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Gödel Escher Finance Charge Preview
16 October 05 from mlmitton 6
It takes a while to get there, but I can tell you that Visa isn't kind to the merchants either.
A few years back, I spent (wasted?) a year of my life working on a class action lawsuit of all merchants, led by Wal-Mart, against Visa/MasterCard. For the purposes of the lawsuit and measuring market power, Visa and MasterCard were treated as one company since, well, they're owned by exactly the same banks. The legal claim was product tying: Visa started their own debit card system and required that Visa branded debit cards be included under the "Honor All Cards" rule.
Around this time, 99-00, most debit card transactions were virtually free to merchants. A few networks were literally free; the most expensive was may 20cents per transaction; and one or two even paid the merchants. Meanwhile, credit card transactions were running about as, John says, 2-4% of the transaction. So debit cards were far cheaper than credit cards. But, merchants still perceive that credit cards result in marginal sales they otherwise would have lost, so they keep the credit cards.
(Brief stop--the very fact that Visa is built around network externalities means that merchants have little choice but to accept them. If every other store in your town accepts Visa, then if you stop, you may well lose a lot of sales. But if every merchant jointly decided to stop, then likely none would lose any sales, and they'd stop losing 3% to Visa)
Visa then introduces their own debit card network. Since every bank is a member of Visa, every bank includes Visa debit, the Visa stamped on the front of the card, while the debit networks are on the back. But, Visa debit has something none of the other debit networks have. Visa debit can be processed through the Visa CREDIT system. This is why you can use your Visa debit card any time you see the Visa logo, and why you can choose to process your debit card as a credit card.
The "Honor All Cards" rule that merchants must agree to means that they have to accept any card with the Visa logo. This creates two problems for the merchant. First, they don't see debit cards provide as much in marginal sales as credit cards. With credit, they pay the fees but get higher sales. With debit, they pay the fees but don't get higher sales.
It gets worse. You'd think that competition would drive merchant fees down, but there's another side to it. A network charges a fee to a merchant, but some of that fee goes to the bank. So banks actually want to brand their cards with those networks that have the *highest* merchant fees, so long as merchants will continue to accept that card. That is, competition can drive prices up. The fledgling debit networks didn't have the market power to drive up merchant rates, hence theirs were so low. But, Visa did have market power, and because of the credit tie-in, merchants had to accept it. Thus, Visa had far, far higher debit rates. It varies, but 25cents+2% would have been typical.
And one more nice step. A debit card will work with several debit networks, as chosen by the banks who issued the card. Visa debit makes them a fair bit of money, while the others don't. Thus, get rid of those other debit networks to force traffic onto the lucrative Visa network, or at least arrange with all the other banks to use Visa as the first-choice option for debit cards.
I could go on about the evils of the credit card companies to merchants, but that seems like a nice narrative. Plus, I was actually working for Visa!
Oh, the most interesting thing I learned from this case: I had a bunch of transaction data for quite a few stores of the type you'd find in a suburban mall. The stores were remarkably consistent in their type of payment; they were all very close to, I think, 75% credit and check, and 25% cash. Except for Victoria's Secret, which was 25% credit and check, and 75% cash.
That still makes me laugh.
14 October 05 from John 4
Aaron, all I was trying to do was, first, to poke a little fun at the easy argument that credit card companies are evil, and, second, to provide as honest an answer as I could to glenn's question about how much a credit card issuer makes on transactions vs. lending (as well as illustrating my point that transaction-only customers are generally not profitable ones for credit card issuers).
There are some good and sufficient reasons why issuers continue to issue cards to payment-only customers, notwithstanding their un- or marginal profitability:
(1) It's difficult to tell ex ante how someone is going to use a card. Most cardholders carry balances, and all but a few carry balances from time to time. Depending on the issuer, people who never carry balances are seldom more than 15% of cardholders, and often a lot less. That said, while people who in fact pay in full every month still get card solicitations, I would bet that the volume of solicitations they receive is a fraction of the solicitations received by known borrowers. When I carried a balance for a few months, my junk mail soared for years afterwards.
(2) Many people don't like to be marketed to as borrowers rather than transactors. Many more people think of themselves as payment-only customers than in fact are.
(3) Mastercard and Visa rules don't let member banks discriminate against payment-only customers. There are several reasons for that:
(a) The networks (Mastercard and Visa) make their money purely on transaction fees.
(b) Transaction volume creates economies of scale in their networks.
(c) Transaction volume makes the networks more valuable to merchants and hence to consumers.
(d) From the outset, the bank card networks were competing with American Express for consumer and merchant acceptance, and they were unwilling to cede the pure transaction business to American Express.
(e) Politically and in terms of PR, the networks want to be regarded as providers of really cool payment services, not marketers of sugar-coated usurious credit lines.
(f) If use of the cards necessarily implied borrowing, some or all consumers might feel there was social stigma associated with card use, and volume in the networks, as well as borrowing, would go down.
(Many people could regard some of the foregoing as evil, and that's a legitimate debate.)
