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This case was prepared by Lee Fennel under the supervision of Gretchen A. Kaslow, assistant professor of BusinessAdministration, and June A. West, assistant professor of Business Administration. It was revised by ResearchAssistant Jenny Mead under the supervision of Patricia H. Werhane, Ruffin Professor of Business Ethics, and R.Edward Freeman, Elis & Signe Olssen Professor of Business Administration, Darden Graduate School of Business,University of Virginia. It was written as a basis for class discussion rather than to illustrate effective or ineffective

handling of an administrative situation. Copyright 1999 by the University of Virginia Darden School Foundation,Charlottesville, VA. All rights reserved. To order copies, send an e-mail to [email protected] part ofthis publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any formor by any meanselectronic, mechanical, photocopying, recording, or otherwisewithout the permission of the

Darden School Foundation. Rev. 5/03.

FINGERHUTS PRICE STRATEGY

Businesses have target niches. Ours is the moderate-income consumer. We neither

apologize for, nor hide the fact that we serve this growing populationeven when others

wont.

Ted Deikel, chairman and CEO of Fingerhut Companies, Inc.

Jane Johnson, director of corporate communication at Fingerhut, let her eyes swim overthe legal pleadings and news clippings that lay before her. It was November 1996, weeks before

the Minnetonka-based direct marketing companys holiday rush, and an unfavorable article hadjust appeared in a major Minneapolis paper, the Star Tribune. The article drew attention to alawsuit pending against the company and suggested that Fingerhut made its profits by exploitingthe poor. In January, four Minnesota women had brought suit in Hennepin County District Court,alleging usuriously high interest rates on merchandise they had purchased from Fingerhutsdirect marketing catalogs. The lawsuit had gained the support of the Minneapolis Urban League,Minnesota COACT, and the Minneapolis chapter of the NAACP; these groups had filed a friend-of-the-court brief in support of the customers. Worse, the lawyers representing the women wereattempting to have the case certified as a class action.1If this move was successful, customers inat least 20 states might become involved.2

John Ellingboe, Fingerhuts vice president and general counsel, seemed convinced thatthe lawsuit had no legal merit and would be eventually dismissed under Minnesotas time-pricedoctrine, an exception to the usury law. Yet Johnson found it deeply troubling that thecustomers had brought the lawsuit at all. One of the things that had attracted her to Fingerhut wasthe high level of social consciousness exhibited at all levels of management. For example, CEO

1Marjorie Kelly, Some Businesses Specialize in Capitalizing on the Poor; Fingerhut a State Firm that TargetsLow Income Folks, Star Tribune,November 4, 1996, 3D.

2Tim Gray, Tampa Bays Latest Catch has Financial, Legal Problems, St. Petersburg Times, May 1, 1996,1E.

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Ted Deikel was renowned for his philanthropy and environmental awareness. But this lawsuitpainted Fingerhut as a predatory company that suckered low-income consumers by using unfairand deceptive marketing techniques. The fact that Fingerhuts advertising and credit policies

might technically be legal didnt necessarily make them moralor did it?

Company Background

The company began in 1948 when brothers Manny and William Fingerhut began sellingseat covers to car owners through the mail. By 1996, Fingerhut had grown into a $1.8 billiondirect marketing superpower, selling a smorgasbord of consumer goodsclothing, housewares,furniture, electronics, appliances, and morethrough an array of specially targeted catalogs. Ithad become the second-largest catalog company in the nation,3with more than 7 million loyalcustomers and about 9,500 employees.

In 1996, it laid off 570 employees in Minnesota and opened two customer service centersin Tampa, a move that allowed it to take advantage of a larger bilingual labor pool and betterwinter weather conditions.4Its earnings had been weak for the past two years, in part because ofrising postal and paper costs and a failed TV home-shopping venture.5 A co-branded Mastercardthat it introduced in 1995 seemed to be catching on nicely, however, and the possibility ofexpanding into the financial services sector offered definite opportunities for growth. (SeeExhibit 1).

The Target Market

Fingerhut consistently distinguished itself from other direct marketing companies byexplicitly targeting those customers with household incomes falling in the lowest one-thirdnationally. In 1996, this amounted to almost 89 million people, or 33.7 million families.6In thatyear, the median household income in the United States was $35,492.7Fingerhuts target marketincluded most of the households in the bottom two quintiles, which had mean household incomesof $8,596 and $21,097 respectively. These two quintiles together received 12.7% of the totalhousehold income for the year.8

This segment of the market had been largely untapped by marketers and underserved byfinancial institutions. Many individuals falling into this category had no credit or poor credit, and

3Mark Albright, Fingerhut Center is Symbol of Companys New Strategy, St. Petersburg Times,September10, 1996, 1E.

