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So, consumers are not turning to debt to fund their purchases anymore, and in fact are purchasing less. Not exactly big news for anyone who pays attention. The news is the way that consumers are reducing their debt load: default. Definitely not the healthy way to unwind bloated household balance sheets, and sure to damage creditworthiness long after joblessness and income flow have been remedied.

What is the point of this depressing diatribe? Consumers are still going to buy things, even after they have defaulted on their loans, but the way they will pay for them is going to change.

As pointed out above, credit cards have become an immensely popular way to pay for goods and services - and not only because it is a buy now pay later transaction. How much

more convenient is it to swipe a card at a terminal than fumbling around with greenbacks? And who among us is not supremely annoyed at ending up with a pocket full of coins (I can’t be the only one)? The technological advances, along with the expansion of access to credit, fueled the growth of paying by card for almost any transaction. With the credit half of that equation drying up, will consumers switch to cash? Not likely, especially when the same point-of-sale infrastructure can be utilized by debit and other cards.

The reason the American economy works (most of the time), is because it is adaptable. The Invisible Hand almost magically allocates resources to their most productive use. This process of creative destruction is constantly at work all across the economy, all the time. One area we have been paying attention to is the payments market. This space has undergone a large shift recently away from writing checks and using cash to

summitV I E WThere is no question that the American economy is driven by consumer spending. A full 70% of GDP is dependent on the buying of goods for personal consumption. So important is this segment of the economy that in the aftermath of the 9/11 attacks President George W. Bush urged US citizens for “continued participation and confidence in the American economy.” The clear implication: keep shopping or the terrorists win. It seems crass and tactless, but the buying of stuff is the largest component of the largest economy in the world. That is the reason GW pushed it after 9/11, and also the reason consumer deleveraging has become such a hot topic as the US adjusts to the New Normal in the wake of the global financial crisis.

The American consumer is suffering from a credit hangover. The real wage earned by workers has essentially been stagnant since the late 1970’s, meaning the purchasing power of take home pay has not changed in 30 years. Yet at the same time, consumer spending has risen from about 63% to over 71% of US GDP. Fueling this seemingly incompatible wage and consumption trend has been low interest rates and increased access to credit of all types: cash out mortgage refis, credit cards, store credit, auto loans, etc. Using debt was ubiquitous, easy and considered savvy. Oh how times have changed.

The outstanding debt held by US households was on an exponential growth curve from the 1970’s right up until the onset of the financial crisis in 2007-08. The continual loading of debt to fuel consumption has hit an inflection point, and consumers are certainly not taking on more debt, and likely have begun a long, slow process of unwinding the debt they do hold. Woody Brock sums up the subject:

Basically, we are witnessing the end of 35 years of binge-borrowing, of over-consumption, and of under-saving. Economic agents of all stripes are cutting back and becoming more conservative — from overextended museums with their copy-cat expansions, to pension funds that overpromised benefits and under-funded liabilities, to loony state and local government expansion, and to individual citizens confronting the depressing triad of wealth loss, runaway medical costs, and joblessness.

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Will the Recession Have a Lasting Impact on How Consumers Pay for Things?

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marketplace in China and the dominance of the domestic market by competitor Alibaba, PayPal has experienced rapid growth in transactions between China and the rest of the world. By seeking to expand in the current environment of economic uncertainty and potential, exponential growth in e-commerce, eBay is well positioned relative to incumbents in the global payments industry.

Consumers are expected to keep consuming, but with more budget-consciousness in their spending habits: seeking better prices; paying with money they have instead of using credit. eBay has taken note. The recent acquisition of Red Laser shows that the company believes consumers will utilize the barcode scanning technology on their smartphones to become more efficient comparison shoppers. Also, eBay’s partnership with Green Dot seeks to translate consumer’s shrinking access to credit to online spending power, by enabling customers to add money to their PayPal account without using a bank. Coupled with protectionist consumer policies that will reduce incumbent interchange fees the increasing use of efficient purchase technology points to growth for PayPal’s service, while reduced interchange fees improve eBay’s operating margins.

paying with plastic, both debit and credit. Now with credit harder to come by, and consumers less willing to take it on, markets are looking for new ways to make it easier for consumers to spend money.

