Decoding the Value in Payments Data
BY VLADIMIR R. RESNICK AND CARL J. HUGENER
Revenue tied to payments products could drive the transformation of financial services companies into financial-and-information-services companies - but not without substantive change to existing organizational structures, privacy protections and the bank/retailer relationship.
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SYNOPSIS | The transformation of the payments system from one based on paper processing to one using electronics is expected to provide banks with cost savings. It could also present revenue opportunities for financial institutions that learn to extract the data embedded in payments transactions. Such data can be used to provide analytical and marketing services to retailers; engage in more effective cross-selling; and open the door to developing and selling information products to commercial clients. Obstacles to such activities include siloed organizational structures, consumer privacy protections and retailers' desire for controlling the customer relationship.
When bankers reflect on the benefits to be gained by the increased electronification of payments, they tend to think of cost savings in the back office. Imaging technology, for example, can reduce the cost of check processing as paper is squeezed out of the system.
Yet there are potential revenue opportunities as well. The digitizing of payments information opens the door for financial institutions to capture and then leverage that information. Banks could, for example, provide analytical and marketing services to retailers; engage in more effective cross-selling to their own customers; and develop and sell information products to commercial clients.
Pursuing such opportunities gives banks the potential to create an entirely new revenue stream, and a new business model as well. Over time, they could evolve from pure financial services institutions to financial-and-information- services companies.
But attaining that goal will require the overcoming of some difficult challenges. For example, financial institutions need to develop a core competency in creating information-based products, which includes acquiring assets and capabilities in retail and consumer marketing, customer relationship management (CRM) and analytics, and database management and integration. Winning over merchants will require building new value propositions and business cases, along with sales plans and sales forces.
Significant change will be required in banks' own financial product development efforts. Reinvigoration will be required in all areas, including design, risk management, operations, customer service, delivery and marketing. Improved cross-selling, for example, would require a single view of the customer in the "front" and "back" offices, the ability to navigate product portfolio complexity and effectively solve customer service issues, as well as the ability to dynamically manage a customer's risk across his or her portfolio.
Banks may also have to develop new disclosure and compliance mechanisms to enable customers to apply for, accept and use new financial products. Banks would need more flexible information technology (IT) systems for analytical and CRM purposes, as well as to cross-sell, educate and communicate with customers. The IT architecture would have to be more scalable and allow for cross-sharing of information and more flexible decision-making.
And finally, banks must rethink and align their organizational structures and hierarchies, their sets of existing incentives (and disincentives), and their processes and systems with these strategies. While all that may seem like a tall order to fill, the benefits of leveraging transaction information should more than justify the cost and effort.
Finding The Hidden Value
DiamondCluster International's analysis indicates that banks today realize on average between $2 and $3 per average $50 transaction. This return comes primarily from interchange fees and interest on credit. Yet there is also some hidden value in payments, namely the data that can be obtained with electronic transactions. The challenge is to properly analyze, aggregate and package this data.
Private label credit card (PLCC) providers know this. They partner with retailers, obtain detailed customer and purchasing data, then analyze and model it for marketing campaigns that, through their effectiveness, compensate both retailer and the issuer. One such PLCC issuer estimates the marketing effectiveness of such a campaign built on transactional data was worth up to $20 million to the retailer, or an estimated $1 to $3 per transaction.
How does this work? The extra data allowed an almost 50% increase in direct mail effectiveness by better selection of targets, offers and timing. The resulting 10,000 incremental new customers were each worth about $2,000 in lifetime gross margin to the retailer.
Such a customer acquisition campaign is far from the only service offering that a bank could build on transactional information. With electronic transactions becoming more prevalent than paper, banks now have significant opportunities to realize even greater value from their transaction data. While we cannot suggest exact pricing, we believe that banks could monetize a significant portion of that value by partnering with retailers and charging them either direct fees or indirect/bundled pricing - e.g., in the form of higher interchange.
Banks can either assist or run targeted direct mail or other marketing campaigns for retailers. Bank-managed data could help retailers identify their best customers and prospects. It could also suggest ways to best entice customers to visit the retailer - either for the first time or for repeat patronage. In a study we conducted over the last year on the opportunities of digital payments, Daniel Olstad, director of payments at consumer electronics retailing giant Best Buy Co. Inc., told us that he sees a "huge opportunity for banks in supporting merchants" by leveraging payments data, going beyond the traditional co-branding or PLCC relationships.
