Corporate Strategy Weekly Radar Update

Week ending Friday 15 June 2012 (Credit Cards Fees, Women+Tech)

Highlights Financial Services Changes announced by the RBA will allow credit card providers to limit merchant surcharges to reasonable cost of card acceptance from 2013, reversing current merchant discretion. The BIS warned that US, Argentina, Indonesia, Russia and Turkey are lagging in their Basel implementation compared to other G20 nations fuels argument Australia is moving too fast Basel III reform implementation. From 2013, APRA requires Australian banks to have a minimum common equity Tier 1 ratio of 4.5% 2 years earlier than most jurisdictions. A key issue raised at ANZ's recent Asian Investors Tour was whether ANZ should sacrifice short term shareholder returns to undertake transformational activity required to become a super-regional bank and generate 25-30% profit from APEA (Asia-Pacific, Europe and America) up from 15% today (driven by insto, whilst retail banking is underdeveloped). BoQ upgraded by S&P to BBB+ from BBB following capital raising and provisions against non-performing loans. (SUN: A+, AMP: A, Bendigo: A-, BoQ: BBB+, Members Equity: BBB) NSW Government announced transactional banking tender (currently held by WBC) - expected to be fiercely contested. CBA's CommInsure lost second financial planning group in two months (Genesys, following WHK Group), with other groups (incl. SUNs Guardian) reportedly reviewing relationship. Other industries QANTAS: 1) Macquarie Group appointed and internal task force established to defend against hostile takeover possibilities. 2) Capital raising to maintain investment-grade credit rating ruled out. 3) CEO Alan Joyce projected that China will account for 1/3 of its tourism arrivals by 2020. BHP cuts commodity price outlook over the next 3-5 yrs, citing international economic uncertainty impacting demand. Australian Economy Global Economy Two indicators in the year to 8 June: Australian corporate equity fell -47% pcp reflecting volatility, whilst issuance of corporate debt rose +36% pcp reflecting low bond rates. Prime Ministers Economic Forum focused on The Asian Century. RBA's Glenn Stevens named Productivity as source of growth "because peak had passed in the terms of trade". 5 priorities were listed: labour, goods, finance, infrastructure and federal state relations; and PM will revive the company tax cut. Modelling of a Wellington 7.6 earthquake done via new disaster prediction software RiskScape shows >600 destroyed buildings and NZ$20bn in recovery. New housing incentives announced in NSW ($35,400 new home subsidy) and VIC (release of 35,000 new housing blocks in Melb). Germanys central bank is considering AUD denominated assets in its foreign exchange reserve portfolio for the 1st time, after decades of favouring USD, Euros and Yen. Spain provided with 100B by EFCF (2.7x the amount deemed necessary by the IMF, and 5x the amount required to recapitalise the Bankia), however sees its credit rating downgraded to Baa3, on review to junk, by Moodys (after similar downgrade by Fitch last week). Greece elections this weekend: pro (Pasok, New Democracy) vs anti (Syriza, KKE, Golden Dawn) bailout + austerity parties. Insights Credit Cards fee changes reflect concerns some merchants (incl. accommodation, travel, taxis etc) are gouging by passing the cost of the Merchant Service Fee via a surcharge well in excess of acceptance costs (~87c / $100 for Mastercard; ~$1.80 / $100 for Amex) (See Appendix for details of the various cards fees) Australian Banks have argued that APRAs conservative approach on Basel will result in hitting the trigger point (5.125% core equity ratio) sooner than international peers, hence risking to raise their cost of wholesale funding, when in fact a 9% Australian core equity ratio is the equivalent of 11.5% in the UK. A contra view is that Australian banks have gained trust and solid ratings by meeting those requirements. Basel will also develop a template to more easily compare the capital positions of banks in different jurisdictions on a consistent basis. However, it won't be ready by 2013 when the new rules kick in. ANZs existing shareholders are largely domestic (75%) and retail (40%) will not favour sacrificing short-term profits to long term returns. Some analysts question whether a dual listing on an Asian stock-exchange could provide a solution. ANZ is now taking a more conservative approach to growth after heavy investments from the past have created a drag in ROE still felt to this day: APEA returns 10.5% vs 16.1% for the Group. CommInsure: 13.2% of risk premium inflows in 2011 (3rd behind AMP and MLC) but recent legacy and claims management problems in disability led to key staff churn and underlying profit drop of 8% for 1H12. Some analysts doubt CBAs ability to sell insurance to retail customers and are questioning the product range. Could CBA divest all or part? QANTAS China strategy was presented in Beijing, and echoes rumours of other Australian companies having their boards visit China in recent weeks (ANZ, IAG, Wesfarmers and Telstra). BHPs cut outlook echoes analyses from economists such as 1 Doug McTaggart who highlights the 150-year fall of real price of commodities as the world grows: analysts question whether the current commodities supercycle has peaked and a windback of capital investment is likely (interplay of commodity prices and investment discussed last week.) As highlighted last week, issuance of corporate debt is gaining favour as alternative funding to bank institutional lending. Corporate tax rate cut expected to be funded from changes to existing business tax deductions, causing debate on its nature. Still in development, RiskScape could become industry standard for hazard and impact assessment: it will provide calculated outputs (replacement costs, casualties, economic losses, disruption) for various events (EQ, landslides, flooding, tsunami).To be monitored given natural events impact on GI. NSW & Vic new housing designed to reignite the construction industry. However, these schemes come at the expense of incentives for established dwellings, and could offset any retail mortgage system growth which arises from the new schemes. Spain: Initial positive reaction failed to sustain: bailout fatigue is kicking in. Observers have been waiting for a EU 'Lehman Moment' however but resolving the crisis long term project.

