Floyd Norris had an utterly silly piece in Friday’s New York Times and I had intended to ignore it, but several readers forwarded it to me and thought that some comments might be in order.
The article begins
What would you think of a proposal to create a consumer financial system in which the poor subsidize the well off?
The first point is that a store doesn’t get the full purchase price when you pay by credit card, instead the store has to pay merchant fees — the cost of the credit card handling the payment transaction on its behalf (providing payment to the merchant, collecting from the consumer, making automatic funds transfers, providing customer service on the accounts, arbitrating disputes). It’s a value-added service that we often take for granted.
The fee structure for this service varies, and one way in which it varies is that premium credit cards come with incrementally higher fees to the merchant. Since those cards often provide rewards back to the consumer, Norris finds someone to quote arguing that food stamp recipients “subsidizing the people who get miles.”
After all, the retail price is the same to everyone regardless of payment method (more or less) so consumers getting something back are being ‘subsidized’. Which means that consumers paying cash or writing checks are subsidizing those who use credit cards, and consumers paying full retail are subsidizing those who use coupons.
That’s a strange concept for a subsidy. Instead, merchants engage in price discrimination and get different dollar amounts from different consumers for the same good. There’s no “subsidy” involved because the merchant chooses to accept the credit card, they believe they are better off making the incremental sales that credit cards provide to them and that they make those sales at a profit.
If a subsidy were involved, the merchant would presumably be making more money if they didn’t accept credit cards!
Of course this isn’t how things work at all, retailers take credit cards because they’re convenient for their customers. They produce more sales and higher dollar average sales. And they’re even more convenient to manage, a card is swiped and money is in the bank. There’s far less paper involved. It’s a time and bureaucracy saver. And cash transactions are more easily diverted by errant employees. In the sense used by the author, then, credit card customers might well be subsidizing those who pay by cash.
The article notes that merchants could offer discounts to customers for using cash, but finds that these are rare. That’s consistent with a value-added proposition for credit cards. Cash customers aren’t actually better customers for most merchants.
And — contra Norris — it makes absolute sense for banks to offer miles to consumers. Credit cards offer a service valued by merchatns and consumers and on the whole (financial crisis notwithstanding) find it profitable to do so. They compete for the business of customers who are most likely to repay their debts. A bank needs smaller margins when its risks are lower, and is happy to bid for the business of such consumers.
As a result banks prepay for billions of dollars in miles, they fund airline bankruptcies and acquisitions, because those co-branded credit cards are frequently their most profitable products. Rather than the middle class users of such cards being subsidized, as a group they are the most profitable customer segment.
Furthermore, in concluding with
You know there is something wrong when a middle-class person can get a part of his purchases refunded by the bank, or can collect miles good for free airline tickets, while paying the same price as a poor person who can get none of those benefits.
The author completely mischaracterizes and stereotypes who has access to rewards.
First, discounts and cashback can be earned by anyone who takes the time to look for them. Savvy consumers earn discounts, not the wealthy. True enough, there are prerequisites like internet access and literacy, but any challenges there can hardly be laid at the doorstep of credit card issuers.
Second, debit cards are now used ore frequently than credit cards. PIN-based debit transactions can now earn miles as well, and in fact the Suntrust-issued Delta debit cards earn a full mile per dollar and come with a generou signup bonus. It’s not only tip-top credit-worthy individuals who have access to miles.
At the same time it’s true that there are consumers without bank accoutns, consumers without debit cards, consumers who use food stamps or cash or checks. And they are not rewarded it. They aren’t viewed as as profitable a customer segment with potentially high charge volume and little repayment risk, and that offends the author.
But to call attracting probabalistically highly profitable consumers a subsidy is to completely misunderstand the dynamics of the relationship.