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 FeesVariation (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

Finance charges dominate bankcard issuers' revenues

 I. Product Differentiation  Heavy Marketing  Difficult for consumers to learn about and compare alternative card products Implications

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 close to production cost (the market interest rate).

Reality Very sticky and high interest rate rates of return for credit card operations are quite 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 loansInterest rates (percent%) Credit Card16 Forty-eight-month automobile loan8.7 Home mortgage loan7 Twenty-four-month personal loan13.5

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 risk In ordinary consumer loans, assets could be seized if the 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 sticky 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 Year $USD Service FeeAnnual 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

Case: Discover card

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