|
Turbocharging the Debit Card
BY RICK SPITLER AND RONALD G. MAZURSKY
Amid intensifying debit card competition, bankers need new tactics to restore growth.
| SYNOPSIS | As the rapid growth in debit cards begins to slow, banks need to consider innovative ways to re-accelerate that growth and improve profitability. Consultants at Novantas LLC recommend a three-pronged approach of segmented marketing, new rewards arrangements that differ from those used in credit cards and partnering with merchants. They also suggest considering some of the new products and markets appearing in the debit card arena.
The debit card has been one of the bright spots in retail banking, providing a steadily growing stream of fee income. Customers have been happy to put aside their checkbooks and use cards to make payments straight from their bank accounts. In 2006 alone, there were 25.3 billion debit transactions worth an estimated $1 trillion, according to the Federal Reserve System, a two-thirds increase since 2003.
Surging demand for the debit card has given banks the luxury of focusing mainly on supplying the product and tweaking around the edges to optimize profitability. Innovation, though certainly not absent from the picture, hasn’t been absolutely essential at a time when transaction growth has exceeded 15% annually.
But a variety of forces are chipping at debit’s revenue growth potential for banks, introducing an era when players must manage the business much more proactively and creatively in order to meet their goals.
One issue is a growing profitability squeeze. Pressure is mounting to offer credit card-style rewards for debit usage, even though debit generates a much lower level of fee revenue per transaction. Meanwhile, an ever-growing proportion of debit volume is shifting to PIN transactions, in which interchange revenue is less than half of signature debit, the transaction format that provided much of the growth in earlier years.
Another major issue centers on new types of disintermediation. For example, new debit players are wedging themselves between banks and their demand deposit account (DDA) customers and skimming off the debit portion of account relationships. Elsewhere, the proliferation of card arrangements and marketing options has emboldened merchants to pursue their own payments ventures, reducing the potential for banks.
Finally, more evidence is surfacing that most of the easy growth in debit has already been realized. At many retail banks, roughly half of all debit card recipients don’t use their plastic at the retail point of sale. Many limit their usage to cash withdrawals from automated teller machines just once or twice a month. Others don’t use their cards at all. Banks have struggled to boost utilization among inactive and low-usage cardholders.
These are not problems that can be solved by simply offering a “plain vanilla” debit card product and deploying it as widely as possible. Between 70% and 80% of DDA customers already have at least one debit card and inserting additional variations of cards into the same wallets becomes ever more difficult. Increasingly there will be a winnowing effect in bank debit card competition, with the more innovative and agile players gaining disproportionate market share at the expense of lagging institutions.
There are three priority avenues of innovative response for retail banks: 1) Learn how to do more business with debit cardholders and prospects by investigating their needs and crafting segment-based responses; 2) Develop new debit rewards arrangements that differ from the credit card; and 3) Become partners with merchants in payments innovation. These are the areas that need immediate attention.
Looking more broadly and long-term, there are also opportunities to reach beyond retail banking’s traditional products and markets (see “Debit’s New Markets and Products,” this page). Many of these initiatives are already in motion in various U.S. institutions and other parts of the world and are destined to become much more widespread. Yet it is not clear that retail banks are paying sufficient attention to the question of future debit competition and the role that systematic innovation will play in growth and profitability.
Plugging the Gaps
The number one place that many banks should look for debit revenue growth is among their own customers who receive but do not actively use their cards.
In contrast with truly active cardholders, who typically use debit for more than 15 transactions at the point of sale each month, many other cardholders are only nominally active, using their plastic perhaps once or twice a month. And vast numbers of debit cardholders make no use whatsoever of their cards at the retail point of sale.
Plugging these activation and usage gaps spells opportunity for the innovative bank. Consider, for example, a large regional banking company with four million debit cardholders, representing an 80% penetration of its checking customer base. If half of these customers actively use their cards—not unusual—that leaves two million people who use their cards only occasionally or not at all.
Doing the math, converting just 5% to active status represents an increase of 100,000 active debit card users and 1.5 million monthly transactions. Based on average transaction frequency and purchase amounts among active users, this improvement represents an annualized revenue opportunity of more than $7 million.
Such opportunities are compelling, and variations of this are seen at retail banks around the industry. Yet many institutions have not yet taken the critical first step of developing targeted offers for prime customer segments, based on a careful investigation of the behaviors, profiles and preferences of active and inactive debit cardholders. Consequently, outreaches often wind up ineffective--not responsive to preferences and variations among prime segments of inactive customers.
A systematic study of debit customers begins with usage characteristics. Along with the volume and value of transactions, this includes activity by merchant category code, by geography, by patronage of specific merchants and by seasonality. The goal is to identify the customer groups having the greatest potential for increased debit patronage, as indicated by their own patterns and successes elsewhere with similar customers.
As prime opportunities come into view, the institution then can conduct consumer research and segmentation studies to learn more about the specific factors that will elicit more business from high-potential customer groups. The next step is to design a series of debit initiatives that support the various goals of acquisition, activation, utilization, retention and cost control and model their likely impact.
Even after all of this preparation, debit initiatives can still fall short unless they first are tested and refined in the field prior to full rollout. The most skilled debit players routinely conduct “champion/challenger” controlled experiments with new card initiatives, carefully observing how target customers respond and then incorporating the findings into revised propositions that again are tested. Some ideas fail and are winnowed out in this process; others not only succeed but are significantly strengthened.
It is worth repeating that differences among customer segments can be huge.
From a demographic perspective, for example, affluent customers hooked on credit card rewards programs differ from free-spending youngsters looking for overdraft protection and more Internet payment functionality; who differ from debt-averse families looking for purchase discounts with local merchants; who differ from recent immigrants who may want to use their cell phones for payments and international remittances. Once the bank recognizes these larger patterns, targeted segment offerings then can be developed on the basis of loyalty, attitudes and customer relationship profitability.
