One of the controversial things I believe is that the economics of credit cards in the US will change drastically in the coming years.
New payment technologies will compete down credit card interchange rates, making it uneconomic for banks to offer frequent flyer miles as incentives for spending on their cards. Basically that competition will do to credit card mileage earning what the Durbin Amendment did to debit cards.
The Durbin Amendment had real consequences of course, and not just for mileage-earning debit cards. It’s not even fair to call them ‘unintended’ consequences, since they were broadly predicted. Banks don’t offer free checking accounts as often as they used to, since those accounts no longer come with consumer debit card use that generates profits to cover the relationship. That’s led to more consumers outside the banking system. (Small banks like credit unions often still offer free checking without large minimum balances, but the Durbin amendment interchange limits don’t apply to their debit cards the same way.)
In the future the margins on credit card transactions will shrink so there won’t be a role for incentivizing transactions to the same degree, or at the same level of expense. It simply won’t make sense for banks to buy so many miles to reward credit card customers once their margins shrink.
Today in the U.S. times have never been better for co-brand credit card partners. Delta signed a $2 billion a year deal with American Express (about $400 million higher than before), and that set off a new round of agreement renewals at record prices — including Chase re-signing United and Southwest Airlines.
There are at least two high priced deals left as American negotiates its next contract (Citibank and Barclaycard both currently service AAdvantage cards and will be bidding) and then Chase will likely have competition from American Express for the re-up of the Marriott relationship as a result of Marriott’s acquisition of Starwood.
However, that could be the high water mark. There are three possible mechanisms by which interchange fees, and thus the economics of credit card rewards, could change:
- Retail power. Costco showed that large enough retailers with co-brand products could essentially accept credit cards for free. It’s unlikely we’ll see more deals approximating Costco’s, but we could see deals that drive down the cost to process credit card transactions.
- Legal changes. Much like the Durbin Amendment drove down interchange fees for debit cards, we could see legislation drive down interchange for credit cards. It’s a trend that’s gone elsewhere in the world, such as Europe and Australia. (Note that although the Durbin Amendment was sold with the promise of lower prices to consumers, that didn’t happen, it was a payoff to retailers.)
- Competition from new technologies. Whether blockchain or otherwise, even the banks themselves are working on new technologies that process payments less expensively. The banks are competing to put their existing business lines out to pasture; creative destruction. As these technologies succeed and are adopted, lower costs to process payments across new networks will make it no longer economical to buy miles to incentivize transactions through those networks. When I started talking about this a couple of years ago, it wasn’t a new idea for banks but it seemed a complete revelation for loyalty programs. At a co-brand industry conference where I gave the opening keynote last week, this issue was very much at the forefront.
None of this will likely happen right away or even soon, Chase has a 10 year deal to lease Visa’s network that gives them a fixed cost no matter the volume of transactions pushed through that network. So the more spend they drive through, the lower the cost per transaction. Their interchange costs are fixed for some time, though if they’re no longer receiving as much income they’ll still need to shift the terms of incentives.
Doing such a long-term deal, though, suggests Chase doesn’t see the economics in the U.S. changing soon — the way they are in other parts of the world.
Last year Australia cut interchange on premium credit card products. In July of 2017 interchange fees will be capped at about half their current level for all cards.
In Australia merchants generally charge fees to accept credit cards. Those fees were legalized but are now under investigation for being ‘too high’ (higher than the cost to process cards). The government is driving to lower costs and also lower fees charged to consumers.
Europe already moved to limit interchange and the credit card situation is different there.
Now, credit cards weren’t as prevalent there as in the US to begin with. And apparently credit card uptake among millennials is low. Cards are also harder to get in Europe than the U.S.
Airlines are having to get creative since it no longer makes sense for card issuers to simply make a large payment for a huge chunk of miles. Air France, for instance, has an agreement with American Express to share in the interest paid by consumers on their card product in exchange for miles given to consumers.
Even in areas where there’s been no such legal imposition of lower interchange, banks are well aware that the ground could shift beneath them. In some parts of the world co-brand credit card deals are now including provisions that would alter the deal if interchange rates fall.
That hasn’t come to the U.S. yet, but the technological forces that will drive change will affect the U.S. as much as the rest of the world. And that will mean changing the economics and face of credit card co-brand deals. Banks and programs will have to get creative, and probably less lucrative as well.
Frequent flyer miles, and co-brand credit cards, are likely to be very different a decade from now.