THE UNIVERSITY OF ALABAMA

Cash Connection
A Payday Lender
February 24, 2011
Dan Young
Drew Herring
Tim Brady
Craig Earley
 Cash Connection

Exhibit 1: Dominant Economic Features

A. Industry Size and Growth

Throughout the mid to late 1990’s Cash Connection was one of several companies

competing in an industry of substantial growth - short-term cash lending. The payday

advance service emerged in the early 1990s, and growth resulted from strong

consumer demand and changing conditions in the financial services marketplace.

Industry growth spawned from a number of changes in the marketplace. First,

traditional financial institutions departed from the small – denomination, short – term

credit market, which can most likely be attributed to its high cost structure. Secondly,

costs were constantly increasing due to bounced checks and overdraft protection fees,

late bill payment penalties, and other informal extensions of short term credit. The

third change that brought industry growth was the continuing trend toward regulation

of the payday advance service that allowed protections for consumers.

Today, it is estimated that there are more than 22,000 payday advance locations

across the United States, which is a much larger number when compared to the 9,500

existing banks in the country. Research shows that these payday advances extend

about $40 billion in short-term credit each year to millions of middle-class households

that experience cash-flow shortfalls between paydays. Analysts estimate that about 5%

of the U.S. population has taken out at least one payday loan at some time. According

to an industry trade organization, more than 24 million Americans say they are

somewhat or very likely to obtain a payday advance. By taking these estimates into

account, it is clear that the industry has thus far penetrated about half its potential

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market and that there are substantial unrealized growth opportunities without having to

entice existing customers to borrow more frequently.

B. Industry Rivals/ Competition

Increased competition in the payday lending industry was partly due to the easing

of federal restrictions starting in the early 1980s. Increasing regulation in the loan

servicing industry as well as the financial industry has only heightened the ease at

which new companies can enter into the industry and remain competitive while

protecting the revenue and profits of companies that are well established in the

industry.

Noteworthy rivals in the loan origination industry include large retail banking

firms such as Bank of America, Wells Fargo, JPMorgan, Chase and Citigroup. These

companies have an increased capability to produce a portfolio of serviced loans. New

companies often find difficulty in purchasing loans from third parties and generating

their own loan servicing portfolios. Individual company performance relative to other

companies within the industry largely depends on the company’s cost structure and

services they offer relative to other lending companies.

The demand for consumer lending and the quality of lending portfolios have been

affected by the performance of equity markets. Positive developments in the stock

market generally result in increases in lending due to the wealth effect of rising share

prices. Such activity allows investors to feel wealthier, which creates more confidence

in pursuing opportunities that will increase their demand for credit. Rising stock prices

has also impacted the quality of the lending portfolios because borrowers have an

increased ability to meet repayments. On the other hand, a decrease in share prices will

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have a negative impact on a borrowers' ability to service debt, resulting in increased

risk for those who extend the credit.

Exhibit 2: Five Forces Model

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A. Rivalry Among Competing Sellers

The competition among rival sellers in the payday loan industry is strong. There

are 22,000 payday advance locations in the United States and also 9,500 banks spread

throughout the company. Stephens Inc. projected in 2008 that the payday loan market

encompasses 10% of U.S. Households. Federal restrictions were relaxed in the 1980’s

making the competition in this industry fierce. But as of late, the increasing regulation

in the loan servicing industry, along with the financial industry has made it more

difficult for new companies to enter and be competitive in the industry. Along with

Cash Connection, other national players in the payday loan industry are Cash Advance

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America, Check & Go, and Check America. The potential for high profits is the

reason why various lending companies are heavily prevalent throughout large U.S.

cities and towns. The start-up cost for a lending firm is only $130,000, which makes it

very appealing to new entrants. Small banks would be competition in the industry

because they are willing to give out payday loans. A large majority of retail banks

have elected not to serve individuals who seek a payday loan. Less than 18% of banks

expand services to unbanked or underbanked individuals. Credit Unions are

competing in the payday loan industry. The low Not Sufficient Funds fees are a big

reason why borrowers join a credit union because payday loans can incur much higher

fee’s over a short period of time.