Both in ramping up debit card usage among established customers and attracting new ones, such variations provide critical context for the different avenues of debit innovation unfolding in banking.
Ramping up Rewards
Rewards programs represent the top area of segment-based debit innovation. Already, about two-thirds of the nation’s larger banks offer rewards to some portion of their debit customers and more than a third of smaller banks do so. Program variations and participation levels will only grow.
Rewards will be particularly important in capturing more large-dollar transaction business. While the debit card already surpasses the credit card in annual transaction volume, interchange revenue hinges on growing dollar volume. According to Novantas projections, it will take another five years or so until the debit card reaches parity with the credit card in annual dollar volume (see chart, “Debit Cards: Steadily Gaining Ground”).
In this light, a burning question for debit issuers is how to win over rewards-driven credit card transactors. Com-posed of more affluent customers, this segment typically pays off its relatively high charge balances in full every month and uses credit cards primarily for payments’ convenience and rewards.
The lesser fee revenue stream of the debit card places retail banks at a disadvantage in attracting this crowd. While issuers garner interchange fee revenue of just under 180 basis points on a credit card transaction, for example, debit card interchange revenue ranges from roughly one-fourth to three-fourths lower. In February, moreover, U.S. House and Senate judiciary committee leaders began drafting proposed legislation that would impose federal ceilings on interchange rates.
Compounding the challenge, new “decoupled debit” players have figured out debit plays that access funds from bank-managed DDAs and route them through the automated clearinghouse network to make payments and tap a rich rewards stream offered in coordination with merchants.
Relationship rewards. One strategy to offset retail banking’s rewards disadvantage is to base perquisites on the total banking relationship, which potentially offers an equal or greater level of points and also binds the customer more closely to the bank. Cleveland-based National City Corp., for example, offers a point-based program that “rewards . . . all your day-to-day banking, like writing checks, paying bills online and using your debit card and credit card.”
There is much to be sorted out behind the scenes to offer such an arrangement, given the need to coordinate information, program management responsibilities and contribution levels among the various product silos within the consumer bank.
Setting conditions. Another strategy is to set certain conditions on rewards participation that support goals such as relationship expansion, revenue optimization and cost control. At Baltimore-based Provident Bankshares Corp., for example, the debit loyalty program is only accessible online, thus avoiding the use of costly branch and call center staff. Moreover, only those customers who use direct deposit can enroll in the program for free. Other banks have restricted rewards programs to signature-based debit, which commands the highest interchange fee within the debit family.
Decoupled debit. A third strategy is to convert a competitive challenge into an expansion opportunity by embracing decoupled debit. By deploying a bank-branded product to acquire debit business from checking customers of other financial institutions, a bank arguably could use this strategy to expand far beyond its branch footprint. Indeed, there are indications that a few major retail banks will launch decoupled debit offerings this year. Caveats are in order, however, as critical questions about enrollment, customer service and defensive strategies remain unanswered.
Merchants as Partners
A much larger universe of possibilities opens up once the retail bank begins to work in partnership with merchants. We see this as one of the most fertile areas of debit innovation. By creating debit programs that help merchants to achieve their marketing goals, banks can elicit substantial merchant underwriting for various types of rewards programs that boost card attractiveness and usage, ultimately bolstering checking account growth as well. Both large and small institutions can benefit from such arrangements.
For example, participants in the TCF Cash Rewards program at Wayzata, Minn.-based TCF Financial Corp. can obtain initial “cash-back” purchase discounts ranging from 2% all the way up to 25% from roughly 750 participating merchants. This program is coordinated by Affinity Solutions, which as of early 2008 was working with 30 different retail banks on programs involving about 45 million debit cards and roughly 10,000 merchants.
In a multi-bank example, small business cardholders participating in the “Easy Savings” program are eligible for purchase discounts of up to 20%, using either debit or credit cards from Bank of America Corp., KeyCorp, Washington Mutual Inc. and Wells Fargo & Co. Sponsoring merchants include Wyndham Hotels and Resorts LLC.
Although co-branding is an old story with credit cards, it is gaining fresh momentum with debit cards, providing yet another fertile area for innovation in partnership with merchants. Bank of America, for example, boasts more than 20 flavors of debit affinity programs, with partners including Habitat for Humanity International, the American Legion Auxiliary and Indianapolis Motor Speedway.
Additionally, Novantas research on new frontiers in co-branding indicates growing receptivity for merchant-branded debit cards in the auto, travel and retailing industries, including traditional and decoupled debit products. Current examples include General Motors Corp., Harley-Davidson Inc. and American Airlines.
The Case for Innovation
It is clear, given the scope of activity in the debit card space, that major retail banks will need much more than a random assortment of product initiatives. A cohesive strategy will consider: 1) the profiles and needs of prime customer segments; 2) the array of options to work with merchants; 3) the capabilities that can be brought to bear by various technology providers; and 4) the actions of both bank and non-bank competitors.
There are additional debit-related opportunities with people who bank elsewhere or not at all or whose primary interest is in mobile or online payments (see chart, “Growth in New Payments Vehicles”). These are meaningful markets, yet there is a significant risk if the retail bank fails to set priorities. We believe the first order of business is to step up debit innovations that are strongly tied to the core demand deposit account; aimed at prime customer segments as identified by careful research; cognizant of growing rewards-based competition; and fleshed out in cooperation with merchants as appropriate.
The good news is that there are substantial payoffs for successful debit innovation. Indeed, debit’s emergence has brought about a historic turning point in payments, with banks now positioned to regain prominence that was lost to the credit card giants in recent decades. And banks of all sizes can and should participate.
|
