
Unlike other examples of our newly vulnerable markets paradigm, there was no rapid change in technology suddenly or made regulatory differential discontinuity that pricing possible. A
steady decrease in cost of computing for analysis, and of costs of storage and classification for the creation of targeted well before mailing 1988. faced by banks in respondin the market include their: 2,) information skill set; and 4.) lists, and had made strateinformation-based gies possible The principal marketing pricing
Nigel
of great accounts: They borrow pay it off, and they pay it off more flamboyantly low-risk revolver People who borrow limits delinquent, line utilized, customof
problems
ing to opportunities
slowly. Or, as Rich Fairbank says, We found the elusive and more, their age plotted clearly of we hit the jackpot! approach more this than trend. and who loans against illustrates
1.) organizational structure; infrastructure; 3.) organizational organizational 5.1. Most cards. culture.
of percent-
Bank Structure competitors have, or used to have, responsible department two very for credit
separate
However,
is responsible
ers who accepted the balance exhibit much more attractive profiles, as shown in Figure 2.
The graph in Figure 2 can be summarized ferently by noting that marketing expenses the balance ment invested close in the in an transfer annuity. product Each represents dollar stream year, over more $1.00 simply of
diffor
for selling; it is their responsibility to maximize the number of cards issued and the total balances In contrast, there is also a credit outstanding. department, and it is their responsibility to minimize exposure to bad loan losses, by limiting who has access to cards These they two but and what groups balances poorly they are allowed. tension, nated Rich are in constant coordi-
an investexpense
results
in an annuity
employed
integrated,
risk
Nigel summarizes the graph We found the sweet spot. 4.3. Capital credit Other Products
managed, approach to sales and marketing that attempted to compute the expected NPV or annuity value of each new account, providing first Signet Bank, and now Capital One, with the ability to respond appropriately to situations like that described above. 5.2. Information Infrastructure and Nigel believed that
including
offers to students
without previous credit history. there are over 3,000 price points
To support
Capital Ones current offerings. Capital One has everything. On the ability to customize account acquisition, they can customize on customer segmentation, market channels, products, pricing, credit lines, and credit approval policies. On account management, they can customize on repricing and retention, credit line increases and decreases, cross-selling. collections and recoveries policies, and
they had to invest heavily in information technology. At Signet they developed what was considered at the time to be the largest Oracle database in the world. The database not only contained detailed data on customers (i.e., their demographics, purchases, activities, etc.), but also supported regressions and other analytics, and stored the results. The generation, storage and analysis of such data enabled Signet to
identify systems
profitable continue
marketing to support
opportunities; Capital
the
is very
and
would
Ones market-
ing efforts.
it may
competitors
of This is in sharp contrast with the actions competitors, some of whom have outsourced all non-branch customer contact, and do not maintain their own databases or do their own servicing. As to do planNigel has said, This is like trying
ning after youve put your planning department through This value where flexibility a guillotine! that infrastructure throughout believed be achieved provides the that critical
need to make to respond to Capital One, it is also clear how very difficult it is for most organizations to accommodate such profound change. In summary, Capital One senior management
believes that their advantage has been sustainable because it is based on a complex combination of structure, information, skills, culture, and commitment. 6. That it will Future said, Opportunities senior management and more also believes difficult that
view
in organizations
that outsource their data processing. Indeed, in 1994, the year of the spin-off, Capital One was willing to incur the expense of $49 million to break its long term outsourcing contract with EDS, since it was seen as necessary achieve maximum flexibility ny [1].
5.3.
become
more
to sustain
this advantage. As other banks begin to follow similar strategies and as competition increases it will become more difficult to maintain margins. Therefore, it will be necessary for Capital One to continue When service points. Signet to refine AT&T and had When over its offerings. all price, had Now accounts Signet over that had the same points, has over
Organizational Commitment
Skill
Set, Culture,
and
23 price
20 price AT&T
Bank would
structure not
and
information advantage
achieve
set to exploit them and the commitment and train the right people. At their the Capital more right One, complex people. with were Above has successful implementation
300 price points, Capital One has over 4,000. Indeed, a senior officer at AT&T UCS believes that all competitors will be forced to adopt similar strategies,noting that When one of your competitors begins down this slippery slope, you have no alternative but to follow. DevelopTeam), will be adjusted
of hiring We
McKinsey
graduate
not competing with commercial all, we know that the key to our and will continue to be our
Scott Barton, Director of New Business ment (or the Growth Opportunities believes that ultimately, all accounts priced efficiently to reflect their risk
been
commitment to hiring and developing incredibly This talented and motivated associates. appears in the Letter to Stockholders, in the companys thoughts annual companies. In addition, the success experienced at Signet and Annual are unlikely reports of Report more for 1995 [5], and similar in the traditional banking to be seen in any form
expected return, a complex way of saying that in credit card issuing, as it is presently structured, it will become increasingly difficult to be profitable for any issuer,s However, profitable opportunities are likely to
continue as long as competitors are less able than the bank to assess the profitability of their accounts. Capital One employs retention specialists, whose job is to keep customers who call to cancel their accounts. Retention specialists are supported by screens and computer models that indicate the effects on profitability of changing a customers APR. While they are empowered to lower a customers APR down to just above the break-even level, their compensation system rewards them not only for retaining profitable accounts, possible but APR. for retaining them at the highest
Capital One requires commitment to a long term strategy of identifying and solving problems. Nigel claims that if none of your initial tests lose money, youre probably too conservative for us. If you cant figure out why they lose money and solve the problems, youre also probably not right for us; we need people with tenacity and superb problem solving skills. Nigel also notes that We truly believe that we have put in place Duplication of the strategy a better mousetrap.
