What credit card legislation means for online retailers

On Friday, President Obama signed legislation that seriously impacts how credit card companies can market and manage consumer credit cards. The legislation introduces new and far-reaching protections for credit card borrowers, but these protections aren’t “free,” at least in economic terms. They will, in fact, be purchased by substantial revisions of how credit card companies do business and, as a result, how consumers are able to use credit.

Ignored in all this are how the changes in card-based consumer credit will affect businesses, such as online retailers and traditional catalogers, that rely almost solely on consumer credit card transactions. Which remote retailing businesses should be worried? What can they do now to lessen the pain?

In as summary form as possible, the legislation seeks to protect consumers by making credit card charges more transparent and managable by cardholders.

On the one hand, credit card companies on the one hand are required to be more open and transparent regarding late fees and more truthful in marketing pitches. On the other, they are required to make managing lines of credit easier and more efficient for payers. For instance, they must now apply principal payments against the highest interest-bearing principal (rather than the lowest). This means, of course, a higher level of transparency about the principal tranches and the interest each bears.

The primary effect of the legislation as written will be to reduce the card issuer’s income. Unless they find some other way to bleed money out of cardholders (such as annual fees) or save money (such as reducing promotional perks), card issuers are going to have less money in their pockets. Over the years, they will find themselves charging lower interest rates and imposing fewer penalty fees. In addition, the increased transparency will, theoretically, produce at least some improved payers, which means less rolling credit and, yes, less income (the better a borrower pays, the less money the card issuer makes).

The million dollar question for remote retailers is this: how will this affect the availability of consumer credit? Will card issuers start closing the spigot? Or will they find other ways to make up these (potential) losses?

Well, first, no-one has a good guess as to how much card companies stand to lose. They will certainly find other ways to make up for this lost income by either charging new fees (including a return to annual fees) or reducing the perks they offer.

But the real question is how much all these ill-gotten gains in high interest and predatory fees actually financed credit risk across the ever-increasing gamut of consumer borrowers.

At the one extreme, the high interest and rapacious penalty fees were simply enough to offset the risk posed by extending ever larger lines of credit to ever worse borrowers. If so, then the legislation will result in lower credit lines across the board and entire classes of borrowers being shut out entirely — in other words, a credit card world that looks more like 1977 rather than 2007. In this case, a veritable army of borrowers are in line to have their credit lines cancelled outright and converted to term loans. And that, obviously, is bad, bad news for remote retailers and online services.

On the other extreme, the extra income card issuers squeezed from high interest rates and shocking penalties was substantially in excess of higher credit lines to ever-increasingly risky borrowers. At that extreme, there will be a much more contained squeeze on credit. Card issuers will see their income decline, but the status quo will easily stand as is for the majority of borrowers. However, risky borrowers will see their credit lines diminish and a few will lose the card entirely. In the long run, however, credit card companies will solicit fewer bad borrowers. Those effects will be felt by online retailers, online services, and catalogers for years to come.

At either extreme, there is a squeeze coming. It will be tightest on the low end of the market, but it may even affect the top end of consumer credit, as well.

And, in the simplest possible terms, if the legislation produces more informed and discipline payers — even a small percentage — this will squeeze remote retailing.

Put another way, the credit card legislation threatens to end the “bad payer feast” that card issuers have enjoyed for the last decade or more. High interest rates, predatory penalty fees, and lax marketing rules allowed credit card companies to turn bad borrowers literally into ATM machines. Now, in a normal, rational world, bad borrowers are bad business for lenders. But in the brave new world of credit card chicanery, bad borrowers slowly morphed into the best kind of borrowers, often, when all is said and done, paying multiples of their original principal.

Whatever you think of it, this new credit business model made possible the explosion in remote retailing — catalog and online. It created entire classes of remote consumers and gave them the wherewithal to join the revolution. Like credit swaps, put options, collateralized debt obligations, and subprime mortgages, bad payer credit cards (and the high interest rates and troops of penalties that came with them) made possible an entire consumer revolution.

And now, as they say, the bill has come.

So, in any scenario, online and direct mail retailers will see some kind of squeeze, but the ones that will hurt are retailers who serve:

  • Teenage and college-age consumers: among the riskiest of borrowers, teenagers and college-age consumers (in fact, anyone under 30) form the bread-and-butter of many online businesses. They will be the first to be squeezed out if the new legislation reduces card issuers’ ability to finance the highest risk borrowers.
  • Impulse buyers: all consumer purchases are technically impulse buys, but some are more rash and impetuous than others. Retailers who depend on consumers making snap, uninformed, and impetuous purchases are targetting exactly the people who gravitate towards the red zone in terms of risk. A surprisingly large number of online retailers (a percentage are simply scam artists) feed their family by selling impetuous purchases to thoughless consumers, but the wherewithal to fuel those purchases will be drying up over the next few years.
  • Subscribers: The subscription pricing model is one of the most practiced and abused pricing strategies in online marketing. But every subscription model has two tiers of customers: those that are aware of the monthly charges and those that aren’t. Some of the less ethical folks — such as freecreditreport.com — depend on these credit card billings flying under the consumer’s radar, so their biggest source of income is the second tier of customers that ignore monthly charges to their card. (But all subscription models make money off of the second tier of “ignorant” customers — that’s part of the business appeal.) However, increased transparency by the card issuers may threaten this model by bringing these monthly charges more into the payer’s view — in fact, by even thumping up against newly imposed limits. In addition, those “second tier consumers,” the ones who don’t monitor charges to their cards (or don’t do anything about it), are more likely to be bad payers, as well.

    Even without the legislation, consumer credit is being seriously squeezed. All it takes to confirm this is a simple trip to your mailbox. Synovate estimates that in the first three months of 2009, credit card companies sent out 372.4 million credit card offers. In the same three months of 2008, they sent out over a billion offers (1.131 billion, to be precise). That’s a drop of almost 70%, which is a number that’s going to reverberate in the online and catalog world for years to come.

    All this means that remote retailers who depend on the consumer groups or pricing models above should give serious consideration to remodeling their marketing or pricing model. They should aim at increasing the percentage of older, more professional, and more responsible consumers. The impulse buy model will suffer, particularly one directed at a younger audience, so online retailers and service providers should seriously consider more relationship-based models of interacting with consumers.

    There is, as I always say, no situation so bad that it can’t be made better than the best situation you can imagine. So now’s the time to seriously examine your online or DM sales model along all its strategic vectors.

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  • One Response to “What credit card legislation means for online retailers”


    1. […] In a previous post, I discussed how the new credit card regulations would affect small businesses and entrepreneurs, but solely from the customer side. But not only has the recession squeezed small business from the demand side, it’s actually tightening the noose from the supply side, as well, since so many businesses use credit cards for what amounts to short-term business loans. And, as outlined in today’s New York Times, the credit card squeeze is having a signficant effect on the economies of small business and startups. […]

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