How Does Direct Mail Credit Card Process Work?

Have you ever wondered how banks or credit unions can mail credit cards offers to you at your current address? How does the process work behind the scene? What impacts a campaign? Why do you receive the same offers from the same issuers but in different envelops? If you have such questions, I am here to pull back the curtain a bit by talking about the Direct Mail (DM) process in general, what impacts the success of a DM campaign and some less known details.

Direct Mail Process

Let’s go backwards from the moment you tear up a mail from an issuer. Whenever an issuer, whether it’s a bank or a credit union, sends you an offer, it must contain information on the offer as well as credit terms and conditions, as mandated by regulations. Inside a mail piece, some issuers include a postage-free envelop that customers can use to send back a filled paper application. Since each piece of paper is an expense, some elect not to send a paper application to save costs, especially during the times of supply chain constraints and inflation. In that case, customers can go directly to the issuer’s website, either by inputing the address manually on a browser or by scanning a QR code. They can also call customer care and apply on the phone.

Each mail piece carries an access code and a reservation code. These codes will be used to identify which offer is attached to an application. Normally, an issuer assigns a unique identifier to an offer for easy and transparent tracking. More on this later.

How do issuers know who you are and where you live? The answer is by working with credit bureaus. Credit bureaus like Experian, Equifax or Trans Union collect a lot of data on Americans. They have your latest address, your social security number, how many trades (mortgage, loans, credit cards…) that you have, how many with a balance that you own, so on and so forth. Issuers can work with these bureaus to pull the names of prospects for DM campaigns. The caveat is that in addition to a fee per name, issuers need to commit that they will send an offer to the names that they pull. Said another way, issuers can’t just call bureaus out of a blue and say: hey, I want to pull sensitive information of these people, but I don’t send them any offer.

Because of this requirement and the fact that each credit card is an unsecured loan that carries risks of losses, issuers must have a plan as to whom they want to send what. To answer these questions, issuers rely on their Credit Risk department, Marketing team and historical data. Credit Risk determines the risk parameters in which new acquisitions must fall. For instance, some banks are more comfortable with people who have little credit history than other banks. Some want to acquire folks with FICO less than 660 than others.

After Credit Risk defines the broad risk parameters, Marketing will work on the specific criteria and offers for a campaign. Each year, Marketing will conjure a campaign calendar that details how many pieces will be sent, when a campaign starts, which offers will be sent, how many applications and accounts can be expected. These details are determined with the help of historical data. Hence, the longer an issuer has been around, the more data it has to make informed decisions regarding DM campaigns.

What Impacts A Direct Mail Campaign?

The biggest factor is whether an issuer sends the right offer to the right audience. People have different preferences. Some don’t like complex rewards structures while others love to maximize rewards points. Some want to transfer balance to a card with a much lower interest rate while others just want to get a cash bonus for their activity. Issuers need to figure out who likes what and sends an appropriate offer. There is a big caveat. Credit cards are highly regulated in the US. Issuers can’t be caught being discriminatory towards any portion of the population. They can use certain behavioral traits as targeting attributes. What they can’t do is to use demographic elements. For instance, income, age, marital status, occupation or place of residence, just to name a few, are strictly forbidden.

Indicators from the bureaus such as how many trades a person has, the age of the oldest/latest trade, the total balance or how many delinquencies a person has can be used in a campaign. Issuers and bureaus themselves also try to use machine learning to build predictive models based on these legal attributes to gain an edge. The better the models are, the more efficient DM campaigns become.

Of course, offers with numerous benefits will excite prospects. As credit card is a fragmented business with a lot of competition, issuers cannot afford to come to prospects with bare bone offers. However, they must also think about their bottom line as rich products tend to be money-losers. Would you apply for a credit card with zero interest on balance transfer and purchase for 20 months, 2% cash back on everything and $400 bonus offer after spending $1,000 in the first 3 months? You likely would, but I can almost guarantee that the issuer of that card would not make a cent of profit. Hence, it’s all about finding that sweet spot between profitability and acquisition efficiency.

Additionally, mail design, paper quality, paper color and copywriting can contribute to the success of a campaign. I am sure you can recall seeing the same offer from the same company, but in different mail designs with different types of paper. Issuers conduct a lot of tests to see which paper or design can generate an extra basis point or two. Furthermore, the use of QR code can also help. USPS currently has a deal in which they will lower the postage expense if issuers use their Informed Delivery service. This is a numbers game. It’s all about finding those extra basis points in response rates.

Behind-The-Scene Details

Let’s start with promo/campaign codes. These codes are usually invisible to credit applicants. They are what issuers use internally to identify offers. In fact, each offer can have two promo codes: the parent code and the child code. The child promo code represents applicants that are upgraded or downgraded, depending on the setup of each campaign. For instance, anybody who applies for a Visa credit card and is awarded a credit line of more than $5,000 will receive a Signature card, instead of a Classic card. Signature cards carry more benefits and give more interchange revenue to issuers. The child promo codes for Visa campaigns are usually assigned to these “upgrades”. For Mastercard, the parent promo codes are given to the higher tier and the child codes are given to the “downgrades”.

What happens between bureaus and issuers? After an issuer finalizes a campaign’s strategy using criteria from a chosen bureau, the issuer will send the bureau such criteria and get back at least three files. The first file will go to the printing house and have some necessary information such as name, address, promo code or a unique identifier tagged to a mail piece called Solicitation ID. The file will not have people’s social security numbers. Nor will it have all the attributes that the bureau has at its disposal because the printing house doesn’t need to have such information.

The second file will go to the issuer and it has fields such as Solicitation ID, promo code and all the targeting attributes that the issuer and the bureau already agreed upon beforehand. These attributes will enable the issuer to analyze campaigns and see what can be the most predictive of success. Almost every issuer usually tasks its Machine Learning team to use multiple bureau attributes to come up with a predictive model so that it can use to generate more applications in future campaigns. Like the first, this second file will not have Social Security Numbers as Marketing or Machine Learning team does not need that kind of data.

