The financial services sector constitutes a fundamental component of the US economy and it is the second largest in the S&P 500 index, thus accounting for 16.72% of the S&P. The sector has undergone notable growth over the past few years. At the end of the 2007/2008 financial crisis, the sector had increased by 8.58% of the S&P 500. In 2013, the sector added 1.09% points to its weighting. The sector’s current index is estimated to be 314.19 (S&P Capital IQ 1). The financial services industry in the US is the largest in the world. All the firms established in the industry are based on financials (Brain 4). The main industry groups in the sector include diversified financials banks, insurance, and real estate (Brain 4). Small and large companies characterize the respective industry groups.
The size of the various industry groups that constitute the US financial sector varies as illustrated by the chart below concerning their percentage of the S&P 500 index.
|Industry group||Percentage of the S&P 500 Index|
|Diversified financial services||16.82%|
The major companies in the banking industry group include Wells Fargo & Company, JP Morgan Chase & Company, Bank of America Corporation, American Express Company, Morgan Stanley, US Bancorp, Bank of New York Mellon, Citigroup. On the other hand, the leading insurance companies include Metlife, Prudential Financial, Berkshire Hathaway, and Hartford Financial Services. The industry leaders in the diversified financial services group include Fannie Mae, General Electric, Marsh & McLennan, and the Blackstone Group.
Consumer finance sub-industry overview & outlook
The consumer finance sub-industry forms a fundamental component of the US financials sector by providing American consumers with their credit needs. Consumer finance includes the various organizations that are established to provide financial credit services to consumers (American Financial Services Association1). Consumer finance companies vary in terms of size and ownership. They range from independently owned firms to multinational corporations that operate multi-billion companies located in different regions. The different types of credit issued by companies in this sector include pawnbrokers, home equity loans, personal credit, travel-related money services, lease financing, credit cards, and mortgages (Martin 322).
The US pawnshops’ market segment is dominated by EZCORP, which has established over 16 pawnshops. The pawnshops are established to meet the financial needs of cash-constrained consumers. Firms in the consumer finance sub-industry have experienced remarkable growth over the past decade. For example, the total revenue amongst pawnshops increased to $6.2 billion, which represents a 2.4% growth between 2009 and 2013 (IBISWorld par. 3). Similarly, credit cards firms have also grown significantly due to their association with other financial institutions such as banks. The leading credit card companies in the US include Visa, American Express, MasterCard, and Discover Card (Akers et al. 25).
The consumer finance sub-industry’s index value is 836.52 and it accounts for 16.82 % of the S&P 500 as of September 26, 2014 (American Financial Services Association 1). The sub-industry’s growth can be explained by the increase in consumer demand for credit. A study conducted by the Federal Reserve System (1) in 2013 shows that consumer credit has increased substantially at an adjusted annual rate of 9.75%. The decline in economic performance coupled with the high rate of unemployment between 2007 and 2009 forced most households to seek finance from pawn stores. Subsequently, revenue amongst pawnshops increased by 4.7% between 2008 and 2009 (IBISWorld par. 3).
One of the consumer finance areas that have experienced remarkable change relates to the flow of non-revolving consumer credit, which entails loans on motor vehicles, mobile homes, education, vacation, boats, and trailers (Federal Reserve System 1). Home and car loans are the greatest drivers of the US consumer finance industry. The growth has arisen from the high rate at which firms in the automobile market segment are adopting consumer finance and leasing strategies.
Examples of the leading finance and leasing companies in the US include Chrysler and General Motors Finance Company. A study conducted by KPMG shows that the volume of car sales is projected to increase a CAGR rate of 2% over the next 15 years. Considering that most vehicles are loan financed, the auto finance and leasing segment will grow at a similar rate (KPMG 8).
The recovery of the US economy from the 2007/2008 financial crisis has increased the consumers’ level of confidence. Subsequently, the year-on-year borrowing amongst the US households has increased to 1.6% in 2014 as opposed to the 1.3% level in 2013 (Akcay 1). Furthermore, bankcard borrowing has improved substantially at an average year-on-year rate of 2.5%. By the end of 2013, personal credit lenders had issued over 9 million bank cards (Akcay 1). The chart below illustrates the change in the volume of the revolving consumer credit from 2009 to 2013.
|[amount in billion dollars ]|
The chart illustrates the growth of consumer finance over the past five years. It is estimated that lenders issued approximately the number of subprime and prime loan borrowers increased to 5.8 million and 15.1 million respectively (Akcay 1). This trend shows that the level of consumer confidence amongst US consumers has increased remarkably.
