Research

Note

Precious Plastic 2002

Introduction
Credit cards are probably the most high profile product
offered by the finance sector. Consequently, the
constant evolution of the market is of interest to many
consumers as well as those in the industry. As the levels
of borrowing and card expenditure rise, the importance
of the sector to the economy also increases. The
crowded marketplace and slowing growth rate of the
sector create several issues for credit card issuers. In this
update to our 2001 publication Precious Plastic the UK
credit card sector, we review the most significant
developments of the past twelve months and consider
the likely response of issuers to the challenges they face.

Section 1 Market review

Significant developments
After a period of tremendous growth and change, the credit card market is showing signs of maturing. In
our view the most significant and interesting developments over the past twelve months were:
The Alliance & Leicester credit card portfolio sale to MBNA
The Alliance & Leicester/MBNA transaction is an example of the type of deals we envisage will lead to a
smaller number of issuers in the market. Richard Pym, Group Chief Executive of Alliance & Leicester
noted that Alliance & Leicester does not have the scale to compete with these [global credit card
issuing] companies. The investment required in systems, risk assessment techniques and product
development to gain an increased market share would not be value enhancing to our customers or
shareholders. Both sides gain from such transactions as synergies are shared and banks are able to focus
on their key product lines.
The purchase of the Providian sub-prime portfolio by Barclaycard
There was significant competition to acquire this portfolio. Providian was one of the few existing
operations with substantial volumes and skills at this end of the credit risk spectrum. Barclays, who has
quietly been building up its presence at this end of the market via innovative pricing and customer
targeting, is now clearly the number one issuer in this segment. The sub-prime segment may prove
attractive to others in the future, however, the problems experienced by Providian in the USA
demonstrates the need for strong capital and deep understanding of the risks involved to be successful in
the long term.
Cannibalisation of margins
Whilst there has been some increase in card penetration, most of the competition is focused on
attracting consumers who already hold other credit cards. As low APRs are the primary incentive given to
consumers, the overall effect is that issuers are gaining new customers from each other at the cost of
an industry-wide fall in margins. Until there is further consolidation of issuers in the market, this
phenomenon is likely to continue.
The introduction of true premium credit cards
In our report last year we noted the potential advantages of re-establishing the concept of prestige
credit cards. In July, Natwest launched their Black card, quickly followed by Halifaxs Carbon card in
September. Barclays are expected to launch a similar product by the end of the year. These cards
represent a high street equivalent to American Express Centurion Card. These cards offer benefits such
as access to international airport lounges and 24 hour concierge services, and have high annual fees. Our
view is that such products can add lustre to an issuers brand and entire range of cards. They fill the hole
that existed in the market for a product with high levels of service and benefits combined with a
revolving line of credit. We envisage similar products will be launched in the future by the major
issuers to cater for the growing mass affluent market. In many cases this will be a defensive measure
aimed at keeping their most valuable customers.
The termination of the Boots/Egg credit card joint venture
In September 2000, Egg launched a co-branded credit card whereby card users could have their Boots
loyalty scheme points automatically loaded onto the EMV chip contained on the card. We believe that
this technology will increasingly be utilised in the future (refer to Section 2). However, in contrast to the
success of the Tesco and Sainsburys credit card ventures, the Egg/Boots card was not successful and the
scheme was terminated in July.

Precious Plastic 2002

Competitive environment
The past year has perhaps been more notable for what did not take place rather than what did. Unlike
previous years, there were no new entrants into the market (excluding Virgin who are merely labelling
MBNA product). Issuers are preferring to allocate their marketing budgets on direct targeting of individuals
rather than the large brand building promotions of the past.
Many issuers are attracting customers via initial APR offers, rather than competing on the basis of their
standard APR. This is a sensible strategy, because it is the profitable, interest paying consumers who are
generally attracted to such deals. Obviously such offers exist on the premise that applicants will pay a
much higher, standard rate after the initial period expires. There is a risk however, that as the number of
issuers offering such deals increases, savvy consumers will constantly transfer their balances from one
special deal to another. The increasing popularity of such deals with issuers suggests that this problem is
not currently preventing these promotions from being overall short-term successes. However, it will take
further time to properly assess whether consumer behaviour justifies the up-front investment issuers are
making in each new customer.
There has been an erosion in the market share of the major banks over the past few years due to the
increasing penetration of monoline providers. Erosion has, however, been limited due to a loyal/inert
customer base. The focus of the dominant banks will be to retain their customers, through reward/loyalty
programmes and convenience, rather than to acquire new customers based on pricing. In our opinion, the
next significant battleground will be over the store-card portfolios of the major retailers. Many retailers have
a large and valuable number of store-card holders and we believe there will be a trend to convert
customers from a traditional store-card to a credit card. Indeed, Marks & Spencer have recently launched a
pilot loyalty and credit card scheme in Wales. Other retailers will be looking on with interest at the results
of this.
Market Share Cards in Issue