The third file will also go to the issuer and be integrated into its decisioning engine. This file will have Social Security Number as Credit Risk and Operations will use it to make underwriting decisions. Of course, these teams don’t need all the targeting attributes as they are less relevant to them than to Marketing.

How do issuers deploy custom models? The answer is that issuers don’t “deploy” the models themselves. Credit bureaus do. After finalizing a model, an issuer will send the “formula” to its chosen credit bureau and the bureau will calculate the score based on such “formula”. The score will be appended to the appropriate files mentioned above and sent back to the issuer every campaign. The issuer will use the real performance data to validate the model and adjust, if necessary.

Every issuer must make sure that all models are in compliance with all lending regulations. Annually, the Office of the Comptroller of the Currency (OCC) conducts an audit to see if financial institutions comply with the regulations. Hence, every model must get approval from an issuer’s Compliance before deployment.

That’s all I have for today’s entry. I hope you find it useful. Drop me a line if you do or if you have questions.

Weekly reading – 8th January 2022

What I wrote last week

Amazon through charts

Amazon’s impact on U.S sellers during holiday seasons

Business

Inside a Year at Peloton: From Pandemic Winner to HBO Punchline. The fact that Covid pulled forward demand isn’t as concerning to me as the management team’s inability to forecast and assess its business; which seems to be the case at Peloton.

No Permits, No Fabs. “From 1990-2020, the time required to build a new fab in the United States increased 38 percent, rising from an average of 665 days (1.8 years) during the 1990 to 2000 time period to 918 days (2.5 years) during the 2010-2020 time period. At the same time, the total number of new fab projects in the United States was halved, decreasing from 55 greenfield fab projects in the 1990-2000 time period to 22 greenfield fab projects between 2010 and 2020.”

Some great investment insights from Philip Fisher. “There are two approaches to accumulating wealth in the stock market. One is to time the market, buying stocks when they are cheap, and selling when they are expensive. The other is to find outstanding companies and hold them”

Chip Makers Contend for Talent as Industry Faces Labor Shortage. This labor shortage in one of the most critical and influential industries in the next few years makes you wonder why in the world lawmakers don’t open doors to welcome more hungry and talented immigrants. The tribal politics, fear-mongering and myopia are astoundingly disappointing and detrimental to the country

Hawaii Is Rethinking Tourism. Here’s What That Means for You. “For the first time, Hawaii’s tourism authority is majority-run by Hawaiian natives, rather than white mainlanders with hospitality degrees. With the input of locals, who range from farmers to hotel owners, each of Hawaii’s four counties has created a strategic plan that stretches into 2025 and focuses on sustainable destination management rather than marketing. The plan relies heavily on community involvement and visitor education. “In the past, visitors were spoon-fed what outsiders thought they wanted,” says Kainoa Horcajo, founder of the Mo’olelo Group, a Maui-based consultancy that helps hotels to reimagine their cultural experiences. “Now, it’s time to take a risk, challenge the visitor, and give them something real.”

How pioneering deep learning is reducing Amazon’s packaging waste. “Machine learning approaches helped Amazon drive change over the past six years, reducing per-shipment packaging weight by 36% and eliminating more than a million tons of packaging, equivalent to more than 2 billion shipping boxes.”

Turn podcast listeners into customers with CTA cards. Quite a big step by Spotify to improve their advertising platform.

Affirm Debit +: The Great Credit Card Unbuilding Is Underway

Other stuff that I found interesting

The Case Against Crypto. “The real world has fundamental constraints that make the technology unworkable, whenever it has to interact with the outside world the benefits of decentralization disappear and the solutions end up simply recreating slower and worse versions of processes and structures that already exist

A good article on China from an experienced journalist, who has spent a lot of time on the ground there. “Everything that can go wrong in urban design has gone wrong in Beijing. Each region has a different personality. The north is economically dysfunctional. Large parts of it suffer from resource dependency, environmental problems, and the population loss that results from these trends. Cities near Beijing showcase overcapacity in steel and coal, while Tianjin is well-known for having falsified its economic data. The northeast provinces nearby have seen a population decline of around 10% over the last decade, while the north as a whole has seen its share of the country’s GDP shrink from half in 1960 to a third today.

Your attention didn’t collapse. It was stolen. “For example, one study at the Carnegie Mellon University’s human computer interaction lab took 136 students and got them to sit a test. Some of them had to have their phones switched off, and others had their phones on and received intermittent text messages. The students who received messages performed, on average, 20% worse. It seems to me that almost all of us are currently losing that 20% of our brainpower, almost all the time. Miller told me that as a result we now live in “a perfect storm of cognitive degradation”. Individual abstinence is “not the solution, for the same reason that wearing a gas mask for two days a week outside isn’t the answer to pollution. It might, for a short period of time, keep certain effects at bay, but it’s not sustainable, and it doesn’t address the systemic issues.” He said that our attention is being deeply altered by huge invasive forces in wider society. Saying the solution was to just adjust your own habits – to pledge to break up with your phone, say – was just “pushing it back on to the individual” he said, when “it’s really the environmental changes that will really make the difference”.”

The Race to Make Vials for Coronavirus Vaccines. Fascinating

Stats

The average credit card balance in the U.S in 2021 was $5,525, according to Experian

2% of U.S menus feature chicken thighs while 42% list chicken wings

45% of surveyed Americans said they plan to shop 50% or more of their groceries online in the next 12 months

“PYMNTS’ research found that real-time disbursements accounted for 17% of all disbursements made in 2021, up from 5.7% last year”

Weekly reading – 25th September 2021

What I wrote last week

Is BNPL replacing credit cards?