Life cycle; mature
The consumer-finance sub-industry life cycle in the United States can be characterized as mature as evidenced by the prevailing industry characteristics. Hooke (77) asserts that one of the core characteristics of an industry in the maturity stage is that its performance corresponds with the prevailing economic environment. Thus, if the overall economy grows by an annual rate of 3%, analysts project that the sub-industries to change by a similar margin (Hooke 77).
The performance of the US consumer finance sub-industry is closely aligned with the prevailing economic trends. For example, it is expected that new car registration in the US will increase from 14.7 million to 17.3 million between 2014 and 2027 (KPMG 9). Subsequently, consumer finance analysts expect auto finance and leasing businesses to grow with a corresponding margin.
Hooke (77) further argues that a mature industry is characterized by a few growth companies. The growth amongst these firms arises from offering high-quality products and services and market expansion. Subsequently, the firms invest in diverse strategies such as consolidation, merger and acquisition, investment in technology, improvement in the quality of their products and services, and the adoption of emerging technologies to improve their competitiveness (Hooke 77).
For example, First Cash Financial Services Incorporation, which is a pawn firm, revenue increased to $20.3 million in 2013 (Yahoo Finance par. 2). The acquisition has become a common mechanism that credit companies are employing to gain market share. For example, in 2000 MBNA, a well-established credit company in the US acquired First Union for $ 6 billion (Moyer par. 4).
Business cycle; cyclical
Industry analysis can also be conducted by evaluating how firms respond to economic cycles. The most common business cycles include expansion, recession, and recovery (Hooke 78). The consumer finance sub-industry is directly influenced by the prevailing economic situation. Subsequently, the sub-industry can be classified amongst industries that have a cyclical business cycle. Hooke (79) asserts that industries characterized by cyclical business cycles experience positive performance during economic upturns and negative performance during economic downturns. The 2008 economic meltdown affected the operations of major financial institutions in the United States due to a decline in consumer confidence.
However, some consumer finance companies such as pawnbrokers were resilient, which is evidenced by the 2.4% growth in revenue between 2009 and 2013 (IBISWorld par. 3). By the end of 2008, the economic recession in the US had worsened, which increased uncertainty within the consumer finance sub-industry. Furthermore, individuals and businesses could not access finance. Subsequently, investment declined and businesses adopted downsizing strategies (Desai 23).
Akcay (1) argues that consumers are increasingly turning to consumer finance institutions in seeking finance to cater to their household finances. The slow pace of economic recovery has motivated this move. Consequently, the industry is likely to experience positive performance in the future. As the economy progresses towards full recovery, consumers will increase their purchasing power, hence stimulating consumer finance institutions to loosen their credit terms (Akcay 1). However, the performance of consumer finance companies, such as credit companies, might be affected due to the legal environment. One of the legal requirements relates to the high tax provision.
Key external factors
English asserts that companies are affected by a myriad of changes occurring in the external environment (55). Firms in the US consumer finance sub-industry are concerned with attaining operational efficiency. Subsequently, the firms are increasingly investing in emerging information communication technologies.
One of the areas that consumer finance companies are shifting to includes the utilization of big data and analytics. This trend has been motivated by the consumer finance companies’ commitment to improving their real-time decision-making capability and delivering a high customer experience. Consequently, technology is expected to form the foundation of the sub-industry’s growth, operational efficiency, and innovation.
Despite the effort being made by most consumer finance companies, a significant proportion of the firms have not succeeded in creating a unique customer experience through technology (Deloitte 11). Therefore, the degree of technology risk in the consumer finance sub-industry remains high. A study conducted by Deloitte (14) asserts that consumer finance companies must ensure effective implementation of their technology systems to avoid potential risks such as system failures, which may adversely affect the institutions’ reputation. In addition to the above issues, the consumer finance sub-industry is faced with the threat of increased cybercrime and fraud. Such issues might adversely affect the competitiveness of the consumer finance companies.
The US consumer finance sector is subject to extensive regulations and compliance requirements. The Federal government or the respective state governments impose these regulations. For example, in 2013, the US government enacted the Dodd-Frank Act, which outlines several rules and regulations on consumer protection, risk management, liquidity of consumer finance companies, and anti-money laundering (Deloitte 8).
