One of the fundamental questions faced by nearly every retailer trying to promote a new product is how to build demand. In most cases, new products are competing with similar products already in use, and their promoters have to underscore how new products are comparable to the old ones, but are at the same time better – faster, smaller, or cheaper. In some cases, however, the products that are offered are entirely new in their class.These are the products that revolutionize the ways in which we communicate (such as telephones when they were first introduced), transport(automobiles) or pay (credit cards).  The particular challenge of building demand for these products is the novelty factor. 

The novelty of credit cards is two-fold. First, cards offer a new means of payment to people who historically relied on cash only. Second, they are a source of quick general-purpose credit.  While some limited forms of lending to consumers existed in socialist economies, by and large, daily experience of shortages on most consumer goods resulted in the so-called “monetary overhang” – too much money held by households, and not enough products to buy.  Most saved upfront and paid upfront rather than relying on credit. So for cultural and historic reasons, one should not expect that postcommunist consumers and merchants would eagerly embrace cards, especially since they are expected to pay for the privilege and convenience.

Besides the novelty factor, an additional challenge for credit card promoters stems from the fact that credit card markets are what economists call “two-sided markets.” These are the markets that through an intermediary (in this case, a bank that issues cards) attempt to connect two segments, merchants and consumers; and each of the segments is sensitive to how well the intermediary performs in the other segment. Cardholders and merchants are said to be mutually complementary, as one group cannot function without the other, and the growth in each group makes joining the other one more attractive. The more cardholders there are, the more merchants would be willing to accept cards, and vice versa. The reverse is also true: no cardholders – no merchants. Unless the vicious circle is broken, the market simply would not take off.  So where should card issuers start?

American credit card issuers that initiated their first mass programs in the late 1950s and 1960s initially targeted consumers. As told in the award-winning book by Joe Nocera, A Piece of the Action, Bank of America – home to what will later become known as Visa – decided that the best strategy was to create cardholders by “dropping” cards onto a large number of consumers at once.  “That’s a word they liked to use in the credit card business to characterize a mass mailing of cards: “a drop,” and it is an unwittingly apt description. There had been no outward yearning among the residents of Fresno, [California] for such a device, not even the dimmest awareness that such a thing was in the works.It simply arrived one day, with no advance warning, as if it had dropped from the sky.” [1]This is how the first 60,000 BankAmericard cards (precursors of Visa cards) were mailed to residents of Fresno in 1958. By the end of next year, Bank of America mailed 2 million more cards to unsuspecting residents of several bigger Californian towns and cities, including “untrustworthy” Los Angeles, a home to “the fast Hollywood crowd, the blue suede shoe boys” (in the words of a Bank of America executive).[2]  Eight years later, during the pre-Christmas sale of 1966, several Chicago banks mailed another 5 million unsolicited cards.

What is so remarkable about these mailings? After all, millions of Americans today routinely receive “pre-approved” offers for credit cards in the mail. What was different then was that individuals received actual cards, ready to be used in merchants’ establishments, without applying for them, without being screened, and apparently, even without their names being verified. So in some cases, cards were mailed to prison inmates, persons long deceased, infants, and even dogs. For example, Shepherdson reports that “[a] dachshund named Alice Griffin was sent not one but four cards, one of which arrived with the promise that Alice would be welcomed as a “preferred customer” at many of Chicago’s finest restaurants.”[3]

As a result of issuing cards indiscriminately and entirely forgoing preliminary screening, after the first 15 months of Bank of America’s credit card program, its official losses amounted to $8.8 million – a huge sum of money for a bank in that era. Instead of the expected 4% of delinquent accounts (average for loans), they comprised 22%. Fraud was rampant and collections – another risk management mechanism – were problematic, as the bank never even established a special collections department, so confident it had always been in its clients. The situation was especially difficult in Los Angeles. There, Bank of America faced a major moral hazard problem, as credit cards seemed to corrupt even once-good clients. New cardholders perceived credit lines as free money, and ran up bills without any intention of paying back.

The Chicago experiment with unsolicited mailing was even more disastrous:credit cards corrupted merchants and postal workers. Merchants worked together with criminals to supply fraudulent slips to banks, while postal workers were discovered "carting off bags of unmailed credit cards to sell on the black market.”[4]  Some cardholders disputed purchases they had actually made, and banks preferred to pay rather than argue, given an already negative reputation credit cards had earned. The situation in Chicago went completely out of control when the press reported a story of a bank clerk who slipped and fell while carrying several boxes of unprocessed merchant slips that were blown away by the wind. Another time a truck loaded with new credit cards flipped over and newspapers published photographs of people grabbing handfuls of cards for future use. Total losses of the Chicagoan banks were estimated at $6 million, though some analysts believed it to had been no less than $25 million.