My thoughts on Visa’s new benefits for U.S Signature/Infinite cardholders

Articles on Business

When to Buy Now, Pay Later, and When to Just Pay Now. “Affirm doesn’t report payments on its four biweekly payment zero-interest loans, it said, or when consumers are offered a three-month payment option with no interest. Afterpay doesn’t work with credit bureaus at all. Sezzle Up explicitly informs users that it will report on-time payments to Equifax and TransUnion. Affirm doesn’t charge late fees, but late or partial payments can hurt your credit score, and may prevent you from using the service in the future. Sezzle Up also reports delinquencies. Klarna and Afterpay revoke access to their platform until payment is made. Both companies also charge late fees, tacked onto your next payment. Afterpay charges $8, or 25%, of the purchase, whichever is less, while Klarna charges a maximum $7, or no more than 25%, of the past due amount. Klarna said it will contact users to collect payment before charging a late fee.

This delivery app went above and beyond for its workers. Then Uber took over. Cornershop’s original operating model was more beneficial and friendly towards workers. After the acquisition, life became more challenging for drivers. It remains to be seen whether the regulation in Chile will allow workers to unionize and force Uber to recognize drivers as full-time employees. This is a classic case of conflicting interests between gig companies and drivers as well as of the important role that governments play in this conversation.

Why the University of Florida gets a ~$20m cut of Gatorade profits every year. A fascinating story on a wildly popular drink.

The Most Important iPhone Ever. “What makes the iPhone and perhaps Apple special is that it seems to deliver things that nobody asks for but then everybody wants while eschewing overshooting a performance dimension that a few demand but most won’t use. The tragedy of overservice and disruption is that if you don’t shift the definition of performance eventually you run out of demand at the top of the performance curve. That opens you up to “good enough” competition from below. Instead you need to re-define the notion of performance: compete on a new basis, reset expectations. That the iPhone can find new dimensions of performance and hence demand is effectively a solution to the innovator’s dilemma.”

PayPal Introduces Customers to the Next Digital Payments Era with the New PayPal App. “The new PayPal app will introduce new features including PayPal Savings, a new high yield savings account provided by Synchrony Bank, alongside new in-app shopping tools that will enable customers to earn rewards redeemable for cash back or PayPal shopping credit and uncover deals with hundreds of merchants. Additionally, the new app offers PayPal customers a single place to manage their bill payments, get paid up to two days earlier with the new Direct Deposit feature provided through one of our bank partners, earn rewards and manage gift cards, send and receive money to friends, family and businesses, pay with QR codes for purchases and redeem rewards in-store, access and manage credit, Buy Now, Pay Later services, buy, hold and sell crypto, as well as support causes and charities they care about.”

Other stuff

The tangled history of mRNA vaccines

Stats that may interest you

“One in five consumers made a purchase using a “buy now, pay later” service within the last 12 months.

One in six consumers who made a buy now, pay later service purchase regret doing so, commonly citing high interest rates, a lack of options to build credit, or making unnecessary or unaffordable purchases.”

There have been 47 startup venture deals in Africa in 2021 so far with the average deal size of $21 million

CPC on Amazon ads is $1.27 in August 2021, up from 86 cents from a year ago, according to a survey

31% of online grocery shoppers use PayPal, according to a new study by ACI Worldwide and PYMNTS

Fuel Wasted Due to U.S. Traffic Congestion in 2020 Cut in Half from 2019 to 2020

14% of U.S consumers said they switched to an iPhone from another operating system in the last two years, a report said

Is BNPL replacing Credit Cards?

BNPL is a red-hot phenomenon now both in the financial and retail worlds. Because most BNPL transactions are funded using debit cards or checking accounts rather than credit cards, one of the main debates is whether it is replacing or will replace credit cards.

When asked about BNPL and its impact on credit card balance, the CFO of Discover, John Greene, had this to say:

What we’ve seen to date is consumer appeal has been on the lower credit quality folks. I think there will be a natural evolution that, that will come up the credit spectrum. We’ve also seen in terms of the firm, some higher credit quality customers actually electing to do a buy now pay later transaction, whether it’s paid in for or something else.

We haven’t seen any discernible impact whatsoever. So where I would likely see that is through new customer acquisition, and that’s — that activity has been very, very robust. The balance sheet on existing customers here, so loans, that’s been impacted by stimulus and kind of how they’ve allocated their dollars within their household. Nothing from the details we’ve looked at that would indicate that buy now pay later’s impacting the portfolio.

Discover Financial Services – Barclays Virtual Global Financial Services Conference

Echoing that sentiment, Brian Wenzel, CFO of Synchrony Bank, said there was no visible impact from BNPL on their credit card portfolio:

Yes. So first, we have studied buy now, pay later impact over the last couple of years as it really has grown, and we partnered with an outside firm to kind of do a deep analysis really on the — at the customer account level to kind of understand the behavior patterns it has. So when we see it and the data we’ve seen, I think, 75% of the buy now, pay later accounts are funded out of a debit account, right? So the view is that they are — you’re using cash and taking what would be a debit transaction through the buy now, pay later. We then looked — and really the impact of our business, and we looked at it and talked a little bit about it in Q&A last week about the impact on our business.

Are we seeing anything that says buy now, pay later is impacting credit? And so when you look at it versus a cohort population of our Mastercard as well as our Dual Cards, we see a low penetration, and we have not seen any changes certainly with how they use credit with us. In fact, they are more engaged with us than our average customer. They generate more revenue for us, but we have not seen any change. So as we look at it — when we look at applications come through, go over some of these products are offering, we have not seen any change, discernable changes.

So when you think about the impact to us in credit, we don’t really see it yet. We think that there is a shift that’s happening probably from cash as a tender type. And I think this is where the merchants and our partners are taking a step back. They are saying, “Yes, we understand your offer, consumers like it. But is this driving incrementality for us, true conversion?

Synchrony Financial – Barclays Virtual Global Financial Services Conference

One may argue that the main business of Discover and Synchrony is credit card so they had to put on a brave face. They might have. But since they are publicly traded companies; which often require them to be truthful to investors, I’ll give them the benefit of the doubt. More importantly, what they say seems to be in line with what Marqeta sees in their 2021 State of Credit report.

