March 4, 2008
BankNews.TV is looking into the costs of starting a bank or launching a credit card in Canada. Why?
It’s simple. When a company like Canadian Tire shows 27% of its revenue accrues from financial services, it becomes easy to see why other companies will want to emulate their success.
Also, considering the current economic situation, where the big banks are reeling due, mainly, to large write-downs, some companies see this as a particularly good time to launch their own financial services.
StartaBank.ca, having run several workshops for potential de novo banks, has found that the number one question that always comes up is 'what is the cost?' While there is no one-size-fits-all answer, StartaBank.ca, due to its intimate knowledge of many different kinds of situations, is able to provide insight into the costs of starting a bank in Canada. It can also shed light on two other very “hot” topics—loyalty and credit card programs.
In order to be brief, this release deals only with two potential routes for companies wishing to fide their way into the banking field. In addition to those mention here, rest assured that there are many additional ways a company might enter the financial services game.
Common paths covered:
Option A, loyalty program with credit card;
Option B loyalty program with credit and other financial services such as insurance, deposit taking, GICs.
Each category is also further broken into subcategories which include:
Option A: white label (Affinity or Co-branded credit card) There are hundreds of loyalty programs out there and many ways these programs have been marketed. Typically these programs have been backed by companies like GE Money, MBNA (with the largest number of affinity programs), and other 3rd parties like CIBC which powers Costco and Shoppers/Pharmaprix card programs.
From a loyalty point of view these relationships have performed well, providing incentives and customer loyalty. They have also appeared to be flexible, offering, for example, 50% more points for own store shopping.
Advantages: instant loyalty program and no cardholder risks.
Disadvantages: issuers keep most of the profits, retailer relies on issuer for data who may be unwilling to share it, retailers are competing with the issuer who see their own cards as major profit centers or are able to offer richer incentives, cardholders often have several cards and use the one that offers the most benefits.
For example, Costco Amex offers 1.5% returns on purchases above $5K, while Amex offers 2% on purchases above 5K for its Gold Cash Back Card. It is often the case that customer data is not made available. It seems that both Costco and Shoppers are not satisfied with their relationship with CIBC.
Cost: customer acquisition costs for new cardholders in the US averages $170 US (Source: cardweb), and require competitive incentives which can either bear a cost or cut into retail margins. It is often the retailer that bears the cost of customer acquisition, but this can sometimes be negotiated.
Option A: joint venture
Recently, an aggressive new entrant has emerged in the financial service field, one that is willing to form joint ventures, offering innovative loyalty programs, sharing of data and much more. The cards make available all the same incentives as existing affinity and co-branded cards plus many additional benefits.
Advantages: instant loyalty program and none to minimal cardholder risk with potential for strong revenue sharing; possibility of acquiring the credit card portfolio at a future date. Retailer will not compete with the issuers own card program. A joint venture of this kind has lots of upsides and allows the retailer to share in what can be a very profitable revenue stream.
Disadvantages: risk that the partner FI does not perform, which will impact the retailer.
Cost: customer acquisition costs for new cardholders in the US averages $170 US (Source: cardweb), and requires competitive incentives which can either bear a cost or cut into retail margins. Depending on how the card is financed, the retailer can choose the risk level and relative reward structure based on its comfort level. Cardholder acquisition costs can also be negotiated.
Option A: becoming an issuer (e.g. Canadian Tire) Canadian Tire was the first credit card issuer that did not have a banking license. This would not be advisable as in the absences of a banking charter an issuer would not have credit insurance and this would increase the cost of capital significantly.
Option B: Owning a bank has become quite fashionable in today’s market. Wal-mart has made unsuccessful attempts in the US and also in Canada, but has opened a bank in Mexico and acquired a major retailer in the UK which offers financial services. Canadian Tire and PC Financial have also opened banks and both have been extremely successful at issuing credit and loyalty cards. In the case of Canadian Tire exceptional profits have been generated.
Option B: white label and/or joint venture with option to buyout It would be possible to white label the financial services of an existing bank with an optional buyout clause.
Advantages: minimal risk to the retailer, revenue sharing and the potential for a buyout option once the model is proven. Ability for retailer to continue to focus on its retail business and still have all the advantages available from offering financial services. Retailer would not have to obtain a banking license in initial phases but would have the option to do so in the future. Retailer could minimize financial risk and gain the expertise of the existing FI thus avoiding many common mistakes.
Disadvantages: possible risk to brand if FI does not perform; reduced profit if services perform well; possibly expensive buyout.
Option B: ownership
Canadian Tire (CT): CT uses its card program to generate loyalty and currently have 4 million card holders. They were the first non-deposit-taking FI worldwide to launch a MasterCard. Their current offer is to use their Gas Advantage MasterCard to offer fuel discounts of up to 10 cents a litre. Something highly appreciated in today’s society. They also have an options card that lets customers earn 1% rewards in Canadian Tire money. The Canadian Tire Money has long been envied as one of the most successful loyalty programs in Canada and it is now a part of the card awards program with their Master Card.
Canadian Tire Bank was established in 2003 as a wholly owned subsidiary of CT Financial Services (CTFS).
Profitability: As a division, CTFS have 4 million cardholders with an average card balance of $1,800. Their aim is to make their card the main card used by their clients and increase the average balance on cards to $2,500. Currently, their financial service division represents 27% of their bottom line. It appears that CTFS has not been as successful at generating deposits in their banking operations.
Cost to retailer of starting its own bank: CT having gained years of experience though prior work with financial services. They were expected to invest $10.2 million to launch the retail banking project in 2003 and hoped to be profitable within two years of its two pilot projects in Waterloo and Calgary. Recently it was announced that the company plans to spend about $28 million in its retail banking operation in 2008, up from $25 million in 2007.
Loblaws is powered by CIBC and has succeeded in gaining 3 million takers for its financial services. One of the main motivators for Loblaws was that they learned from their customers that they received loyalty points from a variety of sources which they really could not use day to day. PC saw this as an opportunity to improve their customer experience and the response to making this part of their loyalty program has been fantastic for them. They have 3 million members.
Profitability: Despite the support of CIBC and the reach of Loblaws, the project was initially losing $90 million per year. Through a turn-around effort, the division became profitable and recently reported profits of $52 million and $2 billion in receivables on their cards.
Advantages: Lower risk for retailer and the opportunity for the retailer to take advantage of the bank’s infrastructure such as ATM, support and capital. Retailer can also offer a compelling loyalty program, keep its profits and minimize risks. Time to market reduced because infrastructure already in place.
Disadvantages: possible risk to brand if the bank does not provide adequate service levels. Apparently PC Financial has several issues with CIBC at the moment
Costs to retailer: Initially it was losing $90 million per year
Summary:
There are many ways companies can enter the financial service industry, from launching a standard co-branded credit card to owning and operating a schedule 1 bank. The costs, revenue and risks can also vary widely. If you would like help analyzing how the economics could impact your company the StartaBank.ca team can help. Contact mark@banknews.tv today.
Sponsors of StartaBank include KPMG, Fasken Martineau, TELUS and Open Solutions (more)
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sales@banknews.tv