evidence
of increased transfer
competition product
is the
legal tise,
operating develop
entity, systems
gain and
new
industry
exper-
the balance
has come
operating
infrastruc-
under assault. According to Nigel, The balance transfer product, which we pioneered in 1991, has enjoyed such spectacular has become increasingly will wave continue to pursue opportunities, success that the market competitive. While we profitable credit balance transfer to roll out the next
ture, create their tests, allow them to incubate and then tune their models, all before profitable rollout can be attempted. team also believes that opportunities to exploit markets 7. outside the U.S.
The senior management
there similar
we have begun
of market-tested
card innovations. (GO) Team originates that the Conclusions clear that the history of Capital One
Opportunities of senior
the belief
management
It appears
skill set, personnel, culture, and infrastructure of Capital One can be used in other settings, to develop and market different products in different, perhaps unrelated run, we see our destiny company, company tion-rich follows, a credit offering industries. not merely In the long as a credit card marketing
and Signet Bank provides considerable support for our theory of newly vulnerable markets. The erosion of profitability however suggests that without fundamental differences in resources, innovations like differential pricing and effective market segmentation will become strategic necessities rather than continuing as sources of If the skills competitive advantage. information-based strategies are difficult general should to acquire, and if they required sufficiently for
are sufficiently
based marketing company. The credit card just happens to be a product which has been transformed There hence by the information are other newly other opportunities revolution. vulnerable markets, for a new entrant and like
exploiting a sequence of opportunities in newly vulnerable markets in other industries. Rich believes that this, indeed, will be the long term source rather of Capital Ones competitive than its positioning in any or market segment: advantage is that around the informaorganizaaccounting and, most a adapt at full grow, we eventual on a dime. advantage, specific pro-
Capital One to use information-based strategies to target an established competitors most profitable customers. Capital One wants Capital to focus core yet to a view Peter the core team on areas where Ones
duct, industry,
strengths can provide advantage, and avoid having too focused or too restrictive of what these strengths might be. As Schnall, Vice President ment, says, We want not being too narrow nities. strategies for
tion-based strategy the people, tional structure, systems, operations, systems, importantly, machine speed. work in that While parallel infrastructure, human the resources, culture. roll to plan policies, We out for
of New Business Developto make certain that we are of future opportuof profitin information-based targeting
are building
able new accounts or in the use of information more generally for relationship management? The GO Team is presently assessing opportunities in a wide range of industries. The company is making increasing investments in non-card targeted marketing; expenditures in 1997 are estimated to be split among balance transfer, other equal balance card products, and both and non-card substantially product products, greater with than GO and other card products expenditures roughly The team
While in hindsight test and learn strategies applied to newly vulnerable markets may appear to be obvious, clearly at the time they were not. The Capital One team sums up their beliefs in the sources of their advantage:
transfer
expenditures.
Our growth is the result of opportunistic origination and account management. The strategy
was the
is, however, all too aware that unfortunately there will once again be a considerable lag between initial tests and profitable rollouts, especially in areas where they must first create a
was
the
easy
We
part.
also
Making
continue to
it work
test the
challen~e!
application of information-based other products, both financial cial, with positive results.
8.
References Anthes, off, G.H. Customer May and data mining pays The Chief InterAge of assistance Operating
1.
15,1995, J. the
of Rich
2.
Deighton, Exploiting
Fairbank,
ment,
Chairman
Director
of
Sloan
Management
Re-
view,
3.
Clemens, E.K. and B.W. Weber, Segmentation, Differentiation, and Flexible Pricing: Experiences with Information Technology and Segment-Tailored Management Strategies, Information Journal Vol. of 11, Systems,
No. 2, Fall 1994, pp. 9-36. 4. Clemens, Market E.K., D.C. Croson Dominance and B.W. Weber,
Underperformance: and the Advantages Journal of Management Fall, 5. 6. Capital Gartner Excellence October 7. Lucas, Credit 8. 1996. One Annual Group, in 8,1996 P.
2. College Arizona
of Business Administration,
repre3. Outstandings, or outstanding balances, sent the amount of money that a credit card issuer is
Report,
owed by card holders. It is generally considered desirable to have high outstanding balances, since this represents money that cardholders have borrowed from issuers, and on which issuers are generally paid a high annual rate of interest.
4.
Gartner Technology
In previous work, we have explored these conditions to a wider range of industries for banking as an industry, [4].
Capitalizing
Card Management,
1995.
Unfortunately
there is
Steiner, T.D. and D.B. Teixeira, Technology in Banking: Creating Value and Destroying Profits, 1990. Dow Jones-Irwin, Homewood, IL,
considerable evidence to support this concern. The assessment of technology in bankhg suggests that even as it creates value for customers it increases competition and the efficiency of pricing, destroying profits for financial intermediaries [8].
9.
Tirole, tion,
of Industrial
Organiza-
(000s)
Loans Accounts I
Number
of Accounts
and Amount
for Capital
One
1989 335
1990 370
1992 1,130
1993 1,850
1994 4,355
1995 6,199
Number
One
letitors
2 Balance-Transfer Product