16 McKinsey on Payments March 2011

Industry dynamics require new

issuer strategies
As we note in U.S. payments trends: Endur-
ing a turbulent passage (page 3), regulatory
uncertainty, shifts in consumer behavior and
atypically high loan losses continue to erode
the profitability of the U.S. and global credit
card industry. We estimate U.S. credit card
profits at $16 billion in 2012, down by nearly
half from their 2006 peak. Pre-tax returns on
assets, meanwhile, will rebound to the 2.5 to 3
percent range by 2013-14, but will likely re-
main below levels established in the middle of
the past decade. A similar story is playing out
in Europe, where regulations enacted between
2004 and 2006 continue to depress the long-
term outlook for profitability (Exhibit 1).
Asian markets offer even less profitability, re-
flecting low consumer demand and high levels
of regulation.
For these reasons, quick fixes will not signifi-
cantly boost future growth. In the previous
issue of McKinsey on Payments we argued for
a new model based on cutting operating costs
(Designing a sustainable card model, McK-
insey on Payments, October 2010). But costs
are only part of the answer; issuers must also
focus on growth. The increase in direct mail
Designing a sustainable card model:
The growth challenge
In the face of dire predictions about the health of the global credit card industry,
a number of issuers are rallying around new positioning, new products and new
value propositions seeking profits there rather than through risk-based charges
and fees. The new positioning includes making finer distinctions among con-
sumer groups. The new products range from family charge cards to programma-
ble credit cards. And the new value propositions include richer incentives for
affluent customers, innovative introductory offers for under- and unserved card
customers, youth-friendly offerings for families, partnerships
for card issuers and merchants, and high-tech solutions as smart cards and mo-
bile payment systems. Together these models may help preserve credit cards sta-
tus as one of the most profitable segments of the payments industry.
Philip Auerbach
David Chubak
Sameer Gulati
JJ Kasper
Maria Martinez
17 Designing a sustainable card model: The growth challenge
solicitations in the U.S. in 2010, for instance,
suggests that issuers have turned their focus
once more to revenue growth (Exhibit 2, page
18). But more effort is needed. We suggest
three integrated actions: issuers must target
their customer segments in a more granular
way; they must create value propositions that
answer the specific needs of their customers;
and they need to develop more effective deliv-
ery channels to get their new value proposi-
tions out into the world.
A reevaluation of credit card
customer segments
To design better value propositions, issuers
must take into account how new regulations
and changes in customer behavior have re-
shaped the marketplace (Exhibit 3, page 19).
Since 2007, for instance, U.S. customers who
value revolving credit have been the hardest
hit of all segments. Issuers, responding to re-
strictions on risk-based re-pricing and fees,
have decreased lines to this segment, raised
their rates and boosted their costs through
new fees. For these reasons mass-market con-
sumers consisting primarily of such re-
volvers were a barely profitable segment in
2010. Nevertheless, we believe that these cus-
tomers cannot be ignored, and that there are
innovative ways to meet their needs. This is
particularly important, as we believe that by
2015 this segment will once again account for
nearly 70 percent of industry profitability.
Meanwhile, affluent consumers who tend
to behave as transactors have emerged as
E.U. Consumer Credit Directive
U.K.
Credit card default: Threshold for intervention
fee per default charge
Clear rules regarding the annual percentage
rates charged by credit cards
Display of Summary Box for store card credit
services (also known as an Honesty Box or
Schumer Box) listing interest rates and
penalty charges, etc.
Bundle of payment protection insurance with
loans banned
France
Anti-usury law
Closure of credit lines after 2 years
of inactivity
Credit/loyalty cards: ban of commercial
benefts related to credit only
Reduction of the maximum length of
overindebtness plans (from 10 to 8 years)
Germany
Standardized pre-contractual
information has to be provided
Effective interest rate shown in
an advertising has to ft the
situation of at least 66% of all
possible customers
Italy
Interest rate cap (antiusury
law): Maximum interest rate is
equal to 1.5 times the average
rate by product
Source: McKinsey analysis
Exhibit 1
In Europe, a wide
variety of regulatory
initiatives have
been implemented
or are under
discussion
18 McKinsey on Payments March 2011
the industrys unsung heroes. The irony,
however, is that while they drove most of the
industrys profitability in the U.S. in 2010,
they do not need revolving credit, and more-
over, they are generally unhappy with the
benefits they currently get from card
providers. For these reasons, they are partic-
ularly susceptible to debit card migration, a
trend encouraged by the Dodd-Frank Wall
Street Reform and Consumer Protection
Act, which provides incentives for mer-
chants to steer customers into debit. Home
goods company IKEA, for example, offers a 1
percent reward towards future purchases for
customers who use a debit card instead of a
credit card. A prime opportunity here, as we
explain later in this article, is in reclaiming
these consumers with enhanced benefits.