Recently, Marqeta released a 2021 State of Credit Report with some interesting insights into how consumers in the U.S, the U.K and Australia use BNPL and credit cards. The report is based on a survey of 3,500 people across three countries. Here are my take-aways regarding consumer preferences in the U.S:

  • 78% of respondents in the U.S use credit cards while 25% actively use BNPL
  • 50% of U.S consumers use credit cards because of rewards, something that is still a weakness of BNPL providers but they are working on it
  • “60% of U.S. 18-25-year-olds said they made more than five purchases on their credit card online each week, compared with 19% of 50-65-year-olds”
  • “79% of consumers surveyed who use BNPL reported having three or less BNPL plans open at a given time, with 45% of people reporting their average BNPL purchase at less than $100.”
  • “Older consumers however, were decidedly against, with survey respondents 51-65 years old voting overwhelmingly (63%) in favor of the credit card-first status quo.”
  • “Americans were again slightly worse off, with 30% responding that they’d struggled to meet payments”

3 out of 4 U.S consumers use credit cards. 60% of the younger segment use their cards regularly every week while the older and wealthier crowd want to keep the status quo. That, to me, is the sign that the credit card business is still healthy and well, at least for now. By no means do I insist that BNPL doesn’t have a chance to overtake credit cards. More and more issuers such as Citi, Amex or Chase introduced the ability to put qualified transactions on installment plans (BNPL). All the major retailers in the country allow shoppers to have a payment plan. Even Apple is reportedly working on their own version of BNPL. Who knows what the future holds? But for now, all signs point to a healthy credit card industry holding their ground.

Some thoughts on new benefits for Visa U.S Credit Cardholders

Per Visa:

Visa Inc. (NYSE: V) today announced the addition of Shipt, Skillshare and Sofar Sounds – as exclusive benefits – for Visa’s U.S. Consumer Credit cardholders. Eligible cardholders can now get a free Shipt membership to receive free same-day delivery on groceries and household essentials on orders over $35; boost their creativity through Skillshare’s online learning community; and get access to presale tickets plus be eligible for a free concert ticket while discovering Sofar Sounds’ global community of music lovers.

Specifically, the benefits vary from one product to another. Signature/Infinite credit cardholders will be able to enjoy more benefits from Visa than other cardholders:

ShiptSkillshareSofar Sounds
InfiniteUp to three years of free Shipt membership (normally $99
 per year)
Free membership for three months plus 30% off annual renewalsSeven-day Visa Exclusive Presale to Sofar-presented events, plus a free ticket with each purchase of one or more tickets to a show during the presale window
SignatureThree months of free Shipt membership, then nine months of membership at 50% offFree membership for three months plus 20% off annual renewalsSame as Infinite
OthersOne month of free Shipt membership, then three months of membership at 50% offSame as Infinite but limit two free tickets per year

You may wonder now if you are qualified for Infinite or Signature benefits. Infinite cards are typically high-end premium cards with a significant annual fee such as Chase Sapphire Reserve or U.S. Bank Altitude Reserve Visa Infinite Card. Hence, if you are already paying in the hundreds of dollars a year for a credit card, chances are that you have an Infinite card.

It’s a bit easier to get a Signature card. Every year, issuers have campaigns to increase credit limit for qualified customers. There are two reasons for it: 1/ a higher credit limit can stimulate more spend from customers and 2/ a Signature card earns an issuer more interchange revenue than a Classic card. One of the key criteria for an upgrade is that customers must have less than $5,000 in credit limit, which is the threshold for a card to be considered by Visa to be Signature. After an upgrade, a Signature card will have more than $5,000 in credit limit.

Therefore, if you have a good credit history and standing, ask your issuer to increase your credit limit to above $5,000. Do check with them if it means you are getting a Signature card. Each issuer will have a different set of criteria to look at, in addition to credit score, to see if they will upgrade your account. There may be a hard/soft credit pull involved and as a result, your credit score may take a hit. However, if your monthly balance doesn’t change, a bigger credit limit means that your utilization would be lower and hence, your credit score would bounce back soon.

I don’t know the exact agreement between Visa and these companies, but if I have to guess, it won’t be Visa that subsidizes these benefits. Visa only earns a tiny piece from every transaction (like 0.2% give or take). The maths don’t add up for them to subsidize these benefits. On the other hand, the likes of Shipt, Skillshare and Solar Sounds have a perfect partner in Visa to market their services and acquire new users. Visa is the biggest card network in the world and in the U.S. It will be highly challenging to find an issuer that doesn’t have a Visa product. After this announcement, issuers will include the new benefits in their marketing: social media, direct mails, emails or websites. Credit card is a highly competitive and fragmented business. Every player pours millions of dollars into marketing and user acquisition every year. Hence, the names of Shipt or Skillshare will be more popular. I also think they will get more new users to the door. The difficult part is to make them stay. But hey, if you want to keep someone close, they have to be familiar with you first. This is about it.

For Visa, this is a good move to deepen their moat. Not only does the network have the biggest pool of merchants AND consumers in the U.S, but they also have the same advantage globally. While powerful, this moat doesn’t guarantee future successes. Visa has competitors circling. Apart from the traditional competitors such as Discover, Mastercard or American Express, there are new challengers on the horizon such as this startup Banked from the UK as well as alternative payment methods such as BNPL via ACH. This new slate of benefits is a plus for consumers as well as card issuers, at no additional cost. It is aimed to acquire new cardholders and keep them on the network as long as possible.

When reading reports, read the footnotes!

It’s not natural for most people to pay close attention to the small fine print in the footnotes. When I was at school, nobody told me about it. But in some cases, what the footnotes contain is very valuable and can change the information that goes before it. In this post, I’ll give you an example of how a $27 billion publicly traded company (Synchrony Bank) manipulates numbers to their advantage and how paying attention to the footnotes can help you jump through that manipulation.