Working with retailers, for example, banks can develop algorithms to print targeted offers on monthly billing statements. Infrequent customers would receive well-timed reminders to entice them back to the store. Further, data from third-party providers such as New York-based ACNielsen could be combined with the bank's own information to indicate the medium in which a retailer should advertise.
Data on prices, product categories and patterns of buying would indicate preferred modes of shopping and allow banks to model attractive retail offers, including pricing and loyalty program parameters. Similarly, banks could facilitate testing of various merchandising strategies in different locations.
Importantly, retailers would be able to effectively expand their loyalty programs beyond their co-branded cardholder base as non-credit card electronic transactions - whether on debit or gift card, via the Internet or through the Automated Clearing House (ACH). These transactions could be captured by the banks, whose analytics and marketing teams would provide additional insights and guidance to enhance existing retention programs. Regular communications to such retention program members would be cost-efficient, since banks could incorporate it with their monthly banking statements.
Lastly, banks would use the information, both historical and real-time, to offer customers financial products that would help retailers move product off their floors, for example, deferred payment loans or pre-approved lines of credit.
PLCC providers currently offer such products. However, their limited variety and lack of versatility inhibit PLCC acceptance by customers. Banks can solve these shortcomings by tying those flexible product features to general purpose credit cards, which are accepted at millions more places than any private label card.
Banks should also develop tailored credit products not necessarily linked to a single payment instrument. There are two reasons. First, versatility of a more flexible solution would attract more customers, which in turn would increase adoption and generate more banking business. Second, the ability of banks to link credit offers to other payment products (including non-credit ones) would heighten the attractiveness and acceptance of these other products. The result of all this is that banks would capture more of the data that is necessary for conducting the information analyses and creating the offers outlined here.
Improving The Cross-Sell
This brings us to the second opportunity banks have in exploiting transactional information: cross-selling to their own customers. Understanding the current needs of buying customers coupled with well-timed and attractive offers would increase the likelihood of a financial product sale.
This could be done directly, such as by offering an installment loan for a plasma TV when the product UPC is entered at the point of sale. Or, it could be done contextually-for example, by offering a pre-approved line of credit to buy a car after the prospect buys a number of car magazines or requests a car report from the Web.
A more intelligent program, for example, would recognize a customer buying an engagement ring and flag the transaction to offer the couple incentives for consolidating their demand deposit account and other finances under the same bank umbrella. Naturally, a system like that would need to be channel-indifferent so that such a cross-sell could be offered in branches, by phone, over the Internet, at the point of sale, at ATMs, and eventually, perhaps even through mobile electronic devices.
Banks could do their cross-selling as part of the "portfolio" approach to help individuals and households better manage their credit. The wealth of transactional and customer information would allow banks to model lending scenarios and let clients allocate credit among a variety of products, either with self-service tools or in the bank itself (with a banker's assistance/advice). Thus, for example, someone who otherwise would have overdrawn his or her credit card line - and potentially be penalized for it or denied an authorization - would have the card balance moved seamlessly and automatically to an equity credit line, freeing up the card's open-to-buy.
This would bring benefits to both banks and customers. Customers would enjoy one-stop service, reduced or eliminated penalty fees such as for non-sufficient funds, and potentially, lower cost of credit combined with a larger open-to-buy. Banks would enjoy the benefits of cross-selling, including higher product revenues and cost synergies, improved customer satisfaction and retention, and new revenue streams in the cases where they could levy fees for such services.
Information-Based Businesses
The final opportunity lies in ancillary information-based business, which is a multibillion-dollar industry. Just last July, IMS Health Inc., a company tracking and selling pharmaceutical sales data, was bought for $7 billion. Information companies such as ACNielsen and Experian have sales in the billions of dollars.
Large banks could use transactional, demographic and third-party data to develop and sell various informational products and services, leveraging multiple one- and two-way channels such as billing statements, telephones (both operator and Voice Response Unit), ATMs and the Internet. They could use those channels to do surveys, tests and research that would enhance the value of their information for merchants and product companies. Retailers and consumer goods manufacturers, for example, would be interested in an analysis of consumer shopping data and behavior, which today they buy from companies such as Information Resources Inc.