B. Threat of New Entrants

The threat of new entrants into the payday lending industry is moderate at this

point. Barriers to entry are the main deterrent in new companies moving into this

field. Increasing federal and state regulations on the loan and financial industry makes

it extremely difficult for a new company to be successful in this market. The level of

industry competition is another barrier to entry because with large retail banking firms

like Bank of America, Wells Fargo, Morgan Chase, and Citigroup are all major

players in the loan origination industry. With the amount of unbanked or underbanked

customers in the payday loan industry, moving into this field is a risk because of the

lack of profitability of this group. There is a threat of new entry into the market

because of the possibility of high profit margins and very low start-up cost. That will

make it easier to enter the market, but long term success is hard to come by in a market

filled with regulations and restrictions.

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C. Competition From Substitutes

The competition Cash Connection faces with substitute products is strong.

Banks, credit unions, credit card companies, and pawn shops offer different features

that might cause a customer to switch from one type of loan to the other. Banks offer

overdraft protection on checking accounts which is considered a very close substitute

of payday loans. Currently the fees relating to overdraft are similar to the fees

associated with payday loans. Credit union’s offer higher rates and lower fee’s than

banks but typically are not associated with payday lenders. Ten to twenty percent of

credit union members chose to do some of their business with payday lender because

credit unions do not offer small, short-term cash loans that can be accessed quickly

and conveniently. It is clear that the customer does not use a bank or a credit union in

the same way he would use a payday lender.

A credit card is the most common way to obtain and use short term credit and is a

viable substitute from a payday lender. With 100,000 transactions a minute, credit

cards have created enormous amounts of debt for the economy. Providian, a credit

card company, targeted the low income, unbanked U.S. customers that were similar to

the one payday lenders often serve. Most of Providian’s customers could not obtain a

credit card from most companies, but they offered a credit card that did not have an

activation fee and they only had to pay the minimum payment on their transactions. In

the end, customers are worse off due to the penalty fees and high interest rates.

Providian was the leader in this innovative way of providing the low income

population with a way to have cash in the short term, and have been followed by other

companies.

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Pawn shops, auto title and subprime home equity could be substitutes to a payday

lender. These stores are often too small to be considered real competition in the

payday loan industry. Borrowers have to front some type of collateral in order to

receive cash which is not a suitable alternative for most consumers.

D. Power of Supplier

The power of the supplier or in this case, the power the lender has in the

relationship with the buyer is moderate. The 2004 survey done by Cypress Research

Group shows why the lender does not have as much power as the borrower. Sixty-Six

percent of customers involved in payday lending have at least one option that offers

quick access to money. Fifty percent have overdraft protection and have major credit

cards. The multiple options a customer has to receive cash means that payday lending

companies must find a way to make their company the most appealing. Payday lenders

can have high fee’s which could send the customer to another store.

Many banks and credit unions are not willing to give out small, short-term loans.

This means the availability of that service goes down and gives more power to the

lenders. Since there is less competition in providing short-term loans, the payday

lenders have the ability to charge higher service fees.

E. Power of Buyer

The power of the buyer or the borrower is moderate in this industry. A study

done in 2007 stated that the borrower benefits more from a payday loan than the

lender. The payday system was set up to benefit the borrower but often times the

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customer cannot pay back the loan on time and incur late penalties. As stated in the

previous section, 66% of customers have more than one option to obtain quick money.

Fifty percent have overdraft protection on their checking accounts and fifty percent

have major credit cards. The borrower’s power can be significant reduced depending

on the emergency of the situation because banks and loan companies cannot get the

money as well as a payday lender.

Exhibit 3: Driving Forces Analysis

Figure 2: Driving Forces

Exit of
Restrictions Financial
and
Institutions
Regulations

Immediate Changes in
Gratification Long-term
Driving growth rate
Forces

A. Immediate Gratification

A key force behind the growth and success of the payday loan industry is the

immediate gratification received from small, short-term loans. The ability of

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companies in the payday loan industry to provide customers on the spot cash is unique

among similar or substitute firms. This driving force of the industry is beneficial

because it will cause demand for the industry’s products to rise. Customers realize that

banks and credit unions will not supply them with a short-term loan, and this increases

the payday loan companies demand because the service they offer is unique. The

ability to receive cash in an emergency situation is especially important during a time

of economic trouble. More consumers will be seeking help because of insufficient

funds creating an inability to pay certain bills. The lender will be able to raise their

fees for emergency loans because the consumer will do anything just to have cash in

his pocket. While the ethics of the company would be in question, this would increase

profitability drastically. In order to manage this driving force properly, companies

must convey the importance and value of receiving instant cash. This will allow them

to convince the consumer that instant gratification will always outweigh future cost to

be incurred.