All of that has been really successful in terms of growing the networks, making them valuable, marketing the cards, and covering political ass. No one wants to mess with a good thing too much. So carrying a certain number of transaction-only customers is essentially regarded as a cost of doing business. No pity is necessary.
Apart from American Express, essentially no one issues a payment-only product (Citicorp still has Diners Club, but you would never notice). And American Express has devoted a lot of corporate energy to trying to launch credit card products (Optima, Blue). That should tell you something about transaction-only business. It can be profitable, but only with a structure different from that of most cards, and there is not a crowd of people clamoring to get into that particular market.
14 October 05 from Aaron Mandel 5
John, let me get this straight. While the credit industry is quite aggressive in recruiting customers and offering new services to existing ones, people who accept these offers and then treat credit card bills as something to be paid immediately are free-riding on the backs of others?
Those poor, poor credit card companies! They'd like to charge more in basic fees so that they could cover the costs of having customers who pay their bills on time-- but they're too shy to ask!
When you had a client in the credit industry, did you work at a reduced rate? If not, why not? I mean, maybe they said they'd pay you what you asked, but you should have known better, just as glenn should have realized that a bill saying "You owe $100" doesn't mean the credit card company wants you to pay them $100.
There are a lot of people who feel that just because someone initiates a commercial transaction does not *necessarily* make it fair or just for the second party to complete the transaction. Parents' groups might feel that Best Buy should take kids' impressionability into account before handing over a violent video game; glenn might feel that credit card companies should be mindful of unclarity in their own terms of service before levying a finance charge; the Spartacus Youth kids glaring at people outside my office might feel that retail merchants should recognize how workers' resources are wrongly expropriated by the iniquity of AmeriKKKan Cop-it-all-i$m and just give everything away for free...
But I have never before heard the suggestion that Mastercard is one of these entities so diminished in its capacity to give consent that people who can afford to pay their bills in full every month ought NOT to.
I mean, me personally, I went and got a credit card by walking into the bank and giving the manager noogies until he relented and issued me one. He really had no choice. So *I* probably ought to cough up a little extra dough each month, lest I unfairly compound the advantage that nature gave me with my charming smile and powerful knuckles. Most credit card customers, though, not so much.
14 October 05 from John 4
Net revenue for the card issuer on purchases runs about 3-4 bps (0.3-0.4%)(the issuer's share of the transaction fee, which varies from industry to industry -- higher for airplane tickets and hotels, lower for supermarkets -- less the capital cost of having the money out to the merchant for 10-40 days before you pay). So every $1,000 you spend probably translates to $4 in net revenue. Marginal processing/servicing cost per cardholder is probably somewhere between $50-$100/year, and acquisition cost (all those mailings and putting David Spade on TV) is probably several hundred dollars per card. If you have a "rewards" card, the net revenue per transaction is probably 1-2 bps.
So, yeah, if you are putting $20,000/year on the card for 3-4 years, you are going to be a marginally profitable customer, but still nothing to build a business around.
American Express provides a decent control: In its core payment card business, it charges $70-$150 per card annual fee, and roughly double the merchant discount (and retains much more of it because it owns the entire network). It has many more high spenders than the average credit card company, great retention, fewer credit losses (since there are theoretically no balance carry-overs, and they can cut off a card faster because they don't have a credit commitment), and somewhat less coverage (because many merchants, especially at the low end, will not pay the AmEx discounts). So that's pretty much what it takes to maintain a business based only on transactions and not borrowing (although AmEx sneaks a bunch of borrowing opportunities in there, too). Ain't no free lunch.
12 October 05 from 2fs 1
And it remains true that, once the situation was pointed out to an actual human being, said A.H.B. should have waived - and should have had the authority to waive - the effects of the infinite loop. The "evil" may not exist at the programming level - although it seems to me it would be fairly easy to set a threshold whereby outstanding balances below X (particularly if X is less than Y percent of a previously existing balance; i.e., where X is essentially finance charges on finance charges) are written off as a cost of doing business (in order to maintain customer goodwill). Any costs could be recovered by increasing penalties for those customers who actually default, or pay late, etc.
I also have less sympathy for the costs of the credit card industry - given how much it spends on unsolicited mailings to everyone including our cats to try to get us to sign on to a line of credit.
12 October 05 from glenn mcdonald 2
Oh, I generate plenty of revenue for CapitalOne by charging things, almost certainly more than some significant fraction of the people who pay higher fees to carry lower balances based on smaller transaction volume. And if you factor in the losses the card companies suffer from balance-carriers defaulting (and the additional costs necessary to pursue recalcitrant payers), compared to the more-reliable, lower-cost revenue stream of payers-in-full generating transaction fees, I'm sure people like me, collectively and individually, are cheerfully profitable customers and guilty of nothing remotely characterizable as freeriding.
But I couldn't find, in a little cursory searching, any creditable breakdown of the balance of credit-industry revenues between transaction fees, interest and penalties, and I'd love to see one.
