By John Racine

Once again, the credit card business has proven itself to be cyclical.

The industry is once again focused on fundamentals after a decade of breathless growth, unprecedented consolidation, and the rise of the credit card as the manage-my-life payments tool preferred by consumers.

Headlines bring almost daily reports on new economic plagues. Government bailouts of established institutions, the acquisition of national icons like Merrill Lynch and the bankruptcy of historically sound institutions like Lehman Brothers are evidence of the tumultuous times in which we live. For consumers, a weak economy is pushing some to their financial limits and causing others to put their plastic away out of concern about inflation's threat to household budgets. For issuers, the credit crunch has squeezed capital access and shifted the focus from growth to portfolio management and damage control. Issuers are tightening underwriting standards as delinquencies rise and charge-offs threaten to rocket.

But in a Dickensian twist, the downturn that challenges one issuer creates opportunity for another. Mark your calendars: History will show that 2008 was a time of great opportunity in the credit card market. The leading CEOs, who have already adjusted their business plans for downside risk in this economy are now focusing on five fundamental opportunities to improve near-term profits and create new growth.

One: Check those underwriting.

Once you have screened for adverse selection, refocus your account acquisition models on segments of the more than 90 percent of house­holds that remain a good credit risk and will need your products now more than ever. One Wall Street analyst recently estimated that issuers have reduced credit limits, collectively, by as much as $40 billion in 2008. At the same time, there are signs that the industry has voluntarily curtailed balance transfer offers over concerns of consolidating credit risk at the household level. Issuers are re-pricing their portfolios to reflect higher capital costs — and because there is less competition.

Still, others are solidifying their brands around the uncertain economic environment. Discover Card is staking out its brand as unabashedly pro-consumer. The company is promoting a “paydown” Web site with tools to help customers and prospects figure out how to create a plan to pay off their credit cards, not just transfer them at a lower APR. The education campaign is a smart way to screen for higher-quality balance transfer candidates.

There is no doubt that the credit binge has given Discover plenty of potential users of its online tools. In the United States, the Federal Reserve’s data shows that consumer installment debt climbed to $2.56 trillion last year, up 22 percent since 2000. Of that, the average American carried $8,565 in card debt. More telling is the fact that the typical American household’s installment debt is 130 percent of their estimated household disposable income — a key indicator of financial flexibility. Anecdotally, the story is similar in developed markets around the globe: Consumers are maxed out and they are carrying more types of unsecured debt than ever before.

Two: Review those fees — the regulators are.

Issuers are always tempted to quickly raise fees across the board and change grace periods on accounts. Higher fees for late payments seem like a good idea, but don’t ensure that a payment will be made. Smart issuers align fees with behaviors that build profitability. We are aware of an issuer that rebates interest when net principal balances are paid down for at least three consecutive months. Their goal is to reduce credit exposure. Another issuer is offering zero interest on charges made and paid off in a monthly cycle, recognizing that many cardholders are using their plastic to manage household needs. In each instance, the issuers are focusing on behaviors that improve the risk profile and profits.

In Australia, the Members Equity Bank Card waives annual fees when charge volumes go above AUD $7,500 a year and was among the first to extend the grace period for interest charges on new purchases. The trade-off in encouraging moderate balance carrying: The company’s APR is in the top quartile of the Aussie market. Also, the bank’s fees are structured to incent “average households” to consolidate their purchases onto a single card.

Competitors are not the only ones watching your fee schedule. Regulators and lawmakers are more inclined to pile on costly new restrictions if they perceive consumers are being gouged or having their pockets picked.

Three: Cross-sell credit management products.

Economic uncertainty creates concern among cardholders about identity theft, credit management and job loss. The truth is that most card issuers push these products as an after thought, shuffling them into the on-hold voice queue or having them promoted by customer service representatives who are generally handling complaints from the very cardholder they then solicit. Not surprisingly, the sales results are abysmal.

We are aware of one major issuer that proactively targets cardholders whose balances have increased at least 25 percent and whose monthly payments have fallen to the minimum. The idea came out of a weekly review meeting of departmental managers who were sharing their frustrations and who discovered a way to help customers avoid going to collection, while reducing their own credit risks. By targeting these customers for outbound sales, the issuer has seen closing rates as high as 15 percent, eight times higher than their experience before the campaign.

Uncertainty can also be good for business. Consider the appeal of identity theft prevention products. While it is difficult to tell if the problem is actually growing, the perception that it is increasing has been aided by multi-million dollar marketing campaigns from credit bureaus, affinity product marketers and others. Experian, TransUnion, LifeLock and other players have driven consumer awareness (and the fear of being a victim) to an unprecedented level. Ironically, history shows that banks — the arbiters of trust as a brand — are the best positioned to profit from this trend by introducing these products. Remember when using a credit card on the Internet was holding back shopping volumes? It was ultimately the leadership of a few major card brands and the associations that made online fraud a non-issue for consumers — though still a cost of doing business for merchants, processors and card issuers.