4Ibid.5Gray, 1E.6Based on data in U.S. Department of Commerce, Bureau of the Census, Money Income in the United States:

1996vii (1996), 60197.7Bureau of the Census, v.8Ibid.

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they were typically unable to obtain credit from traditional lenders or credit card companies.Most were among the estimated 25% to 30% of U.S. households that live paycheck topaycheck.9

A typical Fingerhut customer had a household income of about $18,000. Many customerswere empty-nesters or people just starting families, and most were femalesome 90%,according to a 1986 article.10 In 1996, although only about 5% of Fingerhuts customers wereHispanic, they represented its fastest-growing segment.11

Risk, Choice, and the Low-Income Consumer

Author David Caplovitz stated that two options are available to the low-incomeconsumerforgoing major purchases or being exploited. While he admits that the marketing

system that is targeted to the poor is a deviant one, it persists because it fulfills social functionsthat are presently not fulfilled by more legitimate institutions. The poorest risks are shunted to aspecial class of merchants who are ready to accept great risk. 12

In 1996, the picture was much the same, but some efforts were underway to improve thechoices available to consumers. For example, in 1994 and 1995, a Minneapolis-based groupcalled ACESS (Aggressive Consumer Education and Support Strategies) began offering creditcards for use in Daytons and Target stores to low-income customers unable to meet traditionalcredit requirements.13The initial screening mechanism proved inadequate, however, (almost halfof the payments made by participants were late) requiring ACESS to revamp its eligibilitycriteria.

The Marketing Approach

Fingerhut attracted and retained its target market through strategies tailored to the low- ormoderate-income consumer, including an installment payment option. Boldface monthlypayment amounts and a smaller cash price accompanied each item. Exhibit 2 illustratesinstallment plan details. Virtually all of Fingerhuts customers purchased their merchandisethrough this installment plan.14Coupon books were delivered along with the merchandise rather

9

Juliet B. Schor, Overspent American(New York: Basic Books, 1998), 20.10Eileen Norris, Fingerhut Gives Customers Credit,Advertising Age57 (March 6, 1986): 19.11Albright, 1E.12David Caplovitz,Poor Pay More; Consumer Practices of Low Income Families(New York: New York Press,

1967), 180.13 Susan Lorde Martin and Nancy White Huckins, Consumer Advocates vs. the Rent-to-Own Industry:

Reaching a Reasonable Accommodation,American Business Law Journal34 (Spring 1997): 407.14A 1997 article reported that 99% of Fingerhut customers used the payment plan; Paul Miller, Fingerhut, to

the Bone, Catalog Age14:13 (December 1997): 5.

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than mailing consolidated statements. Typically customers had several active Fingerhutcoupon books, representing different purchases at various stages of repayment.15

Many of Fingerhuts customers would not qualify for other credit options like creditcards and department store charges. A full 40% had so little credit history as to have noinformation available in a credit report. Thus, Fingerhut was taking a risk with new, untestedcustomers, selling them less expensive items. Customers who paid back the balance on timewould then be promotedmade eligible to finance progressively larger purchases. They alsowould receive personalized mailings from the company with messages like Congratulations!Youve been selected to receive our exceptional customer award! along with a certificatesuitable for framing.16 Customers who fell behind on their payments were contacted byFingerhut personnel, who attempted to arrange a viable repayment plan.

Fingerhut made extensive use of its database to personalize its mailings and target

specific customers with specialty catalogs (in 1992, there were about 75 such catalogs, coveringcategories like outdoor living, electronics, and juvenile apparel and toys).17Personalized insertsnoting birthdays, anniversaries with Fingerhut, and recent purchases further enhanced customersperceptions of personal service.18Fingerhut also relied on frequent contact with the customer tolimit bad-debt losses and ensure a steady stream of sales. Fingerhuts customers maintained, onaverage, a seven-year relationship with the company.