Per Synchrony’s Investor Day Presentation

Synchrony shows their acquisition cost and customer lifetime value of their co-branded credit card portfolio

The point of the upper slide is that Synchrony Bank is more efficient than its peers in acquiring new and more valuable accounts. Well, there are some caveats. First, it may well be true that it costs Synchrony less to acquire new co-branded accounts. They partner with some of the most popular brands such as Amazon or PayPal. They don’t need to send out a lot of direct mails or run plenty of digital ads. However, I strongly suspect that they will have to pay these brands a high finders fee as in every time an account is opened, the brands receive a fee. In these cases, I won’t be surprised if the fee is north $100. Technically speaking, the finder fee isn’t classified as an acquisition expense, but to ordinary audience who doesn’t work in banking, the net financial impact isn’t clear from this presentation.

Second, the comparison data is from Argus. Argus collects data from different issuers in the country and shares back to each participant its benchmark’s data. It can be a very useful tool as management teams. The main drawbacks of Argus are 1/ as the identity of the participating issuers is kept anonymous, one doesn’t really know exactly who they are compared against; 2/ Argus data is on a quarterly basis and usually lags behind by 90 days. In other words, since we are not wrapping up Q3 2021 yet, the most up-to-date data in Argus should be for Q1 2021, but I know from personal experience that as of this writing, benchmark data is only up to Q4 2020. My point is that it’s unclear from the presentation that Synchrony is comparing data from the same period.

Last but not least, the way they calculate Customer Lifetime Value is a bit flattering. The footnote, if I interpret it correctly, states that they look at the CLTV of accounts that are on the books for 10 years. In the credit card world, if a customer stays with you for a long time, usually it means that customer is more valuable than shorter-tenured ones. Hence, it seems Synchrony looks at the CLTV of only some of their best customers, instead of the general population of their co-branded cards.

I’ll give you another example of the importance of footnotes. From the same presentation by Synchrony:

Synchrony tries to show how they manage risk

The point that Synchrony is trying to make here is that they grow their portfolio responsibly by curtailing the riskier customer group (subprime, which include the Low and Medium). The confusion comes from how Subprime is defined. In their explanation, Synchrony considers anybody with VantageScore less than 650 to be Subprime. According to The Balance, Vantage Score 3.0 and 4.0 use the same tiers as FICO score and Subprime refers to people with less than 600 in Vantage Score. To the Consumer Financial Protection Bureau, Subprime includes anyone with less than 620 in credit score. To Experian, the threshold is 670. The lack of a universal definition of Subprime means that Synchrony is likely not trying to manipulate the audience in this particular case. Rather, if somebody wants to use this information, they should really need to look at how Synchrony defines Subprime. Otherwise, any comparison would be flawed.

These are just two small examples of how critical information is sometimes buried in the footnotes. There are plenty of other examples. Everyone that publishes something has an agenda and employs tactics to highlight such an agenda and tuck away what can seed doubt. We should strive to be vigilant and mindful while reading others’ reports.

Weekly reading – 7th August 2021

What I wrote last week

I wrote about why credit card issuers should try to get into consumer digital wallets

Business

Pearson bets on direct-to-student subscription shift. I am never a fan of publishers like Pearson for a simple reason: books are murderously expensive in the U.S. In addition to the sky-high tuition fees, students have to pay easily a few hundred dollars or a thousand dollars a semester for books alone. There are ways to go around that challenge, but sometimes these guys work with professors and students are left with no choice, but to make a big splash on books. Pearson seems to be aware of the unsustainability of their current model. By going straight to students, they can establish a direct relationship and avoid relying too much on educational institutions. $15/month means students can pay $75/semester for access to all the books required. However, there are other publishers on the market. If students must get books from multiple sources, it can dilute the appeal of this new service from Pearson. I really look forward to seeing how this strategic move will pan out in the future.

Apple Is Now an Antifragile Company. A nice article on how shrewd Apple is when it comes to securing its chip supply while other struggle. I feel that not enough has been said about what a great job Apple’s management team has been doing. It takes a great deal of discipline to use billions of cash wisely quarter after quarter. The executives also have the foresight to develop their own chip M1 to keep more control of their fate and avoid being in the mercy of Intel. Additionally, the decision to make forward orders in bulk in advance has proven to superior. While others cite the struggle with chip supply as the reason for their relative subdued performance, Apple still posted strong results.

Music labels split over Spotify’s push to promote songs for lower royalties. I haven’t used the Discovery Mode yet, so I don’t know what it is like. I did have a less than stellar experience with the Spotify app; which I haven’t used for a long time. It’s not user-friendly at all. And if what is reported in the article is true, as a shareholder, I’ll be very disappointed. Sacrificing the user experience and the integrity of an algorithm like that over lower royalties and higher margin isn’t in the long-term best interest for the company, in my view.

Disney, WarnerMedia and NBCUniversal wrestle with balancing the value of cable networks and streaming services. I don’t think streaming is the best place for a newcomer with one cash cow to enter. The likes of Apple can arrive late at the part and compete because they have enormous resources and streaming isn’t their top 5 or 7 revenue stream.

The Verge interview with YouTube Chief Product Officer.

5 charts show Amazon’s growing logistics network as it puts inventory closer to consumers. Some great data and information, but I don’t think Amazon is playing the same game as Walmart. Operating huge stores with a lot of SKUs is not Amazon’s strength, at least compared to Walmart, for now. I don’t think it’s wise for Amazon to get into that arena. What I think Amazon is plowing money into is the last mile delivery. If groceries are what needs delivering, they are building out Amazon Go shops and can leverage Whole Foods footprint. However, if we are talking about non-grocery items, then Amazon is taking a very different approach to Walmart and staying at what Amazon has been great at: an online store with great customer services and unrivaled last-mile delivery network

What I found interesting

U.S. generates more plastic trash than any other nation. The amount of plastic bags in supermarkets in the U.S such as Target or Walmart staggered me. I don’t understand why they don’t implement policies that encourage shoppers to bring their own bags or boxes like Aldi does. At Aldi, you have to bring your own bag unless you are willing to pay for one every single time. I don’t think shoppers are bothered by that. If the likes of Target and Walmart can join the fight against unnecessary use of plastic, it’ll be a huge step forward given the reach and size of these retailers.

