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					Credit Card Pricing Strategy
   Davide Capodici, Brooke Chang,
     Brian Feldman, Erica Gluck
http://www.youtube.com/watch?v=jBaPx3sym0I&feature=player_embedded
Table of Contents
1. Analysis of Industry Structure
2. Industry Background
3. Competitive Landscape
4. First Degree Price Discrimination: FICO Score
5. Second Degree Price Discrimination: Types of Cards
6. Privacy Issues
7. Case Study
8. 2011: What's Happening with Credit Cards
9. Bibliography
Why Talk About Plastic?

• As more and more purchases are made
  electronically, less cash physically exchanges
  hands.
• Credit cards offer payment security, flexibility, and
  rewards.
• Even if you don't have a credit card now, you will
  likely have one in the future.
• Understanding how creditors price their cards will
  allow you to get best possible rate in the future!
ANALYSIS OF INDUSTRY
    STRUCTURE
       WHAT ARE WE ANALYZING?

   CREDIT CARD ISSUING VS.     CREDIT CARD
                          PROCESSING AND MONEY
                              TRANSFERRING

The industry's establishments      Establishments in this
issue credit cards, provide        industry engage in financial
funds required to purchase         transaction processing. They
goods and services in return for   provide the actual payments
a payment on a full balance        systems used when
basis.                             payments are made by credit
                                   card.
      WHAT ARE WE ANALYZING?
                              CREDIT CARD
CREDIT CARD ISSUING   VS.   PROCESSING AND
                          MONEY TRANSFERRING
     Our Focus:
CREDIT CARD ISSUING
     INDUSTRY
         A brief introduction to two
          basic External Drivers

Use of         f ( DISPOSABLE INCOME) , +
Credit Cards =
               f ( NATIONAL UNEMPLOYMENT RATE) , -


 • If Disposal Income then DISCRETIONARY
                         EXPENDITURE
   making people more willing to spend money

 • If National Unemployment Rate
   then DELINQUENCY RATE damaging the lenders
          INDUSTRY IN 2006 - 2011

REVENUE: $ 48.3 bn
PROFIT: $3.2 bn

---> Profit to Revenue Ratio = 6.67%
..... it's not high!

Why? Let's explain it through the external
     drivers!
          INDUSTRY IN 2006 - 2011
2008 CRISIS, brings RECESSION

• LOW Disposable Income
• HIGH Unemployment Rate

   both pushes towards a DECREASE in the use of credit
   cards
          INDUSTRY IN 2006 - 2011
RESULTS:

• EROSION OF PROFITS FOR 28% in the overall industry

• MERGERS AND ACQUISITION ACTIVITY: The
  Government aids the most profitable and big players to take
  over the smallest, in order to avoid their bankruptcy

  e.g. - Bank of America's Acquisition of Merrill Lynch (2008)
       - JP Morgan Chase's acquisition of Washington
         Mutual (2008) and Bear Stearns (2008)
          INDUSTRY AFTER 2011
AFTER 2011 ECONOMY IS EXPECTED TO RECOVER:
• LOWER UNEMPLOYMENT RATE
• INCREASING DISCRETIONARY EXPENDITURE
• + RISE OF ONLINE COMMERCE, more money spent
  through credit cards
         INDUSTRY AFTER 2011

RESULTING IN:

• EXPECTED
  GROWTH IN
  REVENUES OF 5.8%
  for years 2011-2016

• EXPECTED
  GROWTH
  IN PROFITS OF
  1.3% for years 2011-
  2016
HOW DO FIRMS MAKE MONEY?
CREDIT CARD ISSUING FIRMS ONLY OFFER ONE
KIND OF PRODUCTS: i.e. CREDIT CARDS .....

...HOWEVER THERE ARE THREE
 DRIVERS IN GENERATING
 REVENUES:
HOW DO FIRMS MAKE MONEY?
1) CARDHOLDER FEE: it is an annual fee that customers
incur for being able to access credit conveniently through
credit cards

• once it accounted for 40% of revenues (IBISWorld)
• now it is slowly being eliminated because of intensified
  competition
HOW DO FIRMS MAKE MONEY?
2) INTEREST INCOME: generated through the debt
associated on a credit card which accumulates over time.

