Capital One: Isn't There More To Life Than Plastic?
Standing in front of more than 200 Wall Street analysts last month, Richard D. Fairbank launches into his sales pitch. Top executives of Capital One Financial Corp. (COF) have already explained how the Falls Church (Va.) issuer of Visa and MasterCards managed to weather the rising interest rates and unprofitable promotions that have waylaid its peers since last summer.
Now, chief executive Fairbank has a much tougher task: Persuading this crowd to stop thinking of Capital One as just a credit-card company. Pacing across a ballroom stage at Washington's Four Seasons Hotel, Fairbank tells the analysts that Capital One has found a perfect new home for the innovative techniques it uses to identify new selling opportunities: the Internet. Linking its terabytes of data on consumers' credit and spending habits with the Net's interactive shopping, Capital One wants to lead a revolution in how loans, insurance, phone service, and a host of other products are sold. "We have a tiger by the tail!" Fairbank declares.
It's a bold promise. But can Capital One--which was spun off from Signet Bank in 1994--really take its act beyond credit cards? After all, the Internet push isn't the first time Fairbank has told Wall Street about sweeping plans to diversify. Just three months ago, Capital One was forced to retreat from an attempt to target customers for cellular phone service sold by its America One Communications Inc. subsidiary. Moving into a market it didn't know as well, Capital One failed to anticipate price wars among big wireless players that drove the price of airtime down by 55%. Instead of setting the stage to expand into a wider range of products, the effort cost Capital One $66 million in the first three quarters of 1999.
CUSTOMIZATION. But if that failure has chastened Fairbank and his co-founder, Capital One President Nigel W. Morris, they surely don't show it. The company has scaled back its move into wireless, and it is now heading on to the next big thing. Indeed, the pair argues that the shift onto the Internet is the logical extension of the strategy Capital One used to rewrite the rules in the credit-card industry. Since they teamed up and began applying data-mining techniques to develop "mass-customized" credit cards for Signet Bank in 1988, Capital One's top executives have relentlessly studied how different classes of customers respond to everything from annual card fees to the color of the envelope used for mailings. This data drives finely calibrated decisions on the rates, fees, and conditions to charge each customer. All told, Capital One pitches 7,000 different MasterCard and Visa variations--right down to cards printed with your snapshot.
To produce that constant stream of new products, Capital One will run 40,000 separate product experiments this year. Sometimes, this research opens whole new markets. Card companies mail heavily to college students, but Capital One was first to discover that the industry's mailing lists covered only one-third of the college population. By applying its profile of students to other mailing lists, Capital One discovered that many seemingly risky prospects--young, unemployed, with little credit history--were in fact highly coveted potential customers. These overlooked students hadn't seen many offers tailored to them, so they responded eagerly to Capital One's mailings, returning 70% more applications than the overworked student lists produced.
Just as important, data-mining has helped Capital One avoid customers who don't pay. It posts the industry's lowest rate for bad-debt charge-offs--3.88% of loans outstanding at the end of the third quarter, vs. a 6.2% industry average. The result is an earnings juggernaut. Capital One racked up 29% average annual earnings gains for the past three years--to $275.2 million in 1998 on operating revenues of $2.8 billion. The stock, meanwhile, has soared. From January, 1995, to its May high of 60, it grew nearly tenfold. Although market jitters dragged it down to 36 on Oct. 15, it has since bounced back to around 50.
The rebound came largely because Capital One dodged last summer's credit-card crunch. For two years, the company had been moving away from the high-cost, high-turnover middle market, where cards are promoted with low introductory rates. When interest rates took off last summer, issuers such as Bank One Corp.'s (ONE) First USA were still flooding mailboxes with superlow--and ultimately unprofitable--teaser rates. Capital One, however, was drawing more than 30% of its loan volume from affluent "superprime" borrowers and 20% from "subprime" borrowers with limited or damaged credit histories.
