The Fifth Anniversary of Reward Card Interchange

Reward credit cards are used by card companies to compete with one another for the business of affluent consumers. Card issuers attempt to influence the purchase behaviors of cardholders with higher spending limits by rewarding them to spend more at merchant locations. And by most accounts they have been successful.

This spring marks the 5th anniversary of rewards Interchange. The decision to implement a higher rate for a rewards card verses a non-rewards card was introduced in response to a growing American Express market share. The competitive landscape in 2005 found MasterCard and Visa card issuers increasingly using rewards as a key component of their cardholder acquisition strategies in order to compete with AmEx for affluent consumers.

So in April 2005, both MasterCard and Visa established new reward card Interchange rate categories. Visa launched two card programs, Visa Traditional Rewards and Visa Signature, both with higher Interchange rates. The swiped CPS Rewards 1 Interchange rate was set at 1.65% + $0.10. Five years later that rate remains unchanged. What has changed is that there are more reward cards in the market. Issuing reward cards to more and more consumers has resulted in an overall increase in Interchange expenses for merchants.

Today reward credit cards are the new norm. And one frequently asked question we hear is why the costs of “reward” incentives are passed on to the retailer?  Yet merchants only directly cover a portion of the actual reward benefit by paying slightly higher Interchange rates. Yes rates are higher but not high enough to cover all of the costs of the reward level which is mandated by the card companies in order for a credit card to qualify as a reward card.

In order to earn the higher Interchange from a reward card, the card issuer is required to meet an established rewards value threshold. This is the value that is returned to cardholders. In 2005, the minimum rewards value for a Visa Traditional Rewards card was to exceed 62 basis points while Visa Signature cards required 125 basis points as the minimum reward value.

This minimum value exceeds what merchants contribute. For example, on a Visa Traditional Rewards card, the merchant’s portion is only 11 basis points of the minimum reward value a card issuer must award -- the difference between a regular credit card (1.54% + 10 cents) and a rewards credit card (1.65% + 10 cents). Or put in other terms, the incremental costs to a retailer of accepting this rewards card is $1.10 per $1,000 in sales.

In fact, this is a common argument against rewards. Most articles talk about reward cards costing as much as 1% more than the cost of accepting standard credit cards and suggest that small local retailers often pay an even greater percentage. While unfortunately this may be true in some cases, it doesn’t need to be the case. Because most merchants are not on direct Interchange pass through, they face very expensive “Non-Qualified” surcharges. However, this is a completely different problem and not a case against reward cards.

All merchants would benefit from a merchant Interchange rate quote where a pass through pricing structure reduces the costs of reward card acceptance; especially for small merchants, where the real lesson on the 5th anniversary of reward card Interchange is to simply pay the reward Interchange - not “non-qualified” surcharge fees.

In a recent NY Times article, The Damage of Card Rewards, the author worries about being a “selfish consumer” because paying with a reward credit card creates a “a sort of reverse Robin Hood problem”, where the poor (apparently defined as people without a rewards credit card) pay subsidies to finance the rewards of the affluent.

From my viewpoint I don’t see the relatively small incremental increase in costs from credit to rewards credit as a major societal issue. Certainly it is not an issue requiring drastic measures like the TX wine shop referenced in the article who “offers a 5 percent discount to customers who use cash.’’ It appears that this merchant is operating on misinformation on the costs of credit and credit rewards.

While the debate will continue over the value of payment card acceptance and the associated costs; merchants, the media, the political class and the providers of merchant services would all be better served by having a greater understanding of the history and intricacies of the payment system.

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