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Capital One:Exploiting an Information-Based

StrategyEric K. ClemonslMatt E. Thatcher2

Abstract: Capital One has exploited an innova-tive approach to targeted marketing, based oncustomer profitability analysis, to achieveimpressive performance as a leading credit cardissuer. It is sustaining its advantage throughinvestment in infrastructure and personnel, andthrough constantly improving its expertisethrough a practice known as test-and-learn.Moreover, it is attempting to generalize thisinformation-based strategy to other industries.

1. IntroductionAfter soliciting 16 banks in 1988 as consultingclients for a radical transformation of their creditcard businesses and after having been turned downby each, Rich Fairbank and Nigel Morris nowenjoy their positions as Chairman / ChiefExecutive and President / Chief OperatingOfficer of Capital One, one of the worlds mostprofitable credit card issuers. As a result of itsrapid growth and its ability to retain profitableaccounts, Capital One was named credit cardissuer of the year in 1995 by Credit Card Manage-ment [7].Since 1992, the dollar value of loans managed byCapital One has increased from $1.7 billion to$12.8 billion and the customer base has grown byover 500% [6]. With total growth in outstandingbalances of 880% between 1992 and 1996, amongthe highest in the industrys, and bad loanchargeoffs consistently among the lowest in theindustry, the stocks price soared between 1991and 1996. Nigel Morris smiles when he adds,Sometimes I pinch myself. Ive been verylucky... helping manage this fabulous company.Sometimes I think Ill wake up and find myselfworking in a woolen mill near my family inWales.The lessons of Capital Ones success in thebanking industry can be extended to a largenumber of other companies in a wide range ofother industries.The company relies heavily on what it terms itsh@nuztion-Based Strategy (IBS). The use of anIBS allows Capital One to develop new and

different strategies by exploiting fundamentaldifferences between itself and its competitors inorganizational structure, corporate culture, anduse of information, Rich and Nigel define aninformation-based strategy as the use of scientifictesting to drive mass customization, enablingthem to deliver the right product to the rightcustomer, at the right time and at the rightprice.As its credit card business matures and ascompetition increases, the company is prepared todiversify into a wide range of industries where itbelieves that its IBS approach will providecompetitive advantage. Indeed, marketingefforts and spending increasingly are committedto ventures outside traditional banking, and thesenior officers believe that it is critical that theynot remain loyal to any industry. Their keystrengths are in IBS, and not in banking or thecredit card industry.We will seek to address the following questionsin this case study:q Does Capital One enjoy a competitiveadvantage?How was competitive advantage achieved?Why were the opportunities identified bySignet / Capital One first exploited by arelative outsider a small regional bankunder the guidance of consultants rather thanbankers?Is the advantage sustainable? Can other bankserode the advantage?What are some other applications of CapitalOnes information-based strategy?

Newlv Vulnerable Markets2.1. IntroductionA large number of industries exhibit character-istics that change the relative balance of powerbetween large incumbents and nimble new en-trants. We use the term newly vulnerable mar-kets to characterize those conditions that enablenew entrants to threaten previously dominantincumbents, even where those incumbents enjoydominant market share and resulting superior coststructures.The following conditions generate vulnerablemarkets:Q Ease of entry It must be possible for newentrants to enter the market and attack estab-

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q

q

2.

Iished firms. Potential barriers to entry,including regulatory restrictions and costsassociated with acquiring distribution orproduction facilities, must be low enough toprovide new entrants with the ability toattack.Attractive to attack New entrants mustperceive that it will be profitable for them toattack. That is, they must believe that thereare market segments where the differencebetween the costs associated with serving thosesegments and the prices that they can chargethose segments will be sufficient to providefavorable profits.Difficult to defend There must be someobstacles that prevent incumbents from immed-iately duplicating the strategies of newentrants, and thus that allow new entrantssufficient time to realize the benefits fromtheir entry.2. Differing Customer Costs and Uniform

PricingIn many industries there are enormous differencesbetween the costs of providing service to differentcustomers:In telecommunications, costs of providingcustomers with local service will often dependupon their distance from the central office, andthus the length of the dedicated local loopthat connects their home to the communicationsnetwork.And in banking, some customers use their creditcards largely as charge cards, paying off theirbalances in full each month; these customersenjoy the free float, but provide only limitedrevenues and even smaller profits for theirissuers.