London’s Crossrail Is a $21 Billion Test of Virtual Modeling. Technology is mind-blowing. So is human imagination

Stats that may interest you

Luggage sales are up more than 460% year over year (Q1 2021)  on Amazon while swimwear sales have more than doubled year over year as of March and April 2021

From 2006 to 2021 per-capita volume consumption of juice and nectars in the U.S. declined 36%

Weekly reading – 20th march 2021

What I wrote last week

The economics of a credit card

Business

Hy-vee CEO shared how Covid shaped the company’s operations moving forward

Why Amazon Fresh stores will likely rock a few boats. As its competitors do more shipping from their own stores, Amazon can get on level terms in that sense with having more stores of their own in strategic locations. Plus, if they can get these cashierless stores to run properly, they will be able to cut back a significant line item on the Income Statement, paid employees!

How Trader Joe’s $2 wine became a best-seller

Telegram App Is Booming but Needs Advertisers—and $700 Million Soon 

The new Google Pay repeats all the same mistakes of Google Allo

Apple brand loyalty hits all-time high as Samsung loyalty dives

Austin Rief: How Morning Brew went from college newsletter to $75 million in 5 years

She Came to the US to Study With Only $300 in Her Pocket — Now She’s a NASA Director For the Mars Rover

What I found interesting

Does Atlantic Canada have a blueprint for rural revival in the post-pandemic era?

Facebook’s GDPR bypass reaches Austrian Supreme Court

Stats you may find interesting

BNPL grew by 215% year over year in Jan and Feb 2021. Total eCommerce spending reached $121 billion so far

As of February 2021, 45% of Square sellers accept online payments, up from 30% a year ago

56% of the people surveyed by AirBnb preferred domestic travel post-pandemic

How do credit card issuers make money? What are the main types of credit cards? A quick look into the credit card world

Launching a credit card product is similar to putting together a jigsaw. There are many pieces: how to appeal to customers, which customers are an issuer’s likely target, what a good experience looks like, how an issuer can make money and how a card can compete with existing products on a market. In this post, I’ll go over my thoughts on the economics of a credit card, the main credit card types that I see on the market (excluding those debit cards that have credit card functions), the appeal of Apple Card and how different cards compare to one another.

Economics of a card

An issuer essentially generates revenue from three main sources with a credit card: interest payment when customers don’t pay off their balance, fees (late fee, annual fee, cash advance fee, balance transfer fee, foreign transaction fee and others) and interchange. Interchange is a small percentage of a transaction that a merchant pays to a card issuer whenever a customer uses a credit card to pay. The more spend is accrued, the more interchange issuers generate. Interchange rates are determined by networks such as Visa, Mastercard, Discover and American Express. The exact rates depend on a lot of factors: the industry or category that a merchant is in, what type of card (high end or normal) is being used, regulations (Europe imposes a limit on interchange rates, unlike the US) and how a customer uses the card to pay (swipe, chip, mobile wallet, online, phone..).

On average, some categories such as Airlines, Restaurants, Quick Restaurant Services, Hotels or Transportation have an interchange rate somewhere between 2% – 3%. Other categories such as Gas and Grocery, especially at Walmart, Target or Costco usually yield a very low interchange rate around 1% – 1.4%. Any credit card that offers higher than 3% in cash back in a category likely loses money on that category as the interchange cannot make up for the reward liabilities. Issuers are willing to offer 3-5% cash back, knowing that they lose money on that front, because they are banking on the assumption that the money that they make up from other sources will offset that loss. Specifically, they are likely to make money on categories with 1%. For instance, if you buy clothes or pay for a subscription online or buy something from a Shopify store, your card issuer is likely to make at least 1% in interchange, after they give you 1% in cash back. Additionally, issuers that offer a rich reward scheme usually impose an annual fee to offset the reward liabilities and the signing bonus that they use to acquire customers.

Hence, cards with no annual fee offer a cash back between 1.5 – 2%. They can’t afford to go higher than that because the maths would unlikely add up. Cards that have an annual fee often come with high rewards and a big bonus. While a big bonus can be an attractive tool to acquire customers, it incentivizes short-term purchase bursts and unintentionally attracts gamers, customers who receive the bonus, cash it out and either become a ghost, if they don’t have to pay an annual fee, or close out the card for good. There are a lot of gamers and gamers aren’t profitable to issuers. However, issuers still dole out a big bonus and attractive rewards because they think that there are customers that stay for a long term and can provide the interest income and fees that issuers need.

Three essential types of credit cards

I call the first type of cards the “Everyday Card”. Examples of this category include Blispay and Citi Double Cash Back. These cards offer a standard rewards rate on every purchase category (1.5% to 2%) with no annual fee. There is usually a 3% foreign transaction fee and there is no signing bonus. What makes Everyday Card appealing is that customers do not need to remember the complex rewards structure. They can just “set it and forget about it”. It earns them respectable rewards on every purchase, even at Walmart.

The second type of cards is the “No Annual Fee With Bonus”. Examples of this category are Discover It Cash Back, Freedom Unlimited or Freedom Flex. These cards’ highest reward rate is usually 5% on a certain pre-determined category that tends to yield a high interchange rate. In some cases, this 5% rate can rotate every quarter, keeping it interesting for customers and making them locked in if they want to activate a preferred category. There is a signing bonus for new customers. Some cards reward customers with a few hundred dollars in a statement credit if they spend a certain amount in the first 90 days. This mechanism is designed to make customers locked in early. The issuers bank on the assumption that once customers earn their signing bonus, they will stick around to keep those rewards points alive. However, it’s not uncommon for customers to cash out their rewards and become inactive afterwards. 

Discover’s signing bonus is designed to keep customers active during the first calendar year. They promise to match the cash back rewards at the end of the first year, but the bonus is a one-time occurrence and doesn’t repeat. This mechanism may keep customers active longer than what an outright statement credit does, but customers can always leave after the first year.

