Individual Case Report on Bank of America and the Chinese Credit Card Market

With its double-digit growth in revenue and net income in 2005, and successful merger with MBNA Corporation (MBNA) on January 1, 2006, Bank of America Corporation (BAC) has become the largest credit card issuer in the United States in terms of credit card balances.

However, strong competitors in the American credit card market such as JP Morgan Chase and Citigroup have pushed BAC to go abroad (see Exhibit 1 for a list of top bank credit card issuers in the USA). Among all of BAC’s foreign opportunities, China has been the most attractive target since its credit market has massive potential (see Exhibit 2 for an overview of China’s credit growth), and the Chinese government has opened its banking sector to foreign investors.

Therefore, BAC entered China by acquiring 9% of the shares in the China Construction Bank (CCB) for $3 billion in June 2005 and was hoping to explore the Chinese credit card market by establishing a joint venture with CCB. In order to gain early-mover advantage and operate successfully in the Chinese credit card market, BAC has to overcome problems such as the host country’s government regulations, institutional voids, and cultural differences. Host Country’s Government Regulations

Even though the Chinese government has started permitting foreign investment in China’s banking sector after it became a member of the WTO in 2001, China’s banking sector is still under tight control by the Chinese government. Besides the fact that 60% of China’s national banking assets are controlled by four of China’s biggest state-owned banks, which are regulated by the China Banking Regulatory Commission (CBRC), each foreign investor can only have a maximum of 19.9% ownership of a Chinese banks. With only 19.9% of equity control in CCB, BAC is unlikely to have significant influence over CCB’s decision making. Institutional Voids in China

According to the Transparency Index, China is seen as a country with low transparency, a high context culture, and uncertain regulatory environments. As a result, corruption is common in the Chinese public sector, and foreign firms are often being forced to engage in bribery activities in order to do business with Chinese firms or build up relationships with Chinese governments. Chinese regulatory bodies also treat foreign firms less favorably; they may enforce restrictions that prevent foreign-invested banks from operating in China.

In addition, China does not have reliable credibility enhancers and information analyzers, meaning BAC has to create its own credit rating agencies to check cardholders’ credit histories. Moreover, because state-owned banks control 60% of the Chinese banking assets and China has a 40% savings rate (see Exhibit 3 for an overview of China’s banking sector), China does not have an efficient financial market for capital exchange. Cultural Differences

According to Hofstede’s dimensions, the Chinese tend to be long-term orientated, save up for the future, and invest in long-term projects. This is also proved by China’s 40% savings rate and the fact that 85% of Chinese credit cardholders pay off their entire bills on a monthly basis. Therefore, to generate profit in the Chinese credit card markets, BAC needs to create strategies that address the deeply rooted Confucian value in the Chinese culture. Situation Analysis

United States Credit Card Industry Consumers in the banking sector can be categorized into two different groups. Individual consumers have moderate bargaining powers since they have to incur moderate to high switching costs to transfer their mortgage loans and credit card and debit card accounts from one bank to another. Corporate consumers, on the other hand, have low bargaining power, as it is harder for them to obtain trust and loans from banks.

The bargaining power of the supplier is high since only a few card associations operate the credit card business, including Visa, MasterCard, and American Express. Additionally, since the U.S. credit card industry was already maturing by 2005, there was fierce competition among the existing bank credit card issuers.

Moreover, the existence of debit cards, PayPal, and other payment methods indicates a strong threat of substitutes. However, due to the initial cost of establishing branch networks and the economies of scale required to earn a high profit margin, the threat of new entrants is low. The overall competitiveness of the U.S. credit card industry is high, which demotivates foreign credit card issuers from entering the market and pushes existing players to search for opportunities overseas. Chinese Credit Card Industry

As previously mentioned in the Introduction and Problems Identification section, the Chinese credit card industry is one of the most attractive targets for foreign investors due to China’s rapid economic development, the credit market’s potential, and removed government restrictions.

However, government regulations, institutional voids, and cultural differences are three major threats that foreign-invested banks need to overcome in the Chinese credit card industry. In addition, since corruption and bribery are common business practices in China, foreign-invested banks may not be able to develop their business networks and form relationships with government officials without engaging in bribery activities. Key Success Factors

Based on the industry analysis, foreign banks that want to obtain large market shares and gain high profit margins in the Chinese credit card industry must be able to: Obtain equity ownership of Chinese state-owned banks

Establish strong political ties with the Chinese government Create strong branch networks in China Reach economies of scale in the credit card industry Manage cultural differences Prevent corruption and bribery Company Analysis Bank of America Corporation Analysis Exhibit 4 shows BAC had good financial performance in 2005, which indicates that it has generated sufficient funds to support its market expansion in China.

Moreover, as the inventor of Visa and United States’ largest credit card issuer, BAC has a strong brand reputation and credit card expertise that help it build up relationships with the Chinese government. With the ability to help CCB manage its consumer risk profiles and improve its risk management program, BAC will be able to influence CCB’s decision making without having significant equity ownership. However, without sufficient local knowledge, a strategy to overcome existing cultural differences, well-established branch networks, and a solid consumer base in China, BAC may not be able to operate profitably in China. China Construction Bank Analysis

As illustrated in Exhibit 5 CCB had the highest return on equity and lowest non-performing loans in 2004 among the big four state-owned banks; therefore, it was the most profitable state-owned bank in China and thus able to use its assets most efficiently. Additionally, its well-established branch networks in Mainland China and many other areas in Asia are considered to be a valuable asset in the banking industry. CCB’s strong banking relationships with Chinese companies also make it an attractive target for foreign investors.