And yet, historically, in many industries domi-nant players have continued to follow a uniformpricing strategy, charging customers prices basedupon average costs, rather than differentialprices that reflect the costs associated withserving these individual accounts:q

q

In telecommunications, state regulators largelydetermine prices and typically over-chargecustomers in cities and suburbs in order tosubsidize higher cost customers in rural commun-ities.And in banking, most banks have historicallynot performed customer profitability analyses,

and instead have charged all accounts pricesthat do not reflect their profitability.

Conditions such as those described above makemarkets attractive for new entrants to attack, asthey suggest that some customers are beingdramatically over-charged under average costpricing strategies, and that they are in factsubsidizing other higher cost customers.Retail banking provides a clear example of how anew entrant can enter an attractive market andacquire profitable market share at the expense ofa previously dominant incumbent firm [3,4]. Inmany industries, firms can distinguish betweenthose customers that account for their profits(i.e., love ems) and those customers that repre-sent loss making accounts (i.e., kill yous ). Inretail banking, for example, the best 20%0 ofconsumers may account for more than 100% of abanks profits, while the bottom 201X0may accountfor all the off-setting losses.Most retail banks in 1988 charged uniform pricesacross consumers for banking services despite thepresence of significant differences in customercosts (i.e., love em and kill you accounts). Thissituation provides an opportunity for competitorsto target the love ems, charging them less for theprovision of banking services than they arecharged by their current bank but at prices thatstill generate profits for the attacker. Suchtargeted marketing and opportunistic creamskimming will leave the incumbent serving alarger proportion of higher cost, kill yous andwill cause the incumbents average costs to riseand profits to fall. In response, the incumbentwill be tempted to raise its prices to compensatefor declining profits, resulting in even morecustomers becoming vulnerable to the new en-trants attack. As the new entrant continues totarget customers being overcharged by theincumbent, as the incumbent continues to raise itsprices to compensate for its losses, and as the newentrant continues to acquire profitable marketshare at the expense of the incumbent, thedefender may begin to enter death spiral [3].That is, for the defender, the worse it gets theworse it gets!There is a literature and supporting theory onhow to perform targeted marketing and toprovide differential offerings (e.g., [2] and onwhy differential pricing is important (e.~., [9]).However, there is very little evidence to suggestthat this was followed in banking prior toFairbanks and Morriss implementation of

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targeted marketing strategies in the credit cardbusiness of Signet Bank in the late 1980s.Competitors reliance upon uniform pricing in thepresence of extreme differences among customersset the stage for Rich and Nigels information-based strategy, and is no doubt the most impor-tant reason for Capital Ones success. Thisstrategy of mass customization represents aquantum breakthrough in marketing effectivenessand has led to tremendous success competingagainst traditional banking industry with itsone-size-fits all approach to marketing. [5]3. Capital One and Competitive Advantage3.1. The Early DaysIn the late 1980s, Rich and Nigel developed anidea, or a vision, for radically transforming thecredit card businesses within banks. The GreatIdea was to enable a bank, through a radicaltransformation of their credit card business, toacquire profitable market share and developcompetitive advantage by implementing target-ed, information-based marketing strategies (orIBS). At that time, they might have articulatedthis vision as follows:q

q

q

q

q

Not all banking customers are equally profit-able to serveBanks do not know who their most profitableaccounts are, so these accounts are vulnerable tocompetitors who could identify themDirect marketing techniques, allowing banks tosolicit many consumers at relatively low cost,has turned some banking products, like creditcards, into a national, rather than a local orregional business.When using targeted direct marketing, it willbe necessary to M different targeted offerings,in order to learn the combination of character-istics that make different products desirable tocustomers and profitable for credit card issuers.Since most combinations of product offeringsmay be unprofitable for most-customers, it willbe necessary to start with small tests, but whenlearning is complete larger rollouts can bemade.