• in 2011 the interest rate was 12% - 19% and generated
  20% of the total industry revenues (IBISWorld)

 However, it is risky:
            1) it may be never be paid back if the
               borrower fails (as happened in 2008)
            2) if the cardholder pays his balance in full
               every month there will be no interest income
HOW DO FIRMS MAKE MONEY?
3) INTERCHANGE FEE: HOW DOES IT WORK?

1.Customer purchases a good for $100 and sends the
  order to the Issuing Bank
2.The issuing bank sends $98 to the merchant's bank,
  and keeps $2: THIS IS THE INTERCHANGE FEE
3.The merchant's bank keep other $0.50 as its
  PROCESSING FEE
4....so the merchant gets $97.50 instead of $100.
HOW DO FIRMS MAKE MONEY?
3) INTERCHANGE FEE: fee charged by a bank to process
credit and debit transaction made on cards from another
bank.
HOW DO FIRMS MAKE MONEY?
....why does he accept this?
  The above mentioned trends are
  a good explanation: the Credit
  Cards Issuers are increasing
  their power, especially with the
  raise of e-Commerce.
  Merchants are aware that not
  accepting credit cards would
  result in a decrease in their sales,
  so they accept to pay the fee.
WHAT ARE THE COSTS INVOLVED?
WHAT ARE THE COSTS INVOLVED?
1. INTEREST EXPENSES: banks borrow money from other
  banks at an interbank rate, and then borrow to customers
  for a higher rate.
  - IBISWorld estimates these costs to account for 20% of
    total industry revenue
WHAT ARE THE COSTS INVOLVED?
2. PROVISION FOR LOAN LOSSES: for the reason stated
   before, some customers may never pay their debt back.
   This expense accounts for 35% of the overall industry
   revenues!
WHAT ARE THE COSTS INVOLVED?
3. WAGES: this industry is labor intensive, it is especially
         true when analyzing customers' credit
         worthiness: human beings are better than
         software.
         Wages accounts for 5.1% of the total revenues
WHAT ARE THE COSTS INVOLVED?
4. ADVERTISING: as we analyzed in class this is
                COMBATIVE advertising.
Q: WHY?
• LIFE CYCLE OF THE INDUSTRY IS MATURE, so there are
   not many more customers to reach
  (IBISWorld estimates more than 83% of households have
   one or more credit cards in 2011)

Q: OK, IT'S COMBATIVE...AND SO?
• Advertising shifts consumer preferences towards the
   advertising firm, WITHOUT EXPANDING the category
   demand.
WHAT ARE THE COSTS INVOLVED?
4. ADVERTISING:
Q: AND HOW DOES IT LINK TO WHAT YOU SAID BEFORE?
• It's interesting to say that, since concentration is in act in the
   industry through Mass, we expect the combative advertising
   to increase after 2011. In 2011 it accounts for 7.6%
WHAT ARE THE COSTS INVOLVED?
5. REWARDS: according to ComScore, 1/3 of the customers
   choose their credit cards in order to maximize their rewards.
 • so, rewards (e.g. frequent flier, cash back..) are extremely
   important to get customers' loyalty and they also ALLOW
   SECOND DEGREE PRICE DISCRIMINATION.
 • They account for 18% of the total revenues in the industry.
WHAT ARE THE COSTS INVOLVED?
6. OTHERS: e.g. administrative, telecommunications
• They as a whole account for 5.6% of total revenues.

All expenses from 1. to 6. amount 93.3%,
so the profits are 100% - 93.3%= 6.7% as stated before.
         COMPETITIVE LANDSCAPE
We will focus on:
1. MARKET CONCENTRATION
2. COMPETITION
3. REGULATION
4. INDUSTRY ASSISTANCE


To infer what is the nature of the
BARRIERS TO ENTRY
         COMPETITIVE LANDSCAPE
1. MARKET SHARE CONCENTRATION: high and increasing

Q: Who are the most important players?
A: IBISWORLD finds for 2011 these market shares:

   o   JP MORGAN CHASE: 27.2%
   o   BANK OF AMERICA: 19.2%
   o   CITIGROUP: 18.9%
   o   AMERICAN EXPRESS: 17.2%
   o   CAPITAL ONE: 4%
        COMPETITIVE LANDSCAPE
1. MARKET SHARE CONCENTRATION: high and increasing

Q: Who are the most important players?
A: IBISWORLD finds for 2011 these market shares:
       COMPETITIVE LANDSCAPE
1. MARKET SHARE CONCENTRATION: high and increasing

CR4 RATIO= 82.5%

HHI RATIO= 1778, extremely high!