B. Restrictions and Regulations

The regulatory influences and government policy changes are a major driving

force in the payday loan industry. The industry is regulated by state and federal laws.

The federal regulatory environment has worked to evolve along with the payday loan

industry. States have the ability to permit or prohibit payday lending but the states can

also set certain restrictions on how companies can lend money. Federal laws are

increasing and giving the federal government more control over the financial services

industry. These restrictions and regulations imposed by states and the federal

government have made entry into this industry very difficult. While this lessons the

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competition in the industry, it does not make it much easier for companies to succeed

under such strict regulations. Restriction and regulations have a negative effect on

demand for the product because the customer is less willing to get a loan if the payday

lending company does not have the ability to be flexible. This driving force will

mostly have a negative effect on the profitability of the industry. The restrictions help

protect the borrower from being charged too much in penalty fees. It also protects

them from being treated unfairly by the lending company. While these regulations will

ultimately make it more difficult for a payday lender to turn a profit, there is some

benefit to heightened regulations. The companies will have the ability to put more

pressure on the buyer in order to ensure that he or she repays the loan. This will

significantly cut down on returned items expense.

C. Exit of Financial Institutions

The payday loan industry has adjusted significantly because traditional financial

institutions no longer offer small, short-term credit advances to its customers. This has

allowed payday companies like Cash Connection and other small lending companies

to make high profits at minimal cost. The traditional financial institutions stopped

competing in the payday loan industry because of the high cost structure of the

industry. Most banks and credit unions are too large to support small loans, but they

have found ways to differentiate themselves in other areas. Overdraft protection in

checking accounts is one way that banks can compete with firms in the payday loan

industry because it gives the customer an alternative to getting a payday loan.

D. Changes in Long-Term Growth Rate

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The payday loan industry has experienced significant growth over the last three

years. Competition in the industry is causing saturation in the market and preventing

firms from having long-term success. The promise of high initial profitability and the

benefits of low start-up cost make entry into this market very appealing to companies.

Cash Connection found that the first payday loan company to establish itself in a

certain area tends to be the most successful. As a result, the saturation of competitors

will hurt the industry as a whole in the long run. Regulations will continue to increase,

which will lower profitability as more firms continue to enter in the market. The

payday loan industry is experiencing large amount of growth in competition but this

saturation will eventually hurt everyone in the market.

Exhibit 4: Key Success Factors

Figure 3: Key Success Factors

A. Convenience

Securing money from traditional banking institutions takes extra time due to a

process that involves credit checks and approval. Payday loans are a quick and easy

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way to receive loans for 2-4 weeks that is covered by the customer’s next paycheck.

All the customer needs is a bank account and steady employment. After setting up an

agreed upon date to repay the company the customer receives the short-term loan.

Twenty percent of non-banking Americans said that due to poor placement,

treatment, hours or language barriers at banks they chose payday loans for check

cashing and quick loans.

B. High Need for Service

Much of the business that Cash Connection receives is due to the level of need

that their consumers have for such a service. Without this service many of these

customers would face very serious consequences. A survey conducted by Cypress

Research Group found that the four main reasons for payday advance loans are to

cover an unexpected expense, avoid late charges on bills, avoid bouncing checks, and

bridge a temporary reduction in income. This service provides customers a quick and

easy way of receiving funds in order to make ends meet.

Cash Connection appeals mainly to unbanked and under banked households.

Many of these people choose Cash Connection based on the financial problems that

they have with traditional banks. The main issues include a minimum balance that

was too high, service charges that were too high, bouncing checks, overdraft fees, not

having enough money to need an account, and credit problems. As the current

traditional banks are moving away from smaller loan amounts and short term credit

and as banks do this there is a greater need for a service that provides for this niche of

people.

C. First Mover Advantage

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The first person to enter a new market that has interested customers is going to

generate attention. By attacking cities and towns that don’t already have a payday

advance location Cash Connection get free marketing through word of mouth, a

monopoly on people who want to use a payday advance, typically a better location,

and brand loyalty.

D. Shrinking Bank Sector

With economic decline comes a decline in the growth of the banking industry.

Banking revenue from 2005 to 2009 has decreased 16.5%. This decline also means a

18.5% decrease in the number of Federal Credit Unions as well as a 20.7% decline in

State Credit Unions. This leads to an increase in the need for alternate banking

options that under banked and unbanked Americans have.