Dr Doug McTaggart is the Chief Executive of QIC and recently joined the Suncorp board (link to bio)

Appendix A: Understanding EFTPOS and Credit card transaction fees in the context of the new RBA rules on merchant surcharges

EFTPOS vs Credit card: 2 different systems with regards to transaction fees EFTPOS - Proprietary: Switch to issuer model Scheme Credit: Switch to Acquirer model

Cardholder

Merchant

Cardholder

Merchant

(surcharge)

(MRbt)
(Monthly) (transaction) (MSF)
(Monthly)

(MSF)
Issuing Bank

Issuing Bank

(Interchange)

Merchant Acquiring Bank

Merchant Acquiring Bank (Interchange) (SF) (SF)

Card Scheme
Source: strategy team analysis Monthly fees paid by Cardholders to Issuing Banks MSF: Merchant Service Fee paid by the merchant to the acquiring bank for the service provided by the Payment Terminal MRbt: Merchant Rebate: negotiated between Merchant and acquiring bank Interchange Fee: regulated, up to $0.05 per transaction by the RBA Those fees drive different behaviours...

Card Scheme
Surcharge: passed on by merchants to recoup the MSF they pay to acquiring banks MSF: Merchant Service Fee Interchange Fee: regulated up to 50bp per transaction = $0.7 per transaction. (based on RBA 2010 stats , Average transaction ~$140) SF: Scheme Fee paid by the banks to the Card Schemes

EFTPOS is a cheaper system favouring smaller transactions because of the low regulated Interchange Fee between banks and the absence of Credit Card Schemes (Visa, MasterCard) taking their clip. In NZ the EFTPOS Interchange Fee is actually zero, making the card a strong contender to cash: it has become a cultural habit to even pay a coffee with ETPOS. On the other hand Card Schemes charge banks with a Scheme Fee, and the Interchange Fee has been regulated with contrasted results. The RBA is attempting to regulate those fees - and some lessons learnt Towards the end of 2002, the RBA imposed a number of reforms upon Australias banks: o Reducing and capping the interchange fees that banks charge each other for credit card purchases, from 0.95% to 0.55%; o Removing the "no surcharge" rule, hence allowing retailers to surcharge customers for purchases paid with a credit card versus those paid with cash or eftpos; and o Allowing non-banks to issue their own Visa or MasterCard branded credit cards Institutions drew lessons from the RBA's move (such as the US Government Accountability Office in a report to Congress, 2009) The intend was that requiring the disclosure of interchange fees would lower merchants fees if consumers changed their behaviour after seeing the different costs associated with different forms of payment, and would shift from higher-cost forms such as rewards and other credit cards toward less expensive forms of payment, such as debit cards. It was expected that with lower card acceptance costs, merchants would pass on their interchange fee savings through lower prices to consumers; however research failed to demonstrate this has happened: prices have stayed the same for consumers. Lower interchange fee revenues for issuers also prompted them to increase cardholder costs or curtail cardholder credit availability. In effect, Australian issuers reduced rewards and raised annual fees following the interchange fee cap. In addition, with less interchange fee income, representatives of smaller issuers such as community banks and credit unions struggled to offer rewards cards and therefore became be unable to compete with the larger issuers in the market. The RBA is now focusing on the Surcharge Fee to address those unintended consequences.

