The Junk Mail Master
Database marketing and mailbox commerce have turned
Capital One into a credit card king. But as consumer debt
maxes out, where can the company grow next?

By NANCY FEIGENBAUM

You don't have to be a Wall Street analyst to understand how Falls Church-based Capital One Financial Corp. has become one of the biggest credit card issuers in the nation.

You don't even have to look in a newspaper or magazine, where there have been plenty of articles in recent years about Capital One's scientific approach to lending, its ability to win away customers in a hyper-competitive market, and its incredible growth curve.

You only have to open your mailbox.

That's where you'll find that Capital One knows its market — namely, you. The company knows whether you pay your bills on time, whether you're a history buff or a World Championship Wrestling fan, whether you rack up frequent-flyer credits or prefer to take the train.

"They clearly know exactly what I'm doing," says Carolyn Campbell, a Williamsburg mother of four who has gotten at least five Capital One offers in this year's mail. Campbell and her physician husband are conservative users of credit. They rarely carry over a balance. They have several credit cards, but they mainly use the one that gives them points toward any airline.

Capital One's mailings to the Campbells have targeted the one card that they use, offering identical terms, but at a cheaper annual rate. The company's Visa Platinum MilesOne Card offers points toward travel on any U.S. airline, charging 9.9 percent interest and $19 a year. The Campbells, who are satisfied with their current credit card, also are tempted to switch.

David West, director of research for Richmond-based Davenport & Co., knows all about Capital One from an investor's perspective, but even he is surprised by the mail the company sends him. "I'm a history buff, and they ... somehow found out that I'm a history buff and interested in English history," he says. Capital One sent him an anglophile's credit card.

Clearly Capital One is doing something right. In less than five years, the company has grown from a midsize division of Signet Bank to one of the largest independent corporations in Virginia. Capital One is based in Falls Church, but it has a huge impact on other areas of the state. Next year, for example, the company likely will supplant Philip Morris USA as the largest private employer in the Richmond area.

Capital One has more than 7,000 workers across the commonwealth. And earlier this year, the company announced it would expand Virginia operations by more than 3,000 jobs and 500,000 square feet during 1999 alone. Capital One projected 2,010 new jobs in Henrico County, 350 in Chesterfield County, 400 in Spotsylvania County, and 315 in Fairfax County. More recently the company announced that it is looking for a new headquarters site in Northern Virginia that could accommodate 1.5 million square feet.

"It's been kind of mind-boggling to me that they've managed this expansion as well as they have," West says.

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As a student of credit card spending, Capital One has quickly moved to the head of its class after spinning off from Signet Bank in February 1995. Its database marketing strategies were the brainchild of Richard D. Fairbank and Nigel W. Morris, who then worked for Strategic Planning Associates, now called Mercer Management Consulting. Neither Fairbank nor Morris responded to requests for interviews in the reporting of this story.

In 1987, Fairbank and Morris approached Signet and other financial companies to peddle their marketing ideas. The credit card business, they reasoned, is about information. Run enough numbers through enough computer programs, and a company could beat the competition by knowing far more about the market. With that edge, the sales pitches could be made sharper, the risks drawn finer.

Signet was the only bank that was interested, and the company hired Fairbank and Morris in 1988, when the credit card division had only 1 million accounts. By 1995, Capital One was an independent company and one of the top 10 credit card issuers in the nation. Fairbank is now chairman and chief executive officer; Morris is president and chief operating officer. As of June 30, the company reported 19.2 million customers with total outstanding loans of $17.9 billion.

With its massive database, Capital One has been able to target the clientele no one else wanted — at least, not at first: students who had never borrowed before, families that had ruined their credit ratings, even professionals like the Campbells who pay off their bills quickly.

But the rest of the industry has hardly been sitting still. Capital One's methods and offers have been copied until it's hard to trace who created them — nor does it matter to consumers loyal only to the best rates. Cheap cards for low-risk customers, student cards and teaser rates have popped up under a variety of names.

A few years ago, massive consumer bankruptcies rocked the credit card industry. Capital One warned that credit risks were rising, but the company met its projections, anyway, West says. Since then, Capital One has grown to more than 12,000 employees worldwide, and it continues to produce annual earnings growth of 20 percent or more.

This year, however, threatens to be another hard one for credit card issuers. Financial stocks took a dive after the country's No. 2 credit card company, Bank One Corp., warned that its profits would be far below expectations. And Wall Street analysts have been grumbling that the field is too crowded to allow companies to keep posting big gains year after year.

In this environment, followers of Capital One can't help but wonder what the company plans to do next. "When I approach Capital One with investors, the big questions I continually get are, 'How will the company be able to produce the growth rates?'" says Todd Pitsinger, vice president and analyst at Friedman, Billings, Ramsey & Co. in Arlington.

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The key to Capital One's future, observers say, will be the company's ability to apply database marketing to new products. And Fairbank has pledged that in a few years the company will be known as much for other products as for credit cards.

Its biggest new venture has been wireless phone service, marketed under the name America One. The company buys cellular phone time at wholesale rates and resells it to retail customers, often throwing in a free phone. Morris believes the spending habits for cell phones are similar to credit cards. He told one journalist, a cell phone is "just a credit card with an antenna."