The Database

It all goes back to the database.Ted Deikel19

Central to Fingerhuts marketing strategy was its massive database system, whichcontained more than 500 pieces of information on each of more than 50 million active andpotential customers.20The information in the database had been compiled over more than 30years and kept up-to-date using state-of-the-art technology.21Deikel termed it the worlds mostsophisticated database. The database application, Fingerhuts Customer Contact System, hadbeen developed with Lincoln Softwares Engineer toolset and was one of the largest client/serverapplications in the world.22

15Sarah Brehm, Catalog Shopper Must Be Careful,MadisonCapital Times, February 21, 1992, 1D.16

Philip Kotler and Gary Armstrong,Principles of Marketing7th ed. (Upper Saddle River, NJ: Prentice Hall,1996), 439.

17 Jim Bessen, Riding the Marketing Information Wave, Harvard Business Review (September/October1993): 150.

18Ibid.19Susan Chandler, Data is Power. Just Ask Fingerhut,Business Week(June 3, 1996): 69.20Ibid.21Harlan S. Byrne, Shopping Made Easy,Barrons(July 25, 1994): 20.22Information taken from a case study on Lincoln Softwares Website http://www.ipsys.com/fingerh.htm.

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The detailed information Fingerhut gathered about each customer, including age, maritalstatus, number of children, birthdays, and hobbies, enabled it to make predictions about the typesof products each individual would be likely to purchase. It then sent each household the

appropriate mix of targeted specialty catalogs.23

Jim Bessen described the astounding degree towhich Fingerhut collected and used computerized information about its customers to achievemarketing goals:

Every catalog mailing and major promotional campaign at Fingerhutthere werenearly 150 in 1992is based on statistically determined predictions aboutconsumer behavior. Fingerhut captures as many as 1,400 pieces of informationabout a household. These include typical demographic items like income andhome ownership, appliance ownership, and purchasing histories for variouscategories of products.24

Pricing Strategies

Fingerhuts focus on the coupon payment method required it to coordinate the pricing oftwo different types of commoditiesthe actual pieces of merchandise that it sold, and theclosed-end credit that was wrapped around each item.25 The installment payment plan bundledthese two commodities together and offered customers a consolidated monthly price.

Pricing theory has recognized that the contextual and conceptual frame of a purchasedecision can have profound effects on the perceived fairness of a price.26The tactic of breakingdown a large purchase into smaller weekly or monthly payments alters the purchase contextdramatically and has been successfully used by marketers to sell everything from encyclopediasto automobiles.27 Instead of focusing the customers attention on the weeks or months of workthat would be required to save up the full purchase price of a particular good, the low monthlypayment invites the customer to imagine enjoying the new purchase by making negligible day-to-day sacrifices on items of little or no lasting significance. Sometimes the insignificance of thenecessary belt-tightening is made explicit, as in the Chevrolet advertisement that boasts, [T]hisCavalier costs less a day than a burger, large fries and a shake[just] $6.23 a day. 28Reframing

23Chandler, 69.

24Bessen, 150.25The setting of a service element such as an interest rate is a pricing decision exactly like the pricing of a

product purchased in a store. Kent B. Monroe, Pricing: Making Profitable Decisions 2nd ed. (New York:McGraw-Hill, 1990), 430. Fingerhut also had to make pricing decisions concerning the shipping and handlingincident to each sale.

26Monroe, 72.27Thomas Nagle and Reed K. Holden, Strategy and Tactics of Pricing; A Guide to Profitable Decision Making

2nded. (Englewood Cliffs N.J.: Prentice Hall, 1951), 309.28Ibid.

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the purchase decision in this way is particularly attractive to low-income consumers, since it fitswithin their paycheck-to-paycheck frame of reference.29

The extension of credit, which allows the customer to try out the good before makingany payments, may also contribute to a perception of value. Because buyers quickly assimilatenew merchandise into their frames of reference once it has entered the home, they are willing topay for the goods rather than incur the loss associated with giving them up.30

Customers are also less price-sensitive if they believe that a particular retailer is offeringthem some uniquely valuable feature that is unavailable elsewhere.31 Fingerhut was able todifferentiate itself from its competitors by extending credit to customers who would not be ableto obtain credit elsewhere. Fingerhuts willingness to wrap merchandise in credit created extravalue for consumers and made them less sensitive to the prices of the commodities included inthat package. Fingerhut also distinguished itself by fostering a socially responsible corporate

image, leading the industry in recycling and other environmentally conscious practices anddeveloping personalized relationships with its customers via its database.