Exhibit 5: Industry Outlook

A. Industry Growth Potential

The payday loan industry has a moderate ability to produce profits. While there is

significant financial evidence to support the positive impact the industry is having on

the economy, it is becoming very difficult to produce profit in this industry. There is

room for growth in the industry, as shown by the amount of competition already in the

industry. The industry contributed over $10 billion in gross domestic product in 2007.

Supports 155,000 jobs nationally and has a total labor income impact of $6.4 billion.

The industry generated over $2.6 billion in federal, state and local taxes. In 2007 the

payday lending industry was able to provide approximately $44 billion in credit.

While all that data is strong there are some barriers in the industry that are preventing

it from growing. The previous exhibits have shown the impact competition is having

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on the payday lending industry. Many companies see the ability to gain short term

profits from the industry, but due to growing restrictions and regulations it becomes

difficult to succeed. Changes in long-term growth rate and restrictions and regulations

are two of the driving forces in the industry that are making it difficult for companies

to experience sustainable profitability.

B. Effect of Competitive Forces

The competitive forces in the industry play a major role in whether or not the

industry is going to be profitable. As shown in the Exhibit 2, the competition among

rivals is strong in the industry and is causing the industry to lose profitability. With

high initial profits and low start-up cost many companies are entering into the industry

and saturating the market. On the other hand, the restrictions and regulations by the

federal and state governments are the main reason it is difficult for companies to

produce long-term success.

C. Effect of Driving Forces

The driving forces in the industry give a mixed idea of whether the industry is

likely to be profitable in the long run. The increased demand to receive immediate

gratification has caused a boom in the payday loan industry and it is why the industry

has its current success. Banks and credit unions have also had a positive effect on the

industry. While they offer substitutes to payday lending, the decision for most banks to

discontinue their lending of small, short-term loans has given opportunity to

companies like Cash Connections to gain an advantage in the industry.

On the other hand, the restrictions and regulations have caused the payday

industry to be a less attractive industry. Profits will likely suffer as a result of

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increased protection of the customer from the lending service. The change in industry

growth rate has also caused the industry to look unattractive and high profit margins

will be harder to come by because of saturation of competition.

Exhibit 6: Current Strategy

A. Overall Strategy:

The current strategy of Cash Connection is based on providing a substitute

banking system to the lower class and the lower middle class. Cash Connections offers

quick cash loans that help hold people over until their next paycheck. By solving these

key issues that traditional banking systems do not address toward lower income

Americans Cash Connection can find loyal and satisfied customers. Establishments in

the payday loan service industry have been very successful in offering quality

assistance and have received an over satisfaction rating of 75%.

B. Services Segment:

The two main services that Cash Connection offers to its customers are check

cashing and payday advance loans. The first service is simple. Customers bring in a

check and they are charged a flat rate to turn their check into cash. The other core

service offered by Cash Connection is much more lucrative. Anyone who has a

checking account and a pay stub showing your current income can qualify for a loan of

up to $500.

Cash Connection started out small focusing on its two core competencies

however in order to continue to find ways to better serve this market Cash Connection

has expanded its basic services to also include bill payments, prepaid phone cards,

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money orders, and money transfers. This differentiation has helped Cash Connection

reach out to new customers and establish credibility.

C. Payments Segment:

Loans offered by Cash Connections typically only last 2-4 weeks or until the next

payday that the customer has. When the customer gets the cash they write a post-dated

check for the amount plus interest that is to be cashed at the end of the loan. If it is a

$100 loan an average number would be around 15%. That is around 391% APR.

Although this is very high this has one of the lowest yearly APRs in regards to quick

cash loans especially compared to bounced checks and credit card late fees.

If a customer can’t pay back the allotted amount in time they can choose to roll the

amount over for an addition $20 per $100. This system that Cash Connections uses

boasts more than three quarters satisfaction with their repayment schedule and the

ability to refinance or renew the loan.

Exhibit 7: SWOT Analysis

Figure 4: SWOT Analysis

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Resource Strengths Resource Weaknesses

 They can provide small convenient
short term loans.
 Has provided significant contributions
to the U.S., state, and local economies.
External Opportunities
 Has only penetrated half of its potential
market.
 Cannot loan amounts over $500.
 The government is trying to gain more
control on financial institutions,
including payday loans establishments.
 Their strategy can be copied by rivals
 Decline in Net Income
External Threats
 Other payday loan establishments.
 Banks and Credit Unions that have
found ways to differentiate themselves
 Credit Cards

Resource Strengths

 Provide small short term loans: They provide short term cash loans that are

paid back the borrower’s next payday. High interest is charged for these loans,

usually $15-$20 per $100 loaned. But, these loans are normally quick and

convenient unlike loans from other financial institutions.

