Raising the Roof on Credit

Question:

Mike is the CEO of a credit card company known as BIG Bank. BIG Bank issues standard credit cards with a rate of 19 percent to prime-rated customers. For years, all of the company’s competitors also issued cards with a 19 percent rate. However, now BIG Bank is faced with a challenge. Mike just read in this morning’s newspaper that his biggest competitor, ABC Bank, has lowered its credit card rate to 15 percent. Mike immediately calls your consulting firm seeking a solution. As a consultant, what is your take?

This case will likely require some number crunching, but you need a lot more information. A great way to approach a case like this is to start with an appropriate general framework and work your way down to the calculations (likely some sort of break-even analysis or profitability impact calculation). Since we have some information about competition and customers, we will start with the Four C’s framework. Don’t forget to state all of your assumptions clearly at the very outset, consider marketing and implementation issues, and provide suitable recommendations.

Candidate: Well, I’m surprised Mike had to read about this change in the paper! Let’s start with the competition, which seems to be the most important issue given ABC’s announcement. Who are the other competitors in the market, and what are they expected to do?

Interviewer: While there are many competitors, including banks and finance companies, BIG Bank and ABC Bank are the two biggest in the industry. Both are well entrenched in several regions throughout the country. The indications we have received so far is that no other competitors have reacted so far. In all likelihood, they are waiting for us to react in some manner before doing something on their own.

The CEO’s reply implies that the rest of the competition is not a major concern at this stage, so you can effectively ignore that issue.

Candidate: What are the financials of the competitor, ABC Bank?

Interviewer: Specifics are not available. However, we know they are similar to BIG Bank. ABC’s financial statements indicate similarity in cost structure.

You can assume that a lot of the financial information you gather for BIG will apply to its competitor.

Candidate: Is ABC’s credit card any different from the one that is offered by BIG Bank at 19 percent?

Interviewer:  There are no substantial differences. Both of them offer similar benefits.

Candidate: What other products does ABC Bank offer?

Interviewer: ABC’s products are similar to ours.

Candidate: That’s probably enough information about the competition for now. Let’s move on to the customer base. Who are the customers? Have you tried to target specific customer segments in different regions?

Interviewer: The customers are prime-rated credit card holders who maintain an average account balance of $2,000. There are 100,000 customers. We have not targeted any specific customer base.

Candidate: While we’re on the topic of customers, what can you tell me about the revenue BIG’s customers generate? What other sources of revenue are there?

Interviewer: Interest on account balances is the only source of revenue.

Candidate: Since we just talked about revenues, let’s move into costs. What are the expenses of BIG Bank?

Interviewer: Cost of funds is 6 percent of average account balances, general and administrative expenses are 3 percent and losses are 4 percent.

Candidate: Are there any immediate opportunities for cost reduction at BIG? Are there any economies of scale? Do the costs decrease when we get more customers?

Interviewer: We continuously look for cost reduction opportunities and there appear to be no significant opportunities at this time. No, there aren’t any economies of scale.

Candidate: That’s a lot of useful information. Let’s touch on capabilities before we move onto some calculations. What is our competitive situation in terms of systems and organizational structure?

Interviewer: Both BIG and ABC use industry standard computer systems, and there is no opportunity for significant improvement in the time frame that will affect the pricing challenge. BIG Bank is building a data warehouse. As far as the organizational structure, ours is very similar to the one prevalent in the banking industry.

Candidate: What advertising and promotion campaigns are planned?

Interviewer: The company periodically uses direct mail campaigns and will continue to do so. We send customers letters separately from their monthly statement.

Since you now have most of the information, you should start providing recommendations based on all the information you have gathered. Although recommendations have to be very specific, it is always better to provide several alternatives.

Candidate: All right, I would now like to take a couple of minutes to consolidate this information into a brief income statement. I would like to see how BIG’s financials look at the 15 percent rate.

Interviewer: That’s fine. Take your time.

You have a few ways to proceed at this point. You could present the information in the form of income statement tables or a straightforward P&L calculation. Moreover, you could take a moment to calculate things and then walk through them, or you could think through your calculations out loud for the interviewer.

Candidate: Basically, there are two scenarios. The company can either hold rates steady at 19 percent or it can match the competitor’s 15 percent rate. At 15 percent, we would lose revenue, but with a lower rate we would likely gain more customers. The question is how many. Based on the financial data, I have constructed a break-even analysis to determine how many customers we would need to retain our current level of income.

At this point, walk your interviewer through your income statement line by line. Beware! Some interviewers will pretend to not know what an income statement is, so be prepared to explain the income statement with exhaustive simplicity.

BIG Bank Income Statement Analysis

Screenshot_2017-07-02-13-07-29.pngCandidate: We can see that at the current customer count, switching to the 15 percent rate would result in about 66 percent reduction in net income. Therefore, holding rates steady at 19 percent is more profitable for BIG unless more than 66 percent of BIG’s customers leave. While BIG should obviously attempt to retain as many of its customers as possible, BIG Bank should be able to retain at least 34 percent of its customers to justify sticking with the 19 percent rate. I would recommend that BIG continue with the 19 percent rate while attempting to prevent customers from switching.

Interviewer: Those are some very interesting numbers, and your recommendation makes sense. But what are some ways we could prevent customers from switching to ABC? I bet that lower rate looks awfully appealing to most customers.

Candidate: There are a number of ways you could attack the problem. For example, opportunities could be identified using customer data to promote other BIG Bank products or products offered through strategic alliances with other companies. Promotional campaigns could be targeted at customers who are likely to carry a revolving balance. Promotional campaigns can also be carried out through the company web site or through your partners’ web sites. Other data-based marketing opportunities include customized mailings based on past spending habits, pre-approved loans based on life events such as marriage, birth of children and home purchase.

Interviewer: Those sound expensive.

Candidate: They can be, but there are ways to accomplish this at reasonable costs. For example, direct mailing involves additional expenditure in terms of postage costs and materials, so it would be better to have statement inserts, those little slips of paper we put inside customers’ monthly statements, which they return to us when they mail us their payments. Statement messages, a line or two of text typed on the remittance stub of each statement, might be effective as well.

Interviewer: Those are good ideas. What else?

Candidate: Over the long term, the company should consider using its data warehouse as a competitive advantage to segment its customer base and target those customers who are likely to be loyal. It’s possible that ABC is doing the same thing, so we might want to start this process in the near future. Data warehouse technology can also be used to mitigate risk by targeting customers who are unlikely to default. That said, while the data warehouse can be a competitive advantage, it will not solve the immediate challenge of a competitor who just lowered its price. But it will definitely provide information on how many customers will remain loyal to BIG Bank or switch to ABC Bank.

In addition, the company could diversify its product line by offering products to customers in different segments such as sub-prime borrowers and students. It could also offer Gold and Platinum cards to differentiate customers. Other benefits like airlines miles, temporarily low APR’s on transfers from other cards to BIG and auto insurance could be offered to retain loyal customers and lure new ones.

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