Jul 5, 2007

The new card business model: merchants pay for everything, cardholders get the perks

An article in Forbes shows how high end premium credit cards depend heavily on the interchange business model (see The World's Most Exclusive Credit Cards). It is surprising to see how the article presents the model in such a simple, clear and transparent way.

“Though lenders aren't going to make much in the way of late fees and interest charges (assuming rich people pay their bills on time and in full, which isn't always the case) they make up for it in the fees they charge to merchants to process transactions. American Express network transactions mean fees of about 4% each purchase, so a $60,000 car charged to a Black Amex could potentially rake in $2,400 in processing revenue. Even if the issuer takes half of that and pays it back to cardholders in the form of outlandish perks, the profits are still good.”

Readers instantly understand that a) cardholders don’t pay much, b) merchants pay lots and c) the issuer gives half of that to the cardholder in the form of perks like points, miles and cashback. I don’t think I have ever seen the complete interchange model described in such a few clear and simple lines.


Looking at American Express’s annual reports, you can see a definite trend that confirms the model. Revenues from merchants are growing and represent almost half of total revenues, while revenues from cardholders are becoming much less relevant.

The Forbes article misses a major angle though. Charge merchants high interchange and give half of that to the cardholder in perks? What a weird, weird business model. American Express gets away with it because so far they have been able to convince merchants of the value of accepting Amex cards. But it is getting harder to demonstrate that value. Visa and MasterCard also offer exclusive high end cards and premium card usage is growing rapidly, creating increasing pressure on American Express, Visa and MasterCard to demonstrate far more value to merchants. This is going to be a very rich area of innovation in the payments space. It is strategic, vital and difficult. But so much more fun and fulfilling than things that we are currently obsessed with, like contactless cards that don't do much more than traditional magnetic stripe cards.

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