 Provides significant tax money to national, state, and local governments:

The total labor income impact of payday loan establishments in 207 was $6.4

Billion. This figure helped to generate over $2.6 Billion in taxes to national,

state, and local governments.

Resource Weaknesses

 Cannot loan amounts over $500: Two states Georgia and Maryland do not

allow payday lending. But, those states that do have limits on the amounts that

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can be loaned. Most states set a limit of $500 for these loans. There are

several other regulations that states place on payday lending services as well.

 Governmental Control of Financial Institutions: State and local governments

often do conduct examinations to ensure that the payday lender is complying

with the regulations it sets. Twenty two states limit rollovers, and another five

states limits the rollovers to just three times. Also, some states limit rollovers

based on who has received debt counseling. State laws often times prohibit

lenders from seeking criminal or civil action against the borrower if he or she

does not complete the payments on time.

 Their strategy is easily copied by rivals: There was a boom in the payday

lending industry in the 1980’s due to a relaxation in federal restrictions. This

along with increasing regulations in the loan industry has made payday

lending highly advantageous.

 Decline in Net Income vs. Increase in Returned Items Expense: The figure

below shows how net income has steadily declined over the last three years

and how the returned items expense has gone up significantly each year. Net

income has fallen by 80% since 2007 and returned items expense has risen by

117% since 2007. It seems Cash Connections is losing their ability to produce

a profit. With the financial czar looming over them, they need to be

performing at the highest possible levels to withstand the regulations to come.

The returned items expense is something they should easily be able to fix. In

the payday loan industry every customer is a risk, but as a company you must

be smart as to who you are going into business with. Performing a background

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checks on a customer’s financial situation should help reduce the expense for

bounced checks.

Figure 5: Net Income vs. Returned Items Expense

Net Income Decline vs Returned Items Expense

Increase
$1,600,000
$1,400,000
Net Income
$1,200,000 Returned Items
Expense
$1,000,000
$800,000
$600,000
$400,000
$200,000
$0
2007 2008 2009
Year

External Opportunities

 Has only penetrated half of its potential market: There are estimates that 5%

of the U.S. population has taken out at least one payday loan. Reports say that

24 million Americans or 10% of the population say that they would be likely

to take out a payday loan. Based on these figures the payday loan industry has

only tapped 50% of it potential market. Cash Connection has the opportunity

to expand its business further through these potential customers.

External Threats

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 Other payday loan establishments: Cash Connection must be sure to keep

other payday advance lenders from stealing their business. In order to

accomplish this they must differentiate themselves from the competition.

 Banks and Credit Unions: Bank of America, Wells Fargo, JP Morgan Chase,

and Citi Group are all major retail banking firms and all are serious players in

the loan serving industry. These companies have the capability to generate a

portfolio of serviced loans. Other companies find it hard to purchase loans

from third parties, and generate their own loan servicing portfolios.

 Credit Cards: Credit Cards are the most common form of short term credit

used by Americans. There are over 100,000 credit cards transactions every

minute.

Exhibit 8: Financial Analysis

Figure 6: Financial Analysis

2007 2008 2009

Total Income $6,348,544 $6,283,860 $5,768,805
Net Income $1,336,617 $342,689 $271,961
Total Expenses $5,011,927 $5,941,171 $5,496,844
Returned Items
$389,147 $690,003 $847,310
Expense
Net Profit Margin 21% 6% 5%

A. Financial Analysis

Cash Connections current financial situation does not look good. As shown in the

table above Cash Connection’s net income has decreased by about 80% since 2007. It

is not producing enough money to cover the long list of expenses that the company

has. The company’s net profit margin has been affected significantly, and with such

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slim margins, it will make it difficult to compete when the regulations and restrictions

keep piling on. The returned items expense or the bounced checks that they have

incurred over the last three years have increased by 117% since 2007. This means they

are not collecting the payments on the loans given out due to bad checks. The alarming

rate at which returned items expense are increasing and the rate at which net income is

decreasing is something that needs to be addressed. With the amount of competition

in the industry, there is no room for slim profit margins because with the increased

emphasis on stricter regulations, companies will fail if they are not financially sound.

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