The magnitude of the losses must have caught issuing banks by surprise.Yet, had they been more careful, we may never have lived to see or use credit cards. The losses were a price to pay for solving the complementarity problem. At the time that these decisions were made, bank executives believed this was their only chance to signal to merchants that there would be enough cardholders to make it worthwhile for them to accept cards.History proved that they were right. In addition to three hundred merchants who signed up in advance, the mass-mailing in Fresno drew another eight hundred more merchants in the next five months. By the end of 1959, about the same time it posted multi-million dollar losses, the BankAmericard program attracted more than 20,000 merchants to accept its credit cards.Eight years later, more than 800 banks were involved in the card business, and 32 million cards were issued in that year alone, the majority through unsolicited mailing. Unsolicited mailings of cards were eventually outlawed by President Nixon in 1970, but by that time, the market was firmly on its feet. Twelve years after the Fresno “drop,” BankAmericard cards circulated in 44 American states, Master Charge cards in 49 states, and around 29 million people had used cards at least once, which was more than 20% of the adult population at that time.

Thus, unsolicited mailing of cards helped American banks solve the initial problem of complementarity; as a result of signing up a lot of cardholders, banks managed to attract merchants, which prompted more cardholders to join. The price that banks had to pay for this in the short run was steep: as applicants’ screening was foregone in the haste of getting cards to as many people as possible in the shortest time possible, banks incurred serious financial losses. Were the banks that undertook card programs not as big and stable, and had they not had as much organizational slack, they would not have likely recovered financially. Yet, the market was successfully born, and the staggering losses accompanying its early development were soon forgotten by all but business historians.

Parts of Nocera’s book were translated into Russian and published in the mid-1990s by one of Russia’s leading magazines covering the plastic card industry.  So it is likely that many of the Russian bankers engaged in promoting cards knew of the story. But they undoubtedly took it as an example of how not to market cards. They appreciated the challenge of developing a two-sided market, but would never dare “dropping” cards the “American way” because in the context of the transitional Russia it could have been a suicidal tactic.As much as they did not trust their prospective customers, they were also suspicious of mail being intercepted or stolen. In fact, in the 1990s, Russian banks did not even mail monthly statements, citing considerations of confidentiality and security, and requiring cardholders to pick them up in person at their local branch. At any rate, most of the banks were small, undercapitalized, and lacked organizational slack that helped Bank of America to withstand the blow of losses and persist with its credit card program.

What the Russian card issuers did instead was to issue cards after an exhaustive analysis of each case to insiders – applicants who had a direct or indirect social tie to the bank, were visible politically or socially, or were anchored in some other way that made the bank nearly confident they would not default.[5] For example, cards were issued to bank’s own employees, to family and friends of the bank’s top executives, to top executives and other employees of banks’ corporate clients, or to politicians, singers, and TV personalities. Here the borrower-creditor relationship was intermingled with workplace ties or close social bonds. For example, issuing a card to a friend of a bank manager was quite safe in the eyes of banks administration. The manager’s position in the bank – as well as the manager’s relations with the friend – were at stake, and it was expected that the manager would do anything to ensure that the friend did not violate trust placed in him or her. Faced with uncertainty and unable to predict the risk of future defaults, banks turned to various strategies of controlling cardholders’ future behavior through social networks and organizational power.

While this strategy left bank fairly confident in its cardholders, it led to only limited market expansion. And very soon, Russian banks realized, just like Bank of America did 35 years earlier, that slow and careful recruitment of cardholders was like swimming against a strong current. It was not bringing them closer to their destination – a market where the numbers of cardholders and merchants are increasing in a complementary manner, and where growth is generated by demand externalities. They needed an equivalent of a steam ship. And a ship they did build. In the subsequent decade-and-a-half, Russian banks pursued two strategies of mass-issuing cards to millions of Russians. However their success in tackling complementarity and uncertainty problems simultaneously remained limited.

