“The next best thing in card payments” - Shifting the bank’s business model of rewarding card holders toward better merchant incentives

By Deborah Baxley, Managing Principal, Keypoint

The US credit and debit card business is under mounting pressure to reform its business model. While the industry has been extraordinarily successful and profitable over the past decades, the time is ripe for transformation. Fast movers will be rewarded.

Since the explosion of card holder reward programs in the early 1990’s, consumers have become accustomed to reaping their benefits. They modify their behavior to maximize returns on airline and other points programs from their issuing banks. In the mean time, card interchange has been escalating – the absolute value of interchange has increased by over 33% for the industry as a whole over the past decade. You can trace the exact same amount of money flowing directly to fund cardholder reward programs. Have we reached the limit of the effectiveness of these programs?

The status quo is played out, and here’s why…

Interchange is increasing – a lot. Merchants and legislators are noticing.
The banking industry faces a triple-whammy – merchant uprising, consumer ire and government enthusiasm for regulation.
- Merchants feel the pinch and they’re fighting it – by encouraging signature debit, experimenting with alternative payment networks such as Tempo, and gaming the payments system by routing to least-cost methods like ACH. Merchants rightly content that they aren’t benefiting from cardholder reward programs. And I quote an outspoken merchant I met at a conference last year, “funding cardholder rewards from increasing interchange is picking the merchant’s pocket.”
- US banks are suffering reputation damage in general from recent bail-outs, and more specifically to cards from escalating late fees, overdraft fees and other fees that have the appearance of gouging the consumer.
- Legislators appear more and more willing to regulate the card industry – evidenced by the Credit CARD Act of 2009. Consumer and merchant groups are making a strong case to cap or regulate interchange.

The banking industry has not done itself any favors. Steadily increasing interchange without a strong case to merchants on how they can benefit, increasing fees to consumers, and inability to proactively address the issues that are bound to surface with consumer protection lobbies leave banks in a catch-up reactionary mode. A business model based on customer’s making mistakes (overdraft and over limit fees) is not sustainable, or defensible. A better alternative is to build a business by helping customers and merchants succeed.

Why not turn the problem in its head? Why not try a win-win-win – a scenario in which bank, merchant and consumer all benefit in a virtuous circle? An emerging business model is merchant-funded reward programs. In this case, the points you accumulate for using your credit or debit card are supplied by the merchant you are shopping at, providing you further incentive to shop there. This results in a 3-way win for consumer, bank and merchant. 2 examples of this business model are www.affinitysolutions.com and www.cardlytics.com. Other examples are popping up every day:

Busey Bank is working with rewards vendors Cardlytics and MyRewards to earn added fees from merchants as cardholders redeem offers. The system will be able to offer up to $200 a year in account rewards to debit .customers
In London, Barclaycard launches Barclaycard Freedom, a credit card reward program with 30,000 local and international retailers partnerships
Bling Nation, a low-cost debit network, is offering merchants the opportunity to design their own rewards programs

Let’s take this as a wake-up call to the industry. A renegade player will likely topple the current business model eventually. What forward-looking player will sculpt the new landscape?