How Much Citibank and Visa Actually Overpaid to Win the Costco Business Away from Amex

It was really shocking that American Express lost their exclusive deal with Costco — on the whole the big players with co-brand cards are pretty much locked into their partners.

A deal with Costco should have been worth more to American Express than to Citibank. Amex had a big installed cardmember base already.

As a result I’ve assumed Citibank was struck by ‘the winner’s curse’ — auction winners tend to overpay, which is how they win the auction. To win the auction for Costco’s business, to pay more than American Express was willing to in order to keep it, Citibank had to be paying more than it was worth.

(Contra this, I passed on some speculation that Citibank’s tax-offsets, an asset derived from past losses, skewed incentives.)

Now some details of the deal come out. (HT: Milepoint) It suggests to me the winner’s curse idea could be in play here, unless Citibank knows a lot more than American Express about the value of the business or unless the win is worth more to the Citibank and the rest of its business than the loss hurts Amex.

Costco Wholesale Corp. has attained a goal that retailers have sought for years: near-zero expenses for credit-card payments.

In a deal with Visa Inc. and Citigroup Inc., Costco’s acceptance costs will be about zero, according to people familiar with the arrangement. That compares with the roughly 0.6 percent of each transaction the retailer pays its current partner, American Express Co. While Costco will still incur small fees on Visa cards issued by other banks, incentives from Citigroup and Visa will offset them, the people said.

…“The numbers didn’t add up,” AmEx Chief Executive Officer Kenneth I. Chenault told investors last month. “We couldn’t accept their financial terms nor their contract terms, some of which would have meant taking on more risk than we were comfortable with.”

Costco’s sales volume is $100 billion and will accept only Visa in US stores. Costco had represented 8% of total American Express spending.

Co-brand deals are complicated three-way relationships between brand, bank, and payment network (in most cases in the US American Express is both bank and payment network). This wasn’t just Citibank doing the deal at favorable terms to Costco, the interchange rate from Visa on the Costco card will be less than 0.4%, compared to an average for Visa products closer to 2%.

About Gary Leff

Gary Leff is one of the foremost experts in the field of miles, points, and frequent business travel - a topic he has covered since 2002. Co-founder of frequent flyer community InsideFlyer.com, emcee of the Freddie Awards, and named one of the "World's Top Travel Experts" by Conde' Nast Traveler (2010-Present) Gary has been a guest on most major news media, profiled in several top print publications, and published broadly on the topic of consumer loyalty. More About Gary »

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  1. The truth is, no one will be signing up for the new Citi-Visa Costco card because of this deal, where I bet there were a lot of people who didn’t have an AMEX but got it because they shopped at Costco. Even if the interchange fee was higher, I don’t see the win for Citi or Visa here.

  2. Exactly. It doesn’t appear that you need to use a Citi visa only at Costco. You just need to use a Visa. Most people already have Visas so this won’t generate that many new cards. Most people didn’t already have amexes when the Costco deal began. I know I signed up for my first Amex in college just to be able to use it at Costco.

  3. Costco model is fantastic and their management and products offerings are top notch. The membership fees they charge are basically profits collected 12 months in advance and that accounts for around 70% of their operational income. It is a money making machine and Amex could not handle a battle with the big guys Citi and Visa. I see it as a huge loss to Amex since many of Costco customers are not the profile of Amex customers but only got into Amex because of Costco. I doubt they will keep an Amex card after the Costco deal is over. I use my Amex SPG for all my Costco shopping and the only issue I see in using credit cards there is that purchases at Costco are not categorized as groceries and not sure if buying gas at Costco will be categorized as gas. Thus, it may not add extra points in those categories for using your card there.

  4. I found the most interesting part of the article to be that the interchange rate for non-Citibank Visa issuers is set at 0.4%. That means that an issuer with a 1% cash back card will be losing money on every transaction that a cardholder performs at Costco. I wonder if the possible $600 million that accounts for will be enough to strain the Visa network politics.

  5. One thing this accomplishes for Citi/Visa is that it greatly reduces the chances of people carrying an AmEx card in their wallet. Even if Citi/Visa is paying a premium for this partnership, they might have determined that it was worth it to reduce the number of active AmEx users.

  6. Worth noting that this ‘crazy’ 0.4 per cent fee is 33 per cent higher than the fee EVERY retailer in Europe will pay to process Visa or MC transactions post October.

    How long is WalMart etc going to accept paying 1.77 per cent in the U.S. when the UK stores pay 0.3 per cent?

  7. Could it also be that Amex is doing a revenue dilution deal here? By letting the business go to a competitor at so low a cost that the competitor can not possibly make money with the deal? Tom mentioned above, probably everyone has at least one Visa in their wallet. So, I doubt that Citibank will receive many new applications. The Costco Amex was fee free and offered so many little extras that I can’t imagine Citibank offering the same. Cardholders received Amex level customer service which is mush better than Citibank’s.

