September 26, 2008

Credit Customers, Lifetime Value, Eddie Bauer

Some of you might have noticed talk in the media recently about our failing financial industry.

So it might be instructive to consider the role of credit within a retail brand.

Back in the day, in the late 1990s, I worked at Eddie Bauer. In the late 1990s, Eddie Bauer was a $1.6 billion dollar multichannel brand that routinely churned out ninety million dollars in pre-tax profit --- not outstanding performance, but not too shabby.

Eddie Bauer was owned by Spiegel, the century-old catalog brand out of suburban Chicago. Spiegel owned a bank, FCNB. That bank provided credit to credit-worthy consumers.

Retailers adore proprietary credit. There's no better way for a retail brand to extract an extra ten percent out of a $100 order than to encourage the customer to make $10 payments for a year at 24% interest.

The theory, then, is that after administrative expenses, proprietary credit can be responsible for nearly doubling the profitability of a customer, as long as the customer fails to pay down their debt in a timely manner.


No Credit With Credit



Demand $100.00 $100.00
Net Sales $70.00 $70.00
Gross Margin $38.50 $38.50
Less Marketing Expense $20.00 $20.00
Less Pick/Pack/Ship Expense $7.70 $7.70
Variable Profit $12.30 $12.30
Add: Interest Revenue $0.00 $10.00
Less: Banking Expense $0.00 $1.50
Net Contribution $12.30 $20.80

On paper, the profitability of a proprietary credit customer looks too good to be true. The fairy tale drives a brand in a new direction.

If we know that the proprietary credit customer is this profitable, then we want to aggressively market credit to the customer, right? And we especially want to market credit to new customers. If credit customers are worth more, then we can prospect much deeper, increase sales, and on the surface, significantly increase profit. In the short term, this is all good.

At Eddie Bauer, we closely monitored the percentage of sales that were generated via proprietary credit. And we were strongly encouraged by Spiegel to amp that percentage, because a higher percentage of sales on proprietary credit resulted in more interest revenue, and theoretically, more profit.

So we amped-up our credit push. New customers were strongly encouraged to sign up for credit. Existing customers were given in-store, catalog, and e-commerce incentives to sign up for credit. Credit customers were offered promotions to take advantage of credit.

A funny thing happens when you focus on credit. You attract a customer who needs credit.

Not surprisingly, this customer is fundamentally different than bank card customers. The proprietary credit customer buys a slightly different merchandise assortment than does the bank card customer. This causes the merchandising division to chase merchandise preferred by the proprietary credit customer, not to chase merchandise preferred by quality customers.

Within two or three years of a consistent, relentless credit push, the brand has been fundamentally changed. Well, the brand has not been fundamentally changed --- the brand is the brand. But the customer file has been fundamentally changed, and the core of the brand, merchandise and customer service, has taken a back seat to proprietary credit.

Ultimately, the brand reverses direction. Instead of selling merchandise to the customer, the brand uses merchandise as a teaser to sell credit to the customer. Eventually, customers max their credit limits. Our analysis suggested that when a customer got within $100 of their credit limit, the customer stopped purchasing. Some customers failed to pay their debts.

When the credit "channel" begins to fail, the whole house of cards crumbles, bringing down everything.

The lessons are clear. By focusing on merchandise, by focusing on serving the needs of a customer, one can build a healthy business. By focusing on selling money to a customer, we don't sell anything of long-term value. Admittedly, we boost short-term performance. Essentially, we push long-term profit into a short-term window, paying a long-term price for the benefit of goosing short-term numbers.

At Nordstrom, credit was viewed in a different light. During my time at Nordstrom, credit was never the primary mechanism for a customer relationship. Strong credit leadership (Kevin Knight), and strong executive leadership (i.e. the Nordstrom family), prevented the business from going down the path that Eddie Bauer took.

Eddie Bauer is still trying to dig out of this problem, nearly a decade later.

And now our nation will attempt to dig out of a period of time when we gorged ourselves on credit.

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