Citi and Amex: Plastic Fantastic?

The financial titans hope their co-branded cards win over better-heeled, prompt-paying consumers. It may not be so simple, however

Until American Express (AXP ) struck an agreement with Citigroup (C ) on Dec. 13 to issue high-end credit cards in the U.S., never had a pair of powerhouses with the two of the most recognizable and valued brands in financial services agreed to do business on a similar scale. Otherwise-hot competitors in the global market for credit-card and other financial services, Citigroup and American Express announced that they'll join forces to issue co-branded cards by the end of 2005.

Citigroup is the largest U.S. credit-card issuer, with about 105 million cards in circulation. "The Citibank deal is obviously a landmark...both parties see strong benefits in working together," American Express Chief Executive Kenneth Chenault told BusinessWeek Online. "The associations [Visa and MasterCard] have said for years that if their bylaws weren't in existence, banks would not issue on our network. That was obviously ludicrous."


  American Express, with 39 million U.S. cards and 60 million worldwide, has been free to partner with U.S. banks since Oct. 4, when the U.S. Supreme Court opted not to hear Visa USA and MasterCard International's appeal of the government's antitrust lawsuit against them. With the six-year case brought to a close, the $2.1 trillion card industry would be changed forever, analysts said.

In January, MBNA Corp. (KRB ) became the first to sign with American Express, even before the court's ruling. The Wilmington (Del.) bank started converting some of its 50 million cards in November. Citigroup now becomes the second outfit to see the benefit in creating a spending venue for customers, especially the high-spending variety who pay up each month.

The merits of such a deal weren't always so apparent. Citigroup executives said earlier in the year that while AmEx had approached them about a partnership, such a move went against the New York-based bank's strategy of building its own brand. Since then, Citi, the world's largest bank in terms of profits, appears to have scuttled its own plan to build a transaction network. Instead, it has struck a deal with MasterCard -- a pact that will put MasterCard holograms on Citi's high-end Diner's Club by yearend, tripling the merchant outlets where it's accepted to 24 million.


  Perhaps to soften the blow to rival MasterCard and Visa, which are now exclusive issuers of Citi cards, Citibank issued only a written statement and declined to provide executives to discuss the new arrangement. "We're looking forward to the new relationship with American Express, and we're committed to providing the same high-quality Citi products and services to Citibank card members using the American Express network that we provide today to all our card members," the statement said. "This agreement will bring together two highly successful and internationally recognized brands."

Citibank will issue the cards, manage the customer relationships, provide service, billing, and credit management, as well as design the card-product features. American Express will process transactions on its global merchant network. Details about how and to whom the cards will be issued were not made available.

The agreement underscores American Express' business model as a network geared toward processing transactions for high-spending customers, analysts say. "There's a lot less risk to processing a transaction than lending money on a credit card. They're building a network-based business model that's much more valuable than it was before," says Kyle Cerminara, a financial services analyst with T. Rowe Price Associates in Baltimore.


  The deals likely couldn't have come at a better time for AmEx and other rival networks. Over the last decade, Discover cards, a unit of Morgan Stanley (MWD ), and American Express have seen their market share of U.S. signature-based cards fall from 16.5% to 10.5%, while Visa's share has held steady. Those 6 percentage points went to MasterCard, according to The Nilson Report, an industry newsletter.

"American Express and Discover are losing market share, and the opportunity that they have to sign distribution deals with financial institutions comes at the 11th hour," says Nilson Publisher David Robertson. "In the short-term, this is a fresh brand they can market, and fresh is good. But if you look down the road, merchants are becoming more and more aggressive and telling card companies they aren't going to pay more and more fees ad infinitim."

Rather than pay American Express' higher fees, merchants want to aggregate as many sales as possible on a single card brand to take advantage of discounted interchange fees based on sales volumes, says Robertson. Still, if "more consumers are going to be carrying the American Express cards, more people are going to demand that merchants accept it," says T. Rowe Price's Cerminara.


  Besides trying to lure new customers to a network that lacks the same number of merchants and retailers as that of rivals, American Express faces other hurdles. In early November, MBNA and AmEx launched the first MBNA Affinity Rewards American Express-branded credit cards to members of more than 1,000 affinity groups. To date, MBNA has already issued more than 300,000 American Express-branded cards.

Yet some customers have bridled at having the new cards substituted for the old, especially since fewer venues and merchants accept them. MasterCard issued a statement on Dec. 13 saying "this kind of experimentation is to be expected. The real test will be how much traction these programs get over the long term. As evidenced by the consumer complaints that have been the subject of media reports over the last several weeks, experimental programs with American Express have thus far proven to be neither innovative nor a win for consumers."

Chenault would not discuss what lessons were to be learned from the first bank-branded cards, but analysts believe that Citi, in light of the revelations of the MBNA launch, will take a more cautious stance. "Citi has a stronger brand than MBNA," notes Bruce Cundiff, analyst with San Francisco's Jupiter Research. "Brand is and has been very important to Citi, so I think they are going to be very selective in the portfolios they migrate. They'll be more careful than MBNA...they'll go for more polling of customers and allowing them to opt-in."


  Partnering with banks isn't all Chenault has been up to since the court ruling. His company filed a lawsuit in U.S. District Court in Manhattan seeking unspecified monetary damages for business lost as a result of the associations' bylaws, which for years prohibited U.S. banks from issuing American Express cards. Named in the suit: J.P. Morgan Chase (JPM ), Bank of America (BAC ), Capital One (COF ), US Bancorp (USB ), Household Bank (HTB ), Wells Fargo (WFC ), and Providian National Bank (PVN ) -- among the largest issuers of U.S. credit cards. Conspicuously absent from the suit were the two banks AmEx has now struck deals with, Citigroup and MBNA.

Indeed, AmEx said it won't seek damages from MBNA and has agreed to reimburse MBNA for certain costs that may be imposed by MasterCard or Visa as a result of this suit.

Now that two of the biggest card-issuers are on board with American Express, it puts competitive pressure on other banks to sign on. Next convert? Observers are putting their money on J.P. Morgan Chase, which has 92 million U.S. cardholders that American Express would like the opportunity to court.

Der Hovanesian is Finance & Banking editor for BusinessWeek in New York

Edited by Beth Belton

    Before it's here, it's on the Bloomberg Terminal. LEARN MORE