Furthermore, the Consumer Financial Protection Bureau [CFPB] regulates the US consumer finance sub-industry. The formation of the CFPB has increased the regulatory pressure experienced by consumer finance companies. Some of the rules that CFPB has incorporated relate to mortgages, student loans, and credit cards. Consumer finance companies are required by the state laws to report their operations annually to the supervisory authorities. Deloitte (8) emphasizes that the US government has become increasingly committed to fostering the growth of the consumer finance sector by adjusting the macro-environment over the past few years. One of the issues that the government has focused on entails developing extensive oversight mechanisms, for example, by focusing on systematic risk.
The second area of focus includes redesigning and remediation of consumer finance companies (Deloitte 8). Consequently, most consumer finance companies are adjusting their infrastructure in addition to improving their risk culture. For example, consumer finance companies are establishing robust data systems and complying with the regulatory requirements. Despite the regulatory requirements, most consumer finance companies have not fully complied with the regulatory requirements, as evidenced by the over $ 100 billion fines, restitution, and litigation cost paid by consumer finance companies for non-compliance.
It is expected that the regulatory pressure in the sub-industry will flow downstream to pressurize small consumer finance companies to restructure their compliance infrastructure (Deloitte 8). Furthermore, the US government is expected to compel small consumer finance companies to take stress tests to expose their deficiencies. Subsequently, some of the consumer finance companies may be forced to reorganize their compliance structure. Therefore, there is a high probability of regulatory compliance becoming entrenched in the sub-industry culture (Deloitte 8).
One of the most notable social changes relates to the growing demand for loans amongst consumers. The demand has been spurred by the US economic recovery and growth in consumer confidence on economic recovery (Deloitte 6). Despite these positive changes, the consumer finance sub-industry is likely to be impacted by the changes in social attitude.
One of the core aspects that might affect their operation relates to their predatory lending. For example, most Payday Loan companies in the United States charge high-interest rates as opposed to mainstream financial institutions such as banks. Montezemolo (2) emphasizes that the annual percentage rate amongst payday lenders is over 400% higher than the rate offered by banks.
Additionally, the repayment period on the principal amount is relatively short. Such policies are likely to influence the consumers’ attitude towards consumer finance companies, such as pawnshops, despite their effectiveness as an alternative source of financing. According to Deloitte (6), the sub-industry’s growth might be adversely affected by the decline in loan demand due to high-interest rates, especially during the recent economic downturn. Similarly, the high interests might also affect the credit card companies. Some credit card companies in the US have been accused of high-interest rates especially within the sub-prime credit card segment. For example, Premier Bankcard Company was accused of its high-interest rates, which were set at 79.9% (Prater par. 6).
A study conducted by the Federal Deposit Insurance Corporation [FDIC] in 2010 shows that over 17 million citizens in the US are unbanked (AARP Foundation 5). This population accounts for approximately 9 million households. Furthermore, the study shows that over 43 million citizens are under-banked. Most of these citizens are within the low-income consumer groups (AARP Foundation 6).
These consumer groups seek financial services from alternative financial service providers. Their choice of alternative financial services such as payday shops, pawnbrokers, and auto and leasing finance companies have been motivated by the fact that these companies are increasingly providing them with services similar to mainstream financial institutions such as banks (Jackson et al. 6).
The US consumer finance industry is directly influenced by foreign factors from the global market due to the global economic integration. The US is a member of different regional trading blocs such as the World Trade Organization and NAFTA. Subsequently, the interconnectedness between the US consumer finance sub-industries and other countries increases credit risk. Due to its international and regional trade agreements, the consumer finance sub-industry is subject to experience fluctuations in its performance courtesy of changes in the interest rate, exchange rate coupled with inflation.
Therefore, if the Euro Zone countries were affected adversely by the sovereign debt crisis, the US will certainly be impacted. Furthermore, most consumer-finance banks have established operations in different countries. Thus, if the branches established in the foreign economies are affected by economic changes, the branches in the domestic market are affected through re-pricing of risk. Subsequently, the cost of obtaining credit from consumer finance companies would increase (English 56).
Porter’s Five Forces
Internal industry rivalry; high
The consumer finance sub-industry is characterized by intense competition. Furthermore, the industry is highly fragmented. The intense competition is associated with the enactment of the 1999 Gramm-Leach-Bliley Act, which allowed different financial service institutions such as commercial banks, insurance companies, and investment banks to diversify their product portfolio into each other’s business lines (Stowell 32).