At first, Russian banks turned towards employing organizations peddling cards to whole working collectives through salary projects. A typical salary project involved an agreement between a bank and an enterprise to issue cards to all of the employees, from the top manager to the janitor, while their salaries were directly deposited to the bank.[6] Banks’ possible losses from unauthorized overdraft or misconduct in the use of the card would be paid by the next month’s salary, and the enterprise would be obliged to notify the bank as soon as the employee was fired or quit.  Popularity of salary projects Russia in the 1990s has been mirrored in other postcommunist countries as well.

Salary projects were attractive to enterprises because they allowed them to save on transporting, securing, and dispensing cash. But from the bank’s perspective, salary projects were an ingenious strategy of quickly mass-issuing cards without any investment into developing an elaborate network of branches and with little investment in advertising.  Prospective cardholders did not have to be enticed. If the management of their company decided on a salary project with a particular bank, workers had no choice but to carry a card of that particular bank.  Each salary agreement allowed banks to sign up hundreds or thousands of new cardholders. Banks hoped this growth in the number of issued cards would also make cards popular among retailers.  Thus, in a way similar to American unsolicited mailings, Russian banks also engaged in creating cardholders rather than recruiting them. But they went even further. Not only did employing organizations enable banks’ access to prospective cardholders, but they also helped them avoid large initial losses that plagued the American credit card market. To the extent that companies exercised control over their employees, they ensured Russian banks’ ability to monitor cardholders, and helped them to control uncertainty. The dual role played by cardholders – as customers of the bank and employees of the enterprise – limited their flexibility, reduced their ability to exit the bank-client relationship (which would mean also quitting their job), and made them available for negotiation and sanctioning by the bank. In such an arrangement, employment became a type of socialcollateral: as long as it was at stake, cardholders could not easily disappear. Thus, compared to the previous strategy of issuing cards to elites, salary projects were much more successful in propelling the development of the Russian card market forward because they disseminated cards beyond exclusive inner circles to wider masses without compromising on security of card issuing.

The Russian state played a particularly important role in this coercive dissemination of cards. The state was eager to transfer salary payments of its employees (doctors, teachers, members of the police force and the military, etc.) into the banks’ hands. Moreover, the idea of salary cards was picked up by municipal governments across Russia, which issued cards to millions of retirees and recipients of other social benefits. For instance, in 2002, the Moscow municipal government through the collaboration between Bank of Moscow and Visa issued Visa Electron Moscow Social Cards to2.5 million Muscovites who receive some 350 types of subsidies from 60 agencies directly deposited to their card accounts. In addition to bank branches, ATMs, and Visa merchants, the cards can be used to pay for public transit, health and medical insurance, and to make government-subsidized purchases at participating stores. 

Have Russian card issuers been as successful as American issuers in attracting merchants and therefore in solving the problem of complementarity? Not really. While the number of issued cards and the volume of transactions were steadily increasing (Figures 1 and 2), the overwhelming portion of that transaction volume was cash withdrawals rather than non-cash purchases (Figure 2). Holders of salary cards went to ATMs to withdraw cash, and then, armed with cash, to the stores. Whatever spectacular growth the credit card market was undergoing, it was not involving the merchants, and therefore instead of a classic two-sided market development, the Russian card market was developing in a one-sided (really, lop-sided) fashion. Through salary projects, banks managed to coerce individuals to have cards, but they could not make them use cards in lieu of cash.

Figure 1: Number of Cards Issued by Russian Banks, 1996-2009

Source: Data from Platezhi. Sistemy. Kartochki (1998, p. 10; 1999, p. 6-7) and Central Bank of Russia (www.cbr.ru). Data are missing for 1999 and 2000.

 Figure 2:  Volume of Total Card Transactions and Purchase Volume Only, 1996-2008

Source: Data from Platezhi. Sistemy. Kartochki (1998, p. 10; 1999, p. 6-7) and Central Bank of Russia (www.cbr.ru). Data are missing for 1999 and 2000.

While salary projects dominated the Russian card market in the 1990s, in the past several years Russian issuers have refocused their energy on mass-issuing cards to Russian consumers in a rapidly growing retail sector. Following a decade-long recession and a devastating financial crisis of 1998, Russia experienced a steady growth of the economy, increase in incomes, and increase in consumer purchasing power. GDP grew 6.4% in 1999, and since then has averaged 6.7% annually (Figure 3). Real incomes have been rising by an average of 11% annually, and the consumer sector as a whole has doubled in size over the last decade. The growth in retail was accompanied by the growth in consumer lending (Figure 4). With consumption and consumer credit taking center stage, banks turned their attention away from employees and towards consumers as the preferred group for marketing cards, and from salary cards to cards issued in connection with express loans. For the first time Russian banks have mass-issued cards that come with credit lines, the possibility of revolving the portion of the credit line that was unused or repaid, and sometimes even with grace periods.

