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How Credit Card Companies Make Their Money

Question: Do the Credit Card Companies make good money out of us card users?

Answer: Yes, obviously . Now, do you wish me to speculate on what bears do in the woods while I’m here?

I could attempt to justify this answer with detailed analytical charts showing average industry profit margins over the last ten years, but frankly this would be superfluous. The mere fact that there are now over 1300 cards on the UK market should in itself tell you how profitable these little rectangles of plastic are- in a free market, such a goldrush only occurs when there are abnormally high profit margins to be made.

YouCard

So, fancy turning the tables- having a go yourself and issuing your own credit card? OK, I suggest giving it a contemporary feel and calling it YouCard- don’t worry, I’ll waive my marketing consultancy fee for that one until you can afford to pay me. Just like any other business, YouCard will have both income and costs to consider and control:

Sources of Income

1. Interest on Outstanding Balances

This is the APR you charge the ‘revolvers’ in YouCard’s customer portfolio- those with outstanding balances at the end of each month. The higher the balance, the higher your income. Many of them may be financially delinquent, but you should learn to love these people nonetheless- they could make you very rich indeed.

2. Fees Charged to Customers

Slipping in a few ‘one-offs’ is always good for the bottom line. Once again, it’s those YouCard delinquents who are most in the firing line. Late payments or exceeding credit limits could trigger charges of around £25 a time, though lately those spoilsport regulators have stepped in to apply an industry-wide £12 cap.

Of course, customers need not do anything wrong to incur a fee- even your convenience users can be charged occasionally. YouCard may choose to levy an annual membership fee, though of course with all those ‘no annual fee’ cards out there this would be a strong disincentive for anyone thinking of becoming a customer in the first place. Cash advances from ATMs and purchases abroad are also fee-hungry transactions.

3. Payment Protection Insurance (PPI)

Fear is a primal human emotion- why not exploit it by selling PPI to YouCard customers? PPI is supposed to cover repayments in the event that the borrower loses income due to redundancy, illness or accident. This may sound like a good idea, but many of the policies sold by card providers are either completely inappropriate (e.g. selling to the self-employed, when payout is only triggered by proof of redundancy), or massively overpriced compared with standalone policies on the market. So, why not incentivise your selling agents (via commissions) to sell these policies by droning on down the phone to new card applicants about the mortal dangers they face if they don’t tick the ‘yes’ box?

Ignorance also works in your favour here- may YouCard customers won’t even realise they are paying PPI, the premiums just being rolled up into the normal monthly repayments. Who reads the smallprint?

4. Interchange Fees

I think we’ve hit the YouCard customers with as many charges as they’re going to take. Time to find someone else to carry the load- how about the humble shopkeeper? Merchants accepting YouCard payments- whether they are the local corner shop, a big retailer or an online vendor- pay you a % Merchant Service Fee for all YouCard transactions. This % rate depends on the relative negotiating power of the individual merchant, but typically ranges from 1-6%. Around 15-20% of your total income can come from interchange fees.

Right, now for the downside- what sort of costs is YouCard going to incur?

Costs

1. Interest

If YouCard is going to lend the money out to customers, it needs to borrow it from someone else. That someone else will charge interest. Even if they are within the same YouBrand group, managers will expect to see a certain % rate of return on the money they’re investing in YouCard.

2. Marketing

You say junk mail- your Marketing Director says a carefully targeted customer acquisition strategy. Low (or zero) introductory APR rates may be attractive in themselves, but new YouCard customers aren’t going to just come flocking without some sort of come-on from those highly paid ‘creatives’.

These direct marketing costs, taken together with 0% introductory APR offers, can mean that you are effectively shelling out around £200 for each new YouCard application. Let’s just hope there’s some high ‘revolvers’ in there so we can start to earn it back!

3. Operating Costs

OK, you’ve spent all this money on getting YouCard customers in- now you need to run an office somewhere to administer all those thousands of transactions. That means paying rent, IT systems costs, staff costs and admin. Every time Darren in Accounts pilfers another box of staples for his home ‘hobby’, that’s 78p off the YouCard bottom line.

And don’t forget my fee for giving you all this advice- business consultants don’t even think about getting their laptops out for less than £1000 a day.

4. Rewards

Ah, yes, those pesky customers will demand their rewards for using YouCard. Holiday vouchers, gift certificates, or just plain old cash- this can cost you up to 2% of the transaction value. Take them away, and see just how long your customers’ brand loyalty lasts- possibly a matter of days.

On the plus side, a recent survey in the US found that half the customers enrolled in a card reward programme for over 5 years had never bothered to redeem the points they had accumulated. No, sadly, I don’t know their names.

5. Bad Debt

Did you take the time to get friendly with those big revolvers I mentioned in the income section? Maybe think again. After a while, it may well become clear that the money they owe just isn’t going to be repaid. Whether you ‘go legal’ or sell the debt off cheap to a collection agency, it’s cost you serious money. At the end of 2006, UK lenders were in the process of recovering around £500m from 165,000 people through County Court Judgements (CCJs).

At this point, you can always fire your Marketing Director for bringing too many ‘delinquents’ into the YouCard customer portfolio- if you can afford her exorbitant redundancy pay-off.

6. Fraud

As if those YouCard customers weren’t bad enough, it turns out there’s a whole load of chancers and charlatans out there pretending to be YouCard customers, purchasing stuff all over the world on cloned cards and fake IDs. In many cases, you will need to honour the debt to the merchant, even though you won’t see a penny from the scoundrel who ‘bought’ the goods. Again, this could be big money. In 2004 the total cost of credit card fraud was over £500m, though the introduction of chip-and-pin has seen some improvement in this area.

Still think that making money out of issuing credit cards is a piece of cake? Certainly, making sure that income minus costs = a positive number can be more tricky than it appears at first.

And its not getting any easier. In recent years credit card company profits have been coming under attack from all sides as never before, with customers, competitors and even governments constantly chipping away at their margins. As we’ll examine next time, these companies will need to think of new and more ingenious ways of operating in the future if the good times are to continue.

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Revolvers, Tarts and Deadbeats – How Do You Use Yours? - Monday 16th April 2007
The Credit Card- Growing Old Disgracefully? - Friday 13th April 2007