Ah, the challenges of commercial prepaid.
When JPMorgan Chase recently announced the potential sale of its government and commercial prepaid card business, it made big headlines. Chase has a massive portfolio from a prepaid perspective – the second largest in the industry for commercial applications.
Large deals drive significant volumes as government distribution of benefits and corporate payroll represent the two largest applications for prepaid use in the U.S. Beyond volume and profits, they extend significant treasury-client relationships and expand consumer touch points.
In addition, Chase is the U.S. leader in combined purchasing and corporate card program management volume, with an estimated $37 billion in 2012. The folks there know the corporate card business, and it’s a key contributor to their Treasury Management solutions.
Why leave now?
So why give it up? Why look to exit a relatively large volume of business that is typically contracted for an extensive period, typically for 5, 7, perhaps 10 years? After a decade of investment, why explore a possible sale of a business that appears to be high-growth, tied to strategic clients, and perhaps a multitude of additional applications?
Like so many strategic decisions, there’s no simple answer. Perhaps Chase simply has decided that the thin risk/reward ratio, and the issuer’s increasing regulatory burden across all businesses, is forcing it to simplify its business lines. Chase has faced nearly uncountable government and legal inquiries, along with tens of billions in settlements, and that has it facing criticism from all angles.
Or, it could be that Chase has decided that the challenges of managing a prepaid business are simply not worth it. It is a difficult business to run profitably, despite the high volumes and synergies with strategic lines of business. Get it wrong, and it can take years to recover.
Difficult value proposition
First, margins are thin. Many prepaid success stories evolved from small, focused companies that did nothing but prepaid. They would become expert in a niche application, such as how to manage the process of onboarding new accounts, optimizing communications between the commercial entity and the consumer, and managing complex distribution methods. Specialization allowed these companies to learn specific nuances of the application and how to make money from small balances.
At the same time, it requires multiple entities to execute a successful program from beginning to end, with each entity trying to earn a profit from a small margin pool. Many entities, small margins – all trying to make money.
Second, if an institution is trying to execute multiple roles – distributor, program manager, processor and issuer – to improve efficiency and control, it needs to be extremely focused on how this integration will achieve scale and not just add to the complexity. Although these programs involve contracts with corporate entities, the economic performance depends upon consumer behavior. Subtle differences between McDonald’s employees and AT&T’s call center can make huge differences in managing a program. While integration allows one entity to make all of the profits, misjudging differences can create costly errors, which show up quickly.
Third, all applications are not created equal. Government programs are not the same as payroll. They serve both commercial entities and consumers directly, but the dynamics are fundamentally different. When margins are thin, understanding slight nuances such as frequency of use, where a card is likely to be used, access to ATMs (or not) and, of course, fee structure and allowance of fees (just to name a few categories) can make a huge difference in whether a program is profitable.
One of the biggest mistakes a company can make when running a prepaid business is allowing itself to chase “bright shiny objects.” They can seriously sidetrack management. Each one is a different process requiring different operational procedures and metrics to earn profits. The distraction isn’t worth it. Each application requires complete focus and attention to ensure proper oversight and operational excellence for long-term, profitable success.
Fourth, keeping up with additional regulations and complexity only adds to margin pressure. If programs are running on the edge, any additional thought of reducing, or eliminating, revenue streams or adding complexity in operations can break the proverbial camel’s back.
’Not worth it?’
So there is a distinct possibility that even one of the largest financial institutions in the world is saying, “it is just not worth it.” Not worth the oversight required on top of razor-thin margins. Not worth the required focus it takes to manage a different business. And not worth it to keep investing after issues with data breaches and the corresponding microscope that is likely to follow from regulators, investors, clients and everyone in between. Particularly after the scrutiny the government has been giving them lately. Enough is enough.
There is an apparent disconnect between the push for electronic distribution of government benefits to save cost against the growing oversight and regulations of the banking industry. It could narrow the margin to an unacceptable level. Chase strategically decided to keep the consumer prepaid business, which is tied to the retail bank. Clearly, the relationships on the government and commercial side weren’t deemed to be worth it.
If Chase does choose to sell, why would anyone else buy? For the same reasons that it seemed attractive in the beginning: scale and consolidation. For entities that are intensely well focused, prepaid can be successful. Specifically in the government-benefits business where margins are exceptionally thin, scale is key.
It may be that we are seeing regulation and thin margins force industry consolidation. After small players figured out how to execute flawlessly, larger entities decided to buy them to minimize the players in the value chain U.S. Bank’s acquisition of FSV is a prime example.
Sooner or later, more consolidation likely will occur. For the few industry survivors, there will be a tradeoff: better scale, but potentially more pressure from regulators on fees and oversight. So you have to ask yourself, is it worth it?