First Annapolis Navigator (April 2011)

April 2011

Jim Banta leads Capital One’s Business Development efforts and was hired in 2007 from Citi’s International Cards division in London to lead Capital One’s entry into Partnerships. Jim has had business development and partner management roles at GE, Chase and Citi, but now calls Capital One and Richmond VA home.

Capital One Financial Corporation (www.capitalone.com) is a financial holding company whose subsidiaries, which include Capital One, N.A. and Capital One Bank (USA), N. A., had $122.2 billion in deposits and $197.5 billion in total assets outstanding as of December 31, 2010. Headquartered in McLean, Virginia, Capital One offers a broad spectrum of financial products and services to consumers, small businesses and commercial clients. Capital One, N.A. has approximately 1,000 branch locations primarily in New York,... More

After the Five Stages – Managing Debit in a Post-Durbin World

Barring a court-ordered delay or new legislation from Congress, the regulations implementing the Durbin amendment to the Dodd-Frank Act will go into effect on July 21, 2011. For banks and networks, that means it’s probably time to move past the Anger, Denial, Bargaining, and Depression and get on with the Acceptance. (However, one client reports moving beyond the five stages and onto a twelve step process!) In this context, Acceptance means beginning to manage for... More

Best Practices for Innovating with Existing Card Products

Card issuers have a variety of opportunities to be innovative, including products, sales and marketing, operational processes, and customer experience; perhaps product innovation is the most visible of all. Large breakthrough product innovations, such as the launch of a completely new card, gain attention because they target new customer segments or geographical markets and are expected to have either a large impact on the issuer’s top line or to be strategic in nature and open... More

Mobile Acquiring: New Tools for a New Market

This article is the second installment in our multi-part series on mobile commerce. During 2011, we will discuss the opportunity and implications of activity in this field.

Over the past two years a number of card acceptance solutions based on popular smartphone platforms have come to market. It is now remarkably easy for anyone with a device running Apple iOS, Google’s Android, or RIM’s BlackBerry OS to accept card payments. Merchants can walk into an... More

1 of 6 © 2011 First Annapolis Consulting, Inc.

Capital One’s Partnership Perspective with Jim Banta

April 2011 Navigator

Stay tuned next month for the first in a series of Mobile Research

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Capital One’s Partnership Perspective with Jim Banta

Jim Banta leads Capital One’s Business Development efforts and was hired in 2007 from Citi’s International Cards division in London to lead Capital One’s entry into Partnerships. Jim has had business development and partner management roles at GE, Chase and Citi, but now calls Capital One and Richmond VA home.

Capital One Financial Corporation (www.capitalone.com) is a financial holding company whose subsidiaries, which include Capital One, N.A. and Capital One Bank (USA), N. A., had $122.2 billion in deposits and $197.5 billion in total assets outstanding as of December 31, 2010. Headquartered in McLean, Virginia, Capital One offers a broad spectrum of financial products and services to consumers, small businesses and commercial clients. Capital One, N.A. has approximately 1,000 branch locations primarily in New York, New Jersey, Texas, Louisiana, Maryland, Virginia and the District of Columbia.

1) What should potential partners know about Capital One and its commitment to the space?As epitomized by our Information Based Strategy we are a data driven company. We are also in our heart a growth company. And as such, our entry into Partnerships is driven by the data that a third of the credit card market is in partnerships and we need to succeed there to grow. That is the strategic imperative behind our partnership efforts.

What we bring to Partners is a fresh viewpoint, a collaborative culture, and a lot of smart driven people who love using data to solve business problems. And a top 5 credit card issuer, a top 10 Bank and of course, the Visigoths - they were a hit at the Kohl’s national meeting.

2) What factors are behind Capital One’s rapid and significant re- entry into the partnership sector?To put it simply - a long runway, a learning culture, and the end of the world as we knew it.

The long runway was Capital One’s commitment throughout the recession to building a Partnership business. The pragmatic decision would have been to not enter or if you were in, exit. That was what most issuers decided. But then, we have the strategic imperative, we had to succeed.

Our learning culture enabled us to put together the critical building blocks, not just in capabilities and processes but more importantly in the skills of our people - how to partner. We love our first partners, Orbitz and MTV because they taught us so much.

