Mercator Perspectives

Rethinking Private Label: Can Decoupled Debit Relieve Retailers’ Interchange Pain?

Since the financial crisis started, consumers have demonstrated an aversion to borrowing, and to some extent, the entire category of credit products. Members of the millennial generation, many of whose parents are still feeling the pain of excessive credit card spending, now prefer debit. Consumers’ fear of debt impacts private label credit in particular because these cards typically carry higher interest rates than general-purpose cards.

As the economy strengthens, many banks appear to be looking for signs of a recovery in the market for private label credit. As far as I can tell, there is little reason to believe it’s coming tomorrow. For now, retailers’ payments strategies might be better served by implementing a decoupled debit program.

Like private label credit, decoupled debit programs have the ability to generate incremental sales through increased loyalty and also reduce payment-acceptance costs. Decoupled debit programs don’t produce interest income, but they also don’t include the risk of credit losses. This is a trade-off many retailers should be willing to make. Several of them sold their credit portfolios during the financial crisis, acknowledging that consumer lending exposed them to too much risk given that it is not central to the retail business.

Decoupled debit programs do have their own risks, however, primarily ACH settlement risk since the issuer doesn’t have real-time access to a customer’s DDA balance. However, this risk is more easily managed than credit default risk.

Merchants that aren’t sold on the merits of a well-executed decoupled debit program need only look at the performance of Target’s REDcard program. REDcard spending reached 14% penetration of in-store sales in the third quarter 2012. Kansas City locations, which conducted a one year pilot before Target expanded the program nationally, already have attained 20% REDcard penetration. National retailers can certainly appreciate the significance of eliminating interchange related expenses on 20% of sales.

Target offers private-label credit and decoupled debit REDcards, but debit account activation is driving the program’s growth. At the end of 2011 spending on Target credit cards accounted for 6.8% of sales, but spending on Target debit cards accounted for only 2.5% of sales. This gap is closing at a remarkable pace 2012. In the third quarter, penetration of Target credit cards increased to 8% of sales, but debit cards grew to 6%. Over the life of the program, consumers have opened about three debit accounts for every one credit account.

There may be an opportunity for other retailers to increase sales and decrease payment acceptance costs by combining a decoupled debit card with a differentiated loyalty program.

What do you think? Is private label credit on the rebound? Is there a future in decoupled debit? Private label and co-branded products are an ongoing research topic, and I appreciate any comments. You can contact me via the link below.

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