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Credit card industry is quite competitive. Competition inside Visa and Master can be described as
product differentiation.
Product Differentiation Card Features
Credit line, Credit limit membership rewards program
e.g. airline mileage rewards program Affinity card, co-branded card
Fees Annual fee
Low annual fee or even zero annual fee Interest rate
Extra features –
cash-back bonus, purchase discount, purchase protection, price protection, frequent flyer miles …
Affinity partnerships have become popular
E.g. Airlines Optima card has the largest co-branded airline program, with 2.8m cards issued by end of 1997
Product Differentiation
Affinity partnerships have become popular since the later 1980s E.g. Airlines Optima card has the largest co-
branded airline program, with 2.8m cards issued by end of 1997
Special Card Features
Issuers offer services besides payment and credit became increasingly popular during the early 1990s Example Features – cash-back bonus, purchase
discount, purchase protection, price protection, frequent flyer miles …
Dimensions Along Which Payment Cards Differ
AT & T Nature of business : Telecommunication
Benefits offered Telephone calling card Discount on AT & T calling Extended warranty
General Motor ( GM ) Nature of business: Auto motor industry
Benefits offered Credit toward buying a car Getting discount in changing a new car
3. Service Fees (con’t)
Dimensions Along Which Payment Cards Differ
Service Fees Variation (Min – Max)
Annual Fee $0 - $88
Late Fee $20 - $29
Cash Advance Fee (in %) 2% - 4% min
Cash Advance Fee (in $) $2 - $4 min
* American Express Green Card has no limit
Amount of Credit Provided
Dimensions Along Which Payment Cards Differ
All credit cards come with a limit on the amount that the cardholder can charge
Larger credit lines are more valuable to consumers but riskier for issuers
Issuers may attempt to differentiate their card offers by extending relatively higher lines of credit than other issuers
e.g. Platinum card developed in 1990.
Interest Rates in 1998
Dimensions Along Which Payment Cards Differ
Interest Rates Variety
Fixed interest rates range from 13.99% to 18.9%
Prime rate + fixed rate (from 2.9% to 11.55%)
Grace Period
From 20 to 30 days
78%
10%
6%4% 2%
Finance charges Interchange fees Late and other feesCash advance fees Annual fee
Finance charges dominate bankcard issuers' revenues
I. Product Differentiation
Heavy Marketing
Difficult for consumers to learn about and compare alternative card products
Implications
Credit Cards Advertising Spending in 1996
0
50
100
150
200
250
Visa MasterCard AE Discover Citibank
Card I ssuer
USD
in M
illio
n
Paradox of Credit Card Lending
Credit card lending is a very competitive market According to Economic theory, when in a
competitive industry, All firms should earn zero profit and price (credit card interest rate) should be cl
ose to production cost (the market interest rate).
Reality
Very sticky and high interest rate rates of return for credit card operations are quit
e high. Is a credit card industry a Competitive Market ?
High and Sticky Interest Rate Credit card interest rates are usually higher than interest rates on other types of consumer
loans
Types of consumer loans Interest rates (percent%)
Credit Card 16
Forty-eight-month automobile loan 8.7
Home mortgage loan 7
Twenty-four-month personal loan 13.5
Sticky Interest Rates The interest rates on credit card loans were sticky to some
degree Tended to respond slowly to cost changes If cost of fund changes, credit card rates will change by
only about 1/12
High Interest Rates Reasons
Riskier than other consumer loans Require a higher interest rate to compensate for higher r
isk In ordinary consumer loans, assets could be seized if th
e consumer defaulted on loan, but credit card loans are not secured by assets.
Adverse selection
Sticky Interest Rates Interest rates are not the only consumer prices that are stic
ky Adding features Increase overall quality
Credit card interest rates help cover many costs of offering credit card services.
Total price = finance charge + annual fees Annual fees fall Total price remains the same.
Facts and illusion Price did not change
Annual fees was replaced by Services fees Services fees are less visible than annual fees to consumers People only focus on annual fees which only accounted for <10%
of the average price
Profit made Nature of business Product differentiation
3. Service Fees
Dimensions Along Which Payment Cards Differ
Trend of Service Fees Charging
0
3
6
9
12
15
18
83 84 85 86 87 88 89 90 91 92 93 94 95 96
Year
$U
SD
Service Fee Annual Fees
Credit card Late 1980s
High profits Rates of return is 3 to 5 times over bank operations overall Attracted many firms into credit card lending
1990s Not as attractive as the past decade AT&T sold its increasingly unprofitable credit card operation to
Citibank
The myth of high profits Questions
Are the worst of times as bad as and the best of times as goods as the profit measurement?
NO!
Biases in Accounting rates of return
Reason Initial high fixed investment or high risk Examples
Credit card industry Oil industry
Risky credit card lending Is 22% rates of return high or low?
If not risky, extremely high If risky, only a marginal business
Credit card lending is risky! Because of uncertainty over new cardholders
so credit card lender is not the money machine, it has not violate the economic principle of competitive market