What are the basic economics behind reward cards? How is it that companies can offer me up to %5 cash back from my purchases? Savvy consumers know that if something sounds too good to be true, it probably is. That is why it helpful to understand how credit card companies make money and why you deserve a reward for helping them do it.

We all know that card issuers are not charities, and even the ones offered by non-profits are merely in marketing relationships with a for profit bank. All credit card issuers make money in the following ways:

Interest payments

Wouldn’t you just love to put your money in a place that earns the kind of interest credit card companies routinely charge? Sign me up for the next savings account you find with a %19.99 rate of return. Once again, Rule Number One of credit card usage is that anyone not paying off their balance in full every month should be using the card with the lowest APR, not be seeking to maximize their reward. While rewards are great, they are only worth a fraction of your interest payments.

Merchant Fees

If you have ever run a business that accepts credit cards, you know that a percentage of your revenue goes to merchant fees, typically between %2 and %4 of each transaction. Clearly reward cards are offering you a cut of this fee in return for your patronage.

Miscellaneous Fees and Services

From annual fees, to late fees to overdraft fees, to credit protection insurance, card issuers are after an ever increasing revenue stream from you, the customer. Even selling your personal information to “marketing affiliates” is a little known revenue stream for your credit card issuer.

Merchant kickbacks

Depending on how you look at this, the reward is either passed directly to you, or shared between the customer and the merchant. You typically get a greater reward from your card when you make purchases from the affiliate issuing the card or a company with a marketing relationship. Airline and hotel cards give you double miles, and I am constantly be barraged by offers of %10 back or more from high profit margin services like flower delivery.

Loss Leaders

Loss leaders are highly discounted goods or services, usually below costs or market prices that entice consumers to shop with a merchant. This pricing strategy works when the merchant also sells other goods and services at profits that make up for the loss on a single item. You do not have to be a mathematician to realize that the %5 reward for gas stations exceeds the credit card fees the station is paying. Nor do you have to be a marketing major to see that the cards that offer a %5 discount on gas at any station are probably not getting a kickback from the all stations for your loyalty. The card issuers are taking a small loss, hoping that they will make it up with other fees and interest payments. That is why people who pay off their credit card balance on time and in full every month are ironically referred to in the industry as “deadbeats.”

Now that you know how the business works, you can start to understand why you deserve an award for using your credit card.

This entry was posted on Tuesday, September 9th, 2008 at 22:00 and is filed under Maximize your Credit Card Rewards. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.