Other Issuers 15%

Barclays 19%

Capital One 4%
HFC 5%
RBS Group 17%

HSBC 8%

MBNA* 10%
HBoS 10%

Lloyds TSB 12%

* includes Alliance & Leicester

Source: Datamonitor

The profitability of the credit card industry is particularly vulnerable to economic downturns and more
specifically to increases in unemployment. The issuers who have recently entered the market have
achieved market share at the cost of achieving below average margins. Whilst it is possible to sustain low
margins during relatively stable economic conditions, their results will be disproportionately impacted by
any increase in bad debt expense. This, combined with less financial backing than the major banks, means
that they will be hardest hit in the event of a recession, and some may even be forced to exit the market.
In the medium to long term, there are likely to be very few issuers, if any, that will continue to operate with
market shares of less than 10%. Card issuing operations are becoming increasingly specialised and capital
intensive. In our view, the UK market is unlikely to support more than six card issuing operations. The
majority of financial institutions will instead concentrate on the marketing and branding of cards issued by
one of the majors, in return for a share of profits.

Precious Plastic 2002

Flexible products
The two newest market entrants, Virgin and Accucard, have launched innovative flexible credit card
products whereby customers are able to select the features of the card they desire. The features chosen
can then be changed on an ongoing basis. Typically, customers have a choice of APR, annual fee, rewards
and card design. The ongoing flexibility of terms offered to customers is expected to result in lower
customer churn.
We have doubts over both the demand for, and profitability of, flexible products. Most consumers who
change card provider do so in search of the best available deal on interest rate. It is difficult to imagine
many consumers forgoing one of the several 0% balance transfer deals on offer in return for a good (but
not necessarily leading) standard APR, particularly as the best flexible rates also attract annual fees. We also
believe that flexible customers are unlikely to generate significant value for issuers. The ability of
customers to change terms after issuance of the card will affect the profits of the issuers. As these
customers have shown a high level of financial awareness by selecting a flexible product, their likely future
loyalty must also be open to question.

Rewards
The biggest development with respect to rewards is the recently announced Nectar scheme. Nectar, which
is effectively an extension of the Sainsburys reward card scheme, allows members to earn and redeem
points at Sainsburys, BP petrol stations and Debenhams. Credit cards issued by Barclaycard and
Sainsburys Bank are linked to the scheme, replacing prior reward programmes.
Nectar is almost identical to a scheme that has been in operation in Australia since 1994. The scheme has
proved to be extremely successful and thirty per cent of the adult population are now members. The
scheme partners with National Australia Banks credit cards and has significantly increased the number of
retail partners since its inception. Similar growth and success of the Nectar scheme would give Barclaycard
a significant advantage over its rivals and improve perceptions of the rewards it offers. This has been an
area of weakness over the past year due to changes and subsequent bad publicity received regarding its
previous reward programme.
For participating retailers, a reward scheme as a means of customer acquisition and enhancing in-store sales
is, in our opinion, more cost effective than existing options (e.g. discounts for account card holders). It also
minimises hit and run whereby customers obtain a discount solely for opening an account.

Borrowing levels are increasing but do not appear to be out of control

The number of credit and charge card users increased by 2 million during 2001, an increase in penetration
of approximately 4%. Demographic changes and increased targeting of the sub-prime market will continue
to increase the number of card users, however there is obviously a limit to the amount of further growth
that can be obtained from this source. It is notable that credit card expenditure has been growing
marginally slower than the number of cards issued. Consequently, the average spend per card fell for the
first time in 2001.