There are several factors that are accelerating the changes taking place in how people pay for things: the Internet & Cloud Computing, the proliferation of smartphones (and other mobile devices such as the iPad), and the consumer credit situation. The first three are clearly related, and the fourth will definitely affect how consumers approach transactions. The question is how all of them will combine in coming years. Summit Creek Capital’s research on eBay provides good examples of how changing consumer patterns will affect the global payments market:

In the wake of the global financial crisis, payment volumes have experienced a decline, and political pressure is being exerted on payment processors by consumer advocacy groups. A New York Times article at the beginning of 2010 highlighted some of the dubious practices that Visa and MasterCard engage in to proliferate their networks, and Elizabeth Warren’s appointment to the Consumer Protection Agency and the Durbin Amendment are both signs of shifting sentiment against large payments processing firms like Visa and MasterCard. As these companies begin to lobby and navigate pending legislation and uncertainty, the growth in worldwide transactions and e-commerce continues, opening doors for eBay’s PayPal to capture market share. Though no stranger to regulatory hurdles and unsuccessful ventures in foreign markets, PayPal continues to position itself for global growth in the payments space. Despite the lack of success of eBay’s

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Disclaimer: All material presented herein is believed to be reliable but we cannot attest to its accuracy. Neither the information nor any opinion expressed constitutes a solicitation by us for the purchase or sale of any securities.

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This specific quote, while clearly speaking to eBay and PayPal’s relative merits, also points to larger themes that will affect consumption across the world. Just as a small example, RedLaser is an app that is downloadable to a smartphone. A shopper can scan a product’s barcode with the phone’s camera, and the phone will display more information on the product as well as prices on the same product at different stores. Pretty damn savvy, and a neat little example that ties together our themes of utilizing a smartphone to access cloud computing power in order to make a more informed decision on how much money to spend. In fact, eBay is so bullish on this technology and PayPal’s mobile payments option, that CEO John Donahoe says that a few years from now we’ll be making more purchases with our cellphones than from our wallets.

While scanning barcodes and paying for goods with a smartphone are incredibly appealing (hopefully we’ll never have to carry wallets again! - did I mention I hate coins?), to be perfectly honest these innovations will not be utilized by all segments of the population. A significant, and unfortunately growing, segment of the US population will continue to be stuck in a cash based economy, without the means to buy a smartphone, or even open a bank account.

One area in particular, where it is impossible to use cash, is online shopping. Online retail is currently the fastest growing segment of retailing, and for the most part transactions happen with cards or some other payments system, i.e. PayPal. It is not just online retail, but also online bill paying that is making having a card not just a convenience, but almost mandatory. So what is a debt-burdened (or debt-free but credit score challenged) individual to do? Well there is another area that is experiencing rapid growth: prepaid credit and debit cards.

Prepaid cards offer the ability to pay with plastic to anyone. In most cases, you don’t even need a bank account. Some cards even function like a bank account. The RushCard is a prepaid Visa card brought to life by the same visionary who put together the legendary hip-hop group Run DMC. The RushCard functions just like a regular Visa card, except the entire spending allowance is loaded on the card in advance - no credit is extended and it does not siphon money out of a bank account. Users even have the option to transfer their paychecks directly onto

their RushCard, or other prepaid card, via direct deposit. A few words (verbatim) from the man, Russel Simmons, on why he thinks the RushCard

is so important:

America operates on plastic. If you don’t have any kind of card, you’re locked out of the American dream. You can’t go to the Internet and buy nothing, you can’t order nothing over the phone, you can’t rent a hotel room.

While prepaid cards are generally targeted towards people who do not have the credit history for a regular credit card, or even

the cash for a bank account, they have been gaining more acceptance and use among middle class consumers who would have traditionally turned to credit or debit cards. One other not-so-encouraging sign of continued growth in the prepaid market: the US Government uses prepaid Visa cards to make transfer payments (such as food stamps & welfare) to those on government assistance programs. Unfortunately for the economy at large, the use of that type of prepaid card does not look like it will slow down anytime soon.

The changing behavior of the American consumer and the trends in global consumerism are examples of the type of macro themes that we are focusing on at Summit Creek Capital. While it is important to stay informed about current events, the confused economic environment is far from resolving itself, which strengthens our resolve to keep our focus forward on nascent trends that are likely to have an impact in the new global economy. We will continue to share these themes and ideas with our clients and colleagues.

The above ad is a great example of what Summit Creek Capital is discussing.