Nonetheless, its lack of risk management processes has limited its profitability. Since BAC already acquired 9% of CCB’s equity ownership in 2005, and the Chinese government does not allow foreign banks to have more than 19.9% of shares in Chinese banks, forming a joint venture (JV) with CCB is considered to be the best market entry mode for BAC. Creating a JV with CCB will allow BAC to split the costs, reduce the market entry risk, gain local market knowledge, build relations with the Chinese government, and obtain access to CCB’s branch networks. At the same time, the JV will help CCB improve its risk management process and develop its credit card business.

However, without having significant equity ownership of the JV, BAC will have less control and earn less profit from the JV. Also, once CCB has gained enough knowledge from BAC, it might withdraw from the JV and become BAC’s biggest competitor. Moreover, even with the joint venture in place, BAC still lacks the ability to: Reach economies of scale in the credit card industry

Manage cultural differences Prevent corruption and bribery Alternatives To successfully manage the JV, remove the existing strategic gaps, and gain an early-mover advantage in the Chinese credit card industry, BAC should include policies and procedures that deal with corruption and bribery in its corporate code of conduct, create specific operating strategies for the JV, and consider the following alternatives. Become the Cost Leader

The transfer fee in China is around 0.75% of spending, which on average is 0.55% below average transfer fees in other international markets. As more issuer banks enter the Chinese credit card industry, the increase in competition also leads to falling transfer fees. In order to attract merchants, the JV should maximize its operational efficiency and become the cost leader of the industry.

Therefore, it will be able to attract merchants by offering them the lowest transfer fee and appeal to individual consumers with its lower interest rates. However, as more than 85% of Chinese cardholders pay off their credit card balances on a monthly basis, this alternative will not generate huge profit for the JV. Additionally, CBRC may perceive the JV’s low transfer fee and interest rate as dumping activities, and prevent the JV from offering them. Focus on a Niche Market—Small Business Entrepreneurs

Because the big four state-owned banks control 60% of the Chinese banking assets, and the nation has a 40% savings rate, China has an inefficient financial market for capital exchange. Also, state-owned banks often treat state-owned organizations more favorably and tend to reject loan applications made by small business entrepreneurs in China. Hence, small business owners have to acquire capital investments through ‘Guanxi’ or borrow funds from family and friends.

With BAC’s expertise in the credit card industry and CCB’s market strength in the Chinese credit card market, the JV could target these small business entrepreneurs and offer them small business credit cards or lines of credit to support their business operations, and generate a high profit margin per consumer. However, this alternative is a two-edged sword: without reliable credibility enhancers, the JV needs to pay extra attention when checking small business entrepreneurs’ credit histories; if the small business goes bankrupt, the JV will incur high bad debt expense. Issue Dual-Currency Credit Cards

With its rapid GDP growth, the quality of living among Chinese households also keeps improving. As a result, having family vacations in foreign countries, sending children to study abroad, and purchasing real estate overseas has become a popular trend in China. By issuing dual-currency credit cards to Chinese consumers, the JV will be able to gain an early-mover advantage, leverage its strengths, and take advantage of the globalized economy.

Although Chinese consumers often pay off their credit card balances at the end of the month, dual-currency credit cards will enable the JV to earn profits from transfer fees, interest rates, and exchange rates. Moreover, as an early-mover, the JV will be able to create entry barriers for latecomers and establish relationships with key stakeholders in the market. Some drawbacks of this alternative are that by being the early-mover, the JV will incur higher initial investments and experience greater technology and market uncertainties. Decision Criteria

As presented in Exhibit 6, each alternative is evaluated on a 1-to-5 scale based on its ability to remove the strategic gaps faced by the JV, leverage the JV’s strengths, and fit with the overall goal of the JV. Even though becoming a cost driver will lead to economies of scale, it does not solve the existing cultural differences and will not enable the JV to gain an early-mover advantage in China.

Focusing on small business entrepreneurs best solves the cultural differences because small business owners lack the ability to pay off their debts month after month; however, a niche market often means fewer economies of scale and less profit. Issuing dual-currency credit cards is the best alternative, even if it does not completely solve the cultural differences issue. It lets the JV reach a larger consumer base, which consists of both individuals who need dual-currency credit cards for leisure and personal issues, and corporations that want to expand overseas. Recommendation

To gain an early-mover advantage in China and maximize the JV’s profitability, in addition to promoting the dual-currency credit card in CCB’s branches, the JV should also utilize CCB’s strong relationships with Chinese corporations and promote the dual-currency credit card to them through work-site marketing. Moreover, to overcome political and market uncertainties, the JV should leverage CCB’s position as a state-owned bank and build up relationships with policy makers. Lastly, BAC should also exploit its relationships with multinational corporations that are interested in doing business in Asia and promote the dual-currency credit card in their workplace as well.

Exhibit 1 TOP BANK CREDIT CARD ISSUERS IN THE USA 2004

Exhibit 2 Credit Growth in China

Exhibit 3 Overview of China’s Banking Sector

Exhibit 4 BANK OF AMERICA’S FINANCIAL STATEMENTS

Exhibit 5

Exhibit 6 Decision Matrix Become a Cost LeaderFocus on a Niche Market—Small Business Entrepreneurs Issue Dual-Currency Credit Cards Ability to remove strategic gaps: Reach economies of scale in the credit card industry 534 Manage cultural differences 354Prevent corruption and bribery behaviours 555Ability to leverage the JV’s strengths3 45 Ability to gain an early-mover advantage in China and earn high profits 3 4 5