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December 16, 2008

Government usage spurs prepaid market

Prepaid usage is continuing to grow strongly in the US, with both open- and closed-loop programmes seeing rises in loading volumes But are growth rates living up to the expectations of the prepaid industry And is open-loop growth still being held back by merchant resistance

By Verdict Staff

Prepaid usage is continuing to grow strongly in the US, with both open- and closed-loop programmes seeing rises in loading volumes. But are growth rates living up to the expectations of the prepaid industry? And is open-loop growth still being held back by merchant resistance? Charles Davis reports.

Economic uncertainty might slow the US prepaid card market, but its growth is expected to continue, thanks in large part to the inertia created by the macroeconomic movement away from credit and towards cash and cheque alternatives. Mercator Advisory Group’s Fifth Annual Closed-Loop Market Assessment, released this month by the Massachusetts-based payments consultancy, reports healthy growth in the closed-loop segment.

The report estimates that the amount of funds consumers loaded onto closed-loop prepaid cards in 2007 grew to $179.6 billion, up 5 percent from the $171.2 billion loaded in 2006. The total loaded onto prepaid cards – both open and closed-loop – was $218.3 billion last year, up 10.3 percent from $197.9 billion in 2006. The amount of funds loaded on open-loop cards totalled $38.8 billion in 2007, up 45.3 percent from $26.7 billion in 2006.

Spurred by government usage

The biggest news in the report is the rapid adoption and roll-out of network-branded cards for government disbursements. State unemployment benefits dispensed through prepaid cards grew 150 percent in 2007 compared to the year before, while court-ordered payments grew 82 percent. Even with these mind-boggling rates, the government sector is slowing when compared to the past few years, as many state programmes have taken an open-loop approach.

US government prepaid programmes, particularly food stamps, represent a large portion (32 percent) of the entire closed-loop market and these segments are experiencing very slow growth. As a result, the government category is a drag on the overall growth of the closed-loop market.

Tim Sloane, director of the Prepaid Advisory Service at Mercator Advisory Group and one of the report’s authors, said that the overall growth rate associated with the network- branded prepaid market has slowed somewhat, but still grew by 44.5 percent from $26.8 billion in 2006 to $38.7 billion in 2007.

“While this represents an enviable growth rate by almost any external standard, it will likely still disappoint an industry that has come to expect triple-digit growth rates,” Sloane said. “This slowdown in growth rates should not be surprising since the increase in total market dollar value simply makes triple-digit growth rates increasingly difficult to achieve. The $11.9 billion increase for the open-loop load is a very healthy increase in market size.”

Incentive applications on the rise

Another market sector of note is the business travel and incentive segment, which grew to $18.51 billion from $14.82 billion in 2006, a growth rate of 25 percent in both open-loop and closed-loop volume. The real story regarding this category is that incentives dominate the category and that both of the incentive markets – employee, and partner and consumer – are rapidly adopting network-branded solutions to their portfolios.

Closed-loop solutions restrict the consumer’s spending to a specific merchant and utilise the store’s own infrastructure to operate. The open-loop card delivers a card-based product that is perceived to be almost as good as cash from the cardholder’s perspective. The downside is that the value chain needed to operate the open-loop product involves many external suppliers (banks, processors, etc), which in turn increases costs.

Mercator said that it has talked to many merchants that fail to see a benefit to using anything but their own gift card for their incentive programmes – consumer, employee, or partner, despite the fact that there are three different incentive programme scenarios these merchants could consider. They can use their card for their own incentive programme, use a different issuer’s card for their own incentive programme, or sell their card for use in someone else’s incentive programme.

“The vast majority of merchants are so focused on costs and savings associated with their own gift card that they typically opt for using their own card for their own programmes,” the report said. “These merchants fail to recognise the unique advantages possible for customers, partners, and themselves when they partner with other issuers to support their programme.”

For example, one merchant that Mercator Advisory Group is working with saw their cost cut in half when they partnered with another merchant on a promotion because the other merchant valued the opportunity to be exposed to new customers and substantially discounted the cost of their card to win the business.

“It is clearly time for closed-loop programme managers to re-evaluate both what cards should be used for internal incentive efforts and how their existing closed-loop gift card programmes can be modified to better compete with open-loop solutions,” the report said.

Benefits of open-loop solutions

To truly appreciate the inroads being made by open-loop network-branded cards into both the consumer and the employee and partner incentive markets, Mercator notes that open-loop solutions are growing at 83.4 percent in the employee and partner market while closed-loop gift cards are losing market share at the rate of -3 percent, dropping in total load from $7.13 billion in 2006 to $6.90 billion in 2007.

In the longer term, Mercator concludes that closed-loop suppliers must become better informed of the benefits associated with open-loop solutions. Some closed-loop suppliers will find that their existing channels and customers are ideal candidates for open-loop products, and that satisfying that demand can be highly profitable.

Open-loop solutions change both the cost and income equations that will prove compelling for some businesses. Open-loop solutions lower the cost and effort associated with deploying card acceptance by utilising the POS devices already deployed for open-loop solutions, and they will increasingly be used to co-ordinate business between co-operating firms.

This leads Mercator Advisory Group to believe that the majority of financial institutions will therefore be locked out of the retail channel unless they either greatly expand the footprint of their ATM or add kiosk functionality to implement a full range of unattended financial services, or expand their branch presence down market to a level previously considered unsustainable.

“Regardless of which approach is taken, time to market favours the closed-loop distributors and the few financial institutions they decide to partner with,” wrote Sloane.

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