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

by Michael Misasi 0

Since the financial crisis started, consumershave demonstrated an aversion to borrowing, and to some extent, theentire category of credit products. Members of the millennialgeneration, many of whose parents are still feeling the pain ofexcessive credit card spending, now prefer debit. Consumers’ fearof debt impacts private label credit in particular because thesecards typically carry higher interest rates than general-purposecards.

As the economy strengthens, many banks appear to be looking forsigns of a recovery in the market for private label credit. As faras I can tell, there is little reason to believe it’s comingtomorrow. For now, retailers’ payments strategies might be betterserved by implementing a decoupled debit program.

Like private label credit, decoupled debit programs have theability to generate incremental sales through increased loyalty andalso reduce payment-acceptance costs. Decoupled debit programsdon’t produce interest income, but they also don’t include the riskof credit losses. This is a trade-off many retailers should bewilling to make. Several of them sold their credit portfoliosduring the financial crisis, acknowledging that consumer lendingexposed them to too much risk given that it is not central to theretail business.

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

Merchants that aren’t sold on the merits of a well-executeddecoupled debit program need only look at the performance ofTarget’s REDcard program. REDcard spending reached 14% penetrationof in-store sales in the third quarter 2012. Kansas City locations,which conducted a one year pilot before Target expanded the programnationally, already have attained 20% REDcard penetration. Nationalretailers can certainly appreciate the significance of eliminatinginterchange 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. Atthe end of 2011 spending on Target credit cards accounted for 6.8%of sales, but spending on Target debit cards accounted for only2.5% of sales. This gap is closing at a remarkable pace 2012. Inthe third quarter, penetration of Target credit cards increased to8% of sales, but debit cards grew to 6%. Over the life of theprogram, consumers have opened about three debit accounts for everyone credit account.

There may be an opportunity for other retailers to increase salesand decrease payment acceptance costs by combining a decoupleddebit card with a differentiated loyalty program.

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