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!

Travel Insurance – outside Canada

Greetings once again and I am going to pickup from last week’s topic of the need for travel medical and dental insurance – this time looking at things outside Canada.

First, of course, the quality of emergency medical and dental care varies widely around the world – particularly outside North America, the European Union, parts of the Pacific Rim and Austral-asia areas. With that as a given, let’s look at coverages.

Many plans have exclusions or limited benefits payable if you have a flare up/emergency related to an existing medical condition – such as a history of heart problems, diabetes, stroke, etc. READ THE LIMITATIONS BEFORE YOU BUY! I am not aware of any travel insurance policies that cover costs incurred on a “medical” vacation or for cosmetic procedures or treatments.

The questions on the application must be completed with 100% accuracy – if you are not sure how to answer them, go and see your doctor – do not “guess” at the answers – this can easily result in your claim be denied or severely restricted. Listing of your medications, dosage and duration of treatment or use of that medication will also be required. Check if the plan has a toll-free number for emergency personnel to call and get approval for treatment. Check if you have to pay the bill yourself first and then submit a claim to the insurance company or if the medical providers can bill the insurance company directly.

If you travel regularly out of Canada, you may be better off purchasing a multi-trip plan that gives you coverage for a full year for a number of trips of varying durations.

To quote the Ontario Ministry of Health and Long Term Care: “You are strongly advised to purchase additional health insurance every time you leave Canada and ensure that the supplementary insurance you have purchased provides adequate coverage.”