However, given the recent Federal Reserve
proposal on debit interchange and its poten-
tial impact on debit rewards value proposi-
tions, this segment may begin migrating
back to credit on its own.
Three segment opportunities
While revolvers and transactors constitute the
card industrys traditional segments, issuers
need to segment the card-holding universe
more completely. A more granular view of
segmentation, given the new regulations and
the reach of card usage, promises to reveal
new opportunities. Three segments in partic-
ular that deserve attention are:
Small business: This segment is not regu-
lated in the U.S. under the Credit Card
Accountability, Responsibility and Disclo-
sure Act of 2009, and has faced obstacles
acquiring credit over the past three years.
By moving this segment from personal
cards to professional and business cards,
U.S. credit card mail solicitations
Billions
2.3
1.4
3.9
5.3
5.7
6.0
2009 2008 2007 2006 2005 2010E Source: Synovate
Exhibit 2
In 2010 the U.S.
saw a revival in the
volume of direct
mail and new
credit card value
propositions
sent to customers
19 Designing a sustainable card model: The growth challenge
issuers can create a value niche. In several
industries and areas, banks are already
opening the spigot to small business and
professional lending.
Underserved and unserved: This segment
comprises about 25 percent of the U.S.
banking population. While regulations re-
strict traditional offers to this group, new
approaches such as prepaid and next-gen-
eration secured cards offer opportunity.
Youth consumers under 21: While new
regulations restrict offers to this group,
opportunities remain to attract and edu-
cate the segment through family bundles
and prepaid cards. Since youth con-
sumers will naturally form the next gen-
eration of customers, issuers must seek
out ways to begin long-lasting relation-
ships with them.
Reshaping value propositions
With a better understanding of customer seg-
mentation, issuers can design tailored and
more creative value propositions. Studies in-
dicate that consumers have walked away from
revolving credit, for instance, partly because
they feel that issuers have been opaque in the
application of interest rates and fees. To re-
capture the revolving credit market, issuers
need to offer simple, easy-to-understand value
propositions to their customers. Bank of
Americas Basic Visa card, for example, offers
an attractive rate tied to prime, no penalty
rates, late fees capped at $35 and a one-page
explanation of terms and conditions. In its
mortgage business as well, Bank of America
offers a home loan clarity commitment, a
clearly stated, one-page explanation of mort-
gage costs designed as a breath of fresh air for
small-print-weary consumers.
Restrictions on risk-based
re-pricing and fees
New payment allocation
Ability to pay
requirements limit line
increases
Consumer deleveraging
Impact on
proftability
levers
Potential
impact on
go-to-market
strategy
Ability to pay
requirements limit line
increases
Potential reduction in
spend given merchant
debit steering
Small business
cards specifcally
excluded from
regulation
Restrictions on
risk-based
re-pricing deter
offering traditional
credit products to
this segment
Restrictions on
acquisitions
without co-signer
or fnancial
means test
New variable-rate strategies
(e.g., variable rates based
on customer behavior)
New fee strategies
Innovative line management
Leveraging of
non-traditional data
in underwriting
Increase in annual fees
for lower-spend
transactors
New earn/burn
strategies
New value-added
services beyond
rewards (e.g., enhanced
customer service)
Increase in small
business and
professional cards,
particularly for
affuent segments
Richer rewards on
business cards
New value
propositions to
reduce risk (e.g.,
partially secured
cards)
Greater use of
non-traditional data
and partnerships to
identify prospects
More
family-oriented
products to
acquire youth
market early
Greater use of
prepaid for youth
segment
Revolvers Transactors
Small
business Youth
Underserved/
unserved
Adverse impact
Little to no impact
Source: McKinsey analysis
Exhibit 3
In the U.S., new
regulations and
macroeconomic
pressures have
complicated the
customer
landscape for
issuers
Other issuers are battling back with pre-
ferred target customer segments. Santander
and RBS offer credit cards with preferred
rates for their current customers. A twist to
this model might include the right of offset
against a customers DDA (or other bank
asset) in return for an improved APR, credit
line and rewards.