   Q: but why does the Government allow M&As?

   A: it is a different case compared to what we
      analyzed in class!! A failure in one of these
      biggest banks can result into the customers
      losing all their savings, the Government
      decided to save who was "too big to fail".
        COMPETITIVE LANDSCAPE
2. COMPETITION: high

• External: there are substitute services, e.g. debit cards,
  personal checks or cash.

• Internal: according to a 2008 AITE Group survey, the most
  important things for a customer are

         NO ANNUAL FEE
         REWARDS
         LOW INTEREST RATES
       COMPETITIVE LANDSCAPE
2. COMPETITION: high

• This leads to a HIGH customers' ELASTICITY OF
  DEMAND:
   leading firms compete on those
   elements, AS FAR AS ANNUAL
   FEE (which recently represented
   40% of the revenue) is projected
   to disappear in the next few years
   according to IBISWorld.
        COMPETITIVE LANDSCAPE
3. REGULATION: heavy

• Bank Holding Company Act of 1968 imposes strict
  capital requirements to banks, especially if they are
  exposed to higher risks.
• Truth in Lending Act of 1968 + Schumer Box are
  designed to protect customers through higher
  transparency of conditions
      all credit cards need to use the same format in order to
       make comparisons easier for customers
          COMPETITIVE LANDSCAPE
4. INDUSTRY ASSISTENCE: high

TROUBLED ASSET RELIEF PROGRAM (TARP):
as we discussed before, the "too big to fail" financial institutions
have been helped by the Government, to soften the effects of 2008
recession.

HOW? The Government bought their assets and equities for a
    total of $700 bn!
     e.g. Citigroup received $45 bn
          JP Morgan Chase received $25 bn
          COMPETITIVE LANDSCAPE
....so: WHAT DO WE INFER ABOUT THE BARRIERS OF
        ENTRY?

1. Concentration: HIGH
2. Competition: HIGH
3. Regulation: HEAVY
4. Assistance: HIGH

Moreover, consider the 5. Life Cycle Stage: MATURE

---> the barriers to entry are really HIGH in this industry!
   Pricing Strategies

First Degree Price Discrimination
How The Industry Works
Credit agencies keep track of
consumer credit history.

Banks originate credit lines and
determine terms.

• Banks lend consumers lines of credit
• Fixed amount of money based
  primarily on income and FICO score
• Terms, including interest rates, are
  determined based on FICO score
Credit Agencies
• Credit agencies such as Experian, TransUnion, and Equifax
  collect information about consumers
• Tied to social security number
• Collect data on:
   o Account history
   o Age of Account
   o Debt
   o Available Credit
   o Payment history (on time or late)
• Determine risk factor by looking at various metrics:
   o Debt-credit ratio
   o Average account age
   o Accounts 30 days, 60 days, and 90 days late.
Credit Card Issuing Banks
• Banks around the country underwrite the credit for each
  credit card.
• Think of credit card as a mini-loan with terms that "revolve"
  around the consumer's use of it.
• Banks finance credit lines with other depositor's funds, much
  like a mortgage or car loan.
• Banks earn fees by charging interest on credit card
  balances that are not paid in full each month.
• Ex.
    o $1050 in charges during January
    o 12% APR (~1% per month)
    o $50 paid off of January statement
    o $1000 principle remaining on February statement
    o Feb. balance = $1000 principle + $10 interest
Other Types of Issued Cards
                     • These cards differ from
 American Express      credit cards in that they
                       must be paid in full each
  Charge Cards         month -- no APR,
                       membership fees.
                     • There are no credit lines
                        o Each purchase is a
                          "mini-loan" from
                          AmEx
                        o Spending ability is
                          determined by history
                          and FICO score
Understanding the FICO Score
Understanding the FICO Score, Con't

•   Scores range between 300-850, high to low risk
•   Payment history 35% -- late payments hurt, on time is good
•   Credit utilization 30% -- ratio of balances to total credit
•   Length of history 15% -- older accounts show experience
•   Types of credit used 10% -- CCs, mortgage, etc. show exp.
•   Search for credit 10% -- each time an application for credit is
    submitted, an inquiry is made to the report. Inquiries stay on
    report for 2 years. More inquiries can hurt score, less can
    improve.