Appendix B: Women are leading a significant shift in technology adoption

"Sorry, young man, you're not the most important demographic in tech anymore" (headline of the Atlantic Magazine on this story) A media intervention has been getting a fair amount of visibility in the last week to be worth noting in the context of the trends monitored by Project Marco Polo (presumably relevant to the Area of Change "My meaning"): Dr Genevieve Bell (Australian born Anthropologist, Director of Intel's User Experience Group, Adelaide's recent "thinker in residence") has been researching Technology adoption and reported shifting patterns to ABC Radio National, Future Tense: http://www.abc.net.au/radionational/programs/futuretense/our-technology-future/4026324 Despite companies' male-focused marketing efforts, women between the age of 40 and 60 have become the dominant users of a wide variety of new technologies in the past years. Men between the ages of 18 and 35, used to be tech industry's most coveted prize. They were the ones who decided what products failed and what products succeeded. But 40 to 60 yo women have become the crucial group shaping Technology's future: o Women in Western countries use the internet 17% more every month than their male counterparts. o in fact they lead usage in Internet usage, Mobile phone usage, location-based services, Text messaging, Skype o in Every social networking site aside from LinkedIn o All Internet-enabled devices: E-readers, Health-care devices, GPS Further points made by Genevieve Bell: o Significant spread of technology which is by no means ubiquitous: even as the NBN and 3G and 4G spread, it is simply the case that not everyone is connected to a high-speed true 2-way broadband, fast download, fast upload. We're still talking about a very uneven distribution of technology, and it will stay that way. o It is safe in some ways to argue that the future of the digital divide may be less about whether the technology is present and more about whether it's robust, accessible and what the price scale to access it is. o This means that contrary to the device "convergence" forecasted a decade ago, a patchwork of connectivity technology and devices is more likely, both fixed-line broadband as well as various forms of mobile broadband. o Both in mature and emerging economic markets, consumers seem to be opting for an ensemble approach to devices; they have many rather than one. (smart phones, laptops, PCs, televisions, GPS devices, digital cameras, etc). o Furthermore, most consumers don't own devices just by themselves, those devices exist within social networks, which suggest a much more complicated landscape than we have historically in some ways designed for. o A key point made by Bell is the false belief that what people are doing in their teenage years will dictate what they do later: she believes that habits of consumption change between when parents fund their kids' media habits and when kids move out: "it is the moral equivalent of saying you go to a buffet, all-you-can-eat, you eat all you can. You go to a restaurant where you have to pay for it by the plate, you change your eating habits." o Her research found that that as people are graduating out of an afforded media, they pare back what they are consuming. Taking a closer look at social networks specifically... Gender balance of social networking site users (% men, % women)
Greater proportion of men users
Facebook Twitter Instagram Pinterest Myspace Google+ Flickr Youtube Linked in Foursquare Digg Reddit Soundcloud Scribd 74% 61% 50% 66%
Functional Networks Social Networks

Greater proportion of women users 58%

62% 53% 72% 62%

Google+ anomaly 64% 54% 54%

54%
52%

Whilst such a classification is always arbitrary and any given user tunes the way they chose to use them, networks can be broadly classified between 'social' and 'functional': 'Social' Networks tend to favour conversations between subscribers: Facebook (Status, Pictures, embedded games), Twitter (status updates, brief statements and links), Instragam (pictures prompting small comments) Pinterest (pictures and links), Myspace (personalised pages built around themes), Google+ (Google's blend of Twitter and Facebook). Functional networks tend to fulfil a more specific utilitarian purpose: online conversation is obviously possible but for a range of historical and ergonomic reason, does not happen as much: Flickr (used by photographers to upload larger resolution pictures), YouTube (video sharing) Linkedin (professional CV sharing) Foursquare (instant location sharing) Digg, Reddit (bookmarks) Soundcloud (music sharing) Scribd (PDF sharing).

Source: Information is Beautiful; Corporate Strategy Analysis Lessons learnt from the "The Google+ anomaly": whilst it is only a very narrow lens, it might inform the reason why Google+ is struggling to generate traffic after a strong start (partly due to the "buzz" around Google as a company, and the quasi automatic sign-up of any user of Google services (gmail, etc). The running joke being that Google+ is still dominated by "geek" males because it missed the important steps that "friend connections" where already established on other networks such as Facebook and Twitter prompting industry observers to ask: "why would you want to go to the hassle of getting all your friends, contacts, family, acquaintances onto 'another' social network?" (unless it is a "killer app", which it isn't) So far, Facebook and Twitter clearly benefit from the "first mover advantage", confining Google+ to an experts' network and an afterthought for the mass of the users. Conclusion The Technology industry is still dominated by young-men-designers and but the levels of maturity means that whilst new products are still released by them, in a Darwinian "survival of the fittest products and services", the adoption is now driven by women who influence Households' purchase patterns. This is clearly echoing Suncorp's recent "Million Dollar Woman" launch. However, as recently observed by Business Spectator's Editor Charis Palmer, this trend does not necessarily mean that products and services must be designed for women only, but must rather be universal enough to not disfranchise them. A nuance to be pondered.
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