As you may have read, I was away for a week. Now I am back. Going through the gazillion emails that were waiting for me—but, no, really, technology makes life easier—I came across a very useful note from a reader named Zoltan. Before vacation, I mused on why, if I always pay off my credit-card balance, Citi keeps me around as a customer. I concluded that the answer was interchange fees—and that these might lead us to a less-dismal future than the one card companies have promised us, the one in which all of our rewards points get yanked away and annual fees come flooding back in. For the record, I did call up Citi—and some other card issuers—but no one wanted to walk me through the math.
Thank goodness then for Zoltan. He writes:
In the recent past, I worked as a management consultant for some major credit card issuers. I can tell you that internally, these companies have a common term for customers like you who pay off their entire balance every month: “freeloaders”.
These “freeloaders” aren’t necessarily unprofitable; some are, most aren’t, on average the group is mildly profitable. If you’re wondering how such a customer can be unprofitable, there are several factors. For one, about 0.8% of that 2%-3% interchange fee goes to rewards. A particularly diligent customer can push that to 1.5% or more by optimizing the collection and redemption of rewards points. Beyond that, the credit card issuer finances everything the “freeloader” buys on the card for 15 to 45 days. Finally, there are the various expenses a customer costs: printing and mailing cards and statements, call center service, various card benefits, etc.
The result is that roughly 20% of a credit card issuer’s customers are unprofitable (this can vary tremendously, depending on the company and calculation – for instance, allocation of fixed costs). This isn’t particularly remarkable, I suspect the number would be similar for Safeway or Best Buy. But this legislation is going to increase that percentage, by either increasing the number of unprofitable customers (the numerator) or decreasing the total number of customers (denominator).
The legislation changes credit card economics fundamentally, making it less profitable. The issuers will try to restore some of the lost revenue by playing with their pricing, rewards, and servicing. A pricing structure built on a revenue model of 30% fees, 40% interest, and 30% interchange, will have to change when the revenue model is shifted overnight to 20% fees, 30% interest, and 50% interchange (these numbers are just theoretical examples).
One company may just raise the interest rate. Others might raise annual fees or reduce rewards. Many will do a combination of things. But the point is that some companies will make changes that will definitely disadvantage customers like you (i.e., “freeloaders”), while other changes will be neutral. Eventually the issuers will settle on an competitive equilibrium or develop their respective niches. However, I can’t think of any fruitful changes they could make that would improve things for “freeloaders”. So on average “freeloaders” will lose out. Will they lose out as badly as the industry implies? No way, but they will still lose out.
For those of you who read Felix Salmon, you might recognize this reader and his argument. Last week when Zoltan emailed us, Felix was not on an email-less vacation. There’s some great additional back-and-forth over at Felix’s place, should you want to wade ever further.