NEW MOVES. Of course, plenty of card companies have lost money serving those customers. Superprime customers can command profit-squeezing low interest rates, for example. Capital One's best offer is a fixed 9.9%, with no annual fee, plus air miles. But Morris says: "You can make a profit on a 9.9% card if you know for certain who you want to give it to." The company uses its data to ensure that superprime cards go to heavy chargers, who generate merchant fees to make up for low interest income. And while many subprime borrowers rack up larger-than-average credit losses, Capital One claims it is able to use careful credit screening and flexible terms--such as low credit lines and partially secured cards--to limit risks.
Yet for all the success so far, Fairbank and Morris know they must move beyond the crowded credit-card market to keep the growth up. And despite the troubled first attempt at diversification, the duo are anything but humbled. They insist that their marketing techniques weren't the problem. The cell phone market shifted so sharply--as big players blitzed each other with massive discounts and heavy advertising--that America One just got overwhelmed, says Elliott Hamilton, senior vice-president of telecommunications researcher Strategis Group: "The carriers' falling airtime prices wiped out the narrow margins that resellers depended on." America One now focuses much more narrowly on lower-income cell-phone users.
Wall Street has been forgiving, citing Capital One's record of low financing costs and relentless product innovation. Analysts surveyed by First Call Corp. agree with Capital One's projection of 30% higher earnings this year, to $357.8 million. First Union Capital Markets projects 1999 operating revenues of $3.2 billion, up 17%.
Fairbank and Morris say that their trademark slicing and dicing of data is already working on the Internet. The company recently became the second-largest Web issuer of credit cards. That's still a small part of its card business, but in coming months, Capital One will roll out a host of online financial services. "They're farther into the Internet than anyone thought because they've been doing all their testing behind the curtains," notes Anna Dopkin, an analyst at T. Rowe Price Associates Inc., which held nearly 2.6 million Capital One shares in its various mutual funds as of June.
PLAYING CATCH UP. But as it takes its Web strategy from testing to production, Capital One faces serious hurdles. Fairbank and Morris admit that Capital One lacks the brand-name recognition needed to draw customers directly to its Web offerings. "Half our customers think we're either Visa or MasterCard," says Fairbank. He says the company will make a heavy push into Web, print, and TV ads next year. Its new ads in Britain, where Capital One and other U.S. issuers are rapidly taking over the card market, don't even mention MasterCard or Visa.
Moreover, competitors are already crowding the Net with financial services. Startups like E-Loan Inc. (EELN) and Telebank (TBFC) are slicing off specialized segments. Capital One's bigger challenge, however, is keeping up with established players like American Express Co. (AXP) and Citigroup (C), which are already rolling out full-service Web sites with products ranging from checking accounts to online-only credit cards. "Capital One is one of the strongest companies in the credit-card lending niche," says Kenneth A. Posner, financial-services analyst at Morgan Stanley Dean Witter. "But it's a long way from creating a full-service financial portal on the Internet."
Fairbank and Morris argue that their company's enterprising culture will speed them past the financial behemoths. The two men, who met in 1985 at Mercer Management Consulting Inc., have created an informal atmosphere more akin to a high-tech startup than a bank. The constant innovation Capital One fosters will capitalize on the Internet's rapid product distribution, they say, to extend the company's expertise in customized products. At its Web site (www.capitalone.com), a card applicant can already get 60-second approval--and soon will get a card number assigned instantly by e-mail. The company has sold $3.6 billion in certificates of deposit on the Web. Bill payment, checking accounts, and ATM cards should arrive by mid-2000, along with CapitalOnePlace.com, a shopping site for financial and other products. Customers will get MyOneWallet.com, a "digital wallet" which will speed shopping by instantly filling out Web retailers' order forms.
These products aren't entirely new--wallets in particular are proliferating on the Web. And in some respects, Web customers are riskier. Those who seek out cards via the Web default twice as often as do those selected via a mail or phone pitch. But Fairbank thinks Capital One can sell a wider range of products online. And the company vows that its push to build a full range of Web products won't slow earnings growth. Fairbank and Morris may be sitting down to a whole new card game, but they refuse to pull back on their bets.