Nigel also stresses that implementing their ideawas made easier because it was not necessary tocreate a new product or a new brand that is,improving the profitability of a banks existingMasterCard or Visa portfolio had far fewer entrybarriers than attempting to create a new brand.

Rich and Nigel acquired these insights byobserving the credit card businesses of many oftheir major banking consulting clients at the time.Once the insight was developed, they solicitednumerous banks as consulting clients to radicallytransform the credit card business by exploitingtheir insights. However, most banks were notinterested in what became known as their infor-mation-based strategy. In fact, it was not untilafter the first 16 banks rejected their solicitationsthat they found a home at Signet Bank.By 1988, the credit card industry was character-ized by competition among banks for scale andmarket share; as a result, the credit card businesshad made the transition to consolidation in thehands of large players. By increasing theircustomer base, banks were able to spread the highfixed costs associated with credit card operationsover a large number of accounts, enabling them tolower prices through economies of scale.In addition, during this period banks commonlyengaged in uniform pricing strategies, creatingattractive opportunities for attack. In addition,the average cost associated with acquiring newaccounts in this competitive environment (cost persolicitation divided by hit rate) was quite high.This too suggests that incumbent banks werevulnerable to an opportunistic marketing strategythat improved hit rates by selectively offeringlower annual interest rates to certain potentiallove em customers.As Rich and Nigel note, while competitors in thismarket appear vulnerable to opportunistictargeting strategies, executing these strategies isnot easy, Or, as Nigel Morris has said, Anyonecan find customers who want your money! Anyonecan find customers who will take it and not payyou back! The trick is to find customers who willtake a lot of your money fast and pay you backslowly.It was in this competitive environment that Richand Nigel attempted to pitch The Great Lieu.Rich and Nigel began to shop their idea to majorbanks, including New York and West Coast moneycenter banks and super-regionals. Although manyof the major banks were willing to work withRich and Nigel in other areas, their Great Ideawas rejected by five of the top six (Citibank,Chase, Bank of America, Bank of New York, andChemical Banking) and fourteen of the toptwenty banks in the U. S.. Reactions were remark-ably similar across institutions:

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q It cant be done! its too expensive, and thedata that you need on individual consumers tomake the strategy succeed is simply not avail-able to the bank

q And we dont need your help; we already doit!Finally, Signet Bank, a small bank looking foropportunities to grow, accepted The Great Mea.However, Signet wanted Rich and Nigel to comeinto the company not as consultants but as sal-aried bank employees with long-term bankcontracts. Surprised by the offer, Rich and Nigelagreed to come into the company as heads ofcredit card marketing and strategy, but only undercertain conditions: Rich and Nigel were to begiven real bank titles, they were to have realcontrol over systems, and they were to be acceptedwithin Signet as line bankers. However, unlikemain-stream employees of the bank Rich andNigel would retain significant profit-sharingpotential. They believed that these conditionswere necessary to allow their IBS to flourish.David Hunt, Executive Vice President of SignetBank, played a major role in the transition. Richand Nigel also received support from Bob Free-man, then CEO of Signet. Perhaps most impor-tantly, David listened to Rich and Nigel, hadthe vision to recognize the potential of theirideas, and helped to generate buy-in within thefirm. As he stated, You think that you can makeIBS work? Then go do it!3.2. Initial PerformanceThe initial period for Rich and Nigel at Signetran from October 1988 when they entered Signetto December 1991. Nigel stresses that the firstyear entailed a large commitment to infra-structure build: building databases, learning thetrade of account management, and figuring outhow to implement this very difficult strategy.In August 1989 they rolled out their test and learnsolicitations in significant scale.The initial implementation of their IBS wasbased on a test and learn methodology. In brief,test and learn consists of the followingq

q

Running some test marketing activities (e.g.,sending out a small, yet carefully selected,sample of direct marketing solicitations)Determining which tests make money andwhich ones do not; this takes some time, andmost of the tests will be unprofitable. How-ever, unprofitable tests are not unsuccessful, if

q

they enable you to determine the basis ofprofitable tests going forward.Then running more programs, more and morelike the ones that proved successful in theinitial test stage.

