A bank that won't be going back into its shell

Just as Egg seemed about to break even, the banking sector has been plunged into turmoil by events in America. But the company's energetic chief executive Paul Gratton has a long-term strategy to broaden its customer base and ride out the downturn

When Egg launched a high-interest savings account in 1998, the internet bank became an early illustration of how the Web might be of more benefit to consumers than dot.com investors. The City questioned Egg's reliance on loss-making financial products and sent the company's shares plunging within days of their stock market debut. Today, however, Egg stands on the verge of profitability. Its shares look in much better shape than those of most other internet companies. But can the company remain profitable now that the economy is entering a more perilous phase?

In its short life, Egg the business appears to have taken as many forms as Egg the food. It has dropped one core business for another, and the only apparent constant has been Egg's courage in commissioning provocative advertising quite out of character for a financial services company.

The company started out in October 1998, its strategy the headlong pursuit of a large customer base. The tactic was simple: promise savers a whopping near-8 per cent return on instant access Web- and telephone-based deposit accounts. Within a year, Egg had changed tack, having gained as many deposit customers in seven months as it had planned to obtain in five years. It now had a captive market for the sale of credit cards, an altogether more profitable business.

Again, the lure was in the interest rate. These were at first set at 4.5 per cent on transferred balances, reverting to the double-digit levels typically demanded by other credit card providers only after a sufficient period for customers to have become attached to the card. In October 2000, 13 months after the card's launch, interest on new purchases was cut to zero.

Egg's market-beating savings rates soon became a distant memory, although the brand had already become associated with value. As Egg's value-for-money proposition became less consistent across its product range, the company took steps to get the world sitting up and paying attention once again. Its marketing department approved the radical adverts put to it by its agency, Howell Henry Chaldecott Lury and Partners. Before long, Egg was starting to win plaudits in the City. By the end of last year, the number of Egg credit card customers had jumped from 218,800 to 744,550, their combined balances almost £1bn. Sure, overall savings deposits were shrinking in response to Egg cutting savings rates, but even here there was growth in customer numbers. This year's interim financial results showed Egg to be retaining credit card customers after the expiry of the zero interest rate terms that had made them sign up in the first place. At the last count, the company had some 1.13 million credit card customers, with a total balance of £1.57bn, and 625,470 depositors entrusting Egg with £6bn funds. And all this with not a loss-making product in sight.

Today, however, the company stands at a crossroads. It is confident of meeting the pledge made in its flotation prospectus – that it will break even at some point during the last financial quarter of the year. But its shares have fallen with the rest of the banking sector in the wake of the terrorist atrocities in the US and worries over the impact on consumer confidence. Before 11 September, the shares had stabilised comfortably above their 160p June issue price. Yesterday they closed at 133p.

When Paul Gratton took over as chief executive from Michael Harris in January this year, the outlook was not much brighter. The share price was hovering just above a low of 97p amid general concerns over Egg's viability as a business. Forty-one-year-old Mr Gratton, who started his banking career in a Nottingham branch of Midland Bank in 1978, had been part of the team at the insurance company Prudential that created Egg in 1998.

It is beyond doubt that the terrorist attacks have dashed both business and consumer confidence, making it likely that the expected slowdown in British consumer spending will be more severe, and come more quickly, than economists had previously supposed. This presents a real headache for Egg. The worry is that falling consumer spending will see its lucrative credit card balances dwindle, and with that, the interest earned on them. Some customers may choose to pay off their bills in full during the interest free period. Others may end up as bad debts. All the while, Egg faces stiffening competition from traditional high street banks, who have lost patience after losing customers to Egg.

Jon Kirk, banking analyst at Fox-Pitt, Kelton, warns that Egg, which reports results every three months, may still be reporting losses for the first and second quarter next year. "Egg has become a credit card business and it's too late to go back now," he says. "I don't see any reason for the shares to go higher from here."

Jonathan Pierce, an analyst at HSBC, likewise warns that Egg may continue to post losses into next year, especially if it launches an expensive marketing drive ahead of the ISA season in March. But he sees a good chance of Mr Gratton getting the shares back comfortably above their issue price over the next 12 months. "You're not buying Egg shares for profits next year," he says. "Losses next year won't be huge and there could be a boost if Gratton signs a deal in Europe."

Mr Gratton is not short on ideas for riding out the downturn. Domestically, he wants to broaden the customer base away from Egg's young, affluent Websurfers. Some 88 per cent of the population are aware of the Egg brand, the sort of showing seen typically among established players such as the Halifax or Barclays. But most of Egg's customers are aged between 25 and 44. Mr Gratton wants to "drive saliency" and convert brand recognition into more hard sales. "We're looking to broaden Egg out to people who want a good deal but are a little less confident than the early adopters. They're people like me, the bulk of the population, who aren't interested in working out how something works."

