Delayed Gratification

By Lauri Giesen

Bank debit card strategy, once focused primarily on interchange fees, is increasingly focused on strengthening customer relationships.

Banks surprised everyone, including probably themselves, by not raising fees in the wake of an out-of-court settlement last year that effectively lowered the amount of revenue they receive from signature-based debit cards.

It remains to be seen, however, whether the restraint amounts to a permanent shift in strategy for banks that issue debit cards or whether it's only a temporary tactic. "A lot of financial institutions still do not have a clear picture of what debit card strategy they should adopt. They know their debit revenues are down, but they are holding off taking any action," says Les Riedl, a consultant with Atlanta-based Speer & Associates.

Many industry experts had been expecting banks to raise debit card fees in the wake of the settlement reached in April 2003 between the two bank-owned credit card associations, Visa and MasterCard, and a group of retailers led by Wal-Mart Stores Inc. Terms of that settlement lowered the amount of revenue banks receive from retailers by an average of about 30% per signature-based debit card transaction. While Visa revised its rates this year based on merchant size, banks say the average transaction fees are still about 20% lower than before the settlement. It was widely predicted that banks would try to make up for that shortfall in revenue by either charging their customers fees for the cards or eliminating the pricier perks that they had offered in hopes of luring customers to use those cards — such as airline miles or cash rebates.

But that didn't happen. Bankers evidently realized that if they started charging for the cards — either through annual card fees or per-transaction charges — they would discourage usage. Furthermore, numerous banks have reported that customers who use their debit cards frequently, much like customers who bank and pay their bills online, tend to be more loyal and keep larger amounts in their accounts than customers who don't use debit cards. Customers with cards tied to mileage and other incentives keep even bigger balances, according to Tony Hayes, managing director of financial services practices at Dove Consulting.

In short, what's underway is a new approach to debit cards. Instead of viewing debit cards primarily as standalone sources of fee income, bankers are increasingly using them for the broader purpose of strengthening customer relationships and hastening the transition from paper-based to electronic transactions. Wachovia Corp., for example, believes in the debit card as a vehicle: "There is still a significant upside to the number of transactions that can be migrated from cash and checks to debit cards," says Janine Tabaczynski, senior vice president and director of access services.

"Even though the revenue has declined on a per-transaction basis, we're still projecting considerable growth in both the number of customers who use debit cards and the number of transactions that consumers are making on those cards."

As long as this growth continues, banks may be expected to refrain from passing on the lower interchange rates to their customers. Increased volume may make up for the lower rate earned.

Volume Strategy

The make-it-up-on-volume approach can be seen at TCF Bank, which reported first quarter debit card revenues of $13.5 million, up 2% from the previous year. That rise occurred despite the fact that the average revenue received on a per-transaction basis was down by 17%.

The Wayzata, Minn.-based unit of TCF Financial Corp. offset the per-transaction decline by encouraging customers to increase the number of debit card transactions made on their cards. The promotions produced a 19% gain over the year-earlier quarter. "I'd be hard pressed to think of any communication that we send out that doesn't talk about the value of our check card," says senior vice president Dan Engel. "There is information inside every statement envelope and often we send out coupons that give discounts when cards are used."

But while TCF has been promoting its card for years and began another round of such promotions immediately after the settlement, other banks took longer to react.

Banco Popular North America, the U.S.-based subsidiary of the Puerto Rico-based Popular Inc. bank holding company, saw its debit revenue fall by about 30% last year. Manuel Chinea, vice president of marketing and product developing for Banco Popular North America, admits the company did consider charging debit card fees, but decided against that option.

"We think we can make up our revenue shortfall in volume," Chinea says. "If, at some point, we find we can't make enough revenue with just volume increases, we may have to resort to fees. But we're not there yet."

To get more debit cards into the hands of its customers, Banco Popular North America mailed 51,000 new cards this spring. Chinea says a card issuance program was essential for his bank because only about 35% of its customers were using their cards. "We know we are under-represented in the market because the industry average is closer to 60%. Our customers include a high number of first-generation immigrants, who tend to rely more on paper payments," he says.

