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Strategy: The U.K. Credit Card Industry in The Late 1980's

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1. Why had the UK credit card industry been so profitable in the 1980s? Which factors were the greatest threats to continued profitability?

At the beginning of the credit card history in the UK there was only one player, Barclays Bank, which started operating the card business in 1966. It didn't seem a profitable business at the beginning but the major banks were concerned that due to the use of the credit card, the logo of Barclay was appearing everywhere. The main sources of income in the credit card business were the interest paid on debt by the cardholders and the MSC income from the merchants. It also provided a free publicity for the Banks, creating awareness of its presence in different businesses and stores.

The advantages for the usage of the credit card are numerous. For the cardholders it was a source of flexible credit, and for the full payers it represented a credit of 55 days free of interest. It also made easier purchase through cashless transactions (promoting instantaneous purchase decisions), benefiting the merchants with an increase in their sales. For the merchants it also represented a reduction in the costs associated with the handling of cash. All these factors lead to an increase in usage of credit cards in the 80's (growth of 19.1% per year); it increased the number of card issued, the number of transactions and the average outstanding debt. By 1988 38% of the UK population had a credit card, representing 6% of consumer spending. With the four biggest banks in the UK (Barclays, Lloyds, Midland and Natwest) controlling the market at both sides (being issuing banks and Merchant Acquirer), the business was very attractive.

However the attractiveness of the market (in terms of growth and profitability) and the low barriers to entry became a threat to these major players. Comparing the cards in circulation for these four banks, in 1984 they controlled 81.4% of the total number but by 1988 the number decreased to 73.5% (a 9.8% decline). Comparing the debt outstanding and the number of transactions, the decrease from their share was around 7%. The banks were suffering competition not only from small banks, but from big stores providing their own credit cards, and by the threat of American Express and Dinners Club entering the market.

The sources of income were affected due to the increase in the competition with reduced MSC fees, lower interest rates to cardholders and by an increase in the number of full payers (reducing the debt outstanding).

2. Should the industry move to a pricing structure with annual fees?

Given the changes in the industry, the decreasing interest rates, the changing habits of cardholders, and the reduction of the MSC fees, the introduction of the annual fee seems and interesting alternative.

Previously the primary source of income was the outstanding debt; however the cardholders were reducing their balances, reducing the income for the banks. The fees will provide the banks with a fixed income. It will also let the banks collect money from the full payers (46% at Barclays and 37% at Lloyds in 1988) that were using the free credit without cost.

The impact would need to be measured in the customers. With a fixed fee the credit card will become less appealing to some but it can be adjusted with a lower interest rate. The reduce in the interest rate might also benefit the banks from an increase in the outstanding debt if cardholders start using more credit due to lower rates, and if the amount of interest paid over higher outstanding balances exceeds the forgone revenues from the reduced rates in the previous lower balances.

Another advantage for the banks introducing annual fees, and reducing the interest rate is that they might be able to find out which customers were the most profitable. With this in mind they might offer special packages to retain these customers.

The competition in the UK banking system is described as civilized, and looking at the Exhibit 3 from the case, it seems that the major banks



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