45

90

40

80

35

70

30

60

25

50

20

40

15

30

10

20

10
0

1997

1998

Outstanding credit card debt

1999

2000

2001

Expenditure billion

Debt billion

UK Credit Card Expenditure and Debt

Annual credit card expenditure

Source: Datamonitor, APACS, CCRG

Precious Plastic 2002

The amount of credit card borrowings per person is increasing. According to APACS, the average
outstanding balances per credit card user had increased from 1,326 in 2000 to 1,406 as at December
2001, an increase of 6%. The proportion of balances subject to interest (an indicator of the use of cards for
borrowing rather than convenience) is also increasing. Recent figures from the British Bankers Association
show that the proportion of balances subject to interest had increased from 77.2% to 79.4% in 2001.
These statistics imply that underlying (non-convenience) borrowings are growing at approximately 8.8% per
annum per person, which is significantly higher than inflation. Whilst this rate of increase is not sustainable
in the long term, reductions in interest rates have acted to reduce the overall interest burden.

Precious Plastic 2002

Section 2 Issues for Issuers

We consider the market to be categorised by four types of issuer. In our view the key issues for each type
of issuer and likely developments are as follows:

Issuer

Market
Share

Key Issues

Likely Developments

Big 5 bank

60%

Falling market share

Increasing pressure on margins
Need for improved IT systems
/analytical ability
Regulator scrutiny

Continued slow loss of market share

Elimination of standard APRs; use of
risk based pricing
Increased use of securitisation
Move to near prime lending
Potential acquisition of store cards

Monoline

22%

Need to achieve critical mass

Reducing number of portfolios
available to acquire
Acquisition costs increasing
Brand weakness

Potential sale or merger of one of

the Big 3 monoline operations
Further acquisitions of small
portfolios
Acquisition or development of
European operations
Potential acquisition of store cards

Internet

5%

Need to attract more traditional

type customers
Potentially disloyal customer base
Below average margins due to
competitive pressure
Overcapacity/small customer bases

Reduction of pricing discount

relative to traditional suppliers
Closure/sale of non-viable
operations

Small/Niche

13%

Above average operating and

funding costs
Lack of clear strategy
Increasingly costly infrastructure
requirements
Lack of expertise

Further portfolio sales to the major

banks and monolines
Transformation into
marketing/customer acquiring
companies

A general concern for all issuers is the future level of interchange fees. An enforced reduction could
potentially result in many of their customers who do not pay interest or fees becoming unprofitable.

One size fits all pricing may become a thing of the past
A clear trend in the UK market is the move towards risk based pricing. Users of such an approach consider
several factors, including credit history, in order to determine the likelihood of future credit losses. The APR
is then set at a rate that reflects this assessment of risk and consequently can range significantly from
customer to customer. For example, the APR charged by Barclaycard currently ranges from 11.9% to
24.9%. Capital One takes a similar approach by offering re-build your credit rating cards for applicants
with poor credit histories, charging rates of around 30%. Clearly such an approach has advantages as it
eliminates the over-pricing and under-pricing of risk that is implicit in a single standard APR. However, the
majority of issuers still offer a single rate for all applicants. Single APRs are easier to promote and require
less use of statistical analysis. In practice, APRs are set at a certain level and applications are approved,
subject to a cap on the risk presented by each applicant. The disadvantage of this is that many applicants
are rejected who would in all likelihood be profitable if a higher APR was offered to and accepted by them.
Whilst issuers can sometimes sell the details of rejected applications to sub-prime specialists, the issuer is
often forgoing a profitable opportunity due to the inflexibility of its pricing.

Precious Plastic 2002

Fraud costs are increasing at an alarming rate chip and PIN should reduce this
significantly
Annual losses from fraud have more than tripled within three years, reaching 228 million in 2001, and are
becoming an increasing problem for the credit card industry. Skimming, the counterfeit production of
cards, has been the primary cause of this increase. In 1998, losses from skimming were 27million, which
had risen to 161million by 2001.