Unfortunately, there is a significant and expen-sive lag between the stage of initial testing andthe stage where learning is realized andprofits are earned, In fact, by December of 1991chargeoffs from Rich and Nigels 1989 solicita-tions had soared to 9.5~0, more than doubling thechargeoffs of the banks total portfolio from 2.6%in August 1989 to 5.9~0 at the end of 1991. As Richnotes, Signet stock price was in free fall! Thestock price plummeted from over $20.00 in late1989 to less than $5.00 in early 1991 (pricesadjusted for a split in 7/93). According to Nigel,We hit bottom in late 1991. From bank cardprofits of $27 million in 1988 and $25 million in1989, forecast profits for 1992 had dropped to zeroby late 1991. The fall in stock price was a resultof bad real estate loans. Had the credit cardportfolio profits actually dropped to zero theresults for the stock price would of course been farworse; fortunately, the IBS began to produceprofits at just this time.Rich and Nigel, however, never lost faith intheir basic conception of strategy for the bank;equally important, neither did David. Theycontinued their focus on testing, nearly doublingthe number of tests conducted from 335 in 1989 to617 in 1991.3.3. The Middle PeriodLate 1991 began a period of triumph for Rich,Nigel, and those associated with implementingThe Great Lieu, which continued through thespin-off of Signets credit card business to CapitalOne in 1994.During this period (1992-1994), growth in receiv-ables and in number of accounts soared [see Table1], especially when compared to its competitors.At the same time, percentage chargeoffs im-proved and were consistently better than industryaverages [see Figure 1]. Not surprisingly, thestock price of Signet Bank surged, allowing thebank to grow faster than 996 of the Fortune 1000!In fact, Signets stock appreciated 5377. betweenJanuary 1991 and the end of 1994.The credit card operation at Signet was doomedby its own success it could not continue as part ofthe bank. The credit card business came to account

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for roughly 2/3 of the profits of the bank. Thisthreatened the stability of the banks gover-nance, when relatively young and relatively newadditions to the bank were accounting for such alarge portion of the banks profits. Moreover, asRich and Nigel began to envision new lines ofbusiness, many outside traditional banking, itwas clear that they would require more freedomof action than would be possible within thestructure of Signet. As a solution, Signet CEO BobFreeman made the audacious decision to spin offthe credit card business as a wholly independentcompany, not associated with Signet.3.4. The Current PeriodThe current period can be considered the timefrom the spin-off in 1994 through the present.During this period, Capital One has continued toenjoy considerable success. They have achievedsuccess as measured in terms of growth in numberof accounts and total outstandings [see Table 1], aswell as in low loan losses when compared to itscompetitors [see Figure 1]. In addition, stockperformance has been strong.Clearly, Capital One has experienced tremen-dous success. By any measure, Capital One hasmore than tripled in the past three years. [5]Capital One continues to rely upon Information-Based Strategies to acquire profitable marketshare and continues to rely upon Test and Learnmethodology for developing and implementingthose strategies. Indeed, testing continues atCapital One, as demonstrated by the exponentialgrowth of its R&D efforts [see table 2].3.5. Assessment of Capital Ones StrategyIt is clear that Capital One has achievedcompetitive advantage. The bank has beenoutperforming most of its competitors in termsboth of market share and of margins. Conse-quently, Capital Ones stock price has more thandoubled since its 1994 IPO, significantly outper-forming both the market as a whole and thebanking sector.4. How Steps towards Achieving Competitive

AdvantageThere is little secret about either the extent ofCapital Ones advantage or the source of thisadvantage. The entire management team be-lieves that the organizations success comes fromits Information-Based Strategy and its relianceupon implementation of IBS via Test and Learn.