Figure 3:  GDP, Retail Market and Real Income Growth Rates in Russia, 1999-2006

Source: Data from Russian Federal Statistical Service, available at www.gks.ru; Alya Guseva, Into the Red: The Birth of the Credit Card Market in Postcommunist Russia (Stanford: Stanford University Press, 2008), 113.

Figure 4: Volume of Loans to Russian Households, 1998-2008

Source: Central Bank of Russia, available at www.crb.ru.

Express loans are small short-term loans extended in stores and shopping malls to finance consumer purchases (electronics, furniture, computer equipment). To reach consumers, banks open up makeshift booths with one or two representatives to accept applications. Consumers are approved while they wait and can walk home with goods they have chosen. According to Russian pollster VTsIOM’s 2006 opinion poll, 59% of all borrowers obtained their loans in stores, while only 38% in bank branches. Some banks extend these loans in the form of revolving credit cards. DeltaBank, recently purchased by GE Consumer Finance, issues Visa Electron Instant Issue cards that can be used for cash advances up to the specified limit or for retail purchases anywhere Visa is accepted. Others, like Russkiy Standart, the current leader of the Russian credit card market, established in 1999 and in 2004 named one of the most profitable banks in the world by The Banker magazine, issues credit cards to those who have successfully repaid their express loans. (Such borrowers become automatically eligible for a credit card). The majority of its cards are revolving credit cards, and the bank considers express loans the main way of increasing their credit card holder clientele. Of the 3.2 million cards Russkiy Standart issued by 2005, only about 100,000 (less than 3%) were issued through bank branches. To attract potential customers, Russkiy Standart works with large stores, such as household electronics retailer M-Video, which reports that 30% to 50% of their sales are now done on credit.

This strategy leaves banks vulnerable, however. Compared to salary projects, the ability of banks to control cardholders has disappeared. Yet screening is at best rudimentary. A few card issuers started to routinely use standard decision-making tools, but the lack of key data (such as verified incomes) and the ways in which these models were constructed (by quantifying applicants’ characteristics based on experts’ opinions and common sense rather than as a result of statistical analysis) did not bring banks closer to calculating statistical probability of default. Decisions on express loans are made on the spot, usually within 30-40 minutes, and bank officers typically have little to rely upon besides the information supplied by the applicant. In some cases, all that is needed to successfully obtain an express loan is one’s passport. Surprisingly, although 76% of banks consider credit risk their biggest problem, according to the information from Russia’s Central Bank, they express profound disregard for screening. Several of the banks I interviewed claimed they were much more concerned with attracting new customers and increasing their market share, preferring to worry about uncertainty and developing screening techniques later.

In summary, card issuers in a developing credit card market are faced with twin problems of complementarity and uncertainty. Unlike Bank of America, which in 1959 rushed to saturate Californian towns with credit cards in an effort to solve the problem of complementarity while completely disregarding uncertainty, Russian card issuers initially decided to proceed with caution. They issued cards to national elites and others connected to the bank. As a result, in the early- to mid-1990s, the Russian card market was small, and except for intentional fraud, essentially risk-free. Salary projects were instrumental in helping the market to expand and to democratize access to cards without exposing banks to greater uncertainty. Both elite issuing and salary projects illustrated the idea that in the absence of means to predict cardholders’ future behavior,[7] existing social ties and organizational structure can help banks control cardholders by putting pressure on them to pay through social ties or precluding their exit by using their employment as a form of collateral.

Russian card issuers’ most recent strategy of targeting shoppers in malls and large stores is successful in recruiting a significant number of new cardholders and spurring card use. It solves the problem of complementarity, but leaves banks no tools to deal with uncertainty. Cards are issued to unaffiliated strangers, and verification of information provided by the applicant is quick and often superfluous. The future success of developing credit card markets in Russia and in other emerging economies depends on whether they manage to find an effective solution to the problem of uncertainty. This involves organizing credit bureaus that would accumulate information about borrowers and assist card issuers in pre-screening the applicants.

Alya Guseva is Associate Professor of Sociology at Boston University. She is the author of Into the Red: The Birth of the Credit Card Market in Postcommunist Russia (Stanford: Stanford University Press, 2008).