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Will consumers rediscover Discover?
Morgan Stanley keeps Discover but the card has work to do to attract consumers
August 18, 2005: 6:10 PM EDT
By Shaheen Pasha, CNN/Money staff writer

NEW YORK (CNN/Money) - Now is the time for Discover Card to show its mettle.

Morgan Stanley (Research)'s credit card unit stayed in the spotlight in recent months as its parent company considered spinning off or selling the company, which had failed to live up to Wall Street's expectations. But Discover Card received a second chance Wednesday when Morgan Stanley's new chief executive, John Mack, announced the company had nixed plans to put Discover Card on the auction block and blamed some of its weakness on previous mismanagement.

Despite Morgan Stanley's newfound faith in the unit, it's not an easy road ahead for Discover Card, which continues to lag its larger brethren when it comes to consumers.

"Discover used to have an aggressive campaign to build its customer base, and it reached down to lower income levels and came up with lots of losses," said Dick Bove, analyst at Punk Ziegel & Co. "They reacted by pulling back their marketing activity and lowered losses and controlled costs, but they lost market share along the way."

While Discover worked to improve its credit quality, competitors such as Visa and MasterCard jumped in, offering their own versions of Discover's flagship innovation -- the cash-back rewards policy.

Now analysts say it's going to take more than just a cash-back policy to pull Discover Card out of its slump.

Discover's Chairman and Chief Executive David Nelms said the company is actively working with merchants to increase the card's acceptability. Nelms said the company has "signed a million small merchants and more than 100 top merchants to take Discover rather than Visa, MasterCard or American Express (Research)."

He said one-third of consumers have Discover cards, but the company is now focused on growing the number of active accounts. Discover has about 54 million cards outstanding compared with Visa's 458 million and MasterCard's 338 million.

Robert McKinley, chief executive officer of, a payment card research firm, said Discover charges lower merchant fees in order to increase its acceptance but that the company doesn't generate extra revenue to plow back into its cash-back rewards.

"They've got a big challenge because competition is pretty intense," said McKinley. "Consumers tend to find that Visa's and MasterCard's cash-back bonuses are better than Discover's."

Nelms disagreed, saying that the company's retail sales were up 8 percent last quarter, and that the company has returned $550 million in cash-back rewards to consumers.

And Discover is embarking on some new partnerships that may interest more consumers. The company entered a partnership with GE Consumer Credit and also offers a co-branded card with Wal-Mart (Research) and Sam's Club.

In addition, a ruling by the Department of Justice allowed Discover and American Express to develop co-branded relationships with banking institutions that work with Visa and Mastercard, which opens a new distribution channel for the company.

Nelms said Discover has entered 50 cash-back bonus partnerships, including a 5 percent cash-back promotion for gasoline purchases, which have been particularly well received among consumers as gas prices climb to record highs.

Still, analysts say the company has more work to do.

Ed Groshans, specialty finance analyst at Fox-Pitt Kelton, said Discover has a competitive advantage over Visa and MasterCard because transactions are done over its own network and the company is able to monitor just how its customers spend their money.

Groshans said the company, like American Express, should monitor its consumers' spending habits and make deals with those specific merchants to provide a better rewards program for its customers.

He added that the consolidation going in the credit card industry brings the company more opportunities. Given MBNA's merger with Bank of America (Research) and Providian's union with Washington Mutual (Research), Groshans said Discover has the chance to grab more customers amid the market disruption.

Nelms said Discover plans to take advantage of the changing competitive landscape.

"With fewer players and people preoccupied we think it might be good opportunity to show what great service we have," he said.

The rest is up to consumers.


For more on Morgan Stanley's decision to keep Discover, click here  Top of page


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