The success of Capital One has been the directresult of the proprietary information-basedstrategy that we have pursued since 1988. Thestrategy leverages information technology,scientific testing and a highly flexible operatinginfrastructure to deliver the right product, to theright customer, at the right time and at the rightprice. [5]The core of this strategy is based upon therealization that customers differ widely in theirprofitability, and that information from avariety of sources can be synthesized to exploitthis customer profitability gradient. IBSrepresents the commitment to exploit this custom-er profitability gradient, and test and learn isthe mechanism for doing so.4.1. Implementation of Test and LearnRich Fairbank explains that in the late 1980s,when he and Nigel were attempting to interestbankers in a test and learn strategy, banks reliedupon black box credit scoring models that wereused to determine whether or not to offer anaccount to an applicant. These black box modelswere usually procured from a vendor, and weresealed in the sense that the algorithms couldneither be examined nor altered. While para-meters could be updated based on experience,allowing the models to be tuned, algorithms couldnot be changed. These models were definitely notdesigned to learn which customers could profit-ably be offered accounts at different rates. Richand Nigel thus advocated turning the creditscoring models off for test offerings, and develop-ing and tuning their own models to determinewhich combination of product, price, and creditlimit could be profitably offered to customers whocould be characterized by a wide range of public-ly available credit and demographic data. Aftera lengthy incubation period, it would be possibleto determine which tests were profitable, and torollout large profitable offerings corresponding tothese smaller profitable tests.The structure of this process explains the initialperiod of extremely unprofitable operations afterthe introduction of test and learn. The degree oftrust needed to turn off the banks credit scoringmodels likewise probably explains a great dealof the resistance that Rich and Nigel encounteredwhen they attempted to create interest in theirIBS approach.4.2. The Balance Transfer ProductThe first breakthrough offering discovered

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through this process of test and learn was thebalance transfer product. This product offerscustomers a lower initial APR for applicants whotransfer their balances from a competitors creditcard. It turns out that this transfer of balances bycustomers ftom higher APR credit cards to a lowerone provides the card issuer with an importantsignal. Customers that do not carry balances findno value in a lower APR and will not take thetime and effort to switch cards. More important-ly, the customers that the balance transferproduct will attract are those customers whohave a balance they cannot presently payoff butwhich they will eventually payoff slowly.Therefore, they care about the lower APR.Clearly, these customers meet Nigel Morrisscharacterization of great accounts: They borrowmoney, they pay it off, and they pay it offslowly. Or, as Rich Fairbank more flamboyantlysays, We found the elusive low-risk revolverand we hit the jackpot! People who borrowmore, and who approach the borrowing limits oftheir cards, tend to be riskier. A graph of percent-age of loans more than 60 days delinquent,plotted against percentage of credit line utilized,clearly illustrates this trend. However, custom-ers who accepted the balance transfer productexhibit much more attractive risk-utilizationprofiles, as shown in Figure 2.The graph in Figure 2 can be summarized dif-ferently by noting that marketing expenses forthe balance transfer product represents an invest-ment in an annuity. Each dollar of expenseinvested results in an annuity stream of more than$2.25 in the first year, close to $4.00 in the second,close to $2.50 in the third year, more than $1.50in the fourth year, and over $1.00 thereafter.Nigel summarizes the graph simply by sayingWe found the sweet spot.4.3. Other Products and ServicesCapital One offers a whole range of products tocredit consumers, including offers to students andto applicants without previous credit history. Infact, presently there are over 3,000 price points inCapital Ones current offerings. Capital One hasthe ability to customize everything. Onaccount acquisition, they can customize on custom-er segmentation, market channels, products,pricing, credit lines, and credit approval policies.On account management, they can customize onrepricing and retention, credit line increases anddecreases, collections and recoveries policies, andcross-selling.

