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Do consumers really want credit card reform?
Federal Reserve Bank of Kansas City - Economic Review, Third Quarter 1999 by Combs, Kathryn L, Schreft, Stacey L
The effective price of a credit card also is affected by the card's nonprice features, which include the number and quality of services that cardholders can access with their cards. Today, many cards offer customers frequent-flyer miles, extended warranties for goods purchased with the card, various forms of travel insurance, travel and emergency assistance, and credit insurance. Standard (or classic), gold, and platinum cards are distinguished in part by the services offered. On some accounts, most of the extra services are available free of charge. Like improvements to the roasting process for coffee in an espresso bar, the provision of additional or enhanced services improves the quality of a credit card, thereby lowering the effective price of the card to consumers.
Making money from cards
Card issuers are in business to make money, and the effective price they charge in large part determines their profits. Interest income depends on the APR, the length of the grace period, the method of calculating the finance charge, and default rates. According to the ABA survey, interest accounts for at least 65 percent of revenue for the average issuer. This revenue is generated by customers who revolve balances. Annual fees and other fees imposed on cardholders account at least for another 11 percent of revenue. For a majority of issuers, other fees contribute more to revenue than annual fees. Nonprice aspects of credit cards, such as the quality of customer service offered and the provision of rental-car insurance, affect issuers' profits through both revenue and cost. Issuers can attract and retain more customers and earn more revenue by improving quality, but they also incur higher costs from doing so.
The credit card industry is unusual, however, in that there are third parties from whom issuers can earn revenue. In fact, the bulk of the remainder of issuers' revenues comes from fees imposed on merchants who accept their cards. These fees, known as interchange fees, are a percentage of total card purchases. The major card associations (Visa, MasterCard, etc.) set interchange-fee rates, so issuers' choice of card association determines their interchange rate. According to the ABA survey, interchange fees account for as much as 20 percent of issuers' revenues, making them the major source of revenue from cardholders who do not hold revolving balances. For the purposes of this article, interchange fees are relevant mainly because of the greater flexibility they provide issuers in setting the effective price to consumers.
III. A LOOK INSIDE THE CREDIT CARD INDUSTRY
In the absence of regulation, the structure of the credit card industry determines the effective price of a card and issuers' flexibility in adjusting the components of effective price. This section discusses the link between industry structure and credit card pricing. Three conclusions emerge. First, although some structural characteristics of the industry tend to induce very competitive pricing, others might give some issuers limited power to price noncompetitively. Second, differing characteristics, supply costs, and revenue potential across consumers make it possible-and even attractive-for issuers to segment the market into distinct consumer groups by offering cards with different price and nonprice features. Third, these features of the card industry are critical determinants of the impact pricing restrictions have on consumers.