Arguably, the low-income market is underservedespecially with respect to credit.Typically, a small number of creditors serve low-income areas and many low-income buyers donot have the transportation or information necessary to shop intelligently.32 A low-incomeconsumer may find few alternative suppliers willing to extend credit, and this will make theconsumer less sensitive to price. Moreover, in setting prices, the risk and costs associated withextending credit must be taken into account.33To the extent delayed payments are tolerated orexpected, pricing must account for that as well.

The Competition

The goods retailed by Fingerhut were available from other sources, like K-Mart and Wal-Mart, as well as Sears and J.C. Penney, which sometimes offered the same items at a lower cashprice. As Richard Tate, Fingerhuts senior vice president of merchandising explained, We cantcompete on price. We are the highest-priced guys in town. The value is not in the total price, itsin the total offer.34

Fingerhuts finance charge was 24.9% APR, and interest rates for credit cards rangedfrom low teaser rates to around 19%. Store charge accounts such as Sears typically fell in the21% to 22% range. However, the interest rate could run higher on closed-end store credit

29James Agger, Big Victory in N.J. Rent-to-Own Case,Legal Intelligencer(October 31, 1996): 3.30Nagle and Holden, 313.31Ibid, 80.32George J. Wallace, The Logic of Consumer Credit Reform, Yale Law Journal82 (1973): 46182, 468.33Monroe, 347.34Ann-Margaret Kehoe, Selling a Solution: Fingerhut Takes a Page from Supermarkets, HFN, The Weekly

Newspaper for the Home Furnishing Network, December 8, 1997.

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arrangements similar to Fingerhuts installment plan. Fingerhut priced both elements of itsbundlethe credit and the products themselvesat higher rates than competitors. If this wasthe case, then why did Fingerhut continue to enjoy such a large share of the market?35

One explanation may be that many customers do not qualify for the types of credit thatwould make alternative purchase decisions attractiveor even possible. Caplovitz made asimilar observation regarding low-income consumers who chose to patronize more expensiveshops in their own neighborhoods: Although some families may buy from neighborhoodmerchants out of ignorance of alternatives, others may do so because they fail to meet the creditrequirements of the more reliable stores. In part, the low-income family is caught up in thechoice of doing without or relying on credit and therefore paying more. 36 Fingerhut providesthese families with an opportunity to purchase quality name brand products at affordablemonthly payments (see Exhibit 3). The availability of credit has long been recognized as thesingle most salient factor in a low-income consumers decision about where to buy.

If a customer cannot qualify for other forms of credit (e.g., a department store charge cardor a credit card) thepriceof that credit becomes meaningless. If that same customer has no cashon hand, the lower merchandise prices advertised elsewhere are likewise irrelevant. Suchcustomers maysave upfor their purchases and pay a lower cash price at a competitors store. Butsocial and cultural factors make this option very unattractive to many consumers. While asavings fund earmarked for a particular item might be raided every time a short-term need ordesire arose, the purchase of merchandise on credit represents an irrevocable commitment.Because the new purchase immediately becomes part of the buyers frame of reference, thethreat of losing it provides a powerful incentive for meeting the payments as they come due.Indeed, many low-income families do not maintain a bank account but choose instead to relysolely on check-cashing services and money orders for their financial needs, even though theseservices also exact hefty fees.37This behavior makes saving up for a major purchase even moredifficult.

Layaway plans traditionally have offered a buyer a means for overcoming the difficultyin saving for a particular item, but here too there are costs and difficulties. Most significantly, alayaway item does not go home with the consumer and so cannot become integrated into his orher lifestyle. The consumer may lose enthusiasm for making payments. Further, there may berestrictions, time limits, or fees which make layaway suboptimal. For example, K-Mart charges a$3 layaway fee and limits the payment period to 10 weeks, far too short for most consumers.Wal-Mart does not charge a fee, but posts a lengthy list of rules and regulations whichcomplicate the transaction and limit consumer choice (like a prohibition on laying away seasonalitems more than a certain number of days in advance of the holiday to which such items relate).

35Jeff Bailey & Scott Kilman, More Borrowers Appear to Be Wising Up about Credit, Star Tribune,March 1,1998, 5d.

36Caplovitz, 98.37Ibid.