The last type of cards usually comes with an annual fee. Examples are Chase Sapphire Preferred or Bank of America Premium Rewards. Cards in this category come with a signing bonus after qualifying conditions are met and with a rich rewards structure. To offset expenses, issuers impose an annual fee. Customer acquisition may not be an issue with cards in this category, but will customers stay around after the signing bonus? Or are customers happy enough to pay a high annual fee every year? Also, these cards’ reward rate is high only in categories with higher interchange rate such as travel or dining. The rate is pretty light (1%) in other categories. While this approach appeals to a specific segment of customers, for customers that want “to set it and forget it”, does it still carry that same appeal though?

If you find credit cards complex and confusing, that’s normal because they are usually designed that way

Most credit cards can be pretty complex and confusing to customers. Let’s start with rewards. A tiered reward structure forces customers to mentally remember all the combinations of categories and rates. If customers have multiple cards in their wallet as they often do, it’s not an easy ask. Of course, there are folks that make a living in maximizing rewards, but that doesn’t work for the rest of us. In addition, it’s not always clear to customers how to categorize merchants. Merchants are categorized by Merchant Category Codes. These codes help issuers set up rewards and help networks determine interchange rates. MCCs are known in the banking industry, but to an ordinary customer, they don’t usually mean much. In some cases, issuers provide a list of qualifying merchants, but they can’t list all the available merchants and the practice is not ubiquitous.

Moreover, reward redemption can be a time-consuming process. Points or cash back earned in this cycle have to wait at least till the cycle ends before they are available for redemption. It can take longer in some cases, especially when it comes to signing bonuses. Here is a list of how long it takes for points to post at different issuers, compiled by Creditcards.com

 How long it takes to redeem the signing bonus?How long it takes to redeem spending rewards
Amex8-12 weeks after a customer hits the spending requirementWhen the current cycle ends
BofAAt the close of the billing cycle when the minimum spend is metWhen the current cycle ends
Capital OneWithin 2 cycles of when the spending requirement is metUp to 2 cycles
ChaseUp to 6-8 weeks after a customer hits the spending requirementWhen the current cycle ends
Citi8-10 weeks after a customer hits the spending requirementWhen the current cycle ends. With Citi Double Cash Back Card, it can take a bit longer if customers don’t pay in full
DiscoverWithin 2 cycles after a customer hits the spending requirementWhen the current cycle ends
US BankUp to 2 billing cycles after a customer hits the spending requirementWhen the current cycle ends
Wells FargoUp to 2 billing cycles after the qualifying period When the current cycle ends
Figure 1 – How long it takes issuers to let customers redeem rewards

The final point in rewards is that issuers tend to deceptively inflate the rewards by posting numbers in points, instead of dollars. Understandably, 100 points sounds much better than $1, even though they have the same value. Nonetheless, it creates an unnecessary level of complexity for customers to mentally convert points into cash, especially when the reward value is big.

Rewards aren’t the only source of frustration for credit card customers. Credit cards are essentially loans on which you may or may not have to pay interest. However, issuers hope that customers will incur interest and fees (as long as they don’t charge off). How often are fees prominently and clearly marketed as rewards? How often do you see in advance the potential interest payment if you don’t pay off your balance? Here is a study by Experian on the concerns that consumers have about credit cards

Consumer concerns about having a credit card
Figure 2 – Consumer concerns about a credit card

Apple Card is designed to do something different

Apple launched Apple Card in August 2019 in collaboration with Goldman Sachs. Customers can apply for an Apple Card right from the Wallet app, which is pre-loaded on an Apple device. The preloading is a significant advantage as customers don’t need to either load another bank app or search for a website and apply for a card. As soon as an application is approved, customers can use their Apple Card immediately either by holding your device near an NFC-enabled reader or paying online. With Apple Card, cardholders earn 3% cash back on purchases at Apple and strategic partners such as Exxon, T-Mobile, Walgreens, or Nike, 2% cash back on others purchases using Apple Pay and 1% cash back using the titanium physical card. The 2% cash back on other purchases can be appealing, but not every offline or online merchant allows Apple Pay.

The biggest selling points of Apple Card are transparency and simplicity. Take their no-fee structure as an example. There is no fee involved with Apple Card. No annual fee, no foreign transaction fee, no over-the-limit fee and no late fee. While Apple remains coy on cash advance fees, their special clientele may not use the mainly virtual Apple Card for this specific reason much. 

The simplicity also goes into their daily cash back. Typically, cash back earned through a credit card can take weeks to be registered and redeemed. Points or cash back earned this cycle must wait at least till the cycle ends before they are available for redemption. With Apple Card, cash back is earned daily in Apple Cash. As long as transactions are posted, customers can see the earned amount reflected in their Apple Cash. In real money term not in points. This takes away an unnecessary step for customers to mentally convert points into cash. Furthermore, Apple Cash can be used at any time, either in a person-to-person transaction, in a deposit back to a checking account or to pay back the outstanding balance in Apple Card. 

In terms of transparency, Apple Card tells customers how much interest they are paying when making a payment. And their APR is on par with other issuers’. In the Wallet app, customers can determine how much of the outstanding balance they want to pay. Depending on the amount, Apple will let customers know in advance their interest so that they can make an informed decision. It is in contrast to what almost all other issuers do. 

Apple Card's flexible interest rate
Figure 3 – A simulation to show interests on Apple Card varies based on how much a cardholder can pay.
Source: Apple

Apple Card only works with iOS devices and Apple Pay can be a challenge for elderly or less tech-savvy customers. Nonetheless, no card is perfect for everybody and the transparency and simplicity can teach us a lesson on how to craft a good customer experience. Despite being available only in the US and all restrictions above, Apple Card’s portfolio balance grew from $2 billion in March 2020 to $3 billion in September 2020 and roughly $4 billion at the end of 2020. Not bad for a portfolio with one card that is restricted to iOS devices. 

Annual fee or no annual fee? Appealing and complex or straightforward and simple?

A good practice in positioning is to use a 2×2 matrix. In this case, I’ll look at Apple Card and the three main credit cards mentioned above through whether they are easy to use and whether they have an annual fee.