250

250

200

200

150

150

100

100

50

50

1998

1999

Fraud losses

2000

2001

Annual card expenditure billion

Fraud losses million

Annual Fraud Losses

Credit card expenditure

Source: APACS, CCRG

The industry has responded by agreeing to issue chip cards, which will require the use of PINs for
cardholder-present transactions in the UK. This undertaking is not inconsiderable. It will require:
100 million credit and debit cards to be issued with a chip;
installation of updated point of sale terminals at 750,000 outlets; and
the training of up to 2.5 million retail staff.
The target is to have 80% of all UK cards in circulation containing a chip by the end of 2004, with 65% of
transactions taking place using PIN authorisation. At this time the aim is for the majority of card users to
expect to use a PIN during their next credit card purchase. Merchants who do not co-operate with the
programme will be charged higher interchange fees.

Opinion is divided over likely uses of the chip

There are some in the industry who envisage chips being used for several purposes other than prevention
of fraud. Applications touted for credit card chips include E-purses, data storage and electronic ticketing.
However, chip cards have been used for several years in countries such as France and no killer
applications have yet been found for the chips. There is a risk that proposed applications may be a
solution without a problem.
In our view, chip cards will provide two key benefits to issuers and consumers:
storage of loyalty programme information. Chip cards are able to not only store membership details but
can also store details of transactions and process changes to members balances at the point of sale. This
will reduce the number of cards consumers will have to hold in their purses and wallets. The chip
functionality can significantly reduce the costs involved in operating loyalty programmes and can
potentially allow issuers to custom design rewards programmes for each cardholder.
acceptance of credit cards for small and remote transactions. Chips contain details of the PIN of the
card. The benefit of this is that terminals can verify that a PIN is correct without contacting the issuer.
Chip cards will therefore facilitate credit cards being accepted by terminals in locations where it is not
possible or too expensive to obtain online verification. Examples of this include vending machines and
mobile card readers.

Precious Plastic 2002

Section 3 Consumer issues

Apathy has a cost
Research released this year shows that relatively few consumers have, or are planning to, switch card
providers. Recent figures from the British Bankers Association show that only 2% of outstanding credit card
balances were receiving introductory rates compared to 79% of balances that were being charged interest.
PricewaterhouseCoopers estimates that if all UK credit card users were to switch to one of the several zero
per cent introductory rate offers, they would collectively save 2.5 billion in interest. The fact that the
major banks have been surprisingly successful in minimising their loss of market share indicates that:
a significant proportion of the population is apathetic towards choosing financial products;
there is a perception that changing card provider is too time consuming; and
the loyalty of consumers is being underestimated.
The resistance of many consumers towards changing credit cards has already resulted in the exit of some
new entrants from the market. They are unlikely to be the last to seek greener pastures.

Differential pricing may become controversial

There has been little public comment on the charging of card holders different rates of interest for the
same card. However, as this practice becomes more widespread, it is inevitable there will be increased
focus on the pricing decisions being made by issuers. Whilst the public is likely to understand and accept
pricing based on past behaviour (i.e. charging more to those with imperfect credit histories), the use of
predictive techniques that consider consumers addresses, age, occupation etc will be more controversial.
As card issuers refine and improve their analytical techniques, the difference in rates charged to the most
and least attractive customers is likely to grow. This may prove controversial if consumers feel they are
being discriminated against for having characteristics that are unattractive to the finance industry. Whilst
these concepts have long been applied in the insurance industry, banks have most commonly charged the
same or similar rates to all customers. It will be a challenge for issuers to move closer to pure risk based
pricing without disenfranchising customers or attracting regulatory/political attention.
Additional attention may also be focussed on over-limit fees. Issuers are becoming increasingly reliant on
these fees as a source of revenues. Few consumers consider these fees when assessing cards and are
usually unaware of the costs until they exceed their credit limit. Issuers have recently been increasing these
charges. The charges are most commonly incurred by consumers on lower incomes who have exceeded
their (usually low) credit limit.