The end of the world as we knew is my view that we will look back on the past three years as a fundamental shift in the broader financial services industry and particularly in credit card partnerships. Historical events converged to create a deal frenzy that ended badly with the onset of the recession. And in the process many Banks and Partners forgot the fundamental reasons they got into partnership in the first place. So partners were ready for a different approach and a different issuer. We are very focused on being that issuer.

3) What criteria does Capital One seek in a partner?We are consumerists - we start from the proposition that you have to create great consumer value. We are also realistic - we know that the credit card in a partnership is a tool that has to enable our partner’s business - through incremental sales, lower costs, additional transactions. It is not about us.

So we seek partners with great brands who need a creative issuer to help them win by creating great consumer value. For example, Kohl’s has an exceptional brand and offers a great customer experience for cardholders. Sony is one of the world’s top brands and a company through Sony Rewards and all their products that puts the customer first. And the future for both programs is exciting, we have an innovation agenda for both programs that will be fun to execute. And in Canada we have partnered with Delta, Intercontinental Hotels and Hudson’s Bay.

4) What is the appetite and bandwidth for more partnerships? As of April 1, we now have well over 20 million partnership accounts, and we are ecstatic with that growth. But remember that growth and innovation are in our DNA, we didn’t work this hard and get this far to stop now. We have an almost unlimited appetite for the right partnerships.

2 of 6April 2011 Navigator © 2011 First Annapolis Consulting, Inc.

After the Five Stages – Managing Debit in a Post-Durbin World

By Lee ManfredBarring a court-ordered delay or new legislation from Congress, the regulations implementing the Durbin amendment to the Dodd-Frank Act will go into effect on July 21, 2011. For banks and networks, that means it’s probably time to move past the Anger, Denial, Bargaining, and Depression and get on with the Acceptance. (However, one client reports moving beyond the five stages and onto a twelve step process!) In this context, Acceptance means beginning to manage for the government-mandated new economic order for the debit business.

While regulations won’t be final until April 21, we likely know most of what is most important (unless we are still in Denial). Debit interchange will be reduced from its current $0.44 per transaction to somewhere between $0.07 and $0.12. Every debit card will have at least two unaffiliated networks enabled, and maybe more (Bargaining to avoid Alternative 2). Merchants will control routing of transactions, although this isn’t much of a change from the status quo.

As a result, large merchants will realize a windfall of $9 to $10 billion, increasing their scale advantages over their smaller competitors. Large merchants accept a disproportionate share of debit volume due to greater PIN debit acceptance and aggressive steering and will, therefore, benefit most from the interchange price controls. Debit rewards as a stand-alone proposition are likely to disappear since the proposed rates are, by definition, below an issuer’s costs (Anger, but more on that later). Consumers will likely see more fees associated with banking services. And the same legislators that passed the bill into law will continue their attempts to distance themselves from the effects of its implementation. Most significantly, the regulations will set off an accelerated polygamous mating ritual among banks, networks, and acquirers, none of whom understand how the new rules will work in practice.

As unattractive as this scenario seems to banks (Depression), life will go on. The demise of the monolines and the inability of non-bank processors to secure “control of the payment system,” illustrate that payments is and always will be about account relationships, and that debit cards are but one important component of the overall deposit account value proposition. We are most likely on the cusp of a massive repricing of deposit accounts in the U.S., from an NSF fee and debit interchange-driven “free checking” model to one driven by monthly fees and explicit charges. Some of those fees will be for holding and using debit cards. By way of example, Chase is testing a $3 monthly debit card fee in at least one market; and other issuers are exploring per transaction fees and associated restrictions on the size and types of transactions that may be performed. While debit card and transaction fees are understandable, First Annapolis generally advocates avoiding pricing structures that will inhibit use of debit because of the associated attractive behaviors and relationship characteristics that come with it.

Other issuers will attempt to capitalize on the higher interchange rates of credit products and Durbin-exempt prepaid cards (Bargaining now). These products can be positioned as debit replacement vehicles, targeted at high and low ends of the balance/income spectrum shown in Figure 1 below. While the potential of these product innovations is promising, we believe that most issuers will retain 65% to 75% of their DDA base in traditional debit. As such, product migration will only address 20% to 30% of the revenue lost to the interchange price controls.