In Europe, Barclaycard is an early leader. At the corporate level and in the card business, Barclays has made account security a cornerstone of their market position. By promoting peace of mind to cardholders, Barclays wins an important psychological positioning among its other European competitors. Not surprisingly, the company appears to be doing well in its efforts to up-sell an identity theft prevention package for as little as $10 per month. The benefit: $100,000 in coverage under certain conditions, credit bureau monitoring, and advice.

Four: Make that loyalty program pay.

Loyalty programs generally reward card usage. In a down market, retool the program to reward profitable behaviors like on-time payments, balance reductions and the purchase of credit products. Most loyalty schemes are aimed at rewarding purchases at a time when more consumers are keeping their plastic in their wallets. At the same time, what consumers value is changing. Airlines have cut available flights, which means fewer seats for rewards to fewer places. At a recent trade show of loyalty experts, many agreed that airline points have lost their appeal in favor of free hotels or free gas cards for car-bound travelers.

Add to this the fact that brands, retailers and merchants are pushing back at the growing cost of point-buying schemes. We are seeing the rise of the merchant-funded programs, such as the Mall Networks or TripRewards.

These programs give retailers, franchises and merchants more control and accountability for how their marketing budgets are spent. This new breed of merchant-funded program offers variety and a lower price-point for issuers.

Clearly, the status quo won’t do. The cost of points is rising even as the opportunity to redeem them shrinks. Even for passive rewards programs, this means that the cost alone will make loyalty programs uneconomic on the average card account. There is no single strategy for a performing loyalty program. (For more trends in the loyalty space, see the article entitled "When Times Get Tough, Bolster Loyalty Rewards".)

Every issuer has to decide which type of customer behavior is most profitable for them and then align rewards — and their costs — to incentives that drive the desired behavior. Two old-fashioned business models are proven for this economy. The first is the reward card as a club. In this model, consumers upgrade to gain a specific benefit such as free or dis­counted hotel rooms or a one-time pur­chase discount at a retailer. This tends to favor card-issuing retailers that want to consolidate their walletshare among customers. The second is the cash-back offer. Consumer surveys show that 15-to-30 percent of every consumer dollar is spent based on a cash-back offer. Co-branded cards issued by gas retailers are winning big with this strategy this year, but it can work for just about any type of retailer. Fans of cash-back offers are notorious penny pinchers, and losses tend to be lower with these types of bargain-hunting cardholders.

One of the most successful models for this is the Virgin Money Card. Targeting younger UK consumers, Virgin offers a unique package of discounts at its other Virgin brands for travel, entertainment and mobile — the things that most dominate their cardholders’ monthly spending. It doesn’t hurt that the card is a leader in balance transfers and provides a standard 50-day grace period. This mix, wrapped around the Virgin brand, makes for a card that is built to reward spending on the things that are at the center of their target customer’s lifestyle.

Five: Invest in product development.

Card markets are moved, and even redefined, by new product concepts. Again, take the success of the Virgin Money Card, which after nearly a decade since its introduction has defined the balance transfer and co-brand card market in the UK. However, Virgin doesn’t have the market cornered on innovation. Sometimes, the best ideas come from the incumbent. After the economic downturn in Asia earlier this decade, DBS Bank, a regional leader based in Singapore, redefined its card business. Beyond an impressive portfolio of status- and rewards-rich cards, the bank wanted to leverage its branch and ATM network in the city-state. In 2005, its POSBank subsidiary introduced the POSBank Everyday Card. The debit card offers instant merchant-funded rebates of up to 20 percent off at more than 400 locations. That ranges from 1 percent rebated on utility payments to 5 percent back on petrol purchases. The card has even added a preferred payment feature that allows customers to automatically finance any purchase over $500, interest free for at least six months. Three years later, no rival has matched the product in Singapore, but it has pointed the way forward for bank issuers looking to bridge the growing gap between their credit card business and the global popularity of debit cards.

During tough times, budget pressures make it too easy to cut out product development. Smartly designed products remain the best organic strategy to create new niches with existing customers; a strong way to win new accounts and a vital investment in building partnerships among retailers, brands and affinity partners.

Creating Growth in Tough Markets
Finally, there is a bonus strategy to consider. In a market where everyone is selling, consider being a buyer. At the moment, the payments industry is on sale as players look to either exit, parse portfolios or sell assets to raise fresh capital. Smart buyers are finding all but premium franchises on sale for 20-to-30 percent off valuations a year ago. This is a market that favors the conservative strategic buyer. Last year’s top-dollar deals by private equity firms have largely unraveled. The combination of a down year and fear are creating sellers just as the economy — and lack of leveraged financing — is reducing the pool of buyers.

Smart buyers are always on the hunt for value-priced market share; for new products to offer to customers and for bargains. Unless they have strong experience and seasoned teams to manage them, most buyers should stay away from turnaround opportunities, shun the temptation to jump into new geographies or create totally new products. Today’s environment favors opportunistic acquisitions and diversification by card issuers, processors and niche-market players that have stable cash flows, strong operational teams and a clear plan to integrate an acquisition.

About the Author

Mr. Racine is a former editor of American Banker and a 20-year observer of the payments industry. He is also founder and managing principal of Altamont Partners, a consulting and M&A advisory firm that serves technology-driven services businesses, including the payments industry.