Terms are dictated by FICO score. Better score means lower
APRs, reduced fees, etc.
First Degree Pricing Using FICO
Score
• FICO scores provide a snapshot of the consumer's credit
  worthiness, and companies price on an individual basis
• Less risky consumers are worth more in the long run
   o More responsible spending, payments on time
   o Have the option of going to other creditors
       Consumers with good credit scores are desired by the
        credit issuance industry
       Offer lower APRs, better terms to attract consumers
• High risk consumers are less desirable, but can be highly
  profitable.
   o Higher risk means higher APRs, worse terms for
     consumer
First Degree and FICO Con't

• FICO scores allow companies to extract the consumer's
  entire willingness to pay for credit
• All history is on the table for both parties to see
• Good for the industry--allows companies to minimize risk
  using a consistent and relatively low cost method.
• Using FICO scores is one of the least expensive ways to
  determine credit worthiness.
   o Background checks
   o In the past, lenders might visit a potential client at home,
     work, or school to get a gauge of their trustworthiness.
   o FICO scores save time, money, and promote consistency
 Second Degree Price
    Discrimination
Consumers Choose Different Cards
     Based on Preferences
Second Degree Price Discrimination
• Firms are aware that different kinds of customers exist, but
  they not always can perfectly price discriminate,

• Firms know each card user is different, and therefore offer
  cards with different benefits and associated fees (menu
  pricing) in order to have customers self selecting.

• Cards function identically as forms of payment
         Second Degree Price
            Discrimination
• Ex. American Express
  o Green Card -- basic, lowest fee $95
  o Gold Card -- entertainment benefits, medium fee
    $125
  o Platinum Card -- numerous benefits, high fee
    $450
Segmenting the Market

• The market can easily be segmented into four major
  categories (IBISWorld):
   o Young adults aged 18-26
   o Adults aged 26-30
   o Senior citizens over 60
   o Businesses

• JP Morgan, industry leader, offers credit to these groups in
  different ways with a "menu-pricing" like strategy

• We will analyze the first two segments as an example.
Young Adults - Freedom Card

• Less credit
  history/experience
• Cards with few-no frills
• Small credit lines
• Cash back as incentive
• Extra cash, or points for
  paying on time              • 5% cash back on up to
• Usually no extra              $1500 in particular
  membership fees or            categories
  annual charges              • If only $1499, reward is
                                1%.
                              • Absorbs
                                consumer surplus
Adults aged 26-60
• Uses cards more regularly for
                   everything:
  o Groceries
  o Entertainment
  o Gas
  o Luxury goods

• Users look for rewards programs, usually offered for an
  annual fee

• Value of rewards only exceeds fee if card is used enough,
  arousing consumers’ loyalty

• Given the cost of maintaining the programs, these cards are
  generally reserved for users with better credit
Case Study in Credit Card Advertisements
Privacy Laws

- The Fair Credit Reporting Act promotes
the accuracy, fairness, and privacy of
personal information by Credit Reporting
Agencies

- The Gramm-Leach-Bliley Act (1999)
protects personal information collected by
financial institutions from foreseeable
threats in security and data integrity.
Gramm-Leach-Bliley Act

- components govern the collection, disclosure and protection
of consumers' nonpublic personal information:

  The Financial Privacy Rule: requires financial institutions to
  provide each consumer with a privacy notice when a
  consumer relationship is established

  Safeguards Rule: requires financial institutions to devise a
  written info security plan stating their preparation and
  continuing plans of protecting clients' nonpublic personal
  info



http://business.ftc.gov/privacy-and-security/credit-reports
Pre-Credit Crisis vs. Post Credit-Crisis
                              • 2006 vs. 2010 credit card
What we will be looking at:     advertising data in 24 of
                                the largest U.S. cities

                              • How the advertisements
                                changed with the economy

                              • Advertising on different
                                levels of credit cards in
                                2006 vs. 2010
         24 Most Populous U.S. Cities
       DOLS Spent on Advertising Per City
               2006 vs. 2010




