1. CREDIT CARD PRICING James Carwana, Dana Dubois, Divesh Goyal, John Petry, Sameer Sharma

2. CREDIT CARD PRICING Question 1 If the bank could only charge an interest rate, what would it be? If the bank could only charge interest, then it would at most charge a 10% interest rate because that is what credit using customers are willing to pay. If the bank tries to charge any higher rate, these customers would not use the bank’s credit card service, and the bank’s revenues would suffer.

3. CREDIT CARD PRICING Question 2 What is the effect on their revenues from credit users if the bank charges an annual fee? We know that in the absence of any fees, the full payers would not provide any revenue to the bank. The remaining 500 users who do use credit, carry an average balance of $500 (given that balances are uniformly distributed between 1 and 1000). A bank could charge these users an interest rate of up to 10%, thus yielding a revenue per user of $50, and an overall revenue of $50*500 = $25,000. If the bank starts charging annual fees, then it will have to lower its interest rate to 8% so that an average credit using customer still pays $50 (if the bank does not lower its interest rate, the additional fees will exceed the customer’s willingness to pay and drive them away). Thus, the bank will still earn a revenues of $50*500 = $25,000 from these users, but in addition, the bank will also earn a revenue of $10*500 = $5000 by charging the full payers an annual fees of $10. In summary, the banks revenues will increase by $5000.

4. CREDIT CARD PRICING Question 3 How would you weigh the pros and cons of charging an annual fee? For this, you can either use an intuitive argument or you can work with a spreadsheet. Your choice. There are both pros and cons of charging an annual fees. Pros The bank will be able to generate some revenue from the full payer segment The annual fees will guarantee the bank a fixed revenue every period, as opposed to having only a variable revenue depending upon the amount of credit used by its customers. This will enable the bank to make better predictions about its earning forecasts By charging an annual fees, the bank will have to lower the interest rate in order to remain within a credit using customer’s willingness to pay. The bank could advertise its lower interest rate to attract more users. Existing users might start carrying more credit and some full payers may also begin to use the credit facility. The bank’s revenues and share of wallet may actually increase due to these factors. Cons The bank may face a backlash from consumer groups or invite scrutiny from industry regulators. In the absence of competition, this move may make the bank appear monopolistic and like it is taking advantage of consumers. If new competitors enter the market, they may be able to capture the the full payer segment by not charging an annual fee By charging an annual fees, the bank will have to lower the interest rate in order to remain within a credit using customer’s willingness to pay. If the average credit per customer increases beyond $1000, say to $1100, the bank’s revenues may actually be lower ( $5000 + [10+(1100*8%)]*500 = $49,000) than hat they might have been without an annual fees (1100*10%*500 = $55,000)

5. CREDIT CARD PRICING Question 4 How might you design an optimal pricing mechanism for the bank? You may just make an intuitive argument. The optimal pricing scheme would generate fixed income from the full payer segment and high interest income from the credit using segment. To achieve this, the bank could use the following policy: Customers with an average outstanding balance of below $100 will be charged an annual fees of $10. The amount of interest paid by these customer will be deducted from the annual fees. Annual fees will be waived for customers with balance above $100. Interest will be calculated at 10%.

6. PRICING FOR PROFIT James Carwana, Dana Dubois, Divesh Goyal, John Petry, Sameer Sharma

7. PRICING FOR PROFIT Question 1 What are the risks in introducing an annual fee for the banks? Risks of introducing an annual fee: Lose customers to competing banks, if those banks do not follow suit Negative reaction from both customers and media Full-paying market size may shrink, depending on willingness to pay Investigation by Monopolies and Mergers Commission; fines or new regulations would add new costs

8. PRICING FOR PROFIT Question 2 Suppose that the banks make choices simultaneously about whether or not to charge an annual fee. What are the outcomes (i.e., equilibria) that you might expect? Nash equilibrium!

9. PRICING FOR PROFIT Question 3 Suppose the game is played sequentially. Is there a leader or follower advantage? Who do you expect to move first, Barclays or Lloyds? Lloyd vs Barclay’s Customer Base Lloyds customer is 5% more likely to convert a transaction into an outstanding balance For every pound of outstanding balance, Lloyds is 3% better at collecting revenue on this balance Lloyds has fewer write-offs per pound charged Generally a first-mover advantage occurs when a company introduces a new desirable product into the market. The opposite is true when introducing an undesirable product. The first-mover has a disadvantage and will be remembered for this action. Bank of America Enron Barclays will move first if and only if it exhausted all of the potential cost reductions and it is must gain additional profits Enormous risk of alienation to base Credit cards approach commodities except for a small switching cost (emotional not financial). In the 1980’s automatic billing was not ubiquitous