A prepaid card has traditionally been the financial equivalent of a short-term romance. Good enough for now, but certainly not something to plan your future around.
As competition has intensified, though, prepaid card providers are increasingly seeking to settle down with their customers. The days of love-'em-and-leave-'em are gone; it's commitment time.
"Ultimately that's the goal, is to get more customers to use it like a traditional checking relationship," said Madiline Aufseeser, a senior analyst with the Aite Group.
The math driving the trend toward longer term relationships is simple. A typical prepaid card is active for six months or less, according to a recent report by researchers at the Federal Reserve Bank of Philadelphia, but revenue generated by such cards multiplies the longer they are in use.
In the past, those realities were not necessarily a problem for incumbent companies like Green Dot and NetSpend. Even with high rates of customer churn, business was booming. The number of prepaid issuers was relatively small, and their pricing remained comparatively high.
But the arrival of American Express, which is teaming up with Wal-Mart to offer the Bluebird card, and JPMorgan Chase, which is offering the Chase Liquid card, has shuffled the playing field. Increased competition is putting downward pressure on prices, making it harder for card issuers to recoup their costs upfront.
Meanwhile, it has become apparent that customers become much more lucrative if they use their prepaid cards for longer periods of time.
The Philadelphia Fed's study examined general-purpose reloadable cards purchased online, and it found that revenue earned from customer fees averaged only $6.65 in the first quintile of use. But that figure grew by leaps and bounds as the relationship continued, and by the fifth quintile, the issuer was earning an average of $176.50 per card from customer fees.
And the benefits of a longer-term relationship were just as striking with respect to interchange revenue.
Doug Greiner, a research analyst at Compass Point LLC, said that prepaid customers have traditionally been transaction-oriented consumers who are quick to switch to another financial provider — in contrast with the more long-term-oriented customers that banks typically seek.
"There's a reason that the banks initially did not want to bank this market," Greiner said.
Now, though, with recent regulations on swipe fees and overdraft fees crimping revenues on retail accounts, many banks seeking new income streams are increasingly focusing on the underbanked. Several large banks have recently begun offering short-term, small-dollar loans that are similar to payday loans, while JPMorgan Chase, Regions Financial and BB&T are among those that are now marketing prepaid cards.
Green Dot, which is based in Pasadena, Calif., and Austin, Tex.-based NetSpend were both founded in 1999 with a focus on providing financial products to the underbanked.
Today, both firms have been seeking to differentiate themselves by emphasizing their deep experience in the prepaid market.
"We have, remember, millions of installed customers. We have been doing this for years and years and years," said Steve Streit, Green Dot's chief executive officer, during a Nov. 1 conference call with analysts. "Literally, we get letters and calls from people whose mothers use our products, and now the daughter is using our product."
Executives at Green Dot and NetSpend also note that the total prepaid market is growing rapidly, suggesting there are enough customers to go around for everyone.
"Our biggest competitor still is by far cash," NetSpend chief executive officer Dan Henry said during a Nov. 1 call with analysts. "There are 68 million underbanked customers out there in this country. Ourselves and Green Dot, two of the biggest collectively, we've got less than 10% of that total market."
In recent months, NetSpend has shown more optimism than Green Dot about its short-term growth prospects. NetSpend signed retail partnerships with Walgreens and CVS, as well as a deal with Intuit that will allow TurboTax users to receive their tax refunds on the Austin-based company's prepaid cards.
But both companies have seen their stock prices fall significantly from their peaks, as investors have grown more wary of new, deep-pocketed competitors. Green Dot shares currently trade at about one-third of their high-water mark from the last year. NetSpend's share price has rebounded over the last year, but it is still down about 30% from its peak in late 2010.
Today both NetSpend and Green Dot are focused on finding ways to develop longer-term relationships with their cardholders — most notably, by pushing to enroll their customers in direct deposit, but also with products like online bill pay.
During NetSpend's Nov. 1 earnings call, Henry spoke about the possibility of tripling the number of the company's customers — currently around 1 million — who have direct deposit.
"I got to think that getting 3 million customers on direct deposit is absolutely a manageable and doable target," he said. "And I'd like to see us go beyond that."
In 2010, 19% of active prepaid debit card users had direct deposit, and that number climbed to 22% this year, according to a November report by the Aite Group. The report projects that by 2016, the direct deposit ratio will climb to 26%.
The Philadelphia Fed study, which analyzed more than 280 million transactions on 3 million prepaid cards, sheds light on why direct deposit has become a focus for prepaid issuers.
The authors found that among general-purpose reloadable prepaid cards purchased in retail stores, those purchased by people who did not enroll in direct deposit generated lifetime revenue of $11.95. By contrast, cards bought by those who did enroll in direct deposit generated revenue of $152.80, largely because they use the cards for more transactions.
For card issuers, the trick is figuring out how to identify those customers who not only have a need for a prepaid card, but also can be persuaded to use it as their primary transaction account.
Robert Hunt, director of the Payment Cards Center at the Philadelphia Fed and one of the study's co-authors, said that the prepaid card industry is roughly where the credit-card industry was 25 years ago in terms of its ability to match products to customers' needs.
He added that the task facing prepaid issuers is complicated by the fact that many U.S. consumers are still relatively unfamiliar with how prepaid cards work.
Still, interest in prepaid cards is clearly growing.
Aite Group's Aufseeser projects that the size of the prepaid debit market in the United States will double between 2012 and 2016 — though she doesn't see new entrants significantly eating into established players' market share. Barring acquisitions, she estimates that Green Dot's 26% market share will shrink by just one percentage point over that four-year period, while NetSpend's 21% share will increase by the same amount.
"We've got a growing market," she said. "So for a new entrant to come in and to build that load volume, it's going to take some time."