This will mean softening the creative edge of Egg's ad campaigns, which have recently personified the bank as an obsessive stalker creeping up on its customers and crawling into their beds unawares. Mr Gratton says the initial creative work from the agency was even more provocative, and risked breaching advertising guidelines. Mr Gratton's own mother raised an eyebrow at some of the ads. "She wanted me to change career at one point," he says, adding that the next campaign will include characters that will help the bank connect to a broader base of consumers.

The shifts are also a sign that Egg, as a business as well as a brand, is growing up. Mr Gratton's working day is no longer dominated by meetings about day-to-day operational concerns. "There's less working out of the immediacy and more thinking about where we need to be in 2003/2004. I don't need to watch the cross-sales on an hourly basis," he says. The maturing company also feels ready to venture into Europe, although some analysts are sceptical about just how much of a boost this might provide. An alliance with Microsoft to promote Egg through Microsoft's consumer websites drew little praise from investors. The holy grail here is a tie-up with a retailer on the continental mainland, such as the French hypermarket chain Carrefour, to replicate an existing partnership with Boots aimed at converting holders of the chemist's loyalty cards into Egg credit card customers.

Meanwhile, Egg's longer-term ambitions appear to be obstructed by delays to the roll-out of broadband internet services. Mr Gratton wants to re-introduce face-to-face contact with customers, but via the TV, PC and handheld computer screens. "In the traditional salesman model, the bulk of the process involves someone getting cramp filling in a form, which could be done by the customer, who needs no more than a bit of hand-holding and reassurance that they have done it right," he says.

The availability of video conferencing over the high-speed internet would open up the possibility of large numbers of customers buying sophisticated financial products, such as pensions and mortgages, online. But when will this become a reality? Rather than add his voice to the uproar over the snail's pace at which British Telecom has introduced broadband, Mr Gratton chooses his words carefully. "We've got the technology to do it now. As for when it happens – well, you'll have to ask BT."

Still, the outlook is not all doom and gloom. It is hard to see a rival start-up operation taking on Egg at its own game. Since Egg launched in 1998, the market for savings accounts has become much more competitive, with traditional banks launching a host of high-interest current accounts and internet-only savings accounts. So an upstart rival would need a very rich parent, with very steady nerves, to provide the sort of savings rates that would attract customers away from their current banks in the volumes that Egg achieved.

Indeed, Mr Gratton is happy to commend Egg shares to investors who would otherwise consider a safe-play banking stock such as HBOS or Barclays. "I don't think we ever were a dot.com. We were just a company that saw the internet as a convenient point of discontinuity from which to launch. We're not viewed as a high risk stock. We're here and we're staying."

Even so, if the economy takes a turn for the worse, Mr Gratton may discover that risk is something you never get away from.

FACT FILE

Market capitalisation: £1.09bn

Operating income: £93.2m in 2000 (£19.7m)

Pre-tax losses: £155m (£150m)

Main business: Savings, credit cards, mortgages, personal loans, investment and insurance products, accessed by phone and the internet. Egg has a joint venture with Boots to convert holders of the retailer's loyalty card into credit card customers

Key executives: Roberto Mendoza, chairman; Paul Gratton, chief executive; Stacey Cartwright, chief financial officer

Employees: 1,876

A FLEDGLING COMPANY THAT'S GROWING UP AT LAST

October 1998: Egg launched as division of banking arm of Prudential, the insurance company. The company offers instant access savings account paying 8 per cent interest – over twice the market average

January 1999: Egg cuts savings rate to 7.25 per cent

February 1999: Egg cuts rate to 6.5 per cent in response to base rate cuts

April 1999: Restricts deposit account applications to the internet

May 1999: Savings rate cut to 5.85 per cent, again following base rate cuts

July 1999: Launches internet-only savings account paying higher rate of interest

September 1999: Launch of Egg Card, a Visa credit card applied for online and managed primarily online with a standard rate of 9.9 per cent and balance transfer rate of 4.5 per cent. Launch of Egg shop, an online shopping portal

February 2000: Maiden annual results show pre-tax losses of £150m

March 2000: Launch of Egg Invest, a supermarket of mutual funds. Egg becomes the 15th most visited website in the UK

April 2000: Partnership with Boots to launch combined loyalty and credit card. Egg notches up its millionth credit card customer

June 2000: Egg shares float on the London Stock Exchange at 160p, later rising to 178.5p before falling below the issue price. Credit card business obtains its millionth customer.

October 2000: Egg credit card balance transfer rate cut to zero

November 2000: Egg shares touch a low of 97p

January 2001: Paul Gratton replaces Michael Harris as chief executive

April 2001: Egg shares return to their 160p issue price