Value-Based Card Pricing vs. Cost-Based/ Market-Based Pricing

While some card issuers are offering special cardholder price discounting – no fees, low interest and balance transfers to raid competitors – none of these are really new initiatives.  Given the lowering of outstanding card loans which many have suffered, we are surprised only that these strategies weren’t implemented far earlier.

This current round of price discounting, however, has less to do with the economics and pricing fundamentals of the business than it does with market share strategies by those card issuers who need to build outstandings.  That goes for large scale, medium size and small card issuers alike.

P/L “Effectiveness Rates” of
Most Popular Credit Card
Pricing Models, 1980 – 2013

•   The industry has gone through three primary pricing cycles:       cost/market/& value-based.
•   Why would you use 1980’s cost-based pricing as your model today?
•   The card industry must begin to use a “Value-Based” pricing model which,
when combined with cost & competitive models, is up to three times
more effective than earlier pricing programs.        Source:  R.K. Hammer/Card Knowledge Factory®

Card ROA Volatile

Due to the high-risk unsecured nature of the credit card product and cautious consumers’ spending patterns, it is clear to many that you can’t make enough money on interest income alone to sustain profitability (which is already under competitive fire).  Card profits, which are often described as “hefty” by some outside observers, are really not that high relative to the risk assumed, and in fact have fallen sharply over the past several years, from 4.25% ROA in 2008 to 2.10% in 2010; only in 2011 and 2012 has the card ROA finally risen to more normalized levels:  3.00% and 3.35% respectively, with a 2013 forecast of 3.65%.

In the distant past, issuers priced products on what we would call “cost-based” models, and later, market-based, pricing models.  Cost alone, however, is only one component of establishing price.  One reason industry profits have come under the gun lately is precisely due to that blind focus on costs to set prices, some of which have declined (cost of funds, for example).  This set up the industry for the recently unleashed attack on cardholder and interchange pricing, often citing lower/falling transaction/operating costs.

Pricing Model Shifting Again

It has been our contention for many years that we should focus not only on costs or competition, but on the inherent value that the product delivers – what we term “Value-Based” Pricing.  You cannot give away a valuable portion of your product mix and make it up in volume; yet that is what we’ve done for years with grace periods, limited use of transaction fees, enhancements and other components of the credit card business model.  We are fast approaching what some call the “end-game,” where every move could be your last.

As necessary investments in decision-sciences, scoring and expert system improvements continue to show the incremental earning gains previously predicted, issuers are going to have to again contend with being bashed.

If the card industry insists on continuing to use “Cost-based” or “Market-based” pricing alone, at the expense of “Value-based” models which should also be used, at least you won’t have to ask what that loud cracking sound it…it’s the thin (financial) ice breaking up under our feet.

More News