Mar 16, 2007

Interchange wars, premium card pricing abnormalities, and a radical vision of how things could be

Adam Levitin’s latest paper (Priceless? The Social Costs of Credit Card Merchant Restraints) describes how high-end premium credit cards are able to offer higher rewards points because merchants are charged higher interchange fees on those cards. He also describes how premium card usage has grown in the last few years, causing merchants to pay much more to accept plastic. "For example, Visa Signature cards, which carry the highest level of rewards and are available only to affluent consumers, comprise only 3.5% of all Visa cards, but account for 22.2% of all Visa purchases."

What? 3.5% of Visa cards account for 22.2% of purchases? Premium card usage is exploding, merchants pay the highest interchange fees when those cards are used … and yet they get little additional benefit. How long can that last?

As I was writing this post, the Wall Street Journal announced that Visa is launching a high-end Signature card with even higher interchange fees. Merchants will pay, on average, 14% more per transaction when cardholders pay with a "Signature Preferred" card compared with a regular Signature card, which already earns more interchange than basic credit cards. The higher interchange fees will allow Signature Preferred cardholders to enjoy more generous rewards rates.

Merchants pay more to finance the bank's premium card loyalty program, yet they cannot refuse to accept those cards. How long can that last? In most businesses, when you come up with a new and better and more expensive product, you pitch the new product’s special benefits to your customers and hope to get them excited enough to buy it. Why doesn’t that happen with product launches like this one?

Adam Levitin’s paper and other rumblings in the market, suggest that the interchange battle is focusing more and more on breaking down the no surcharge rule, so that merchants can pass the cost of plastic on to the customer. For simplicity, they will probably charge a single rate, the highest interchange rate that they themselves are charged by banks for premium cards. Imagine the impact on card usage.

But here’s a radical vision of how things COULD be. Imagine that premium cards offered merchants new features that solved real problems for merchants, in new and unique ways that other solutions cannot. Imagine that these new premium card features got merchants genuinely excited about accepting the cards. Imagine that the no surcharge rule had been abolished long ago and a growing number of merchants have decided to charge customers for card usage. If premium cards gave merchants true value which other cards did not offer, merchants would want to encourage use of those cards over others, even cards that are cheaper. You could see merchants charging for all cards EXCEPT premium cards. Imagine this sign at the checkout: “2% surcharge on all Visa purchases (except Visa Signature)” rather than the current surcharge signs like this one and this one.

Sound way too radical? If you look at the way most businesses work, what I just described is not nearly as radical as the current interchange pricing model.

1 comment:

Graeme said...

It's a very interesting point and one that is already under attack in Australia. For years card loyalty programs were being funded by the merchant. However, recently, the governing bank body in Australia removed restrictions on merchants not being able to charge more for credit transactions. That shifted the reward balance back to the issuing bank (and the cardholder). I think it is a model that is being viewed by many other countries.