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NAACP vs. Fingerhut

Fingerhut targets poor and minority neighborhoods fairly aggressively, said Anne

Bergman, an attorney who drafted an amicus curiae (friend of the court) brief on behalf ofseveral groups interested in the outcome of the lawsuit, including the NAACP and the UrbanLeague. Lenders like Fingerhut really siphon money from these areas.38

Two basic arguments seemed central to the attack on Fingerhut. First was the allegationthat Fingerhut was charging an effective interest rate that exceeded the legal limit fortransactions of the type in which Fingerhut was engaged. Minnesotas general usury statuteprohibited lenders from charging interest rates in excess of 8% annually, but was riddled withexceptions and had limited applicability. Bill Crowder, one of the attorneys for the customerssaid that under Minnesota law, anybody can charge up to 8% interest. There are statutoryexceptions for savings and loans, banks and credit cards. But Fingerhut doesnt fit within those

exceptions.

39

Fingerhuts Ellingboe contended that the usury law was never meant to apply tofinancing that accompanied the sale of merchandise. Such sales, he argued, were covered by thecommon law time-price doctrine which permitted merchants to charge a lower price for cashsales than for sales on time.

The second prong of the attack on Fingerhut was the assertion that it was preying onlow-income people through deceptive or misleading advertising. Critics noted that the lowmonthly payments were prominently displayed in the catalogs next to color pictures of themerchandise. The finance charge, effective interest rate, shipping and handling charge, and totalcost of an item could only be found by referring to a tiny print in a multi-column table on anotherpage. Bergmans brief accused Fingerhut of playing hide-the-ball with bottom line informationto confuse and exploit less-educated, less-sophisticated customers.40 This argument, whichdepended to some extent on assumptions about the relative powerlessness and vulnerability ofthe target market, called into question Fingerhuts overall marketing strategyindeed, even itschoice of a target market.

Jane Johnson decided that the second argument was the one of primary concern for thecompany. She doubted that the public would base buying behavior or attitudes towards thecompany on the outcome of a technical legal argumentalthough she certainly hoped thatEllingboe was right in predicting the outcome of the case. Far more important, she thought,would be the publics perceptions of Fingerhuts practices. If Fingerhut were viewed asmanipulative and sneaky, coaxing hard-earned dollars from the poor through tricks, fine print,and hide-the-ball credit terms, the blow to Fingerhuts image could be devastating.

38Gray, 1E.39Ibid.40Kelly, 3D.

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Fingerhuts Response

Fingerhut CEO Ted Deikel had wasted no time in responding to the unfavorable news

column that had appeared in the Star Tribune. In his response, which appeared in that same paperthe following week, he asserted that Fingerhuts finance charges were legal under Minnesotastime-price doctrine, which allows merchants to charge a different price for an immediate cashsale than for a purchase taking place over time. He also called the suggestion of unethical orpredatory practices an outrage.

There is nothing tricky about what we do, Deikel wrote:

We provide our customers with purchasing options, and for those customers whodo not have credit cards or enough free cash on hand to pay for items in a singlepayment, our in-house credit plans offer them the flexibility of buying

merchandise in installments over time. And we make it easy. Unlike mostretailers, Fingerhut will extend credit to customers who do not have a credithistory, often without requiring credit applications or down payments. The risk isall ours.

Deikel also pointed out that by choosing to serve a riskier market segment, Fingerhut suffered abad debt ratio two to three times the industry average, which was 15% of sales. He emphasizedthat Fingerhut enjoyed tremendous customer loyalty, and that many customers remember whenFingerhut was the only company that offered them credit when no one else would. 41 Indeed,Fingerhut customer Marilyn Gnat, a retired salesclerk and mother of nine children, had expressedprecisely that sentiment in a recentBusiness Week article: When I started out, Fingerhut was theonly place that would give me credit.42

Social Factors

Inner-city Chicago resident Jean Shelby paid over $1,100 for a TV/VCR combination onFingerhuts installment plan, although the same item was available for a cash price of less thanhalf that amount elsewhere. Her explanation was simple: I want things right away.43 Herattitude was not an uncommon one. In recent years, consumers at all income levels have beenopting for costlier credit purchases because of the perceived comfort, convenience, and statusadvantages associated with immediately acquiring the goods. As Juliet Schor recently noted, thefraction of Americans disposableincome that goes toward debt servicing continues to rise; it hasnow reached 18%. The total amount of debt held by the average household has increasedrelentlessly for decades, and it now equals just about what that household makes in any given

41Ted Deikel, Fingerhut Serves Its Customers Well, Star Tribune, November 11, 1996, 3D.42Chandler, 69.43 Charles W. Lamb, Jr., Joseph F. Hair, Jr., and Carl McDaniel, eds., Principles of Marketing, Annotated

Instructors Edition, 2nd edition (Cincinnati: SouthWestern Publishing, 1994), 210.