5. Sustaining Competitive AdvantageWhy did so many powerful banks reject thestrategic recommendations offered by Rich andNigel? Why were they not understood andadopted by the banks and used as the basis oftheir strategies, even before The Great Idea?Unlike other examples of our newly vulnerablemarkets paradigm, there was no rapid change intechnology or regulatory discontinuity thatsuddenly made differential pricing possible. Asteady decrease in cost of computing for analysis,and of costs of storage and classification for thecreation of targeted mailing lists, had madeinformation-based marketing and pricing strate-gies possible well before 1988.The principal problems faced by banks in respond-ing to opportunities in the market include their:1.) organizational structure; 2,) informationinfrastructure; 3.) organizational skill set; and 4.)organizational culture.5.1. Bank StructureMost competitors have, or used to have, two veryseparate organizations responsible for creditcards. The marketing department is responsiblefor selling; it is their responsibility to maximizethe number of cards issued and the total balancesoutstanding. In contrast, there is also a creditdepartment, and it is their responsibility tominimize exposure to bad loan losses, by limitingwho has access to cards and what balances theyare allowed. These two groups are in constanttension, but they are frequently poorly coordi-nated or not integrated at all.Rich and Nigel employed an integrated, riskmanaged, approach to sales and marketing thatattempted to compute the expected NPV orannuity value of each new account, providing firstSignet Bank, and now Capital One, with theability to respond appropriately to situationslike that described above.5.2. Information InfrastructureTo support its IBS, Rich and Nigel believed thatthey had to invest heavily in informationtechnology. At Signet they developed what wasconsidered at the time to be the largest Oracledatabase in the world. The database not onlycontained detailed data on customers (i.e., theirdemographics, purchases, activities, etc.), butalso supported regressions and other analytics,and stored the results. The generation, storageand analysis of such data enabled Signet to

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identify profitable marketing opportunities; thesystems continue to support Capital Ones market-ing efforts.This is in sharp contrast with the actions ofcompetitors, some of whom have outsourced allnon-branch customer contact, and do not maintaintheir own databases or do their own servicing. AsNigel has said, This is like trying to do plan-ning after youve put your planning departmentthrough a guillotine!This view that infrastructure provides criticalvalue is shared throughout the organization,where it is widely believed that the necessaryflexibility cannot be achieved in organizationsthat outsource their data processing. Indeed, in1994, the year of the spin-off, Capital One waswilling to incur the expense of $49 million tobreak its long term outsourcing contract with EDS,since it was seen as necessary to do so in order toachieve maximum flexibility for the new compa-ny [1].5.3. Organizational Skill Set, Culture, and

CommitmentBank structure and information infrastructurewould not achieve advantage without the skillset to exploit them and the commitment to hireand train the right people.At Capital One, successful implementation oftheir more complex strategy begins with hiringthe right people. According to Nigel, Wecompete with McKinsey for the best graduatestudents; were not competing with commercialbanks... Above all, we know that the key to oursuccess has been and will continue to be ourcommitment to hiring and developing incrediblytalented and motivated associates. Thisappears in the Letter to Stockholders, in thecompanys Annual Report for 1995 [5], and similarthoughts are unlikely to be seen in any form in theannual reports of more traditional bankingcompanies.In addition, the success experienced at Signet andCapital One requires commitment to a long termstrategy of identifying and solving problems.Nigel claims that if none of your initial testslose money, youre probably too conservative forus. If you cant figure out why they lose moneyand solve the problems, youre also probably notright for us; we need people with tenacity andsuperb problem solving skills. Nigel also notesthat We truly believe that we have put in placea better mousetrap. Duplication of the strategy

