KONNOR VON EMSTER – DECEMBER 3RD, 2019 EDITOR: DAVID LYU
What does NASCAR, Victoria’s Secret, Barnes and Noble, and Carnival World Cruises all have in common? They all have their own co-branded credit cards that loyal customers can apply for, spend with, and use to receive large discounts on their favorite items—the company’s products. But some of these deals sound too good to be true, so how do they happen? Additionally, some of these cards can mask greater fees than their competitors, so how can consumers protect themselves?
If it was not a sound business decision, companies would not pursue their own branded credit cards. Co-branded credit cards take advantage of sponsorship, often between a retail store and a credit provider. For example, in the case of the NFL credit card, the NFL organization teamed up with Visa to create the credit card. Purchasing NFL products using this credit card provides twice the points of normal purchases to customers, doubling the rewards one would receive through a normal credit card; however, this only applies to a select range of purchases, which in this case are NFL products. The same follows true for many others, such as the Barnes and Noble card and the Jet Blue card, both of which offer even more generous packages: Barnes and Noble’s offers a staggering 5% cash back on all Barnes and Noble purchases, while JetBlue’s card offers 6 times the normal points. With these generous offers, it is hard to understand how companies make money off of these credit cards. However, as we all know, there is no free lunch: companies can and will make money off of you.
To understand this, one must look at how credit card companies themselves earn profits. The intricacies of these transactions are quite complicated, but their profit-making mechanism can be simplified as follows: whenever a good is bought with a credit card, the merchant is charged 2-5% of the purchase price. This covers all the transaction costs incurred by the various entities involved: the issuing bank, the acquiring bank, and the credit card networks. The issuing banks often gain some small percentage of this amount, while the credit card networks, such as Visa, Mastercard, Discover, and American Express (often referred to as “clearinghouses”), earn a fixed or variable rate “swipe fee.” These fees are relatively small, but add up quickly, considering the sheer volume of transactions. Credit cards were used to buy over $3.5 trillion in goods and services in 2017, for example.
The 2-3% margin is relatively standard for most companies, although surprisingly, this margin has not changed at all despite very different marginal costs due to technological advancements. With lower marginal costs, credit card companies can give up some profit to offer rewards. Those with the greatest rewards would be able to steal customers from other competitors. A common reward is offering cash back, with many as high as 1.5%. Offers such as these are small enough that credit card companies can still make money through the margin.
But the scenario differs when companies offer up to 5% cash back, as Barnes and Noble does on their co-branded card. In this scenario, the company is likely paying the merchant a negotiated margin, and then adding a discount of their own to the purchase price of their goods. Economists assume companies are profit maximizing; thus, the marginal benefit Barnes and Noble receives from giving customers a discount on their site through the credit card overshadows the cost. Barnes and Noble may also profit off of other transactions made on the card that do not relate directly to purchases through their online and retail stores, although the details of these contractual agreements are not entirely known. We do however know that these negotiations are still profitable, as many companies still offer these deals.
These deals are heralded as great opportunities for loyal customers to receive deals on the brands they purchase often, but there are some serious drawbacks. Theoretically, if every company had a card that a customer could apply for and receive, customers could receive large deals by carrying many credit cards from all the major parties they spend on. This may hurt the companies if they expect profits from other purchases, leading to a forced exit from the market. While this may be ideal, there is evidence that suggests that holding a vast number of credit cards would hurt consumer credit.
Co-branded credit cards do not offer great rewards in non-branded companies when compared to classic, non-branded credit cards. As mentioned before, some non-branded cards offer as much as 1.5% cash back for well-qualified, creditworthy customers. In contrast, almost every credit card in Barclay’s roster did not provide any cash back offers, and very often offered comparatively lackluster point rewards on non-branded purchases. Therefore, it is only financially sound to apply for the co-branded card if the utility from the purchases from that company far outweigh the opportunity cost of a card with higher cash back rate or points incentives on general purchases, on top of the disutility from the worsened credit score from applying for another credit card.
The discounts one receives from the company may not be worth the opportunity cost of choosing a co-branded card over substitutes, so consumer beware—the shiny company logo on the card may be costing you more than the company.
Editor’s note: The contents of this article do not constitute financial advice; readers should do their own research before making personal finance decisions.
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