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year.44In a consumer guide, the American Bar Association declared credit almost as Americanas apple pie.45

Obtaining certain consumer goods is extremely important across all sectors of society.Credit offers consumers a buffer against fluctuations in their income due to hardships or illnessesand provides the ability to make purchases that are commensurate with their lifetime earnings. 46As the ABA consumer guide explains, Only you can decide whether it is worth the cost of thefinance charge to have a car or other goods and services now, rather than later.47

Alternatives to Traditional Credit

Pawnshops and title pawnbrokers

Pawnshops are a traditional venue for short-term credit, dating back to the turn of thecentury, and they have recently experienced a resurgence of popularity. Between 1986 and 1996,listings for pawnshops increased 60% nationally.48 They are exempted from general usurystatutes and are often permitted to charge 20% or more per month, or 240% annually. At least11 of the 13 southern states allow pawnshops to charge 240% on loans; Georgia allows 300%. 49While the consumer loses use of the goods and pays a high interest rate, the pawn broker stillbenefits by gaining ownership of the merchandise for a fraction of its value.

Title pawnbrokers specializing in automobiles operate a bit differently: a cars title istaken as collateral for a small loan, often for only a few hundred dollars and usually for no morethan 10% of the vehicles value.50The effective interest rate for such short-term loans may beover 900%.51The borrower maintains possession of the vehicle in the interim, but if the loan isnot repaid on time and in accordance with the terms, the car is promptly repossessed. At thatpoint, the car belongs to the title broker, who can resell it (perhaps even to its former owner) at aprice close to its actual valuean amount that may be more than ten times the amount of thedefaulted loan.52

44Schor, 72.45American Bar Association, You and the Law(Chicago, 1993), 243.46Wallace, 478.47

American Bar Association, 243.48Mary Kane, Fringe Banks Profit from Customers Without Banks in Michael Hudson, ed.,Merchants of

Misery: How Corporate America Profits from Poverty(Monroe, Maine: Common Courage Press, 1996),5257.49Hudson, 5257.50R. Robin McDonald, Lawsuits to Decide Legality of Rates, Fees, Atlanta Constitution,February 22, 1998,

5d.51Kathleen Keest, Cost of Credit: Regulation and Legal Challenges(Boston: National Consumer Law Center,

1995), 59.52McDonald, Lawsuits.

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One of the newest and costliest forms of short-term credit is the lease-back.53 Underthis arrangement, a dealer buys merchandise from a consumer in need of short-term creditatelevision set, for exampleand pays the customer in cash. But instead of taking possession of

the item, the dealer allows the customer to lease it back from the company at a high weekly ormonthly rate. To get the merchandise back, the customer must pay not only any outstandingrental amounts, but also a buy-back price and sales tax. Lease-back dealers claim they areimmune from attack under state usury laws because they are not actually making loans butmerely buying, leasing, and selling merchandise. If, however, the customers cost werecomputed as interest, the annualized rate would be about 900%.54

Secured credit cards

Secured credit cards offer an opportunity for consumers to establish or repair their creditby borrowing their own moneyat a price. In order to set up a secured credit card, the customer

must deposit cash to secure the credit line. The credit limit is usually equal to the amount ondeposit, and interest rates are often higher than on unsecured cards. The idea is that this willhelp them clean up their credit records and graduate to real bankcards, one commentatorexplains. But they pay a high costapplication fees of $65, annual fees as high as $75, interestrates reaching 22%.55 Meanwhile, the money left on deposit receives either no interest or abelow-market rate. This differential between what the money could earn on the open market andwhat is paid by the secured credit card vendor is a very real cost of this option.56 Because asecured credit card requires a large initial cash outlay, it has all the drawbacks associated withsaving up for a major purchase, making it a difficult and unattractive option for manyconsumers.