Requirements for the New World: Recognizing that most issuers will need to impose fees of some sort and that product migration opportunities have practical limits, certain capabilities will become competitive requirements for issuers going forward:

Scale: With interchange rates capped below the cost of issuance, scale will become a competitive requirement. Issuers will focus on reducing the overall cost of issuing a debit card, not just their allowable costs (Anger returns). In past work, we have observed issuers with per transaction costs more than double the average cost observed. In a low interchange environment, these cost disadvantages will be highlighted.


Figure 1: Household Distribution


By Erik Howell and Marco MazzonettoCard issuers have a variety of opportunities to be innovative, including products, sales and marketing, operational processes, and customer experience; perhaps product innovation is the most visible of all. Large breakthrough product innovations, such as the launch of a completely new card, gain attention because they target new customer segments or geographical markets and are expected to have either a large impact on the issuer’s top line or to be strategic in nature and open up a new set of potential opportunities. Incremental innovation on existing card products, such as changing a product’s pricing, benefits, or target customers, is far less visible and glamorous, but is still key a tool for increasing revenue growth and profitability of card businesses.

Ideally, card issuers should have a portfolio of product innovation initiatives that span from short to long-term, from existing to new products, and that also include multiple customer segments. By continually working on a diverse and balanced portfolio of innovations, issuers ensure that they invest for both the short and the long term and spread innovation risk over time and across customer segments.

However, our experience suggests that financial services companies often overlook incremental innovations and miss out on harvesting this low hanging- fruit.

The pressure to focus on incremental innovation is far less intense in financial services than in most other industries because financial products do not become clearly obsolete easily. For example in the consumer electronic industry, Apple must continually innovate its latest iPhone or otherwise competitors will catch up with product functionalities and customers could switch preferences in a relatively short period of time. Technology companies, like Bill Gates Founder of Microsoft, once commented “[We] are always 18 months away from failure”. Such pressure to keep up to date with change is not even close in financial services. Customer awareness of different financial products benefits is far less perfect, customers often perceive financial products to be fairly undifferentiated, and are less prone to switch from one supplier to another. Nevertheless, superior products remain the foundation of long term success for any financial services company.

Incremental innovations on existing products are often much easier than creating new products because they build on an already existing product platform and customer base. The degree of change involved is smaller than in new product innovation, thus carrying lower risk of execution and acceptance failure, as the existing customer base is a relevant source of market insights.

Overall, innovation initiatives are an important revenue management tool and are often allocated meaningful financial resources. A funnel approach to evaluating product concepts can help to manage the risk of failure or of misallocating resources. The funnel approach requires

Best Practices for Innovating with Existing Card Products

Diversified payments capabilities: With the elimination of stand-alone debit issuing profits, banks with diversified payments businesses will be better positioned than their competitors. Key capabilities include prepaid and credit card issuing for consumers and small businesses, activities that many banks have either avoided or exited in recent history.

Sales and service efficiency and effectiveness: Attracting new customers to all channels, providing them with the optimal product solutions, and servicing them effectively and efficiently (again in all channels) will be competitive requirements for issuers of all sizes. Multiple studies and market experience have shown that service quality and convenience trump price in determining consumers’ choice of financial institution. These capabilities, more than any clever pricing scheme, will be the best tools for creating long term value.

New loyalty propositions: As mentioned earlier, traditional points-for-spend rewards models for debit will no longer be viable on a stand-alone basis. That said, consumers have been conditioned to be rewarded for their business and loyalty. Issuers will be challenged to develop loyalty programs that recognize and reward the most attractive relationship characteristics. Importantly, financial services has exhibited a high correlation between relationship breadth, relationship duration, and overall profitability, suggesting the viability of relationship-based loyalty programs.

Real value: One expected result of Durbin and Reg E regulations is a return to more direct pricing of financial services, suggesting a reduction in the subsidization of some customer segments at the expense of others. This pricing environment has allowed less efficient providers to compete via complex and, occasionally, customer unfriendly policies and pricing tactics. Absent these pricing levers, banks will be increasingly required to provide real customer value in product offerings, service levels, and convenience, for which they will charge a reasonable price. This new customer value equation will benefit those banks with quality products, sophisticated sales skills, flawless service execution, and competitive cost structures to the detriment of their less effective competitors.

