Credit cards are arguably the most successful retail financial product introduced this century. Just 40 years after their creation, they are ubiquitous among consumers, indispensable for retailers, and a major money-spinner for the banking sector. Yet the card industry has recently undergone wrenching changes. No doubt about it: though cards continue to displace cash and checks and to capture a growing share of consumer spending, the competitive environment of the future will look dramatically different from that of the past. Card issuers must reevaluate their strategies to reflect the new challenges and opportunities that lie ahead.

In 1996, the profitability of the credit card industry fell below 1.3 percent return on assets (ROA) after averaging 3.1 percent over the previous four years. Many issuers were caught unawares at a time when the US economy was booming and card revenues, charge volumes, and outstandings (the total balances unpaid by cardholders) were growing at double-digit rates. Profitability recovered marginally in 1997 to 1.5 percent ROA, but a number of issuers suffered credit problems, and several leading players (including AT&T, Advanta, and Bank of New York) exited the business. Meanwhile, the mergers of Bank One, First USA, and First Chicago NBD and...