by the competition is very difficult, and wouldtake them years of patient investment.While it may be clear what changes competitorsneed to make to respond to Capital One, it is alsoclear how very difficult it is for most organiza-tions to accommodate such profound change.In summary, Capital One senior managementbelieves that their advantage has been sustain-able because it is based on a complex combinationof structure, information, skills, culture, andcommitment.6. Future OpportunitiesThat said, senior management also believes thatit will become more and more difficult to sustainthis advantage. As other banks begin to followsimilar strategies and as competition increases itwill become more difficult to maintain margins.Therefore, it will be necessary for Capital One tocontinue to refine its offerings.When AT&T offered all accounts the sameservice and the same price, Signet had 23 pricepoints. When AT&T had over 20 price points,Signet had over 300. Now that AT&T has over300 price points, Capital One has over 4,000.Indeed, a senior officer at AT&T UCS believesthat all competitors will be forced to adoptsimilar strategies,noting that When one of yourcompetitors begins down this slippery slope, youhave no alternative but to follow.Scott Barton, Director of New Business Develop-ment (or the Growth Opportunities Team),believes that ultimately, all accounts will bepriced efficiently to reflect their risk adjustedexpected return, a complex way of saying that incredit card issuing, as it is presently structured, itwill become increasingly difficult to be profitablefor any issuer,sHowever, profitable opportunities are likely tocontinue as long as competitors are less able thanthe bank to assess the profitability of theiraccounts. Capital One employs retention special-ists, whose job is to keep customers who call tocancel their accounts. Retention specialists aresupported by screens and computer models thatindicate the effects on profitability of changing acustomers APR. While they are empowered tolower a customers APR down to just above thebreak-even level, their compensation systemrewards them not only for retaining profitableaccounts, but for retaining them at the highestpossible APR.

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Further evidence of increased competition is thefact that the balance transfer product has comeunder assault. According to Nigel, The balancetransfer product, which we pioneered in 1991, hasenjoyed such spectacular success that the markethas become increasingly competitive. While wewill continue to pursue profitable balance transferopportunities, we have begun to roll out the nextwave of market-tested credit card innovations.The Growth Opportunities (GO) Team originatesfrom the belief of senior management that theskill set, personnel, culture, and infrastructure ofCapital One can be used in other settings, todevelop and market different products in differ-ent, perhaps unrelated industries. In the longrun, we see our destiny not merely as a credit cardcompany, but as an information-based marketingcompany offering a variety of products in informa-tion-rich industries. [5]. Rich augments this asfollows, We have never viewed ourselves as justa credit card company. Were an information-based marketing company. The credit card justhappens to be a product which has been trans-formed by the information revolution.There are other newly vulnerable markets, andhence other opportunities for a new entrant likeCapital One to use information-based strategiesto target an established competitors mostprofitable customers. Capital One wants to focusthe core team on areas where Capital Ones corestrengths can provide advantage, and yet toavoid having too focused or too restrictive a viewof what these strengths might be. As PeterSchnall, Vice President of New Business Develop-ment, says, We want to make certain that we arenot being too narrow in our view of future opportu-nities. Is our core strength in information-basedstrategies for test and learn targeting of profit-able new accounts or in the use of informationmore generally for relationship management?The GO Team is presently assessing opportunitiesin a wide range of industries. The company ismaking increasing investments in non-cardtargeted marketing; expenditures in 1997 areestimated to be split among balance transfer,other card products, and non-card products, withGO and other card products expenditures roughlyequal and both substantially greater thanbalance transfer product expenditures. The teamis, however, all too aware that unfortunatelythere will once again be a considerable lagbetween initial tests and profitable rollouts,especially in areas where they must first create a

legal operating entity, gain new industry exper-tise, develop systems and operating infrastruc-ture, create their tests, allow them to incubateand then tune their models, all before profitablerollout can be attempted. The senior managementteam also believes that there are enormousopportunities to exploit similar strategies inmarkets outside the U.S.7. ConclusionsIt appears clear that the history of Capital Oneand Signet Bank provides considerable supportfor our theory of newly vulnerable markets. Theerosion of profitability however suggests thatwithout fundamental differences in resources,innovations like differential pricing and effec-tive market segmentation will become strategicnecessities rather than continuing as sources ofcompetitive advantage. If the skills required forinformation-based strategies are sufficientlydifficult to acquire, and if they are sufficientlygeneral in their applicability, then Capital Oneshould enjoy a prolonged period of profitability,exploiting a sequence of opportunities in newlyvulnerable markets in other industries. Richbelieves that this, indeed, will be the long termsource of Capital Ones competitive advantage,rather than its positioning in any specific pro-duct, industry, or market segment:Capital Ones competitive advantage is thatthe entire company is built around the informa-tion-based strategy the people, organiza-tional structure, systems, operations, accountingsystems, human resources, policies, and, mostimportantly, the culture. We are building amachine that can identify opportunities, adaptinfrastructure, and roll out products at fullspeed. While those opportunities grow, wework in parallel to plan for their eventualobsolescence. This company can turn on a dime.Were built for change.

