From loyalty programs to the true cost of credit cards

Moving past the cost of loyalty programs to credit cards

My last blog covered how the costs of all the loyalty programs are passed along to all consumers – even those who don’t belong to such programs. Credit card costs have been in the news a great deal in 2013 and even received a mention in the Speech from the Throne that opened the new Session of Parliament.

Most readers will remember the Competition Bureau finding earlier this year in FAVOUR of credit card fees being passed along to all consumers rather than just those who use the cards. The issuers of the credit cards were, of course, ecstatic with the ruling – merchants not so much and consumers not at all, but then, cynic that I am, did anyone really expect the Bureau to side with consumers over large financial institutions – both national and international in scope?

So let’s do some math (sorry). For simplicity, I will use a card issued in three flavours – a basic, no-fee, no-reward format (Bronze), a fee-based card that also provides extra loyalty bonuses in the form of “points” redeemable for merchandise gifts from the issuer’s pre-selected catalogue (Silver) and the third is a Gold card (also fee-based but at nearly twice the level of the Silver card) that gives points that can be redeemed for travel – allegedly unlimited travel without blackouts and restrictions.

Having operated business that accepted credit cards, I know all too well the costs involved. First the merchant pays a fee to be able to accept each type of credit card. Then they have to rent at least one of those ubiquitous terminals that work at least some of the time. Their banking institution will sometimes charge an additional processing fee to handle the credit card vouchers while other card issuers have a fixed-fee arrangement (as a percentage of the TOTAL amount charged, including tips and taxes!).

A typical fee schedule for this hypothetical card series would look like this:

Card User Charge Merchant Charge
Bronze $0 annual fee 1.75% of total amount charged
Silver $120.00 annual fee 3.15% of total amount charged
Gold $225.00 annual fee 4.65% of total amount charged

I am NOT quoting fees for ANY specific credit card currently in use. These are illustrative only and roughly represent a mid-point of charges currently at work in our economy. Each card issuer and supporting financial institutions are completely free to set (and change) their own fee schedules.

With these fees charged to the merchants and vendors on the total amount put on the purchaser’s card, it is no wonder that the card companies and issuing institutions are raking in obscene profits at the expense of both the merchant and consumers – regardless of their incomes.

If you were a merchant, how much of these merchant costs would you include? 1.75%? 3.15%? 4.65%? Plus somewhere the cost of “buying into” the use of the card and terminal rental has to be included – the merchant can’t afford to take any loss with margins being so tight!

Most users today have either a Silver- or Gold-type credit card so the merchant has to plan for at least the Silver fee and a large percentage of the Gold fee – say 4.15%? On everything. Whether the purchaser pays in cash, uses a debit card (there are fees for these cards too but are usually less than .60% depending on merchant volume) or a credit card. Oh, the merchant also pays GST and possibly PST on top of these fees!

The low and modest income person or family who can’t qualify for any credit card, well, they are all still is paying the fees. Is this fair? This says nothing of the usury interest rates of sometimes more than 24% being charged on any outstanding balances.

Make sure you understand the costs and how they affect you!

Loyalty and rewards programs – free??

A conversation with one of my grand-daughters

I always enjoy chatting with Jeannette – 23, very smart – we starting talking about “free flights” from a well-known loyalty program used by many retailers. I asked her if she really thought they were free – and she said yes. She had never been charged any extra money when she handed the retailer this card so she figured the rewards were free.

So we discussed that and finally it dawned on her that since the flights did in fact cost money (if she wanted to take the trip on her own without the loyalty “points”) someone was paying for them. So now she had to figure out who was paying and how much they were paying.

I explained that the retailer who accepts such cards (including credit cards that have loyalty programs attached to them), is paying a percentage of the sale amount to a loyalty provider and in turn the loyalty provider (after deducting expenses and of course some profit), uses the net amount as electronic cash (actually an early concept version of Bitcoin) and pays the airline or cruise line or hotel or resort accordingly at some pre-negotiated discount rate.

Time for some numbers – and I will EXCLUDE the fees charged by credit cards just for the sake of simplicity.

A typical loyalty program works their calculation backwards starting with how many “points” they want people to accumulate before they can have a “reward”. So let’s assume the program provider decides to track process in multiples of 100 “points”. By going to various vacation-type providers and after some negotiations with them, the provider figures that 100 “points” needs to have a nominal “cash” value of $150. So 1 point = $1.50. Next, the provider has costs to administer the program and they estimate it costs them $15 to do the administration behind the $150 nominal value. Next, they decide that a reasonable profit is $5.00 per $150 of nominal value. So where are we now?

We need $150 plus $15 plus $5 = $170. So how much does the loyalty provider charge the retailer or merchant? The retailer decides that a customer will need to spend $50 to get 1 “point”. So 100 points means the customer has to spend at least $5000. Time to calculate a product markup to cover this added expense.

170/5000 = 3.4% markup on all products to cover the cost to the retailer of this loyalty program. This is a mark up on EVERY product they sell. It is a markup to EVERY customer or client WHETHER OR NOT they belong to the rewards program.