DOLS
*These were the top 25 most populous cities in the U.S. in 2006. San Jose was removed from the list because we did not have
the data for it, so all of the cities are ranked 1-25. The population information is from the U.S. Census Bureau.
 Advertising Rank - 24 US Cities
      2006                   2010
1.    CHICAGO         1.    SAN FRANCISCO
2.    BOSTON          2.    DALLAS
3.    DALLAS          3.    LOS ANGELES
4.    NEW YORK        4.    CHICAGO
5.    SAN FRANCISCO   5.    NEW YORK
6.    PHILADELPHIA    6.    WASHINGTON,DC
7.    LOS ANGELES     7.    SEATTLE
8.    DETROIT         8.    BOSTON
9.    WASHINGTON,DC   9.    HOUSTON
10.   HOUSTON         10.   PHILADELPHIA
11.   CHARLOTTE       11.   PHOENIX
12.   SEATTLE         12.   SAN DIEGO
13.   BALTIMORE       13.   DETROIT
14.   PHOENIX         14.   MILWAUKEE
15.   INDIANAPOLIS    15.   SAN ANTONIO
16.   MEMPHIS         16.   BALTIMORE
17.   FT MYERS        17.   COLUMBUS,OH
18.   MILWAUKEE       18.   INDIANAPOLIS
19.   COLUMBUS,OH     19.   AUSTIN
20.   AUSTIN          20.   MEMPHIS
21.   JACKSONVILLE    21.   JACKSONVILLE
22.   SAN ANTONIO     22.   CHARLOTTE
23.   EL PASO         23.   EL PASO
24.   SAN DIEGO       24.   FT MYERS
By the Numbers
Scaling Back Advertisements after the
Crisis
American Express Advertisements
              Pre-Crisis
     "Membership Has Its Privileges"
            Post-Crisis
"Don't Take Chances, Take Charge"
http://www.youtube.com/watch?v=qWhh78JLSIY&fe
ature=player_embedded




          Post-Credit Crisis Advertisement
MasterCard Advertisements
             Pre-Crisis
             "There are some things
             money can't buy. For
             everything else, there's
             MasterCard"

             Post-Crisis
             "There are some things
             money can't buy. For
             everything else, there's
             MasterCard"

             Discounts on various items
             offered on MasterCard's
             home page
http://www.youtube.com/watch?v=yNMD70M91GA&f
eature=player_embedded
      Discover Card Advertisements


Pre-Crisis
  "What if"




                        Post-Crisis
                           "Get Cash Back:
                              This One's On Me"
              Visa Advertisements
Pre-Crisis                                  Post-Crisis
"Life Takes Visa"                            "Let's Go"
"Visa. It's everywhere you   "More People Go with Visa"
want to be."
  http://www.youtube.com/watch?v=Xy_PxLw1B_c&feat
  ure=player_embedded




Pre-Crisis: Excessive Consumption; Easy Money.
Trends in Amex Card Advertisements
Amex Cards, cont.'d
In 2006- $30,649,266 spent on American Express Blue Card
Ads

In 2010- $21,528,612 spent on American Express Zync Card
Ads
 Conclusions About Credit Card
   Television Advertisements
Before and After the Credit Crisis
• Advertisements were more expensive before
• Encouraged wilder spending habits
   o Evidenced by the changed advertisements and
     slogans
• Fewer advertisements in 2006 vs. 2010
• TV Ads were about half the price in 2010
• Less money was spent on advertisements
• Ads promised more rewards
• Less emphasis on careless spending
What's Happening Now?
2011: Credit Cards in the News

• Revolving credit, or credit-card use, fell $2.71 billion to
  $794.03 billion in February (WSJ)
• The Credit Card Act of 2009 was enacted in February of
  2010
   o Credit Card companies have been struggling to find new
     ways to generate revenue
   o Laws protect students and others from unnecessary fees
     and bad credit
• Chip and Pin cards are starting to roll out in the U.S
• Late payments and defaults have been declining
  (Businessweek)
Bibliography
1. http://www.creditcards.com/credit-card-news/advertisements-credit-cards-
   economy-changes-1273.php
2. http://www.census.gov/newsroom/releases/archives/population/cb07-91.html
3. http://pressroom.discovercard.com/data/articles/2006/08/24/20060824112230
   0.shtml
4. http://www.sfgate.com/cgi-
   bin/article.cgi?f=/g/a/2011/04/18/investopedia51787.DTL
5. http://blogs.wsj.com/economics/2011/04/07/consumers-step-up-student-auto-
   loans-cut-back-on-credit-cards/
6. http://blogs.creditcards.com/2008/10/credit-card-issuers-cut-tv-advertising.php
7. http://blogs.creditcards.com/2011/02/super-bowl-credit-card-commercials.php
8. http://www.businessweek.com/ap/financialnews/D9MKBPQ81.htm

				
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