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 Fees Variation (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

78%

10%

6%4% 2%

Finance charges Interchange fees Late and other feesCash advance fees Annual fee

Finance charges dominate bankcard issuers' revenues

I. Product Differentiation

Heavy Marketing

Difficult for consumers to learn about and compare alternative card products

Implications

Credit Cards Advertising Spending in 1996

0

50

100

150

200

250

Visa MasterCard AE Discover Citibank

Card I ssuer

USD

in M

illio

n

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 cl

ose to production cost (the market interest rate).

Reality

Very sticky and high interest rate rates of return for credit card operations are quit

e 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 loans Interest rates (percent%)

Credit Card 16

Forty-eight-month automobile loan 8.7

Home mortgage loan 7

Twenty-four-month personal loan 13.5

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 r

isk In ordinary consumer loans, assets could be seized if th

e 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 stic

ky 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

0

3

6

9

12

15

18

83 84 85 86 87 88 89 90 91 92 93 94 95 96

Year

$U

SD

Service Fee Annual 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