The established consumer finance companies are adopting diverse strategies to enhance their competitiveness. Large consumer finance companies are adopting specialization strategies to attain optimal market dominance. Moreover, the companies are divesting their non-core operations to attain operational efficiency. The mid-sized companies are adopting mergers and acquisitions on top of organic growth strategies. Conversely, small consumer finance companies are focused on attaining adequate operational efficiency. Thus, these firms are increasingly adopting consolidation strategies to overcome the burden associated with complying with the instituted regulations.
The threat of entry; low
The threat of new entrants into the US consumer finance sector is considerably low due to the regulatory requirements and the intense competition. Investors are required to secure a special license from the Federal Reserve and the Consumer Finance Protection Bureau. The firms established in the industry are forced to adopt effective operational strategies to attain market growth, for example, by luring their competitors’ customers. Thus, the likelihood of a new entrant gaining sufficient market share is difficult. Furthermore, the sub-industry tends to favor large companies due to economies of scale as opposed to small companies.
This aspect explains why small companies are consolidating their operations through mergers and acquisitions. Moreover, the large consumer finance companies already established are enhancing the barriers of entry through their specialization strategies.
The threat of substitute; high
Consumer finance companies are established to provide customers with credit finance such as loans. Some of the major companies in this sub-industry include banks, pawn companies, credit card companies, and lease financing. The growth of the financial services industry has led to the establishment of different non-bank institutions, which are offering consumers credit finance and other consumer financial services.
For example, Paypal Incorporation provides its customers with an opportunity to conduct banking transactions through ATMs. On the other hand, mobile phone and manufacturing companies such as Sony, Microsoft, and General Motors are diversifying their operations into the consumer finance sub-industry by offering their customers credit services. Furthermore, firms within the banking sub-industry are restructuring their operations by minimizing the barriers involved in accessing credit finance. This trend illustrates that the threat of substitutes in the consumer finance sub-industry will continue to grow (Plunkett 302).
Supplier bargaining power; moderate
The supplier bargaining power amongst companies established in the consumer finance sub-industry such as Payday Loan and Auto Leasing and Finance companies is influenced by the collaboration between buyers and sellers. For example, the consumer’s demand is influenced by the prevailing economic conditions. On the other hand, the regulatory authorities such as the capital market authority influence the number of loans that the firms can issue, which shows that the consumer finance companies do not have substantial power in determining their credit base (Venzin 24).
Buyer bargaining power; low
The buyer bargaining power refers to the ability of consumers to influence the price of a product or service. The clients’ bargaining power in the operation of consumer finance companies is extremely low. The relationship between consumer finance companies and their clients is based on a win-win situation. Subsequently, negotiations between consumer finance companies and customers are based on a situation that will benefit both parties. For example, before advancing credit finance, consumer finance companies must ascertain the customers’ ability to repay the loan by evaluating their cash flows. Furthermore, the consumer finance companies ensure that the cost of credit is set at a point that benefits both parties.
The consumer finance sub-industry is subject to several strengths, weaknesses, opportunities, and threats as outlined below.
- Resilience; despite the adverse effects of economic recession on the financial sector, the consumer finance sub-industry is relatively resilient as evidenced by its performance. Most consumer finance companies have sustained a positive performance despite the adverse effect of the recent recession as depicted by the growth in consumer credit.
- Product diversification; most consumer finance companies have developed diversified product portfolios, hence improving their ability to reach diverse customer groups.
- Profitability; the profitability potential in the consumer finance sub-industry is high because of the rising demand for consumer credit.
- Business cycles; the sub-industry operations are directly influenced by changes in the local and foreign financial markets.
- Corporate governance; the sub-industry continues to experience challenges such as fraud due to poor corporate governance structures, which increases the risk of collapsing.
- Market growth; despite the sub-industry being at the maturity stage, there is a high potential for growth through the adoption of diverse strategies such as specialization, market consolidation, and formation of mergers and acquisitions.
- Economic recovery; the sub-industry will benefit from increased consumer confidence due to the prevailing economic recovery in the US.
- Strict government regulations; the establishment of new consumer finance firms may be affected by the strict regulations imposed by the US government. Moreover, the sub-industry’s growth may be affected by the restriction on growth and scope of operation by the proposed Finance Crisis Responsibility Fee.
- Economic recession; the sub-industry’s growth might be affected by the occurrence of financial crisis both in the local and the international market.
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