    So what is Citibank’s contract term on this? If Citibank loses a lot of money on this deal, when can they bail?

  8. this type of competition reduces profitability of all credit card issuers. Looks like they are taking off from where the airlines used to be

  9. Uh, so maybe Gary can explain this: Costco pays nothing to process 100bn in cards each year. Zero. How on earth are reward cards sustainable in that environment? Assume Walmart and other large retailers are smart as Costco and get closer and closer to zero, maybe with some government assistance. Isn’t the end-game here “no more reward cards”? Am I missing a cut somewhere that is going to enable a card issuer to pay someone 1% of their transaction back? Say a customer like me who doesn’t have a balance? SHDM.

  10. bode: Some of the clues are in the article. Issuers only get 20% of their revenue from the processing fees, the other 80% are from interest and other fees. The value to the co-brand issuer is new customers who will also spend elsewhere, and who will carry balances. As others have pointed out, this was a much better bet for AmEx than for Citibank, since most people already have a Visa.

    I think Gary is right and Citi and Visa have overpaid substantially. It will be interesting to see how this all shakes out.

  11. I think it’s four things
    1 Citi’s DTA position meant it’s pre-tax and post-tax returns were the same. AMEX effective tax rate was 34%. It’s not a little thing, it’s the main thing.
    2 Visa can’t overpay, they can only underpay if they win. As a publicly traded company who makes money from transactions, more transactions = higher Visa revenue.
    3 Banks who aren’t Citi who issue Visa cards are the losers as they get the lower interchange amount Visa negotiated and may be spending more in funding transactions, fraud, merchant disputes, and the cost of rewards.
    4 Citi’s DTA position meant it needs to generate pre-tax profits or have the ability to show they will from a financial modeling perspective. The value, or loss of DTAs is subjective, even when there are general guidelines.

  12. Citibank did the deal for one single reason. To sign up Costco members for Citibank card products. Those cards may carry annual fees. In any case some people here don’t understand how credit cards really work. Those here pay bills in full and don’t pay a dime of interest. Others come up short one month and carry a balance. Those interest fees are generally sky high. The Costco customer is a prime customer because they pay to go into a store to shop. Higher incomes and good credit risks. And tons of small business. They will make something on interest charges. Amex will go in a different direction. I recently did a private study via Skype with them for hand picked top tier business customers.

  13. I’ll take a different approach and say this is a WIN for VISA and maybe Citi. I picked up the Costco Amex when I joined Costco 8 years ago. From that point forward, most of my spend went on that card. Except for places which didn’t take Amex, in which case VISA normally got the business. I didn’t give it much thought. Most of my travel was ground-based, and in the housing bust, I bought a few cheap condos around the state and use those instead of hotels.

    Since the announcement, I’ve gone card shopping and discovered the world of points & miles. All of my new cards have been VISAs and all of my spend is going on those now. The Costco Amex is still getting my gasoline purchases @3%, but that’s about it these days.

    Just like the airlines and their rewards programs no longer depend solely on how many butt-in-seat miles you earn, VISA and Citi are planning on making the profit on all of the other areas of revenue other than Costco. As of Oct 2014, credit card debit in the US is $882.6 billion. Average debt for an indebted household: $15,611. Assuming 10% APR (hah), That’s $1561 in interest per year. I’m sure that $1561/year is more than Citi would have made from transaction fees for the same cardholder.

    Also note that it’s VISA and Citi, not just Citi. VISA’s fully aware that people with Amex often use Amex primarily and Visa secondary. I’m sure some $$$ has been promised to help assuage any fears about Costco’s lower transaction fees.

    Re: holding onto the Costco Amex after Feb/Mar 2016, it’s not possible — the agreement transfers ALL cardholders of the Costo Amex to Citi. I’m sure Amex will desperately try to retain as many Costco members as possible…BUT… plans on how they hope to accomplish this haven’t been mentioned anywhere. Looking at many of the boneheaded moves Amex has made in recent years, I’m thinking they’ll create NO new products and instead try to get existing Costco cardholders over to one of their paid products. BAD move and it won’t work.

  14. So far Costco do not accept credit cards, besides American Express. I assume they will accept just Visa cards issued by Citibank. I see the gain on the Costco costumer that they will sing up for the card. “Of course they will pay interest rates” by the way have you notice that Costco costumer service employees, always are pushing you to sign up for American Express? It will be the same with Visa from Citibank. Maybe Costco doesn’t pay any fee but in return is a marketing tool for Visa and Citibank on which Costco will pay for it. “Labor etc.”

