Happy New Year! We at TPAtlanta are excited to continue to do our best to keep you informed about the latest happenings in our industry through 2006.

It's no surprise that the payments business is under attack. For banks and their credit card businesses, the plethora of electronic payment types is irreversible. It also should be worrisome.

Technology plays an ever-increasing role in the payments business, and those organizations that are savviest about technology are in fact not the established full-service banks.

As historical reference, non-banks such as First Data Corp. began buying banks' payment-processing businesses and used technology to bring scale and, thus, price advantages to this business in the 1980s.

In the 1990s, the payments innovations centered in banks' 'front office-functions' such as sales, marketing and services responsible for finding, acquiring and serving customers. In 1991, a new monoline bank, Capital One, was created inside Signet Bank and was one of the first to the use of technology to crunch data for tailoring credit card offers to individuals instead of larger consumer segments.

Capital One also pioneered the balance-transfer account, which funneled consumer debt from other credit cards to a Capital One card with a better interest rate. The company exploited technology and generated enormous wealth, last year generating a $1.5 billion profit on $4.8 billion in revenue. In addition, MBNA, which was recently acquired by Bank of America, led the way with the affinity credit card and had a net income of $2.7 billion in 2004.

Over the last decade, the focus of payments innovation has been at the cash register and in the payment product itself. Merchants such as Wal-Mart Stores Inc., Target Corp. and Walgreen Co. have been irate about rising interchange fees and for good reason: it is eroding their slim margins.

In response, retailers have been encouraging customers to use PIN debit instead of signature debit, converting checks to automated clearinghouse transactions and even participating in independent debit card networks such as Debitman, which processes PIN-based debit card purchases.

Is the $24 billion in annual interchange fees really at risk in the U.S.? Should banks be concerned about it or the threats that technology poses to their lucrative payments businesses, which for some is responsible for up to 40 percent of total income? The answer is yes.

A little more than 10 years ago, the bankcard industry was highly fragmented -- with Citicorp at a 15 percent share, MBNA at seven percent; AT&T and First Chicago both at five percent; and First USA, Household Bank and Chase, each with a four percent share.

Fast forward a decade and the picture is extremely different. Last year, just five institutions - J.P. Morgan Chase, Citigroup, MBNA, Bank of America and Capital One - controlled three-quarters of the bankcard market. MBNA and Capital One, together, commanded nearly a quarter (23 percent) of the market, the same size share as Chase. Now with MBNA becoming part of Bank of America, the bankcard market is even consolidating further.

With the market so consolidated, it's ripe for innovating newcomers to steal shares of the credit card business in years to come.

For this decade and beyond, not every bank can expect to stay a leader across the payments value chain. At TPAtlanta, we forecast that they have three options in front of them:

Strategy Options

The first strategy calls for becoming a scale player. But how much scale is enough?

Competing on scale will not be a strategy for every bank. Even some of the largest will choose not to do so because of the huge and ongoing technology investments this business requires. First Data, for example, is having difficulties keeping up to speed with the changes in technology required to be a market leader and is testing the waters to sell their credit card processing business unit. And do not be surprised to see Capital One become an acquisition target itself in 2006!

The second strategy - integrating banking products on behalf of consumers - over time will be critical for full-service banks to survive the withering attacks on their credit card businesses.

Besides overcoming the technical hurdles to doing this (each financial product typically is supported by its own information system), the bigger question is how to link banking products in ways that delight consumers and keep them using the bank's checks, credit cards, and debit cards. Imagine, for example, the ability to help a consumer spread his purchase across his demand deposit, credit card, home equity and other accounts at the point of sale. In this way a bank could become a financial adviser, a service for which it might be able to charge a fee. Doing so would mean bringing the sophisticated debt-financing practices of large companies to the individual consumer.

The third and final strategy that banks can pursue to protect and increase their payments business is a radical departure for many. It is based on the premise that the information about a payment is more valuable than the transaction revenue itself. Banks could use their payments information to improve how they sell their own products and how retailers promote their products to consumers.

The airline industry discovered this in the 1980s with their computerized reservation systems. Airlines such as American and United made huge profits from providing information about flights, in some years generating greater profits from their systems than from flying airplanes. American Express segmented its cardholder database for years, looking for opportunities to sell travel-related products and services.

Cross-Selling

Banks could follow the lead of companies such as Wells Fargo in using payment data to cross-sell services and other financial products. Wells Fargo sells twice as many financial products to its consumer customers as does the average bank (4.5 versus 2). Its goal is to sell an average of eight products to each customer, a target it achieved with 12 percent of its banking households in 2003.

Cross-selling financial products can be highly profitable. Wells Fargo generated $672 million in after-tax profits by selling additional financial products to its mortgage customers in 2003, profits above and beyond its hefty earnings on the mortgages themselves.

Retailers realize that the place banks hold in the purchasing value chain is one that gives them valuable information and exposure to consumers before they visit a store. Just before entering a store, a consumer often will take cash from an ATM, cash a paycheck at a branch, check a deposit online or phone a bank call center to check on a deposit. Thus, the bank is often the last place the consumer goes before entering a store.

Retailers such as Best Buy believe that banks, by leveraging their consumers' purchasing data, could help them drive traffic to their stores. Of course, consumer privacy must not be sacrificed. But banks have a unique opportunity to sell important aggregated data to retailers, to create joint marketing campaigns with non-competing retailers which, in turn, would reduce each merchant's marketing costs, and to make other money off their payment data.

The electronification of payments once again will reorder the industry. Banks that can recognize the opportunities and pursue them quickly and smartly will maintain and increase their lucrative payments businesses. And by leveraging payment data in ways that add great value to consumers and retailers, they may make even bigger fortunes from entirely new payments businesses.

So, as you crank up your new initiatives in 2006, we invite you to share them with us so that we can use the TPAtlanta forum to track and share what is working and what is not. We look forward to serving you throughout the year.

Calvin D. Johnson, Publisher
publisher@tpatlanta.com
Trans Atlantic Systems, Inc.