Costco Fiasco Exposes the Pitfalls of Deep Integration

If there is a takeaway from Citigroup's not-quite-stellar rollout of the Costco Anywhere Visa card, it is this: Even in modern times, the transition of large card portfolios from one issuer to another can prove disastrously complex.

After major complaints occurred in June from Costco members who were having trouble activating their new cards when Citi and Visa began the transition to replace American Express cards, it was revealed this week that Citigroup had sent a batch of e-mails to the wrong account holders, saying those card memberships at Costco had lapsed. The only problem was they hadn't, and Citi was left scrambling to appease irate customers again.  

The problem stems from the complexity of the portfolio's integration with Amex, said Gil Luria, analyst with Los Angeles-based Wedbush Securities.

"This deal is unprecedented in scope," Luria said of the transition of 11 million member cards. "American Express' reliance on Costco, and Costco's integration of American Express was broad and deep, so it is very hard to just change that overnight and we are seeing that transition pain now."

The industry has shown on more than one occasion that any changes in issuing, acquiring or payment processing for a retailer's card brand can result in challenges, stemming from increased customer inquiries to a more nightmarish scenario when cards don't work when consumers present them at the point of sale.

With far fewer accounts, at about 2 million, prepaid card provider Green Dot had considerable woes in moving payment processing from TSYS to Mastercard. It resulted in a period of time four months ago in which nearly 59,000 Walmart-branded prepaid cards simply did not work.

As far back as 2010, JPMorgan Chase and Starbucks proved that major brand names are not immune to card portfolio problems. They did not have rollout issues years earlier with what became the popular Duetto card, but did put an end to this credit card romance by terminating Duetto's use and illustrating some of the pressures a card portfolio can face from the economy, costs and ongoing expectations.

No matter which bank or card brand is involved, the key aspect of dealing with card portfolios is predictability, said Brian Riley, an independent payments consultant with past experience at Citi.

"For it to be 100 basis points better is just as bad as being 100 basis points worse at the end of the day because you are trying to give your investors guidance," Riley said. "A good surprise can have a bad effect if it turns out to be something you are not expecting."

A couple factors worked against Citi in that regard. The bank could not address Costco customer questions until Visa had completed its acquisition of the portfolio from American Express.

It resulted in "eight months of pent up demand during which time we couldn't address questions on the new product or existing accounts as the portfolio was with a different issuer," said Jennifer Bombardier, senior vice president of public affairs for Citi global cards and consumer services. "The call volume was groundbreaking as of June 20 [official launch date]."

Calling the transition "one of the single largest portfolio conversions in history," and with a brand as popular as Costco, the consumer interest and questions were unprecedented, Bombardier said.

In the early days of the launch, Costco customers experienced longer wait times, but Citi has responded to the demand for new cards and the average call waits were as low as just a few seconds the past weekend, she added.

"It is important to note that despite some of the reports in the media and elsewhere, the vast majority of call volume was related to a number of topics, including card activation, payment queries, online setup and things of that nature," Bombardier said. "They were not complaints."

In addition to being such a large portfolio transition, the Citi/Visa takeover from American Express at Costco has garnered much attention from investors, particularly those who questioned the economics of the move for Visa.

Four months ago, Visa CEO Charlie Scharf was defending his company's position in obtaining the Costco pact, which some investors felt was too steep considering the store's cost to accept Visa transactions was reportedly near zero, while the expense of loyalty and rewards programs have been on the rise.

Scharf essentially said his company could withstand the lower transaction fees because the warehouse shopping business model is sure to bring many new customers into the Visa fold.

Visa did not respond to inquiries about Citi's rollout problems by deadline.

Citi is confident that its most recent measures of proactively communicating with customers about activation options; updating its FAQ section online; and increasing staffing at call centers (in addition to Costco adding up to 20 new employees to enroll new card members and answer questions); will greatly smooth over the transition.

Bombardier said Citi has added "a few thousand" people over the past year for customer service support during the transition.

Citi can also find a level of satisfaction in the results of an independent survey from Lightspeed regarding the Costco conversion in which 81% of respondents rate Citi's communications as positive, while three in four shoppers have rated their experience with the new card as "excellent." Lightspeed surveyed more than 500 Costco Anywhere Visa cardholders.

"We've seen just shy of 900,000 applications for the card and continue to see extraordinary interest and engagement in the product," Bombardier said.

For its part, American Express has put up a strong face in the wake of losing a Costco portfolio that represented about 10% of Amex cards in circulation. It was able to report a profit increase of 37% in the second quarter from the $1 billion gain on the sale of that portfolio.

In addition, Amex executives have told investors for the past year that they are confident they can convert many of the Costco cardholders into other Amex products to limit the damage from the lost business. 

Because so much of information regarding negotiations is private, whether American Express used its customer service record as a bargaining chip in negotiations with Costco can't fully be known at this time. And none of that matters to Cit or Visa now.

Even though there is some "egg on the face" of Costco, Visa, Citibank and Citi Merchant Services over the rollout issues, there are no "big red flags" for any of them to worry about, said Larry Berlin, vice president with Chicago-based First Analysis Securities.

"If you shop at Costco, and you use Visa, you are going to keep doing it," Berlin said. "There are reasons to go to Costco and reasons to use a credit card, and that's not going to change."

A transition of this size is a "tough thing to do," Berlin said. "You expect to see smaller snafus for a while, and you will probably see a few more ahead as well."