Target Card Tests Future of Store-Branded Debit

National retailer Target (TGT) is fabled for its sophisticated use of customer spending data. In one much-ballyhooed incident, a company mailer advertising maternity clothes and nursery furniture reportedly alerted a Minnesota man that his high-school daughter was pregnant.

So it makes sense that Target has emerged as a leader in store-branded debit cards. The goal of such cards is to use data analytics and discounts to cement customers' loyalty.

The real mystery is whether store-branded debit cards, which also have gained some traction at gas stations and convenience stores, will catch on more broadly. The plastic cards pose a competitive threat to banks and credit unions that rely on swipe fee revenue from consumers who are wary of credit cards.

Store-branded debit cards were supposed to die after price caps on swipe fees took effect in 2011, since one of its major advantages was that it allowed retailers to avoid paying the hefty interchange fees that banks were charging. Those fees have fallen sharply over the last two years.

Yet Minneapolis-based Target is showing that under the right circumstances, store-branded debit cards can still work for retailers.

Consumers who have a Target debit card increase their spending by an average of 52%, according to a presentation the company made last year. In the second quarter of this year, sales on the debit cards surpassed sales on Target's credit cards for the first time, according to the company.

"It is the right product for a large set of guests who simply don't want another credit card in their wallet," Target Chief Financial Officer John Mulligan told analysts earlier this month.

Because of Target's strength in analyzing data, the company may be better positioned than other retail chains to profit from issuing its own debit cards, says Steve Heusuk, a senior manager at CUNA Mutual Group, which provides financial products to credit unions.

Target is an industry leader in using its customers' purchase histories to send them offers that are relevant to their personal circumstances — whether it's maternity clothes for expectant moms or cheap furniture for college freshmen.

"I'm not sure that that capability is widespread throughout the retail industry," Heusuk says.

But some experts believe that store-branded debit cards will be part of the strategy employed by the Merchant Customer Exchange, or MCX, the fledgling consortium of retail chains that is looking to challenge the traditional electronic payments system.

Target is participating in MCX, and so are certain gas station and convenience store chains, including QuikTrip and Shell, that have experimented with store-branded debit cards.

Retailers participating in MCX are "going to be trying to promote payment vehicles that attach the consumer to them," says Eric Grover, a payments industry consultant. He predicts that store-branded debit cards will be part of MCX's strategy.

Store-branded debit cards, which are sometimes referred to as decoupled debit cards, are generally linked to consumers' existing bank accounts. Usually they can only be used at one particular retail chain. When the cards are swiped at the cash register, they trigger an electronic transfer of funds, which is cheaper for the merchant to process than a debit card authorization over the Visa or MasterCard system would be.

Because electronic transfers often take more than a day to complete, store-branded debit cards open consumers to the risk that their banks accounts will not have sufficient funds to make the purchase. Those consumers can find themselves getting hit with bank fees.

There is also risk for merchants. They have to swallow the cost when their customers make a purchase and don't have enough funds in their bank accounts to cover the bill. "I think it takes a pretty sophisticated business model," says Nessa Feddis, a senior vice president at the American Bankers Association.

Retailers rely on discounts to persuade their customers to sign up for, and then use, the cards. Target, which declined an interview request, offers virtually the same package of benefits to customers who swipe the company's debit cards as it does for Target credit card users.

Those perks include free shipping at Target.com and 5% off all purchases, both in stores and online. Cumberland Farms, a gas and convenience store chain operating mostly in the Northeast, offers customers who use its store-branded debit card 10 cents off every gallon of gas. Shell gas stations offer 2 cents off each gallon.

The savings in swipe fees helps merchants compensate for the discounts. But Target's 5% discount is likely significantly larger than the amount it pays Visa and MasterCard to process purchases on bank-issued debit cards.

In order to make generous rewards programs work, retailers need to change people's shopping habits — turning occasional customers into habitual ones. That business model seems to make more sense at retailers that sell products that consumers buy frequently than it does at stores that specialize in more expensive items.

"The economic model works in everyday-spend categories," says Peter Guidi, vice president of sales at National Payment Card Association, which provides the technology for store-branded debit cards to Cumberland Farms and other regional gas and convenience store chains.

But Mike Grossman, the former chief executive officer of Tempo Payments Inc., a pioneer in store-branded debit that went out of business in 2011, has doubts that today's cards are really leading to a big increase in customer loyalty.

He wonders: is the store-branded debit card prompting shoppers to return to Target more frequently? Or are customers who are already inclined to shop often at Target more likely to sign up for the cards?

"I guess I have some skepticism that it's actually all that lucrative," Grossman says.

Another longstanding problem with store-branded debit cards has been that many people don't want to fill their wallets with a piece of plastic that only works at one retailer. With the rise of mobile wallets, though, that problem may be receding.

Cumberland Farms, relying on technology from National Payment Card Association, is now allowing mobile payments on store-branded debit transactions. "Tens of thousands of consumers are paying with their mobile phone at the gas station," Guidi says.

MCX has revealed little about its plans, but the group has said that it is working to develop a mobile commerce platform that will be available through virtually any smartphone. Members of the group have also spoken about their desire to develop tools to increase customer loyalty.

More details could be forthcoming in October when Dodd Roberts, a senior executive at MCX, is scheduled to speak at the Money 2020 conference in Las Vegas. Forty-six retail companies are participating in MCX, according to the group's website, including Wal-Mart Stores, Sears and Best Buy, in addition to Target and numerous gas and convenience store chains.