Regardless, I stick with my opinion that there's negligent evil going on here. If it were me who was in charge of these business rules and their software implementation, they would be different.
12 October 05 from John 4
You realize, of course, that in all likelihood no person actually planned or intended what happened to you. Someone programmed the computers; the computers recognized the transaction as a cash advance (which was probably a function of the deal whereby Thailand decided to accept the card and meant that Cap One did not take its usual fee from the "merchant"); the computers correctly calculated finance charges on the cash advance from the date of the advance (your agreement, and all other agreements, so provide); the computers correctly applied a rounding convention that in and of itself is probably both rational and inconsequential both to Cap One and to its customers as a group. Perhaps it was evil not to anticipate this problem, but not very: it does not come up often (and when it does come up, it is intended -- the nub of the problem here is that you did not know you were taking a cash advance from Cap One's standpoint). Certainly, if one is not a Muslim there is no inherent evil in charging finance charges on finance charges for the period during which they are unpaid. Your experience shows the rationality of the $.50 minimum finance charge: If you collect $.50 from 100 customers with $.01 legitimate finance charges, it possibly covers the cost of dealing with the 1% of irate customers who will call and attempt to deal with issues at the level of pennies.
The credit card business is profitable, but not incredibly so, certainly not at a level which would permit dropping rates on balances from 32% to 14%. People who use their cards as a payment mechanism only (i.e., who do not borrow) are generally not profitable customers. American Express makes money off of them, but by charging them and merchants much higher fees. Historically, card companies have continued to service them in order to maintain and expand the volume of their networks and to make card acceptance more attractive to merchants, and because most of them at least occasionally go through periods of net borrowing and finance-charge paying.
So who's evil? You are freeriding on a social good (the ubiquitous acceptance of payment cards). Your insistence on demanding that others irrationally pay attention to cents-level details, and that others adopt your particular vision of commercial morality, creates administrative costs completely disproportional to any economic interest you have. Those costs can only be recovered by spreading those costs among millions of other customers who may very well not agree with you. And aren't you responsible for computer programming in the first place?
I am being facetious, of course, but not completely. One of my clients used to be in this business (since sold), so I am pretty familiar with it. It's not so damn easy. Very few of the people involved are actually evil. Credit cards / payment cards are an amazingly useful product, but far from free to offer and to maintain. If you are not paying your share of the cost -- and you probably aren't -- then you are implicated in the high rates / high fees system, too.
10 October 05 from 2fs 3
At least when you sign a mortgage (in Wisconsin at least) there's a requirement that the total amount that you're paying, interest inclusive over the life of the mortgage, must be stated. It's a sort of artificially frightening number - I mean, how much you spend on *bread* over fifteen years is going to an intimidatingly large number - but at least it's there.
What's maddening about the incident you describe is you did what responsible credit card users should do (from their perspective): you paid off what you owed. And you might naively think, oh, I owe someone money, they'd want me to pay them back...but obviously, that's not how credit card companies think. No, they'd prefer you pay them...but just slowly enough so they know you're alive. If they were handlebar-mustachio'd black-cape-wearing villains in 19c melodrama, they'd find some ingenuous way to kill you very very slowly, making sure you're alive enough to give them the display of pain they're interested in.
10 October 05 from glenn mcdonald 2
And never mind the cost of taking my (toll-free) call(s) to complain.
Our "fax machine" here at work is now just one of the many ostensible functions of a tank-sized copier with a stack feeder, and I can't see a way to jam a loop through it. Good idea, though.
Interestingly, this month's Consumer Reports had an article on credit-card fees and even an end-of-the-issue editorial calling for some re-regulation and reform. Ugly stats. When somebody has to plaintively suggest that interest-rates be capped at 10% over the prime rate (down from 28% over it!), evil has clearly taken deep root. Raised rates are an obvious evil, and reduced grace-periods and self-perpetuating fees are an insidious one, but arguably lowered minimum payments are the most cynical of all, blood-sucking disguised as medicine. CR suggests that card statements be required by law to state, alongside a minimum payment, how long it would take to pay off the balance at that rate, and how much would be paid in interest over that course. Their example bill would require 36 years to clear the balance, incurring over $9000 in charges on what was only a $5000 balance to begin with.
But this is just one of the practically innumerable places in our economy where myopic numerism destroys under the banner of growth. Teach Economists to Subtract isn't just an ecological idea.
8 October 05 from 2fs 1
What's also maddening about this is that it almost certainly costs Capital One (or anyone else) far more than 50 cents to generate the statement indicating that you owe 50 cents. Not that it's enough to affect their profit margins, not that I'd care if it did.
I'm surprised you had that much difficulty - or at least, I didn't (with a different credit card company) some years ago. Of course, you could have paid them, say, 52 cents, then badgered them to cut you a check for 2 cents... And of course, there's always the old Black Fax: tape together three sheets of black construction paper, start it through the fax, and while it's running tape the ends together to form a loop... (Not so good for your phone bill, granted...)