While for many issuers, the worst case scenario for Durbin regulations proved to be overly optimistic, the current spate of government intervention into private enterprise may be an opportunity for others. Clearly, the revenue hole created by the regulations will be difficult to fill in the near term, but long-term market share gains are possible. However, these gains will only be realized by those competitors with the best products, service quality, and value for their customers.For more information, please contact [email protected]

the innovation concept to go through multiple review and approval stages through which it can be killed at any time, thus reducing the risk that a concept fails at rollout. A high ratio of innovation concepts killed at early stages is not negative per se, and it is actually the desired outcome of the process. Killing a poor concept on which the bank has invested limited resources is far more efficient than seeing its roll out fail. As an example, the funnel process can be broken into five stages. At the first stage, the innovation working team may present to more senior managers the concept with an initial hypothesis on the benefit, if approved by management, the concept would then require a more specific business case in the second stage, then a full product design in the third stage, a pilot in the fourth stage, and finally approval for full roll-out in the fifth stage.

Each stage should then have somewhat different evaluation metrics. The strategic fit of a concept with the overall corporate strategy is often the very first question to test. Initiatives should support and build on the cards business’s strategy rather than distract from it. After that, key metrics might slightly vary by innovation type. Financial metrics such as NPV and ROI combined with estimated of difficulty of implementation should always be included.

For purposes of innovation on existing products, we find it helpful to break a product into its various components, and then brainstorm a variety of opportunities, such as the examples listed in the table below.

Card issuers have a variety of opportunities to innovate with products, and because new product innovation is often the most top of mind, the benefits of incremental innovation on existing products is often overlooked. Our experience suggests that including incremental innovations on existing products into issuers’ portfolio of supports revenue growth and profitability by diving short term results, lower investment requirements, and less risk than by focusing solely on breakthrough new product innovations.For more information, please contact [email protected] or [email protected]


Product Component Example OpportunitiesCustomer Segments &

Channels• Test product response rates on new combinations of customer segments and channels (e.g., target different

customer profiles in direct mail vs. telemarketing)Form Factor • Change the shape, color, design, or material of the card

Branding • Re-branding existing products, such as re-naming “Gold” or “Platinum” to a new brand

Customer Value Proposition

• Raise/lower pricing elements; test different offers on pricing (e.g., monthly/annual service fees waived if customers have X behavior)

• Changing payment terms on credit cards (e.g., adding additional flexibility, ability for customers to do installments)

• Adding or modifying rewards programs (e.g., change presentation from points to cash back)

Soft Benefits & Enhancements

• Add new insurances (e.g., civil liability) or change insurance parameters (e.g., increase limit for out of country medical assistance)

• Add new benefits with high perceived value (e.g., restaurant access)• Partner with merchants to provide discounts or benefits (e.g., sneak preview on new fashion seasons)

Utility • Test payment functionality such as contactless or mobile• Test customer service functionality such as Internet self-service improvements

Mobile Acquiring: New Tools for a New Market

By Ben BrownThis article is the second installment in our multi-part series on mobile commerce. During 2011, we will discuss the opportunity and implications of activity in this field.

Over the past two years a number of card acceptance solutions based on popular smartphone platforms have come to market. It is now remarkably easy for anyone with a device running Apple iOS, Google’s Android, or RIM’s BlackBerry OS to accept card payments. Merchants can walk into an Apple Store to buy an encrypting card reader that fits like a case around their iPhone. Or they can download acceptance software from an app store and get a free card reader in the mail. Or they can go through the web to one of a dozen other providers – the diversity of options really is surprising.

Mobile acceptance solutions have the potential to change the acquiring industry by opening up a whole new segment of small merchants for whom existing solutions just do not make sense. That said, acquirers cannot simply offer a smartphone-based solution and expect the world to beat a path to their door. It will take the right formula of product, price, and service to be successful in this new segment.

Mobile acceptance devices have been around for some time. The first wireless terminals were introduced in the late 1980s; as with any new technology, the initial design was not perfect. Early wireless terminals were expensive, unreliable, and bulky. These devices evolved over


the past twenty years, though, and one terminal manufacturer has reported wireless terminals accounting for as much as one-third of new equipment sales in recent years. Purpose-built mobile terminals found a receptive audience in direct sales, livery services, sporting events, and trade shows. And these rugged terminals will continue to be the best tool for some applications.