  15. Orlando: Visa is a network; I don’t think Costco will be able to only accept Citibank Visa. That’s what makes this different — Citibank and Visa have conspired to screw over other Visa issuers.

  16. As Kevin and AlexS have said, the winner here is Visa. Forget Citi – they overpaid. For Visa, even if there is no new Citi-Costco card, Visa will be getting a fee for every transaction swiped at Costco. Credit, Debit, Prepaid – you name it, Visa will get something. And all of this is 100% INCREMENTAL. They never had this before and now, they will.

    People may get another Visa card from a different issuer (say airline points) or keep their existing one and now start to shop at Costco or just cancel their Amex and pull out their existing Visa card.

    Regardless of how little Visa will make per transaction – it is definitely going to be above their cost, it is definitely all new business and therefore Visa will be the biggest winner.

  17. The weirdest part, to me, is that Citi seems to overwhelmingly issue MC rather than Visa. So why would their partner for this deal be Visa? Perhaps part of what’s in it for Visa is getting Citi to issue more Visas?

  18. I still think Citi will come out good in this one. Keep in mind that Citi’s gaining every single Costco-branded Amex card customer as part of the deal. Roughly 5.5 MILLION accounts. Using recent surveys, ~42% of those surveyed carry a balance. There’s money to be made there.

    @Mike: I think that’s where VISA comes into play. They want a piece of the Citi pie as well and probably helped broker the deal with Costco.

    The more I think about the deal, the more I think it’s probably a good deal all-around. Costco wins the transaction fee game, Citi gains 5.5 million new accounts, Visa gets a foothold and the transaction fees of Costco members, which are usually quite a desirable demographic.

  19. @Mike Citi issues Hilton cards as Visa, for instance. No doubt there was an auction with MasterCard and Visa just as there was one between Citi and Amex.

  20. my guess is that AMEX will now make a big big effort to retain those customers that have costco cards…..something like a card no fee for first year, 4 points per dollar the first yearand thereafter a reduced fee and 2 points per dollar spent.
    This is an important and large group of above average customers. If amex wants to keep them as card holders they will need to do something. But many will stay with out any incentive. I think AMex will not be hurt to the extent that many had predicted.

  21. Couldn’t Amex keep the true rewards card as is and just issue current holders a new card without the Costco branding? They could just issue an annual statement credit vice a check to use at Costco.

  22. Paul: They could do that, but it wouldn’t help Costco shoppers. Costco will be switching to _only_ accepting Visa. No AmEx, no Mastercard, no Discover.

  23. Jered,

    It is possible for Costco to accept Citibank cards only. The point of sale software will just need to be programmed to accept only cards with the first four digits assigned, by VISA, to Citibank. The first 4 digits, on your credit card, tells who the issuer is. Private labelled cards will still have the issuer’s 4 digit number.

    The deal apparently includes a lower rate for non-Citibank VISA cards. This probably means Costco intends to accept non-Citibank VISA cards, or have the option to. Costco.com accepts most credit cards, the last time I checked.

  24. Anthony: Does the VISA merchant agreement allow one to do so? I’m sure it’s theoretically possible to only accept a single bank’s VISA cards, but it’s generally not in the interest of VISA to do so and I would have figured it was disallowed.

  25. VISA typically does not sign merchant agreements directly with a merchant. Merchant Acquirers and Processors sign merchant agreements, subject to the rules of VISA. Although VISA is now a public company, they are still probably run by the same 5-6 biggest banks, even though there are probably 18,000 member banks. If Citibank wanted the VISA rules to be changed, to allow the Costco deal to happen, it probably happened. Citibank is a huge Mastercard issuer. Citibank has been back and forth with VISA, since the beginning. To win Citibank’s business, would VISA make some minor adjustments, if necessary? When the deal was announced, VISA stock popped. What do you think?

    VISA only makes a very small percentage of each transaction, an interchange fee. I don’t remember how much it is, but I think it used to be .0011 something cents of each transaction. VISA used to be essentially owned by the member banks, so there was no need for VISA to make money. The 35 cents + 2% goes to everyone else, not much to VISA. To gain Citibank’s business and Costco’s, is a big deal for VISA, percentage wise.

  26. I forgot to mention. Profit is not always the biggest motivator. Being the BIGGEST is many times the biggest motivator. While Costco, by itself, will not make Citibank the biggest card issuer, processor, etc., it will definitely help them get there.

  27. I don’t know why there’s this endless conversation about whether Costco will accept all Visas or just Citi Visas. They will accept all Visas.

    Why?
    1) Visa wouldn’t have it any other way. They have always demanded that stores accept all their cards if they accept any
    2) If they didn’t, why would it be a Visa in the first place? It could just be a Citi Costco private label card

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