Marketing cellular phones, however, has been costly for Capital One. Until recently, the company hadn't broken out specific numbers for America One, but analysts could see that the company's overall bottom line was suffering. West says the phone giveaways that Capital One used as incentives were especially pricey because, as soon as a customer signed up, the company took a hit for the full price of the phone.

When the company reported specifics for the first time, the losses were larger than expected. For the quarter that ended on June 30, America One had revenues of $36.8 million and losses of $28.7 million. In the same quarter a year earlier, the telecommunications business cost the company $6.2 million on revenues of $12.8 million. No other year-to-year numbers have been released yet, but America One's losses for the first half of the year totaled nearly $57 million on $67 million in revenues.

Capital One also warned in the quarterly report that while the quality of its credit card customers has improved rapidly in recent years, that trend is due for a downturn, West says. "They weren't saying that the world's coming to an end, but that, hey, things are great, and you can't expect them to get a whole lot better," West says.

The company reported record earnings overall that quarter, achieving profits of $87.5 million compared with $82.4 million a year earlier. The company's stock split three-for-one on June 1.

Nevertheless, some analysts recommended that investors dump Capital One stock. But West says they overreacted. Capital One tends to be "pretty conservative [in conversations] with the Street," he says. It was during a telephone conference about the June 30 report that Capital One warned about credit ratings approaching their pinnacle. West doesn't see this as a veiled forecast of doom but a precise description of what the company expects — a changing market.

As for the big loss in the cell phone business, Capital One blames that on a hyper-competitive industry — conditions the company has seen and survived before on the credit card side, West explains. Capital One hasn't given up on cell phones, but has already shifted the way it's spending money to sell them. For example, the company conceded that it has started to de-emphasize the costly phone giveaway program.

In a July press release, Fairbank called the telecommunications losses consistent with expectations and noted that they "reflect our upfront marketing investment in this rapidly growing business."

Without going into details, he pledged to find profit in the wireless phone business: "In response to aggressive competitive pricing, America One is significantly slowing its investment in certain core wireless market segments and, over time, will increase its investment in market segments that are generally not being served by major wireless competitors."

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Capital One hones its databases by constantly building on what it already knows. The company not only tries to learn about potential clients, but keeps a close eye on those who have signed up already.

As its annual report explains, Capital One checks in on accounts several times a year to assign new credit scores. And the company posts new "behavioral" scores once a month. Have a customer's habits changed lately? Do they fit a pattern that suggests they are a greater risk than before? If they're credit-worthy, is it possible to offer them a better deal that will get them to use Capital One cards more often?

"They may not have the best technology, but I think they're the best user of technology in the industry," says Pitsinger, the analyst at Friedman, Billings, Ramsey. "And that's been demonstrated time after time."

The result is a company that understands a great deal about credit risk — a talent that would seem basic to any financial institution but is harder than it seems, West says. With its computer models, he says, Capital One can identify the person worth taking a chance on, despite a horrible credit rating.

Moreover, Capital One may be aggressive in its marketing, but it is conservative in its scope. Higher-risk clients get lower credit limits and higher interest rates, a tactic that has drawn criticism from some consumer groups.

Then there's the company's ability to get the right cards to the right people — "mass customization." Capital One didn't offer the Campbells just any card, for example: It offered them a frequent-flyer card that topped the one they already use. "They're putting a Capital One card in someone's wallet that already has a City One card" and others, Pitsinger says. "The trick is getting the customers to use your card."

By itself, even a huge amount of information is not enough to keep a company growing. Analysts give much of the credit so far to Fairbank and Morris, who constantly re-engineer their company to exploit the latest consumer trends.

As a result, Capital One often finds unlikely groups of customers before other big players do. It's a trendsetter at making money from high-risk customers, for example. It's also now a leader in courting the opposite kind of credit card user: the one with an excellent credit rating.

Getting to new markets first is important, West says, because the credit card industry is so aggressive that the competition is never far behind. Canada and the United Kingdom are among the company's latest targets.

"Capital One has the ability to kind of zig when everybody else zags," West says. "I give management a lot of credit for [staying] ahead of the curve. They've done a great job of that."

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West doesn't expect Capital One to explain precisely how it expects to grow. Just as the company has moved quietly into new credit card markets, it is likely to keep its cell phone strategies "off the radar screen." But West does expect these strategies to include ideas that other companies haven't tried.

In this respect, Capital One may have ducked the punch that Bank One took earlier this summer when it announced an earnings shortfall. Bank One was criticized for being slow to move away from costly offers crowded by lots of competitors, such as super-low teaser rates. Capital One had already done so.

"Bank One appeared to have dug itself into a hole while other major companies continue to be soundly profitable after recovering from the problems of the mid-1990s," Reuters news service reported, summarizing comments from analysts and fund managers. Still, several analysts issued "sell" recommendations on Capital One and many other financial stocks later in the summer. They are worried about a downturn for the entire industry.

Even if that doesn't happen, Capital One will have to diversify if it wants to maintain its aggressive growth curve.

Analysts say the only big surprise from Capital One would be if it stayed the same. This company started off differently from the competition, and observers like West and Pitsinger expect it to grow into something even more distinct.

"They may surprise people," West says. "I think they'll expand both into other financial services and nonfinancial services."

Pitsinger says: "They're absolutely still unique. They're trying to take the [database] marketing process to the next step."