Payday and tax refund anticipation loans

Some check cashing services offer an expensive form of short-term creditloans usingthe customers own post-dated check as collateral. These loans, in small amounts, for terms ofonly a week or so at a time, may have effective interest rates of 700 to 2,000%. 57Keest providesan example of how such a loan might work:

Connie Consumer gives them a present or post-dated check for $256. In return,she gets $200. They withhold a fee of 28% of the amount advanced. Thebusiness agrees to hold Connies check until a later date (usually her payday).When that date comes, Connie can either redeem the check for the full facevalue, or write another post-dated check to cover it, paying another service fee.The effective yield on this transaction? If she redeems the check after two

53R. Robin McDonald, Lease-back Schemes So Much Worse than Pawning, Atlanta Constitution,February22, 1998, 5d.

54Ibid.55Hudson, 7.56Monroe, 432.57Ibid.

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weeks, it is 681% APR. If she redeems the check after 10 days, it is about1,000%; after 15 days, it is over 2,000%.58

Similarly, people expecting tax refunds can get short-term refund anticipation loansthrough commercial tax preparers like H&R Block. But the effective interest rate for these loansfalls between 50% and 200%.59Bob Williams, a manager at Associates, offers a rationale for thehigh rates his loan company charges on short-term loans: [A] lot of people need our services.All were trying to provide is a service to people who might not be able to get credit elsewhereand let them have the opportunity an upper class person might have.60

Rent-to-own

Rent-to-own offers another alternative for low-income consumers. Most rent-to-owncustomers, like most Fingerhut customers, have household incomes of less than $36,000, and are

unable to obtain credit.

61

David Hudson explained Rent-to-own customers routinely pay two,three, and four times what merchandise would cost if they could afford to pay cash. For example:A Rent-a-Center store in Roanoke, Virginia, recently offered a 20-inch Zenith TV for $14.99 aweek for 74 weeksor $1,109.26. Across town at Sears, the same TV was on sale for$329.99.62

In the past, rent-to-own dealers have been able to avoid state and federal creditlegislation, since they claim to be leasing a product rather than extending any sort of loan. Readliterally, the TILA (Truth in Lending Act) definition of a credit sale does not include a RTO(rent-to-own) agreement because the customer does not contract to pay the value of the goods heor she is acquiring, agreeing merely to pay for a weeks or a months rental.63 By 1996, 43states had rent-to-own statutes regulating the disclosure of the full cost, although few placedlimits on what the customer could be charged.64 Where limits were attempted (for example,requiring that the total payments be no higher than twice the dealers cash price), they wereunenforceable.

Fingerhuts Dilemma

In the context of the other options available to its target market, Jane Johnson felt thatFingerhuts pricing strategy offered customers an affordable way of obtaining valued consumergoods on credit. Its tried-and-true installment pricing method had gained the loyalty of millionsof satisfied customers. Viewed in this way, the allegations of four customers did not seem

58Ibid.59Hudson, 10.60Hudson, 45.61Shelly Branch, Waynes New World: Another Trashy Business,Fortune(February 2, 1998): 29.62Hudson, 146152.63Martin and Huckins, 385426.64Martin and Huckins. 396, n. 72.

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significant. But no matter how fair and reasonable Fingerhuts pricing strategy might seem tomanagement, Johnson knew that the lawsuit and its related publicity could damage Fingerhutsimage as an ethical, socially conscious company. And there was always the chance that

Minnesota could abolish the time-price doctrine through consumer protection legislation, asmany other states already had. Was the lawsuit a wake-up call suggesting that Fingerhutsstrategies targeted at the low-income market were ripe for revision? Johnson picked up a legalpad and began to write, her mind racing. She had to meet with Ted Deikel and Rachel OBrien,vice president of customer relations, in a few hours to decide on a strategy.

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Exhibit 1


Fingerhut Financials

Income StatementAll amounts in millions of US Dollars except per share amounts

Jan 1998 Jan 1997 Jan 1996

Revenue 1,609.2 1,535.0 2,027.4

Cost of Goods Sold -- 738.9 830.4

Gross Profit -- 796.1 1,197.0

Gross Profit Margin -- 51.9% 59.0%

SG&A Expense -- 901.3 1,103.5

Depreciation & Amortization -- --

Operating Income -- (105.2) 93.5Operating Margin -- -- 4.6%

Total Net Income 75.5 69.3 40.2

Net Profit Margin 4.7% 4.5% 2.0%

Diluted EPS ($) .087 1.40 0.83

Balance Sheet

Cash -- 145.4 61.0

Net Receivable -- 823.7 547.4

Inventories -- 124.4 127.7

Total Current Assets -- 1,369.1 988.2Total Assets -- 1,751.8 1,352.0

Short Term Debt -- 144.1 73.1

Total Current Liabilities -- 678.2 422.3

Long Term Debt -- 345.2 271.5

Total Liabilities -- 1,081.7 746.7

Total Equity -- 670.0 605.4

Shares Outstanding (mil) 0.0 0.0 0.0

Source: Hoovers Online, www.hoovers.com/annuals/7/0,2168,10827,00.html.