You are paying for the program whether or not you use it. So you may as well get it and use it since you pay for it regardless! Oh, by the way, PST and GST are added on TOP of this cost too since it is embedded in the item cost – so increase that by 12% in BC!

My next blog will compound the cost of markups when credit cards are involved!

Loyalty points, reward programs and credit cards revisited!

As a result of my last blog, I received some questions about loyalty programs and points and their true costs – including some from my nephew Derek.

Points, miles or whatever, they all have a value – so somewhere money is changing hands – and the only source is consumers – all of us – whether or not we collect points/miles or ?? we are paying something towards the prizes or awards that are claimed. In order not to offend any vendor or card company, I will use the name MERCHANT for the store/business/retailer/restaurant, POINTSPLUS as the name of the program and C-CARD for the credit card that may be used.

MERCHANT hopes to increase repeat purchasing in their business. They decide to have a business relationship with POINTSPLUS. POINTSPLUS says happy to have you on board, here are the costs. For your customers to get 100 points, you have to generate enough revenue to send to POINTSPLUS a total of $1000 plus a handling fee of 20% – so 100 points to the customer means it will cost you $1200.00. PP will do all administration, redemption etc. So now MERCHANT has to figure out how many points to allocate for each $1.00 spent in their business. If MERCHANT decides to add 2% to all prices, then 2% divided by $1200 means MERCHANT will need to add approximately 1.6 cents – call it 2 cents to every item sold and for every $60000 in gross revenue, MERCHANT will have collected $1200 in extra revenue. Doesn’t sound like much but they charge this extra cost to every customer – whether or not they collect POINTSPLUS – everyone pays it on every item.

Now for C-CARD costs. C-CARD has 3 kinds of cards – Bronze, Silver and Gold. Bronze is just a simple charge card – nothing extra included. Silver allows cardholders to collect flyer miles at the rate of 100 miles for each $1200 spent and Gold gives cardholders flyer miles plus automatic rental car insurance and lost luggage insurance. C-CARD charges MERCHANT a percentage of sales charged at 3 different rates depending on which version of card a customer uses. Bronze cards result in a charge of 1.5% to MERCHANT, Silver cards are 3.7% and Gold card use results in a charge of 4.7%.

MERCHANT knows they are not allowed to charge users of the different cards a different price, and the C-CARD user agreement doesn’t allow MERCHANT to give customers a discount if they pay cash, so MERCHANT has to add another 4.7% – to cover their maximum cost – to EVERY item they sell!!

So the POINTSPLUS loyalty program adds 2 cents to everything and C-CARD adds 4.7% then the merchant needs to add at least another 1% to cover their additional costs of trying to adminsiter all of this internally on their books – so now it is 2 cents plus 5.7% – to ALL customers whether or not the use any credit card at all or they belong to POINTSPLUS. Remember in-house programs and charge cards (usually from department stores) work exactly the same way!!

Hope this clarifies things and remember, There Ain’t No Such Thing As A Free Lunch!! Cheers

TANSTAAFL – do you agree??

With pardons to others (like me) who prefer correct grammar, TANSTAAFL – There Ain’t No Such Thing As A Free Lunch!

It seems we are constantly bombarded with advertisements and special offers that say FREE this and FREE that – what nonsense! Does anyone seriously think that any business is in business to give things away for nothing? Of course they aren’t – so how does it work?

To illustrate, I am going to use the current plethora of FREE texting offers on smartphones, iPads, iPods, Blackberry, Blueberry and everything else. The first concept is simple – it costs money to transmit text or voice or video or data or pictures – everywhere in the world. Cost for the lines, for the equipment, for the poles, holes, employees, electricity, buildings, property, etc. (plus taxes of course!!) So if the end-user (you and me) isn’t being charged for these – who is being charged – or are we??

Two parts to the answer – the base rate for using the service is increased to everyone to cover these costs – it may only amount to a few cents each month, but it is there somewhere – hidden – but there – either in monthly fees, setup costs, network fees or some other means – OR/AND you and I get hit with dozens of advertising emails and texts and links sent by business subscribers who want us to buy something – so we are paying now in two more ways – one by having to take the time to filter out and delete these annoying missives and two, the cost of the items we buy contains some component to cover the cost of advertising – for print, audio, text, video – all types of advertising.

The same is true for things like Airmiles, loyalty points – the cost is buried in the underlying items – loyalty isn’t free and neither are Airmiles or points – someone, somewhere, somehow is paying – either the merchant who belongs pays some $$ to the promoters (and who do you think pays more in the cost of goods to pay these promoters their $$???) or a percentage of sales (but then the cost of the goods to everyone goes up again!) or the credit card issuer – ever wonder why when you pay with cash you don’t get a discount?? When we pay with cash, the vendor makes a bigger profit that when we use a credit card or debit card (because of merchant charges made by the card issuers) – could it even be possible that the cash-paying customers are subsidising the customers who pay with pieces of plastic???

Good heavens – there is nothing for free – what a jolt to our system!!