Capital One Financial


A division of Signet Bank until its initial public offering and subsequent spin-off in 1995, Capital One employed the seven guiding principles as an integrated whole to leapfrog rival credit card issuers in the 1990s and subsequently grow into a dominant global credit company.

The founders of Capital One, Richard Fairbank and Nigel Morris, while working as management consultants in the mid-1980s, observed that banks were not exploiting modern technology to identify profitable customers and deliver a customized product. They realized that not all customers were alike: a strong customer profitability gradient , or huge difference in the profitability of best, worst, and average customers, existed.

Credit card issuers earn money primarily from interest charges on the balances that customers carry on their cards and through a variety of fees (e.g., late fees). An issuer s best customers, love ems ”those who carried a high balance and paid it off slowly over time ”were as much as a hundred times more profitable than average customers. Worst customers, or kill yous, who paid their charges off every month, held no balance, and thus paid no interest or fees, represented a loss. Accordingly, Fairbank and Morris decided to build a business to serve the love ems and carefully avoid the kill yous.

Whereas national credit card issuers at the time were following a strategy based on scale ”spreading fixed expenses over the largest possible customer base ”Capital One employed an information-based strategy based on skill . The systematic gathering and analysis of detailed customer information created opportunities for detailed customer segmentation, targeted marketing, and differential pricing campaigns . By employing sophisticated data-mining techniques and simple screening mechanisms, Capital One identified the most profitable customers and determined which combination of price and characteristics would be most desirable to each individual. Hypotheses were developed to predict how to attract and retain profitable customers, and live tests were developed and launched to assess these hypotheses. This hypothesis-driven test and learn approach formed the basis of the company s information-based strategy and, ultimately, Capital One s success.

Targeting Critical Vulnerabilities. The critical vulnerability of incumbent credit card issuers such as Citibank, AT&T, and other major players was their inability to recognize the source of their profits. Oblivious to the differences between love ems and kill yous, incumbent issuers charged the same card rate to all customers; this one- size -fits-all rate meant that profitable love ems were cross-subsidizing unprofitable kill yous.

Capital One created a major dilemma for Citibank, AT&T, and others by opportunistically picking off their best customers. If the incumbents ignored Capital One s attack, they would lose their profitable accounts. If they wanted to mount an effective response, they would have to replicate Capital One s information-based strategy or lower the rates for the best accounts. Lowering rates charged to the best accounts would erode profits by reducing the cross-subsidy for the worst accounts, and state usury laws inhibited raising the rates charged to the worst accounts to offset this action. Replicating Capital One s strategy would require a major investment in information technology. Reluctant to respond, the incumbents opted to do nothing.

Boldness. Having identified this opening, Capital One weighed the risks of its unproven concept ”high start-up costs with a small customer base and a considerable lag time between market testing and payback (if any at all) ”against the potential benefits of redefining the credit card market. Despite the rejection of Capital One s idea by more than twenty of America s largest banks, Signet, a small regional bank in Virginia, finally saw the merits of Fairbank s and Morris s idea. Signet afforded them the opportunity to make the massive investments in information technology and people that their new approach required. The company s initial difficulties highlighted the boldness of the move: from the start of operations in 1988 until 1991, Capital One accumulated steep losses.

Boldness was thus central to Capital One s initial success, and it continues to be a central tenet of the company s culture today. To encourage risk taking and individual initiative throughout the organization, CEO Rich Fairbank hands out Capital One s version of the toilet seat award mentioned in Chapter 5 to the employee who has come up with the most promising idea but the least effective results.

Surprise. To carve out its place in the industry, Capital One relied heavily on stealth to surprise its competitors . It used a difficult-to-detect direct-mail campaign to poach customers from unwitting banks. Unlike the large majority of its competition, it developed its data systems in-house, shrouded from the prying eyes of outside vendors . It was and continues to be extremely disciplined in its dealings with the media in an effort to prevent critical company information from being divulged in the public forum. It has avoided markets, even those with strong customer profitability gradients such as retail insurance, where regulation required full disclosure of pricing strategy to protect its sophisticated pricing models from competitors. And it has limited the scope of consultants projects to prevent reengineering of its pricing models and best practices.

Focus. Capital One brought overwhelming resources to bear on a small yet highly profitable segment of the market: cardholders who carried a high recurring balance, presented a relatively low risk of default, and were inclined to pay high finance charges. The company made massive investments in building databases, learning account management, and recruiting top performers; Capital One claims to pay as much as double for talented managers. As the company has sought growth opportunities and expanded into new businesses such as automobile lending, small business lending, medical lending , and credit recovery, it continues this practice of focusing its best people, best systems, and utmost attention from senior management on high-value opportunities.

Decentralized Decision Making. Capital One has always relied heavily on the judgment of talented problem solvers who, at the point of decision, conduct market tests, interpret trial data, and identify profitable market opportunities.

As evidenced by the more than forty-five thousand market tests conducted in 2002, all Capital One employees have the freedom to formulate hypotheses, undertake sometimes-costly efforts to prove them, and immediately present promising results directly to their supervisors. A successful test can result in a new product, and the employee who identifies it may receive more than praise: he or she may be awarded the opportunity to manage the new product.

To ensure a greater likelihood of success for its decentralized approach, Capital One meticulously screens its employees in the recruiting phase and then conducts comprehensive training and mentoring throughout their employment. During the recruiting phase stringent personality and analytical tests and a lengthy case-based interview process ensure all new hires have the integrity, intelligence, and leadership skills necessary to perform in Capital One s highly decentralized, quantitative, and somewhat freewheeling culture. Though Capital One has some of the highest relative recruiting costs in corporate America, the exhaustive screening efforts outweigh the potential downfalls of errant decentralized actions. Further, Capital One employees go through extensive ongoing job- related training ”in areas such as risk management, legal compliance, and ethics ”throughout their careers.