Smartphone-based solutions are exciting, not because they can replace mobile terminals, but because they open up card acceptance to a fundamentally different market segment: casual merchants. We generally place sole proprietors with $20,000 or less in potential card sales into this category: baby-sitters, dog walkers, housekeepers, artists, independent tradespeople, craftsmen, flea market vendors, and seasonal retailers are all top-of-mind examples. There may be as many addressable merchants of this type as there are card-accepting merchants today. In other words, solutions that unlock the micro-merchant market could double the American acceptance base to 15 or 16 million participants and generate more than a billion dollars in revenue for the acceptance industry.

It remains to be seen exactly what product formulation will appeal to this new merchant segment. From a consumer perspective, mobile acquiring offerings fall into one of three camps. There are “open” product-centric solutions, a variety of offerings positioned in alignment with a particular acquirer, and at least one non-traditional merchant aggregator.

VeriFone is experimenting with a direct-to-consumer distribution model that positions its solution as more open than competitors. VeriFone’s PAYware Mobile encrypting card sleeve is sold through retail stores, and its PAYware Connect gateway allows consumers to use an array of acquirers including First Data, Elavon, Chase Paymentech, WorldPay, and others. VeriFone is positioning the PAYware Mobile product as a product-first, service-second offering.

A number of other providers have geared up to supply the traditional merchant services resale channel with a mobile solution. Each provider takes a somewhat different approach to bundling the hardware, software, and gateway service that makes mobile acquiring work. ROAM Data provides all three of these components. Apriva provides a gateway and open software that is certified to work with hardware from a number of different vendors. ID Tech has focused on creating a hardware offering that has been adopted by Intuit, North American Bancard, and others. ROAM, Apriva, and ID Tech are not the only players in this space; in fact, a broad field of competitors is fighting for distribution and adoption.

Square employs the most unique model in the market today. Their value proposition is not specifically focused on technology; like others, they offer a proprietary bundle of hardware and software. Square’s business model is its differentiator. The company acts as an aggregator for processing through Chase Paymentech. Because Square itself is the merchant of record in the payment networks’ eyes, they have more flexibility in how they board and underwrite merchants. Users need only provide their bank account, mailing address, and social security number to accept card payments. There are limits to this “light touch” boarding model (high volume customers are subject to additional review), but it does allow Square to quickly board and activate users.

For acquirers, success in mobile acquiring also means getting it right on pricing, sales, and service. In all of these areas, acquirers must recognize that casual merchants may have different views on card acceptance than traditional retailers. Casual merchants are more likely to evaluate these services from a consumer context, which may mean they will be less receptive to complex pricing strategies and onerous sign-up and other requirements. Given that signing new customers is one of the most expensive aspects of acquiring, acquirers will have to leverage low cost sales and servicing channels to create a profitable business in this niche. And merchants who act like consumers will pose new risk management challenges for acquirers who step into this arena.

It is too early to call winners in the mobile acquiring space today. What is certain is that mobile acquiring has been an area of high interest for good reason. The opportunity to dramatically broaden merchant acceptance is a very exciting prospect. And today’s smart phones are just the first act in what this technology can do; the addition of NFC and other features will enable new transaction-use cases not even envisioned today.For more information, please contact [email protected]

First Annapolis is a specialized advisory firm focused on electronic payments. We offer consulting and a suite of M&A advisory services to a diverse client base that includes credit/debit card issuers, payment networks, retailers, transaction processors, prepaid specialists, mobile operators, T&E companies, affinity groups, trade associations, and other industry stakeholders.

Our market coverage is international in scope with a primary focus on North America, Latin America, and Europe. First Annapolis is headquartered in the Baltimore / Washington, D.C. corridor and Europe is served through our office in Amsterdam. In total, we have over 70 professionals across our practice areas giving us one of the largest and strongest advisory teams focused exclusively on electronics payments.

Our practice areas are organized by product/service and aligned with specific industry segments. In addition to core strategy consulting, we offer specialized services across all of our practice areas. Clients benefit from our specialization, depth of industry expertise, wide network of industry contacts, and our ability to offer strategic and tactical advice.

First Annapolis Navigator (April 2011)

Economy & Finance

Transcript of First Annapolis Navigator (April 2011)