Credit card positioning
Figure 4 – A 2×2 positioning matrix for credit cards

Let’s look at the positioning chart above. On the top right corner, we have an ultra-luxury card such as The Platinum Card from Amex. This card’s annual fee runs up to $550 and while rewards rate can range from 1x to 10x, it is not easy to remember all the details or to redeem rewards. On its left side, we have cards such as Capital One Venture and Chase Sapphire Preferred. These cards’ annual fee is $95, lower than the Platinum Card’s. Similarly, the complexity of cards such as Chase Sapphire Preferred is still high. Capital One Venture has 2x rewards rate on every purchase, making it less complex to use for some users, but it’s still time-consuming to redeem cash back. 

Moving further left, there is Capital One Quicksilver. This card’s annual fee stands at $39 and it offers 1.5x on every purchase. It’s in the middle of the spectrums. On the “no annual fee” side, we have two groups. The first group features cards such as Freedom Flex and Discover It Cash Back. These cards offer a 5x reward rate, but it rotates every quarter and to some customers, that can add some complexity. The other group features cards such as Citi Double Cash Back and FNBO Evergreen. These cards have no annual fee and offer 2x on every purchase. Nonetheless, they still have a complex fee structure and a reward redemption process that can be improved.

The point here is that it’s very competitive on the top half of the chart. All these cards have their own unique selling points that appeal to different customer segments. What they do have in common is that their fees and reward redemption are pretty complex.

On the other side of the x-axis, there are Apple Card and Upgrade Card. Even though it’s straightforward to use Apple Card as there is no fee and cash back is earned daily, the use of Apple Card depends much on whether customers have an iPhone and whether merchants enable Apple Pay. 40% of mobile users in the US don’t own an iPhone and as discussed above, older and less tech-savvy customers may not find Apple Pay comfortable. Without Apple Pay, the titanium card itself earns customers a paltry 1% cash back. 

Upgrade Card is a credit card issued by Sutton Bank, a medium sized bank in Ohio with $500 million in assets, and marketed by Upgrade. There is no fee with Upgrade Card. Here is what the company claims on its website

Not all traditional credit cards charge fees. However, creditcards.com’s 2020 Credit Card Fee Survey found that the average number of fees per card is 4.5. For example, the 2019 U.S. News Consumer Credit Card Fee Study found that the average annual fee (including cards with no annual fee) is $35.23, the average late fee is $36.34 and the average returned payment fee is $34. 01. The Upgrade Card charges none of these fees. Over 90 percent of cards charge balance transfer fees and cash advance fees. The Upgrade Card enables you to transfer cash from your Personal Credit Line to your bank account with no fees.

Source: Upgrade

With Upgrade Card, customers earn 1.5% cash back on all purchases as soon as customers pay off balance. The 1.5% cash back rate is lower than what Apple Card customers earn using Apple Pay, but on the other hand, Upgrade Card is device-agnostic and doesn’t rely on any mobile wallets. Hence, it is more accessible. However, Apple Pay allows customers to earn and use rewards daily while Upgrade Card only allows customers to redeem rewards after they make full payments.

According to the book The Anatomy of The Swipe, medium sized banks are essentially unregulated and can charge a higher interchange rate than big regulated banks. Hence, it’s very likely that Upgrade Card’s interchange rates are higher than those of cards issued by the likes of Chase or Capital One. The higher interchange rates can help offset rewards liabilities and generate revenue.

In fact, I am surprise to find no product like Upgrade Card from big banks. I suspect it would take a huge investment in infrastructure by legacy banks to offer the Daily Cash feature that Apple Card has. But legacy banks can essentially waive all fees like Upgrade Card does. While the likes of Chase, Discover or Capital One have more expenses than a smaller platform like Upgrade, they also have more popular brand names than Upgrade; something that would help tremendously in customer acquisition.

In summary, the credit card world is highly competitive. If an issuer follows the conventional way of launching a credit card, it will surely have a lot of competition and little to differentiate itself from competitors. In the upper half of Figure 4 above, I do think all the concepts and variations of rewards and economics have been tried. To be different, an issuer has to think differently and appeal to customers more with a superior customer experience (easy and simple to use) and less with complex features.

Where debit meets credit – This debit card features credit card benefits

I came across an interesting startup called Point, which offers Point App and Point Card. Point App is a mobile wallet application from which you can apply for and manage your Point Card. Point Card is a debit card that offers benefits similar to those of a credit card. Benefits include 5x points on subscriptions such as Netflix, Spotify, Hulu and some others, 3x points on food delivery & ride share, 1x points on everything else, no foreign transaction fees and more. Instead of banking on your missing your payments, Point makes money from interchange fees which are a small percentage of your spend and a subscription fee. In order to use Point Card, a customer must pay $7/month or $5/month on an annual plan.

I think this card will be helpful to those who are conscious of their budget and interested in credit-card-like benefits. 47% of Americans carry credit card debt that amounts to $890 billion in total in Q1 2020. Failure to make payments on time results in a high interest which often comes in the range of 13% – 26%. Further inability to make payments repeatedly will put a revolving customer in a vicious cycle as in that case, compounding interests work against him or her. I work for a bank and a credit card issuer and let me tell you: we want you to be delinquent on your credit card debt. It’s a significant source of revenue and profit to issuers. With Point Card, the risk of delinquency is taken away as you can only spend money that you actually have. There is no temptation to make impulsive purchases on credit and break personal budget.

Point Card may not make sense for every one, though. I mean, if you are willing to pay a few bucks a month to have a cool-looking debit card and some nice features that mimic those of Apple Card, by all means. If you want to break even on a $5/month annual subscription at 1x points redemption rate, you’ll need to spend at least $500/month for this investment to make sense financially. If a family puts all utilities, car insurance and subscriptions, and other discretionary expenses on a Point Card, it can easily exceed $500 while the family can avoid the risk of delinquency.

I do think it’s an interesting concept that can appeal to a group of consumers. As a fan of personal finance, I want to see more folks in control of their own finance and stay away from the temptation from card issuers. I hope that as Point scales and continues to be nimble without a big budget in marketing as well as physical branches, it can offer more rewards to attract more customers.