But Chinea also believes his customers will be receptive to debit cards because many do not have a credit history and can't qualify for credit cards. The bank plans to emphasize that debit cards offer all the convenience of credit cards without the credit qualifications or risk of incurring debt. After the push on card issuance, Banco Popular will look at programs to spur greater use of those cards.

Such go-for-growth strategies seem to have become the industry norm in the wake of the Wal-Mart settlement. "More banks are focusing on how to use the card to broaden the relationship between the customer and the bank, not just to generate fee income," says John Gould, director of consumer credit for TowerGroup, a Needham, Mass-based consulting firm.

Some banks are working both sides of the demand equation — consumers and retailers. In addition to trying to boost customer usage, they're working to get both credit and debit cards accepted by a wider range of merchants, with fast-food restaurants and recurring utility, newspaper and insurance bill payments high on their prospect lists. If they are successful — and there are early indications that such acceptance is growing — there will be even more opportunities for consumers to use their cards and increase transaction volumes.

Studies by Boston-based Dove Consulting, in fact, have shown a gradual increase in the use of debit cards for in-store payments, from 21% of total payments in 1999, to 31% last year. Some of that conversion to debit cards has come at the expense of checkwriting as the check market share at the point of sale fell from 18% in 1999 to 15% in 2003, according to Dove. "Banks can fee their way of this situation or they can grow their way out," says Hayes. "Everyone seems to be agreeing the latter is better."

Affinity Marketing

As banks encourage customer activation and usage of debit cards, they are increasingly adopting incentives. J.P. Morgan Chase & Co. and Keycorp, for example, both have cards that offer airline mileage rewards while U.S. Bancorp offers several different debit cards that allow consumers to select how they want to be rewarded, including cash rebates, airline miles and other merchandise.

Some rewards programs have an altruistic bent. Cleveland-based Charter One Financial Inc., for example, in April introduced a debit card that makes donations to five different children's charities whenever a cardholder uses the card to make a purchase. This card is the latest in an ongoing effort since 2000 by Charter One to promote its debit cards.

The bank also has its more traditional "Mega Rewards" program that allows customers to accumulate points that can be redeemed for airline tickets, gift cards, gasoline purchases or a host of items. And in the next few months, Charter One plans to introduce a series of "affinity" cards that will reflect different customer tastes and lifestyles. The first card will be for Chicago Cubs baseball fans, with a Cubs logo on the front. Cardholders will periodically be able to enter contests for free tickets or other perks related to the baseball team. Customers with the card can also participate in the Mega Rewards program.

"We want to tie our debit cards closer to our affinity programs," says Julie Robbins, senior vice president of finance for Charter One. "Ultimately, we'd like to be able to offer 30 or 40 different debit card options for customers to choose from. Customers who use their debit cards a lot tend to be our best customers and we use our promotions as a means to reward and retain those customers."

Wachovia is likewise pushing its debit cards through special promotional programs, including several held in conjunction with Visa and other Visa debit card issuers. The Charlotte-based bank is participating in several sweepstakes in which customers are entered into a contest each time they use their cards.

Wachovia also sees the value in using debit cards to reward and ultimately retain its most profitable customers. It has a gold debit card, for example, that it provides to customers with high account balances. This card has many of the same benefits offered to customers of gold credit cards, such as immediate replacement of lost and stolen cards and extended warranty guarantees on items purchased with the card.

In addition, Wachovia has a loyalty program for users of its business debit cards. With that card, users get points for every purchase made. The points can be redeemed for a variety of items that are likely to appeal to business executives, including gift certificates at Office Depot or free hotel stays and airline tickets.

While Wachovia is considering adding similar perks to its consumer debit cards, the emphasis for now is on small businesses. "The small business market is a very desirable segment to our bank," Tabaczynski says. "It is important to us to acquire new customers in this segment and keep them satisfied."

First Manhattan Consulting Group vice president Andy Dresner agrees affinity cards can be helpful — he especially likes the Cubs card offered by Charter One. But he also says it's important that banks look at partnerships with other companies whose markets overlap their own when developing these incentive programs. Airline cards, for example, make sense for U.S. Bancorp and Keycorp because they have a large geographic base and their airline partners serve the same markets they do. Such arrangements, however, would not make sense for community banks, which would be better off partnering with local businesses or charities that appeal specifically to their local markets.

