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Article published in Issue Number: 070102

Card tricks: Shuffling rewards, at whose cost?

By Ken Musante, Humboldt Merchant Services

How do you increase revenue per unit without increasing prices? Change the size of the box. General-merchandise retailers (who have advanced degrees in price creep) understand this well. Cereal manufacturers do it routinely to sell larger quantities or increase a product's price per ounce. Displaying smaller boxes beside large ones spurs consumers to rationalize purchasing the "economy" box.

When a national fast-food chain did away with its triple burger, sales of its double burger declined markedly, while its single-burger sales experienced a corresponding increase. The reason? Customers didn't want to order the largest sandwich on the menu. When the chain reintroduced the triple, sales of the double increased to prior norms.

Ever wonder why mid-level gas is not determined by averaging the prices of premium and regular gas? Can't you achieve the same octane rating as mid-level at a lower price by filling half your tank with premium and half with regular? There are many examples across different industries in which marketing or packaging enables retailers to earn additional returns. Perhaps this occurs even within the bankcard industry.

Fast play

When Visa U.S.A. introduced three-tier rewards interchange pricing in April 2005, issuers had to migrate entire bank identification numbers to the rewards category to qualify for premium interchange. So, Visa established programs to more selectively market to cardholders. My interpretation of the company's strategy follows:

Card Type Interchange category Market

Visa Signature

Visa signature rewards


Visa classic, gold and platinum

Visa traditional rewards

Mass market

Visa classic and secure cards

Visa traditional

No frills / low cost or subprime

Since October 2005, however, issuers have been able to move cardholders to one of the premium products individually. This allows issuers to migrate cardholders more rapidly, drastically increasing the percentage of premium (more expensive) transactions.

Humboldt Merchant Services has seen its percentage of rewards transactions grow from less than 2% in April 2005 to 13% in November 2006.

As Visa upgraded its systems and quantified revenue opportunities, more issuers shifted cardholders into the higher-tier rewards programs. With the shift in card programs, issuers have given their cardholders additional value in exchange for the higher interchange they earn.

Visa launched a signature preferred card in September 2006, offering issuers an even greater opportunity - without increasing interchange.

Split pot

As any avid rewards-card user knows, rewards have value and encourage cardholders to transact. Visa requires issuers to provide specific minimum rewards in basis points, depending on the reward and card type.

For example, with Visa traditional rewards, issuers typically provide one mile toward a frequent flyer program for every purchase dollar. Signature cards require a higher minimum payout.

By setting minimum basis points for rewards, Visa blocks issuers from advertising a Visa rewards card with a miniscule reward relative to dollars spent by the cardholder. If it did not do this, issuers could take advantage of premium interchange without providing a perceived value to cardholders.

Cardholders aren't the only ones who benefit from rewards programs. Visa, issuing banks and acquirers all get a boost as well. In many aspects, Visa is product-agnostic. As long as it has volume growth, Visa has revenue (assessment) growth.

And there is little differentiation in assessments among card types. Cardholders can choose which card type to use, so Visa is offering more options to stave off competition.

Although rewards and signature products are more expensive for issuing banks, they benefit from increased bankcard balances and corresponding interest income. Also, in addition to premium interchange, cardholder loyalty increases and attrition decreases.

Historically, acquirers have benefited from increased transactions. To be sure, interchange's complexity increases the workload. This manifests in more complicated pricing, as well as larger customer service and training expenses, and less merchant satisfaction.

Nonetheless, the increased volume more than compensates acquirers for their work. Further, many premium or rewards cards are downgraded, making up for the higher interchange.

Short stack

However, signature products are no boon to many merchant classes. Petroleum retailers, grocery stores, medical and dental offices, auto-body and automotive-repair shops, gyms, lawyers, dry cleaners and publishers of periodicals will not see sales increase when cardholders upgrade to signature cards. These merchants will, however, face increased processing costs when cardholders use these upgraded cards.

With Visa's signature preferred product, issuers must provide an even greater reward to cardholders for each dollar spent. The target market is affluent cardholders, spending more than $50,000 per year.

Both Visa and these cardholders will be pleased. Based on this demographic, Visa is clearly targeting high-volume cardholders and enticing issuers to upgrade cardholders to this premium product.

Of course, issuers will require more interchange incentives in order to provide the added cardholder value. How can issuers afford to do this otherwise?

To pay issuers more while not raising interchange or developing a new category, Visa will apply the commercial interchange rate to signature preferred transactions beginning April 2007.

Issuers will receive greater income for each dollar spent - all without any increase in interchange. Said differently, acquirers and merchants will feel the full brunt of this new card type: Starting April 2007, consumer signature Visa transactions will cost acquirers and merchants 30 basis points more.

As most acquirers already downgrade signature transactions on three-tier merchants, acquirers will either absorb the increase or pass it along in the form of a price increase to their customers. Some merchants will likely absorb 100% of the increase.

Why do I feel like the box is getting smaller?

Ken Musante is President of Humboldt Merchant Services. Contact him by e-mail at or by phone at 707-269-3200.

Article published in issue number 070102

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