Banks, insurers and others could use purchasing behavior information to enhance their risk management. For example, someone who recently bought home improvement services or new baby items may be considered a lower risk than a person who has been spending heavily in bars. Clearly, such detailed information, if provided to outside parties, would raise privacy concerns. However, it could either be used internally for banks' own purposes or, in the aggregate, codified into a proprietary score for use by others, similar to FICO scores.
In sum, banks would be in an ideal position to assist in the market research, segmentation and direct marketing activities of many consumer-oriented companies. Today, Experian and Acxiom Corp. play this role. The banks' advantage over such firms would be the ability to offer these products either stand-alone or bundled with commercial finance services. Banks' relatively low variable cost of creating such information-based products would mean great flexibility in pricing. The information product business would also allow banks to learn more about their own retail and commercial customers.
Implementation Challenges
While the revenue and profit potential of these strategies is significant, banks face big challenges in implementing these strategies. The three most significant are: internal resistance at banks; consumer privacy protections; and retailers' desire for customer control.
Internal Resistance
Banks have not been tremendously successful in cross-selling financial products because of their siloed structures, i.e., separate business processes and information systems supporting each financial product. Banks must rethink their organizational structures to allow inter-product group cooperation, analysis and exchange of information. That will require creating incentives and removing the often-hidden penalties for cross-business cooperation.
Further, banks will have to alter their IT architectures to allow the unhindered flow of information between separate databases, systems and applications. These objectives may require an operational layer (both organizational and functional/technological) to serve as an umbrella over the product businesses.
Consumer Privacy Protections
In recent years, a number of regulatory changes have been instituted to protect consumer privacy. The Gramm-Leach Bliley Act of 1999 (GLB), for example, prohibited sharing or selling customer credit information to outside parties. However, GLB does allow banks to work closely with retailers, just as PLCC providers and co-brand issuers do, to share some non-credit-related information such as marketing and purchase behavior. Further, retailers' rules for sharing information are more lenient than those for banks. Therefore, retailers can find ways to provide their customer information to banks and have the latter perform required analyses and marketing activities on their behalf.
In almost all cases, retailers and banks have found success in obtaining personal information and avoiding negative publicity by offering customers incentives such as first purchase or ongoing discounts, especially if this information is then used for the customer's benefit.
Retailers' Desire For Customer Control
While retailers must work with banks, they may resent sharing information about "their" customers, fearing loss of customer control and the potential of this information to benefit their competitors. To address retailers' concerns, banks would have to erect "firewalls" around specific customer information, while building aggregated data into informational products.
These kinds of data and marketing programs are already attractive to some retailers. For example, department store chains such as Neiman Marcus and Federated have outsourced their PLCC and co-branded cards to their PLCC issuers. They have also created marketing alliances with them. As banks' information business grows, more and more retailers will find that they cannot afford not to partner with banks in such alliances.
To get into the information business, the banks would have to work alongside other transaction payment industry participants, including merchant acquirers, issuer processors and payment networks. Banks would have to develop approaches that minimized the competitive threat of these players, while maximizing their value to the bank.
Merchant acquirers and payment networks probably present the biggest threats - and opportunities - for banks. Merchant acquirers such as First Data Corp. or Bank of America Merchant Services are well positioned to provide information services to retailers. Each captures nearly all electronic transactions for a given retailer. The networks, such as MasterCard and Visa, on the other hand, carry a large percentage of transactional information for nearly all retailers - and thus serve as the "links" between them and the banks.
However, banks enjoy the strongest position to drive and benefit from the transaction information opportunity. While acquirers and networks could be ideal aggregators of payment information, they by and large lack control of the data "water-source" that resides with banks: the information about the customer and the control over the payment product. Also, retailers would be more likely to resent an acquirer that gained control of customer information as opposed to an individual card issuer, which has a more fragmented role.
Therefore, banks might find it useful to involve acquirers and/or networks, using them as data suppliers and aggregators for information product "manufacture." In that role, the credit card acquirers and networks would partake in the information product manufacture. Retailers, meanwhile, would be motivated to provide the information that banks need because retailers' influence would be assured by the competitive structure of this new market.
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