While in hindsight test and learn strategiesapplied to newly vulnerable markets may appearto be obvious, clearly at the time they were not.The Capital One team sums up their beliefs inthe sources of their advantage:Our growth is the result of opportunisticorigination and account management. Thestrategy was the easy part. Making it workwas the challen~e! We also continue to test theapplication of information-based strategy toother products, both financial and non-finan-cial, with positive results.

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8. References Acknowledgements1.

2.

3.

4.

5.6.

7.

8.

9.

Anthes, G.H. Customer data mining paysoff, ComputerWorld, May 15,1995,Blattberg, R.C. and Deighton, J. Inter-active Marketing: Exploiting the Age ofAddressability, Sloan Management Re-view, Fall 1991, pp. 5-14.Clemens, E.K. and B.W. Weber, Segmenta-tion, Differentiation, and Flexible Pricing:Experiences with Information Technology andSegment-Tailored Strategies, Journal ofManagement Information Systems, Vol. 11,No. 2, Fall 1994, pp. 9-36.Clemens, E.K., D.C. Croson and B.W. Weber,Market Dominance as a Precursor of FirmsUnderperformance: Emerging Technologiesand the Advantages of New Entrants,Journal of Management Information Systems,Fall, 1996.Capital One Annual Report, 1995.Gartner Group, Gartner Group AnnouncesExcellence in Technology Award Winner,October 8,1996 press release.Lucas, P. Capitalizing on Credit Cards,Credit Card Management, August 1995.Steiner, T.D. and D.B. Teixeira, Technologyin Banking: Creating Value and DestroyingProfits, Dow Jones-Irwin, Homewood, IL,1990.Tirole, J. The Theory of Industrial Organiza-tion, MIT Press, 1988.

The assistance of Nigel Morris, President andChief Operating Officer of Capital One, of RichFairbank, Chairman and Chief Executive, ofScott Barton, Director of New Business Develop-ment, and of Peter Schnall, Vice President of NewBusiness Development, is gratefully acknow-ledged. The support of the Reginald H. JonesCenter, Project on Information Industry Structureand Competitive Strategy likewise is acknow-ledged.

End Notes1. The Wharton School, University of Pennsylvania2. College of Business Administration, University ofArizona3. Outstandings, or outstanding balances, repre-sent the amount of money that a credit card issuer isowed by card holders. It is generally considereddesirable to have high outstanding balances, since thisrepresents money that cardholders have borrowed fromissuers, and on which issuers are generally paid a highannual rate of interest.4. In previous work, we have explored these conditionsand their application to a wider range of industries [4].5. Unfortunately for banking as an industry, there isconsiderable evidence to support this concern. Theassessment of technology in bankhg suggests that evenas it creates value for customers it increases competitionand the efficiency of pricing, destroying profits forfinancial intermediaries [8].

(000s) 1992 1993 1994 1995 1996Loans $1,452,742 $3,265,565 $6,197,423 $9,089,278 $12,804,000

Accounts I 1,672 [ 3,118 I 5,049 I 6,149 \ 8,565Table 1:

Number of Accounts and Amount of Receivables for Capital One

YEAR 1989 1990 1991 1992 1993 1994 1995Number of Tests 335 370 617 1,130 1,850 4,355 6,199

Table 2:Number of Tests run by Capital One

1060-3425/98 $10.00 (c) 1998 IEEE

7/28/2019 Cap1 Case Study Ibs

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Figure 2Risk-Utilization Profiles, Illustrating Balance-Transfer Product