It’s incredible to see the progression of credit card rewards over the past few years. Years ago most people were earning one point per dollar spent, while nowadays we’re seeing so many amazing new bonus categories.
The new gold standard was set a couple of years ago when the Chase Sapphire Reserve® Card was introduced. This was a premium credit card designed for people who don’t usually get premium credit cards. While the card has a $450 annual fee, it offers a $300 annual travel credit, 3x points on dining and travel, a Priority Pass membership, and much more. Chase has said that they’re not sure they’ll ever make money from the card, given how lucrative it is.
However, since then we’ve arguably seen some cards introduced that are so generous one has to wonder how credit card issuers can afford to offer these rewards. For example:
- The Blue Business℠ Plus Credit Card from American Express (no annual fee) offers 2x Membership Rewards points on the first $50,000 spent every calendar year
- The American Express® Gold Card ($250 annual fee) offers 4x Membership Rewards points on U.S. dining and 4x Membership Rewards points on U.S. supermarket purchases (on up to $25,000 of spend per year)
- Changes were just announced to the Citi Prestige Card, which will offer 5x points on dining and air travel
So, while there’s obviously huge competition among issuers to gain market share, is all of this sustainable? Let’s take a closer look.
How credit card issuers make money
Historically credit card issuers make money in three ways, including through:
- Annual fees on cards
- Interest/financing charges, an other fees (including late fees)
- Credit card transaction fees (where they get a percentage of each transaction, which varies depending on the type of card)
The Chase Sapphire Reserve: a prime example
I think it’s most useful to use what Chase has said about the Chase Sapphire Reserve when looking at how the credit card landscape has changed. As premium credit cards are being picked up by more millennials, Chase has found that people are spending a lot more on dining and travel than they expected (after all, that covers a huge number of expenses for urban millennials), and fewer people are financing charges than expected. That combination means that their revenue per cardmember is down, and their expenses are up.
Chase has also indicated that while they expense customer acquisition costs over the first 12 months, it’s typically seven years before they make money on a consumer.
What Chase has done exceptionally well is how they’ve tried to engage with these new enthusiastic cardmembers in more ways. They realize it’s going to be tough to make money on cardmembers directly from their spend if they’re not financing charges and they are earning 3x points in many categories, so they try to engage with them in other ways, including with Sapphire Banking, special mortgage offers, etc.
It’s brilliant of them to try to extend relationships in this way.
How important is market share, really?
Historically the credit card industry has been very profitable, and as of now it still is. That’s because the margins for most credit cards are still huge, because since people aren’t optimizing their credit card spend.
In many ways the investment in premium cards seems less profit-driven and more market-share driven. They’ve in particular been going after affluent urban millennials, even if they’re losing money on them.
It makes me think of Uber. They of course have a huge amount of market share, but they lose money on rides. I do question how they’ll ever get to a point where they’re profitable. Then again, in today’s economy market share seems to often be more important than profitability when it comes to how companies are valued.
Are credit card rewards a race against the clock?
This raises a whole other question. We’re getting to the point where I wonder how much more generous card issuers can be, as they battle for market share.
But arguably the credit card industry on the whole faces a much bigger challenge. Every industry evolves, and the credit card & payment industry is no different.
Originally credit cards were introduced for the ease as well as security with which you can pay. But over time in a battle for market share, they’ve turned into huge rewards programs that consumers are obsessed with.
Many retailers aren’t happy with this, though. For example, Amazon has been on the attack against reward credit cards. Different kinds of cards come with different merchant fees, and major retailers want to unbundle that.
If a card issuer wants to accept any Visa product, then they have to accept all Visa products, including Visa Signature and Visa Infinite. This matters because those cards have higher fees, and they want to be able to opt out of accepting those products.
There are bigger implications here beyond just what type of credit cards can be accepted. We’re seeing mobile payments evolve, so over time I imagine this industry will get more “efficient” as well.
That efficiency may very well come in the form of this going nearly full circle, where we essentially see phones act as secure debit cards. Your fingerprint or face might be required to use your phone as a payment method.
With a new entrant we could see a system that has much lower fees for merchants while possibly offering even better security than credit cards. Clearly credit cards feel threatened by this, which is why they’ve been evolving into the mobile payment space.
Every industry evolves to become more efficient and lower cost (just look at how airline tickets are sold nowadays), and the credit card industry isn’t immune from that.
As consumers there has never been a better time to be using credit cards. I do think we’re nearing “the best of times.”
I imagine the major card issuers are getting to the point where they’re going to be losing money on these premium cards that offer huge spend bonuses. Of course they’ll make money on some and lose money on others — that’s natural in any industry.
It’s not just those of us really maximizing bonus categories that are doing well with these cards, but even your average urban millennial who spends a lot on dining and travel (including transportation) probably comes out ahead, especially as we see fewer premium credit card users financing charges.
I have a hard time imagining things will get much better than they are now. I also think that eventually the industry will see some technology advancements that largely drive down costs to merchants, and in turn, will lead to fewer rewards for us. What I don’t know is what that timeline looks like — will it be in a year, a decade, or further out.
What do you make of the direction that the credit card industry is headed?