Dresner also likes the idea of developing affinity cards in line with customer segmentation programs, noting that a bank should offer various reward options to appeal to high-income travelers, sports fans, patrons of the arts and charitable donors.

Both Wachovia and TCF are considering how to tie their debit card strategies to customer segmentation. If Wachovia does decide to add incentives to its consumer cards, for example, it will most likely be part of the retail bank operation's overall segmentation strategy, meaning that the rewards and benefits will be targeted to specific customer demographics.

While TCF does not currently offer a debit card with an incentive offering, Engel says "in the not too distant future, it is likely that we will pull that trigger." While he is not ready to divulge what type of incentives his bank will offer, he says it is likely that there will be different types of incentive cards targeted to different customer segments.

Cost Considerations

As effective as the incentive programs might be in stimulating usage, they raise questions about the underlying economics of debit cards, particularly in the wake of the Wal-Mart settlement. In some cases, Hayes says, the cost of providing the perks almost equals the revenue a bank gets from interchange revenue.

Airline miles, for instance, reportedly cost a bank two cents per mile. With many airline incentive programs, cardholders receive a free mile for every $2 in purchases. Under the lower interchange rates, banks could pay as much or more for the miles than the revenue they would receive, according to TowerGroup.

But Hayes says banks may want to maintain the programs if they look at the bigger picture. "Reward costs might eat up all the interchange revenue, but is the card rewarding and keeping customers who maintain high balances in their accounts? If so, it might be worth the investment.

"Everyone used to look at debit cards as being a bank product," he adds. "But the larger institutions today are viewing the debit card not as a product, but rather as an access device to the demand deposit account (DDA). Then, they look not at the value of the interchange revenue, but at how the card enhances the value of the DDA and the customer relationship."

Indeed, some experts argue that the revenue tied directly to card use is not the point. Banks instead should look closer at how card perks can be used to retain existing customers and attract new ones. For example, First Manhattan's Dresner argues that card revenue alone is insignificant when assessing a customer's profitability.

According to Dresner's model, as shown on page 44, a customer uses an average generic debit card for four to six debit transactions per month, spending between $200 and $300 per month. Such activity generates between $1.50 and $2.25 in interchange revenue before processing and related costs of between $1 and $1.50 a month. The result: The bank earns about 50 cents to 75 cents per month per customer. At $6 to $9 annually, this per-customer revenue is insignificant compared to the average annual $220 pre-tax profit that banks generate per customer on the entire transaction account.

Noting that cards that offer airline miles typically appeal to high-income consumers and business executives who tend to be profitable bank customers, some observers have suggested banks give the card with perks free to those customers they want to retain while charging an annual fee for the card with perks to customers who do not maintain a high minimum balance in their accounts. Most banks offering airline miles, for example, already are charging between $25 and $50 a year for the card. Some will waive the fees for their best customers.

"What's important is that banks develop card strategies that are intended to attract new customers, not just cannibalize existing customer accounts," Dresner says.

If banks want to make the card part of a broader customer retention program, they might want to consider making the debit rewards part of an overall bank rewards program. Consider, for example, Banco Popular's Premia card, which is offered only in the bank's Puerto Rico market.

With the Premia account, customers accumulate points for paying bills online, using credit and debit cards, maintaining a large balance in their checking or savings account and taking out loans. By rewarding activities associated with a multiple number of accounts, the bank is encouraging customers to use more accounts. Points accumulated under the Premia program can be exchanged for a variety of rewards that fit a customer's desires and are not tied to just one type of reward.

Not every bank is willing to foot the bill for such a reward program. Even Banco Popular's North American sister operation isn't sure it wants to invest in a similar offering for the U.S. market. "We're still evaluating various options to encourage customer card usage and we haven't decided whether we will duplicate what our sister company offers," Chinea says.

Ms. Giesen is a freelance writer based in Libertyville, Ill.

Copyright © 2004 by Banking Strategies, published by BAI.

back to top