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Steven Pearlstein

All Credit To the Local Card Player

By Steven Pearlstein
Friday, January 14, 2005; Page E01

Among the business success stories in the Washington area, none is more spectacular, or less heralded, than that of McLean-based Capital One Financial.

Fifteen years after being launched as the credit card subsidiary of Richmond's Signet Bank, Capital One has become the third-largest issuer of credit cards in the most debt-soaked nation on the planet, with customers in about one in every three U.S. households. And since it went public a decade ago, it has been growing an average of 30 percent a year, delivering shareholder returns of 24 percent.

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The Puzzling Allure of David Huber (The Washington Post, Jan 7, 2005)
Get Over The Gadgets and Deal the Cards (The Washington Post, Jan 5, 2005)
Column Archive

Here's the rare company that has been able to weather the inevitably bumpy rite of passage from start-up to corporate giant without losing its entrepreneurial spunk. And with its clever "What's in your wallet?" ad campaign, its brand awareness rivals that of American Express.

Now, with a market value of $20 billion, Capital One is poised to leverage its core strength -- an awesome ability to use information about its customers to earn more from each one than most of its competitors -- and transform itself from a credit card issuer into a full-line financial services giant.

The Capital One story is a case study in mass customization -- the ability to tailor products to individuals and small market niches. Management consultants Richard Fairbank and Nigel Morris saw a competitive opening in a credit card industry that offered essentially the same credit card deal to the half of America that had the highest credit ratings -- a $20 annual fee and a 19.8 percent interest rate.

By testing different offers to prospects with different demographics and credit histories, and carefully tracking and analyzing their subsequent payment histories, Capital One was able to identify the "good risks" among those without cards -- a subprime market that, even after allowing for somewhat higher loan losses, had generous profit margins. To existing cardholders, the company presented the chance to transfer the outstanding balances to a new Capital One card with a teaser rate of 9.9 percent.

Over the years, as Capital One gathered more data about customers' financial behavior and computers became faster and more sophisticated, the company was able to refine everything about its operation in an effort to raise response rates, lower operating costs and reduce the risk of nonpayment.

Such aggressiveness also had a downside. The company developed a reputation for inflicting financial penalties on customers who are even a day late or a dime short on their payments, prompting a lawsuit last week by Minnesota officials.

A wake-up call from federal regulators in 2002 forced the company to tighten administrative controls and move away from its traditional emphasis on the riskier but more profitable subprime market. Profit growth is likely to slow further as the credit card market reaches saturation and other companies catch on to the customization game.

That's where diversification comes in. Capital One is already the second-largest auto lender in the country other than the automobile companies themselves. And following small acquisitions, it is beginning to use its testing and marketing prowess to make business and home-equity loans. Capital One is on the prowl for a deposit-rich bank as a low-cost source of funds to finance this loan growth.

Co-founder Morris, a Brit by birth, last year decided to cash in some of his chips and retire early enough to mount a second act, probably in the nonprofit area, he says. But Fairbank, who is closing in on billionaire status, remains energized by the prospect of doing an end run around regional banks like First Union and Wachovia and using his national base of 47 million customers to challenge the mega-bankers of Citigroup, J.P. Morgan and Bank of America to be financier of choice for Mr. and Mrs. America.

In pursuing that strategy, Capital One is likely to run into Countrywide Financial, the mortgage giant, and its larger but largely unbranded credit card rival MBNA. It's unlikely they'll all make the final cut, but I rather like the odds on the home team.

Steven Pearlstein can be reached at pearlsteins@washpost.com.

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