Tempo. Refining its offerings so frequently that competitors found themselves in a constant state of reaction ”often to one of its earlier moves ”Capital One also maintained a rapid tempo. When AT&T s Universal Card finally responded with a differential pricing technique of its own, Capital One had three hundred differently priced account offerings to AT&T s twenty. When AT&T matched Capital One s three hundred, Capital One had more than four thousand. Indeed, even as the rest of the industry showed signs of slowing down in 1998, the company introduced successful new products at a blistering pace . . . Of the more than six thousand credit-card deals it offer[ed in 1999], half didn t exist six months [previously]. [7]

And when competitors finally responded to its information-based strategy with similar offerings intended to poach its customers, Capital One had already staffed highly trained employees as retention specialists. These specialists were afforded the authority to negotiate with individual customers to preserve relationships with Capital One ”albeit at lower but still profitable rates.

Time and time again, competitors responses to Capital One s moves were too little, too late. But as these responses have become increasingly sophisticated, Capital One has had to innovate new methods to stay one step ahead. Recognizing that its products life cycles melt like ice cream [8] when market conditions change or new competitors replicate its strategy, Capital One quickly exits markets, such as dial-around long distance and cell phone capacity reselling , when it deems that they have become structurally untenable. To make these timely exits, it relies heavily on the judgment of its people and even goes so far as to evaluate managers on the timeliness of their decisions to enter and exit a product s life cycle.

Combined Arms. Whereas most credit card issuers were configured into divisions of independently functioning silos that rarely interacted with one another, had misaligned incentives, and thus acted with different goals in mind, Capital One combined marketing, information technology, and credit risk management into a single unified function. Marketing associates and data analysts were formed into integrated marketing and analysis teams within each business unit with a singular objective of maximizing their respective business s profitability. The aim of this combined arms approach was to exploit information technology to accomplish marketing s goal of maximizing revenues and credit risk management s goal of minimizing exposure to potential defaults. Within each team programmers tapped the powerful databases and built sophisticated data models, and business analysts in turn used the data to segment customers and create credit policies down to the individual customer level. And the team members worked hand-in-hand to constantly test and learn and refine the millions of customer profiles.

The findings from these vast, continual analyses provided Capital One with invaluable and unique insights into the behavior of credit card holders and guided the company s successful efforts to profitably grow its information-based business. Capital One was able to extend credit judiciously to love ems while carefully screening out the kill yous. Moreover, statistically derived screening mechanisms watched for signs of deteriorating customer quality, and differential pricing captured greater revenue per card by estimating with greater certainty individual customers willingness to pay.

With data information technology, marketing, and credit risk management housed separately in different silos, competitors could not match Capital One s growth without increasing their exposure to potential defaults. Nor could they match Capital One s low-risk profile without sacrificing growth.

Capital One s exhibition of all seven principles has produced dramatic results. In the seven consecutive years since going public, revenue has grown at a nearly 40 percent compounded annual rate, earnings have grown at more than a 20 percent rate, and return on equity has remained above 20 percent. [9] Given that very few companies in the S&P 500 achieve this triple-double in a single year, this track record is remarkable .

Today, even in an economic downturn, Capital One continues to thrive. Owing to a customer base that has reached nearly forty-eight million internationally ”a 900 percent increase since the IPO ”its data processing operations enjoy considerable economies of scale, making it a low-cost producer. At the same time, its revenues per customer continue to rank near the top of the industry, while its bad-loan charge-offs remain relatively low. Its marketing slogan What s in your wallet?! has overtaken both American Express s Don t leave home without it and MasterCard s Priceless . . . for everything else there s MasterCard in recognition among credit card holders across the United States. And it has even become the single largest customer of the U.S. Postal Service. Beyond these successes in its core competency, Capital One has successfully extended its hypothesis-driven test-and-learn approach to numerous new markets and established operations in six countries outside the United States. [10]

Leadership Lessons

More impressive than Capital One s exhibition of all seven principles is the way in which the principles complemented and reinforced one another. Both the boldness and the focus of its initial attack reinforced the company s use of surprise to stealthily pick off competitors customers: while the audacity and long odds of Capital One s offensive meant that competitors dismissed the threat at first, the attack s narrowness and precision made it less immediately noticeable. Decentralized decision making reinforced Capital One s efforts to maintain a rapid tempo: because frontline employees could quickly refine or add product offerings and even change the terms or rates on a card, without having to wait for approval from superiors far removed from the action, competitors were constantly forced to play catch-up. And decentralized decision making, targeting critical vulnerabilities, tempo, and focus enabled reconnaissance pull: most of Capital One s new product innovations and new market entries were the result of frontline employees identification of critical vulnerabilities and management s immediate willingness to commit the resources necessary for exploitation.

[7] Byrnes, Nanette, The BW 50: The Best Performers, BusinessWeek , March 29, 1999, cover story.

[8] Overholser, George, senior vice president, new business development, Capital One, personal conversation, November 10, 2002.

[9] Barton, Scott, Capital One, personal conversation, 2002.

[10] Overholser, George, personal conversation, November 10, 2002.




The Marine Corps Way. Using Maneuver Warfare to Lead a Winning Organization
The Marine Corps Way: Using Maneuver Warfare to Lead a Winning Organization
ISBN: 0071458832
EAN: 2147483647
Year: 2005
Pages: 145

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