Some issuers are offering lower rates and ex-
panded credit lines to customers who mitigate
risk for the issuer. In the U.K., the Egg combi-
nation deposit/credit card not only pays a high
interest rate on net positive balances, but
charges a low variable APR on net negative
balances. Similarly, the Flexicard from Com-
merzbank in Germany offers revolving credit
linked to a debit card, with revolving rates
lower than typical overdraft charges.
Affluent customers want richer rewards and
additional benefits, and some issuers are re-
sponding. Chase, for instance, recently un-
veiled its Ultimate Rewards platform, which
offers flight selections without blackout
dates and other restrictions. Citi, mean-
while, has turned its sights to commercial
cards, which have fewer restrictions. Citi
now offers some new customers an AAdvan-
tage Mastercard with 75,000 promotional
bonus miles, beating most airline acquisi-
tion promotions.
Banks are not alone in advancing such of-
fers; retailers are entering the financial serv-
ices market as well. Marks & Spencers
&More credit card, targeted at prime
transactors, not only gives card users special
M&S points (redeemable at Marks &
Spencer stores), but triple points for other
in-store purchases. And consider Citis ex-
periment with Citi Specials, a program that
offers cardholders exclusive discounts and
certificates on both local and national prod-
ucts and services.
For the underserved or unserved, prepaid
and reloadable cards are available. In the
U.K., the O2 Money card is a prepaid debit
card targeted at near-prime students. It fea-
tures an online money manager to help
students manage their expenses. Some pre-
paid and reloadable cards function like
credit and debit cards and even offer free bill
payment and free checking.
Given the breadth of innovative payment ap-
proaches, do traditional credit cards still have
a role? The answer is yes. Start the customer
relationship with prepaid and reloadable
cards, then allow responsible users to gradu-
ate over time to more traditional credit card
products. Family-oriented cards can be built
off existing usage. The Amex Family Charge
Card, for instance, allows parents to set
spending limits for additional cards on a sin-
gle account. It also issues separate account
numbers for additional cardholders, so the
entire account does not have to be closed
when one card is lost. American Express en-
courages parents to add their teens to these
cards; it helps them understand credit and
develop financial responsibility.
How can issuers capture smaller and more
specialized segments? Spains Banesto offers
a card that gives soccer fans two euros for
every goal scored by Real Madrid. Likewise
20 McKinsey on Payments March 2011
In the U.K., the O2 Money card
is a prepaid debit card targeted at
near-prime students. It features an
online money manager to help
students manage their expenses.
21 Designing a sustainable card model: The growth challenge
Linea in Italy issues an AC Milan card that
offers discounts on soccer tickets. Many is-
suers offer cards that donate to environmen-
tal organizations. These include Rabobank
in the Netherlands and OMC in Japan. Trio-
dos bank in Spain even advertises the fact
that its cards are made of recyclable materi-
als (Exhibit 4).
Other cards offer high-tech allures: some are
programmable credit cards, such as those
made by the start-up company Dynamics.
This cards magnetic strip is activated only
after a secret PIN is entered. Another version
allows users to switch from credit to debit and
back again with the press of a button. In the
future we can expect more smart cards with
programmable magnetic strips. Citi is experi-
menting with a 2G credit card that has a bat-
tery, an embedded chip, a card-programmable
magnetic strip and two buttons on the front of
the card that allow users to choose between
normal transactions and those that apply re-
wards or points toward the purchase.
Reengineering delivery
While new value propositions offer the oppor-
tunity for innovation, a truly new growth
model requires innovation in delivery as well.
The Internet is already rife with creative part-
nerships between issuers and merchants.
When customers book with American Air-
lines, for example, they automatically see mul-
tiple offers for the Citi AAdvantage card. As
they move forward in the booking process,
they receive increasingly tailored offers. A
standard banner ad might start the search
process, but by the time the customer is ready
to purchase a seat they have been offered a
Lets card users track expenditures and choose when to pay
off larger purchases
Chase Blueprint
Offers a fxed rate tied to prime and a one-page explanation
of terms
Bank of America Basic Card
Offers high interest on net positive balances and low variable
APR on net negative balances
Egg Combo
deposit/credit
card
Revolving credit linked to a debit card, resulting in lower rates
than the typical overdraft
Commerzbank Flexicard
50% bonus points at 5 merchants designated by cardholder
and any merchant where $5,000 is spent in a calendar year
Choice of over 200 rewards
American Express Favorite Places
Rewards Card
Cash card, credit card and e-money combined in one card Major banks All-in-one
cash card
For the affuent: discounts in top restaurants worldwide;
airport priority passes; and comprehensive travel insurance
Guangdong
Development Bank
GuangFa
Platinum
Innovation Market Issuer Description
Source: Press and Web site research
Exhibit 4
Issuers across the
globe have
responded to
changing regulation
and consumer
behavior with new
value propositions
specific seat discount (such as $50 off ) if they
sign up with the card.
