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Risk reward – The challenge of market entry timing, Part 2

In a continuation of my previous entry, I’d like to take the concept of the first-mover and specifically discuss the relevance of this to the current bank card market.

Here are some statistics to set the stage:

• Q2 2009 bankcard origination levels are now at 54 percent of Q2 2008 levels
• In Q2 2009, bankcard originations for subprime and deep-subprime were down 63 percent from Q2 2008
• New average limits for bank cards are down 19 percent in Q2 2009 from peak in Q3 2008
• Total unused limits continued to decline in Q3 2009, decreasing by  $100 billion in Q3 2009

Clearly, the bank card market is experiencing a decline in credit supply, along with deterioration of credit performance and problematic delinquency trends, and yet in order to grow, lenders are currently determining the timing and manner in which to increase their presence in this market. In the following points, I’ll review just a few of the opportunities and risks inherent in each area that could dictate how this occurs.

Lender chooses to be a first-mover:

• Mining for gold – lenders currently have an opportunity to identify long-term profitable segments within larger segments of underserved consumers. Credit score trends show a number of lower-risk consumers falling to lower score tiers, and within this segment, there will be consumers who represent highly profitable relationships. Early movers have the opportunity to access these consumers with unrealized creditworthiness at their most receptive moment, and thus have the ability to achieve extraordinary profits in underserved segments.

• Low acquisition costs – The lack of new credit flowing into the market would indicate a lack of competitiveness in the bank card acquisitions space. As such, a first-mover would likely incur lower acquisitions costs as consumers have fewer options and alternatives to consider.

• Adverse selection – Given the high utilization rates of many consumers, lenders could face an abnormally high adverse selection issue, where a large number of the most risky consumers are likely to accept offers to access much needed credit – creating risk management issues.

• Consumer loyalty – Whether through switching costs or loyalty incentives, first-movers have an opportunity to achieve retention benefits from the development of new client relationships in a vacant competitive space.

Lender chooses to be a secondary or late-mover:

• Reduced risk by allowing first-mover to experience growing pains before entry. The implementation of new acquisitions and risk-based pricing management techniques with new bank card legislation will not be perfected immediately. Second-movers will be able to read and react to the responses to first movers’ strategies (measuring delinquency levels in new subprime segments) and refine their pricing and policy approaches.

• One of the most common first-mover advantages is the presence of switching costs by the customer. With minimal switching costs in place in the bank card industry, the ability for second-movers to deal with an incumbent is not one where switching costs are significant issues – second-movers would be able to steal market share with relative ease.

• Cherry-picked opportunities – as noted above, many previously attractive consumers will have been engaged by the first-mover, challenging the second-mover to find remaining attractive segments within the market. For instance, economic deterioration has resulted in short-term joblessness for some consumers who might be strong credit risks, given the return of capacity to repay. Once these consumers are mined by the first-mover, the second-mover will likely incur greater costs to acquire these clients.

Whether lenders choose to be first to market, or follow as a second-mover, there are profitable opportunities and risk management challenges associated with each strategy.  Academics and bloggers continue to debate the merits of each, (1)  but it is the ultimately lenders of today that will provide the proof.

[1] http://www.fastcompany.com/magazine/38/cdu.html