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New co-branded Costco card beating expectations despite initial glitches

CostcoWholesale Corp. executives conceded Sept. 29 that the transfer of the company'slarge co-branded card portfolio to Citigroup Inc. from longtime partner did not occurwithout some highly publicizedoperational glitches, but said the new Anywhere Visa is performingahead of internal expectations in several respects.

ExecutiveVice President and CFO Richard Galanti said that more than 85% of the nearly7.5 million accounts transferred to Citi from American Express through a Juneportfolio salehave been activated. And, as part of the new co-branded card partnership withCiti, Galanti said that 1.1 million Costco members applied for the new card,resulting in 730,000 new accounts and a little more than 1 million additionalAnywhere Visa cards entering circulation.

"It'sstill early," said Galanti, speaking during a conference call to discussresults for Costco's most recent fiscal year, which ended Aug. 28. "Welaunched only 14 weeks ago, but so far we're beating our initial expectationsin terms of conversion, usage and new sign-ups to the card."

TheCostco executive's comments echoed those of Citi CFO John Gerspach during anappearance at an investor conference earlier this month.

"The Costco portfolio continues to exceed ourexpectations for customer engagement and new account acquisitions," hesaid.

Galantisaid that the reward structure of the new card will result in an increase incash-back rewards to members of between 40% and 50% relative to that associatedwith the previous American Express product — something that he expects to be adriver of sales for the "next several years" and to further Costco'sgoal for the card to hold "top-of-wallet" position for purchases madeboth outside and inside the warehouse club. A key element of the rewardsprogram is an increase in cash back on Costco purchases to 2% from 1% previously.Cash back on gas purchases has increased to 4% from 3% on the co-brandedAmerican Express card.

Gerspachsaid that initial cardholder spending patterns for purchases outside and insideCostco had been running in line with his expectations.

Galantiobserved that he has heard anecdotally about an uptick in bigger-ticketpurchases by members in the weeks after the conversion after a "bigdecline" leading up to that event.

"Youhad people that wereusing debit their whole lives because they perhaps did not want an AmericanExpress card or they applied for one and did not get one," he said."And so for 16 years, they used cash, check and debit. Now for the firsttime, they can use a credit card. And I'm sure that's where we saw many ofthese new signups as well."

Costcodoes not believe it has lost business in any material respect as a result ofthe conversion.

"Ourview has been we don't think that many people left Costco because they can'tuse their American Express card," Galanti said. "American Express isa great brand and it was a great relationship for many years. But at the end ofthe day, they come to Costco because of our quality value."

TheSept. 29 event was Costco's first live conference call with investors andanalysts since the conversion took place. Citi and American Express discussedthe impact of the portfolio transfer and new co-branded partnership on theirrespective results during second-quarter earnings calls in July. Citi isscheduled to report third-quarter results on Oct. 14; American Express isexpected to do so five days later.

Gerspachcautioned during his recent remarks that the company expects core expenses inCiticorp to be "slightly higher" on a quarter-over-quarter basis ascompared with previous guidance for a slight decrease.

"Asyou bring on even higher amounts of new accounts, you're not going to getrevenue off of those new accounts immediately, but that is going to have someimpact on your expense base, and that's what we're seeing," he said."We also — [and] I don't think it's a big state secret — we had somedifficulties in the Costco conversion, and we needed to put some additionalcosts in that first month in order to make sure that we were servicingcustomers the way that we feel that they needed to be served, and the way thecustomers deserved to be served. So you'll see some of that expense pressure."

Fromoverall growth and franchise perspectives, Gerspach described the new portfolioas being "quite good." It is an observation to which his Costcocounterpart would likely sign on.