By David Henry and Dan Wilchins
NEW YORK (Reuters) - Gordon Smith, credit card chief of JPMorgan Chase
As he takes apart an engine, he puts pieces in plastic Ziploc bags to keep track of where they belong. He videotapes the disassembly, in case he forgets how to rebuild.
"It would be really embarrassing to take a pile of pieces back to the shop and say, 'I took it apart. I'm an office worker. Could you put it back together for me?" Smith quipped in an English accent in a recent interview.
Smith is using that same careful approach to rebuild Chase's credit card unit. And the model he is using resembles that of American Express Co
Smith, who joined Chase in 2007 after 26 years at American Express, took over operations of a travel agency in JPMorgan's private equity unit, allowing him to offer better travel rewards and a better corporate card.
He built up the bank's Paymentech unit, which processes card transactions for merchants. He created the Sapphire card for wealthier customers whose big spending earns him more processing fees.
Smith is also applying several lessons taken from the consumer finance industry's playbook: improving customer service, combining many rewards programs into one and shedding cards that are not profitable enough. Along the way, he is spending hundreds of millions of dollars mailing card offers.
Step back and look at what Smith is building, and it looks a lot like American Express: a business that caters to rich clients and relies increasingly on processing fees to make money.
That has made American Express the most consistently profitable of the major financial services companies, outpacing more glamorous businesses like Goldman Sachs Group Inc
There's big risk in this strategy for Smith, though, and at stake is more than his 1969 Jaguar XK-E or his 1972 Triumph TR6. Credit card companies have tried to follow American Express's strategy for years and have failed.
Chase starts with some big disadvantages. Although its Paymentech processes transactions for merchants, it does not run the Visa or Mastercard global networks that accept its cards and influence how much it can charge for credit card transactions.
American Express runs its own network, which allows it to charge merchants a higher price for delivering wealthy clients. American Express can earn more on transactions than Chase.
But Chase's credit card business is second in size only to American Express's, and contributed 12 percent of JPMorgan's $17.4 billion of profits last year. If Smith pulls off the transformation, the rewards could be handsome.
Some analysts believe he is among a small group of potential successors to Chief Executive Jamie Dimon, even though the 53-year-old Smith is just 2-1/2 years younger than Dimon, 55.
"Smith would do well with even larger responsibilities in the company. He's a very talented executive," said Moshe Orenbuch, a veteran industry analyst at Credit Suisse.
Jamie Dimon in an interview said Smith is "an extraordinary executive on multiple levels."
Dimon has given Smith more responsibility in recent months, including oversight of JPMorgan's auto finance and student lending business, and responsibility for marketing the Chase retail banking brand and shaping up Chase's information networks.
Smith is making progress. Profits have recovered under his watch. He's improved the bank's customer service rankings for credit cards, and he is getting ahead of competitors who also issue MasterCard and Visa cards.
"Chase is taking share of big spenders who previously had loyalty to other issuers," said David Robertson, publisher of the Nilson Report, which publishes news and research on consumer payment systems.
Robertson says that since Smith arrived, Chase seized 1.15 percentage points of market share while Bank of America Corp
Boosting market share in consumer finance businesses is usually a game of inches.
"That is a huge change," Dimon said.
REWRITING CHASE CODE
Smith, who grew up in the quiet coastal town of Peacehaven in southeast England, says he owes some of his success to his training as a computer programer, which taught him to focus on details as well as the broader picture.
"When you are doing systems work, you have to take a high-level view of what you want to do, and you have to turn it into lines of code that will actually do something," said Smith, whose first job at American Express was programing.
Smith is doing some heavy rewriting of Chase's code after expenses for losses on card balances reached an astounding $18.5 billion in 2009.
That coupled with a grim outlook for lending spurred Smith to scale down risk by extending less credit to customers who carry more than $20,000 of debt on all their cards. Within two years, balances of such higher-risk customers were down by 40 percent.
He has also cut card loans outstanding by 20 percent to $125.6 billion in June from $157 billion at the end of 2007.
Smith still likes interest income when he can get it safely. He created a product he calls Blueprint, an online budgeting program to support customers who will occasionally use their cards to borrow, with plans to pay back what they owe.
As he reduces credit risk, he is boosting profits by processing transactions, a move that Dimon supports.
Every time a customer spends on a credit card, the bank that issues the card earns, on average, about 1.75 percentage points of the transaction as a fee, according to Credit Suisse's Orenbuch.
