Credit card industry is quite competitive.

1

• Credit card industry is quite competitive.
• Competition inside Visa and Master can be
  described as product differentiation.

2
Product Differentiation

• Card Features
• Credit line, Credit limit
• membership rewards program
• e.g. airline mileage rewards program
• Affinity card, co-branded card
• Fees
• Annual fee
• Low annual fee or even zero annual fee
• Interest rate

3
Product Differentiation

• Extra features
• cash-back bonus, purchase discount, purchase
  protection, price protection, frequent flyer
  miles
• Affinity partnerships have become popular
• E.g. Airlines Optima card has the largest
  co-branded airline program, with 2.8m cards
  issued by end of 1997

4

• Affinity partnerships have become popular since
  the later 1980s
• E.g. Airlines Optima card has the largest
  co-branded airline program, with 2.8m cards
  issued by end of 1997

5
Dimensions Along Which Payment Cards Differ

• Special Card Features
• Issuers offer services besides payment and credit
  became increasingly popular during the early
  1990s
• Example Features cash-back bonus, purchase
  discount, purchase protection, price protection,
  frequent flyer miles

6
AT T

• Nature of business Telecommunication
• Benefits offered
• Telephone calling card
• Discount on AT T calling
• Extended warranty

7
General Motor ( GM )

• Nature of business Auto motor industry
• Benefits offered
• Credit toward buying a car
• Getting discount in changing a new car

8
Dimensions Along Which Payment Cards Differ

• 3. Service Fees (cont)

• American Express Green Card has no limit

9
Dimensions Along Which Payment Cards Differ

• Amount of Credit Provided

• All credit cards come with a limit on the amount
  that the cardholder can charge
• Larger credit lines are more valuable to
  consumers but riskier for issuers
• Issuers may attempt to differentiate their card
  offers by extending relatively higher lines of
  credit than other issuers
• e.g. Platinum card developed in 1990.

10
Dimensions Along Which Payment Cards Differ

• Interest Rates in 1998

11
Finance charges dominate bankcard issuers'
revenues
12
I. Product Differentiation
Implications

• Heavy Marketing
• Difficult for consumers to learn about and
  compare alternative card products

13
Paradox of Credit Card Lending

• Credit card lending is a very competitive market
• According to Economic theory, when in a
  competitive industry,
• All firms should earn zero profit
• and price (credit card interest rate) should be
  close to production cost (the market interest
  rate).

14

• Reality
• Very sticky and high interest rate
• rates of return for credit card operations are
  quite high.
• Is a credit card industry a Competitive Market ?

15
High and Sticky Interest Rate

• Credit card interest rates are usually higher
  than interest rates on other types of consumer
  loans

16
Sticky Interest Rates

• The interest rates on credit card loans were
  sticky to some degree
• Tended to respond slowly to cost changes
• If cost of fund changes, credit card rates will
  change by only about 1/12

17
High Interest Rates

• Reasons
• Riskier than other consumer loans
• Require a higher interest rate to compensate for
  higher risk
• In ordinary consumer loans, assets could be
  seized if the consumer defaulted on loan, but
  credit card loans are not secured by assets.
• Adverse selection

18
Sticky Interest Rates

• Interest rates are not the only consumer prices
  that are sticky
• Adding features
• Increase overall quality
• Credit card interest rates help cover many costs
  of offering credit card services.
• Total price finance charge annual fees
• Annual fees fall
• Total price remains the same.

19
Facts and illusion

• Price did not change
• Annual fees was replaced by Services fees
• Services fees are less visible than annual fees
  to consumers
• People only focus on annual fees which only
  accounted for
• Profit made
• Nature of business
• Product differentiation

20
Dimensions Along Which Payment Cards Differ

• 3. Service Fees

21
Credit card

• Late 1980s
• High profits
• Rates of return is 3 to 5 times over bank
  operations overall
• Attracted many firms into credit card lending
• 1990s
• Not as attractive as the past decade
• ATT sold its increasingly unprofitable credit
  card operation to Citibank

22
The myth of high profits

• Questions
• Are the worst of times as bad as and the best of
  times as goods as the profit measurement?
• NO!

23
Biases in Accounting rates of return

• Reason
• Initial high fixed investment or high risk
• Examples
• Credit card industry
• Oil industry

24
Case Discover card
25
Risky credit card lending

• Is 22 rates of return high or low?
• If not risky, extremely high
• If risky, only a marginal business
• Credit card lending is risky!
• Because of uncertainty over new cardholders
• so credit card lender is not the money machine,
  it has not violate the economic principle of
  competitive market