Retailers are not banks, but they can keep their customer relationships 'sticky' like banks do with the appropriate use of credit. This is especially true for hard-goods retailers like hhgregg (HGGGQ), Aaron's (AAN), and Conn's (CONN 0.98%), where their customers need credit to buy big-ticket items such as electronics and furniture.

Third-party credit
Started in 1955, hhgregg is a specialty hard-goods retailer with a strong presence in the Eastern U.S., where its 228 stores are located. hhgregg's current credit offering is its private-label credit card offered through GE Capital, which accounted for more than a third of fiscal 2013 sales. This represents a 530 basis point increase from 2011, when private-label credit card sales represented 28.7% of total sales. In addition, GE Capital, not hhgregg, bears the credit risk associated with private-label credit card sales.

Despite strong take-up rates, hhgregg estimated that about one-third of the applicants for its private-label credit card were rejected by GE Capital because of their credit standing. In response to this, hhgregg expanded its credit offerings to regain lost sales from this group of customers. Firstly, it launched a secondary finance option targeted at lower- to middle-income consumers in September. Secondly, it plans to complete the roll-out of lease-to-own options through Rent-A-Center's RAC program to all its stores by the end of the second quarter of fiscal 2014. 

In-house credit
Unlike hhgregg, which outsources its entire credit offerings to third parties, Conn's utilizes both in-house and third-party financing options. While Conn's also has third-party financing and rent-to-own payment programs similar to that of hhgregg, its proprietary in-house credit program is the dominant payment option, responsible for financing 80% of its sales.

Moreover, Conn's in-house credit encourages repeat purchases and purchases of higher-ticket items. As of the third quarter of fiscal 2014, repeat customers accounted for 71% of Conn's credit balances due under its in-house credit program; the average selling price for a television set at Conn's of $1,069 is also more than double the industry average selling price of $465.

Conn's in-house credit business gives it a competitive edge over its competitors utilizing third-party credit options.

Firstly, Conn's in-house credit business targets the unbanked and underbanked population, who can't get access to credit. hhgregg is moving in the same direction in expanding alternative credit offerings to lower- to middle-income consumers, but ultimately there are certain limitations and restrictions leveraging third-party credit.

Secondly, Conn's offers favorable interest rates below those of non-bank lenders and fast credit approval. In fiscal 2013, 65% of its customers' credit applications were automatically approved by Conn's proprietary standardized underwriting model.

Safety first
As a rent-to-own company leasing and selling hard goods, Aaron's is responsible for managing its internal credit risks like Conn's. It relies primarily on the security interest over the leased goods. In the event of a default, it can repossess and sell the collateralized merchandise.

Aaron's also monitors cash collections closely. It goes a step further by calling its customers a few days before their payments are due. Customers are reminded to pay on time or renew the lease agreements for an extended period if needed.  

The key difference between Aaron's and Conn's is that Aaron's doesn't evaluate the credit scores of its sales and lease ownership customers. In contrast, Conn's actively manages its credit risk by segmenting its customers based on their credit worthiness. Customers with credit scores above 650 have access to low- or no-interest financing options on selected products, while those with credit scores between 550 and 650 are offered fixed-term, fixed-payment installment terms for their purchases. Customers who don't qualify for either are advised to use the rent-to-own payment option.

Foolish final thoughts
Credit, particularly in-house credit, is an important marketing tool for hard-goods retailers because it stimulates greater brand loyalty and higher average ticket sizes. Of the three hard-goods retailers, Conn's stands out for its long-standing in-house credit program (45 years) and customer segmentation underwriting process.

Furthermore, Conn's has greater discretion over the extension of its consumer credit with its in-house credit program. In contrast, third-party financial institutions are likely to restrict credit to consumers if capital markets deteriorate.