In Smith's most-recently reported quarter, the take helped push his fee revenue to nearly 40 percent as much as his interest income, nearly twice the proportion as in 2007.
And now that Chase is making fewer dubious loans that require big loss provisions, Smith's bottom line is rising again. Return on equity in the unit rose to 35 percent in the first half of this year from 1 percent in the first half of 2010. The company has told analysts to generally expect 20 percent returns on equity.
The first half of 2011 may be unusually high for return on equity because the firm's delinquencies fell precipitously.
9 A.M. CLASSES IN CUSTOMER LOYALTY
Every morning at 9 a.m., Smith has some 500 managers on a conference call for 30 minutes to review calls from customers.
They receive basic information about a client or two, listen to the interactions and discuss how the process could have gone better.
Smith pushes his staff to recognize what he calls customer "moments of truth," experiences that define how cardholders think about Chase.
One is when someone loses a card and needs a replacement immediately. (Smith has a team to get new cards to remote locations.) Another is when suspicious charges appear on accounts and must be discussed.
One lesson Smith and his executives have taken from these calls is how much customers hate to be transferred.
"You hear the tone from the customer drop when that happens," Smith said. "As soon as you get to that first transfer, customer satisfaction begins to drop, even though the problem gets resolved."
His response: train representatives to solve more problems themselves. It's a logical answer, but not an easy task given that Chase has 12,000 people taking calls and answering mail.
Chase's standing with customers improved more than that of the industry last year, said Michael Beird, director of banking services for research firm J.D. Power.
But Smith needs a lot of those kinds of fixes to make more progress in customer service and loyalty for Chase, particularly with competitors trying to improve their game.
Chase ranks only about average in credit card customer satisfaction, behind top-ranked American Express and the slightly lower-ranked Discover Financial Services
Smith, said Nilson's Robertson, is trying to create something many people doubt can exist: good service from a big bank.
Smith has been spending a lot of money on marketing and the bank's rewards program. Since 2008, the bank's annual spending on marketing has risen nearly 40 percent.
The unit's overhead, including marketing expenses, reached 41 percent of revenue at the end of the quarter in June, up from 31 percent in 2008.
He increased marketing spending at the end of 2009 when he rolled out his new products with mailings and broadcast advertising. The new products included the Sapphire Card, the INK card for small businesses and other card accounts with new rewards programs.
Chase has pushed the industry to send out more mail for new accounts and aggressively offer customers cash back for their rewards points. He has promoted additional perks, such as the transferring rewards to airline frequent-flyer accounts, point-for-point.
That has raised concerns among stock analysts about how far industry-wide spending and price-cutting might go.
"Chase has really kick-started the mailbox," said Andrew Davidson, senior vice president of research firm Mintel Comperemedia.
In the second quarter of this year, card companies sent nearly 1.3 billion new account offers to U.S. addresses, up from about 850 million a year earlier, said Davidson.
Citibank this year has followed Chase's lead and now the two banks are responsible for most of the mail, said Davidson.
Cardholder spending on new Chase accounts came in 53 percent higher in the last quarter of 2010 compared with a year before. Now Smith has to make sure he holds onto those gains to get the real payoff from all his spending.
Dimon says he is confident in the investments.
"In the recession, Gordon and I saw eye-to-eye," Dimon said. "We are going to run this company for the future ... and we had lost so much money, nobody is going to notice an extra couple of hundred million dollars."
HARD TO COPY
Every credit card company from Capital One Financial Corp
Companies try to woo them with lagniappes galore: rewards programs, sign-up bonuses and so on. The strategy is easy to conceive, but hard to execute profitably.
Bank of America invented what is now the Visa card in the late 1950's as a replacement for the credit that local drugstores and grocers offered their customers.
For most banks, lending through credit cards is in their DNA, but with weak demand, it's not the source of profits it used to be.
"People have been nipping at American Express's heels for a decade, off and on," said Brad Ball, an analyst at investment bank Evercore. "Some have been somewhat successful, but arguably American Express is a premium product with a premium customer and a premium brand, so they can have premium pricing."
Smith over time can make his business look more like American Express's, but without a network, he may never be able to fully duplicate it, analysts said.
He has considered purchasing or building one, but the only network that any company could realistically buy, namely Discover Financial Services, is not as globally available as Visa and Mastercard.
Clients care most about their cards being accepted in as many places as possible, Smith said. "We obviously think about these things a lot, but that would really be the challenge, and it would be a tough one." (Reporting by David Henry and Dan Wilchins in New York. Editing by Paritosh Bansal and Robert MacMillan)