Thanks to the dynamic nature of the Web,
issuers can interact with prospects as well,
creating dialogue that cannot be achieved
with direct mail. When American Express
launched its youth-oriented Zync card, they
also started the Zync Tank, the cards on-
line community, where users can suggest
new benefits and even vote some of them
into existence.
In the past, issuers in the U.S. and Europe
have at times encountered risk problems with
their Internet-acquired customers. Fortu-
nately, issuers are now in the position to col-
lect purchasing data on valuable customers
and incorporate this information into new un-
derwriting methods. They can also leverage
online partnerships, which help the issuer col-
lect valuable data around each prospective
customer, thereby mitigating some of the risks.
Some Internet banks (like traditional banks)
use this broader relationship with customers
to manage risk. Smile Internet bank in the
U.K., for example, offers a loyalty reward
which provides better credit card rates to cus-
tomers with a current Smile account.
Mobile phone payments will also continue to
shape new markets. Visa introduced a mo-
bile phone payment system earlier this year
that lets a mobile phone work like a credit
card: consumers can purchase a mobile
phone with a near field communication chip
built in. They simply connect the phone
through the Internet to a financial institu-
tion and create a payment account. The con-
sumer can then wave the phone at an
NFC-enabled checkout counter just as they
would swipe a card, and the transaction is
completed. In a different model, Barclaycard
US has a partnership (Isis) with AT&T, T-
Mobile, Verizon and Discover, through
which it hopes to become the mobile pay-
ment provider for the 200 million-plus sub-
scribers of the three carriers.
Technology standards are not yet fully com-
patible across markets, and there is friction
between some competitors. But as the tech-
nology issues shake out, opportunities will
emerge for card issuers to partner with mo-
bile and small business acquirers to capture
new business. Square, a start-up from a co-
founder of Twitter, is taking advantage of
just such an opportunity, offering an app
and a small plastic cube that plugs into the
headphone jack of an iPhone, iPod Touch,
iPad or Android phone. Users can then
swipe a credit card through the cube, and
complete a credit card transaction, with the
cash drawn out of a bank or credit card
source. Square is marketing to businesses
that neither have nor want a relationship
with traditional credit card vendors.
A commitment to transformation
What strategies should issuers be adopting
now? We suggest the following preliminary
guidelines and actions.
Redefine the customer. Issuers generally di-
vide their customers into just two groups
revolvers and transactors. However, con-
sumer segments need to be more finely
22 McKinsey on Payments March 2011
Visa introduced a mobile phone payment
system earlier this year that lets a mobile
phone work like a credit card: consumers
can purchase a mobile phone with a near
field communication chip built in.
23 Designing a sustainable card model: The growth challenge
sliced. Teens, families, the affluent and the
cardless all have different needs that must
be addressed through segment-specific
products. Furthermore, these distinctions
will not be static; they will need to be mon-
itored and reconceived as necessary.
Redefine the product. A better understand-
ing of the customer allows for tailored, in-
novative value propositions, which demand
new products, features, business models
and channel strategies. Several financial in-
stitutions have launched innovative busi-
ness units and innovation groups to meet
the challenge.
Commit to rapid prototyping. To refine
new value propositions, issuers need to roll
them out faster and more frequently,
through means such as limited tester
groups for new features and phased intro-
ductions. The process of commercialization
must be lean, focused and nimble.
* * *
Credit cards used to be a high-profit business,
and it can be again. But it will be significantly
more challenging and competitive. Issuers
must design a new model that manages oper-
ating costs and generates revenues in a sus-
tainable manner. Only through an integrated
approach to each of the new barriers to
growth can issuers hope to succeed again.
Philip Auerbach is an associate principal,
David Chubak is a principal and JJ Kasper is a con-
sultant, all in the New York office.
Sameer Gulati is an associate principal in the Lon-
don office, and Maria Martinez is a principal in the
Madrid office.