PINs will reduce the number of credit cards that are used
Approximately two thirds of credit cards that are being issued are going to people who already hold at
least one credit card (source: APACS). As a result, the average number of cards in issue per user has been
gradually increasing. The introduction of chip and PIN could result in a significant reversal of this trend.
Within two years, cardholders will be required to remember and use a PIN for the majority of their
transactions. This presents a significant challenge for the industry as the vast majority of consumers
currently do not know their credit card PINs. Credit cards will be placed at a particular disadvantage to
debit cards because PINs are already known and used for ATM transactions. It is likely that consumers,
faced with having to learn several new credit card PINs will either learn only one, or alternatively use their
debit cards instead. In the lead up to mandatory PIN use, issuers will be fighting to ensure their card is the
most favoured by their customers, in order to survive the culling that may take place during chip and PIN
implementation. They will also need to focus on making it as easy as possible to choose PINs to deter
credit card users from switching to debit cards (particularly those who use credit cards purely for
convenience rather than funding).

More consumers may choose to tick the box

It is a requirement of the Data Protection Act that credit card applicants are offered the choice to elect not
to receive marketing material or have their details provided to third parties. Issuers spend large sums
acquiring new customers, which can be defrayed by cross selling additional products and services to
customers. It is considerably more difficult to generate these revenues from customers who opt out of this

Precious Plastic 2002

process by ticking the relevant boxes on the application form. As the amount of direct marketing material
being sent to consumers continues to increase, more consumers may react by choosing to opt out by
ticking the box. This could potentially create problems for issuers who are currently generating additional
income from their credit card customers. In addition, if opting out becomes more widespread, issuers will
find it harder to obtain high quality mailing lists.

Section 4 Conclusions
Despite significant competition, relatively few consumers are switching to better deals. If all consumers
switched to an introductory rate offer, they would collectively save approximately 2.5 billion in interest
within six months. This is equivalent to 87 per credit card user.
One size fits all APRs are likely to slowly become a thing of the past. Differences in the rates offered to
the most and least attractive customers will continue to increase, but may be subject to
political/regulatory attention. This attention may also extend to over limit fees.
Fraud is now a significant problem. Whilst the introduction of chip cards will help to address this, the
required use of PINs may induce consumers to reduce the number of cards they will use. Chip cards
open up the potential for issuers to compete on card functionality rather than purely price.
We continue to believe that there will be further consolidation. Smaller issuers will continue to sell out to
the major banks and larger monoline card specialists as they lack expertise and economies of scale.
Issuers are increasingly chasing market share rather than growing the size of the overall market. APRs
have been falling steadily. The big five banks can afford this due to their large back book; other issuers
may suffer to a greater extent, particularly if economic conditions deteriorate further.
The relative market positions of the credit card specialists and major banks is stabilising. The industry is
now awakening to the potential high value of store card users. A new battleground will be in
converting the cards held by these customers from expensive, limited acceptance cards to more widely
accepted and potentially profitable credit cards.

Precious Plastic 2002

More about the Financial Services

Valuation & Strategy team
We provide specialist valuation advice on transaction
and investment decisions, strategic market analysis,
valuation opinions, portfolio reviews and advice on
competition and regulation issues.
We work with our clients to develop qualitative and
quantitative analyses of their business, brands,
products/services, customers and markets. From here
our clients are able to define and rigorously evaluate
their strategic options, enabling them to position
resources where they will create the greatest value.

For more information please contact:

Richard Thompson, Partner
Telephone: +44 (0) 20 7213 1185
e-mail: richard.c.thompson@uk.pwcglobal.com
Richard Barfield, Director
Telephone: +44 (0) 20 7804 6658
e-mail: richard.barfield@uk.pwcglobal.com
Anthony Maybury-Lewis, Assistant Director
Telephone: +44 (0) 20 7804 5592
e-mail: anthony.maybury-lewis@uk.pwcglobal.com
Adrian Watson, Manager
Telephone: +44 (0) 20 7213 2002
e-mail: adrian.watson@uk.pwcglobal.com

Your worlds

Our people

2002 PricewaterhouseCoopers
Drawing on the talents of more than 125,000 people in 142 countries, PricewaterhouseCoopers provides a full range of business advisory services to leading global, national
and local companies and to public institutions.
PricewaterhouseCoopers refers to the UK firm of PricewaterhouseCoopers and to other member firms of the worldwide PricewaterhouseCoopers organisation.
PricewaterhouseCoopers is authorised by the Institute of Chartered Accountants in England and Wales to carry on investment business.
VS FS 034