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Exhibit 1 (continued)

FINGERHUT COMPANIES INCPartial 1998 Financials

Filing Period 1998/03/27 1998/06/26 1998/09/25Filing Type 10-Q/1 10-Q/2 10-Q/3

Assets

Cash $167,494,000 $162,052,000 $31,624,000

Receivables $726,847,000 $750,688,000 $269,211,000

Inventory $121,918,000 $125,150,000 $198,741,000

Deferred Tax Asset $214,560,000 $213,500,000 $85,015,000

Other Current Assets $12,929,000 $14,987,000 $12,826,000

Current Assets $1,320,922,000 $1,348,077,000 $734,288,000

Net Property Plant & Equipment $266,903,000 $265,400,000 $216,604,000

Total Assets $1,699,102,000 $1,737,442,000 $1,096,908,000

Liabilities

Accounts Payable $139,999,000 $149,166,000 $187,618,000

Income Tax Expense $4,803,000 $13,989,000 ($11,975,000)

Current Liabilities $608,408,000 $629,686,000 $538,761,000

Allowances $181,101,000 $181,962,000 $103,772,000

Common Equity $465,000 $472,000 $502,000

Deferred Tax $27,550,000 $18,762,000 $22,263,000

Long Term Debt $345,187,000 $345,149,000 $149,000

Total Debt $345,263,000 $345,225,000 $125,225,000

Total Liabilities $1,021,059,000 $1,036,473,000 $575,084,000

Retained Earnings $381,503,000 $392,310,000 $169,216,000

Shareholders' Equity $678,043,000 $700,969,000 $521,824,000

Income

Net Sales $272,964,000

Total Operating Revenue $367,335,000 $795,635,000 $949,374,000

Cost of Goods Sold $128,651,000 $283,994,000 $450,271,000

Interest Expense $10,279,000 $19,382,000 $13,827,000

Income Before Tax $12,322,000 $32,166,000 ($31,970,000)

Net Income $5,505,000 $18,177,000 $3,059,000

Earnings Per Share: Basic

Earnings Per Share: Diluted

Cash Flow

Capital Expenditures $7,328,000

Depreciation and Amortization $20,033,000

Operating Activities $41,901,000

Investing Activities ($7,328,000)

Financing Activities ($12,497,000)

Cash at Year Start $145,418,000

Cash at Year End $167,494,000Source: Data Extracted by Edgar Scan from the PricewaterhouseCoopers Global Technology Centre.

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Exhibit 2


Fingerhuts Installment Plan

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Exhibit 3


Product Cost Comparisons1

PRODUCT

SOURCE

HamiltonBeach 48-oz 8-speed Blender2

ReebokSatellite 2000Cross-Trainer

(Mens)

Eureka 9 ampUpright Bravo IIVacuum Cleaner

with free hand vac

Pentium 233 MHzMMX Computer

with colorBubblejet Printer3

Fingerhut Cash $49.99 $79.99 $99.99 $1,299.99

FingerhutInstallmentCredit (includesShipping &

Handling)

$5.89/mo for12 months =

$70.68


$106.68


$129.48


$2,087.64

CompetitorsPrice

(Sears)$19.99(10-speed; doesnot includefood processingattachment)

(Sears)$54.99

(Sears)$69.99

(Circuit City)$949.00(266 MHz;price is aftermfgr rebate)

(Prime TimeRental)$139.99/mo for24 mo. =$3,359.76

1Information compiled in August, 1998, from current advertising circulars, catalogs, and Internet sources.2The Fingerhut model includes a food processing attachment, which consists of a work bowl with a 3-cup

capacity, and a food pusher.3 Both Prime Time Rental and Fingerhut include a Canon color bubble-jet printer. Circuit City includes a

Lexmark color Jetprinter.

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