Credit Card Sticky Price
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Credit Card Sticky Price

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  • In total, the systems spent more than $600 million on advertising their cards in 1996. Citibank outspent all others issuers with advertising expenditures of more than $60 million

Credit Card Sticky Price Credit Card Sticky Price Presentation Transcript

    • Credit card industry is quite competitive.
    • Competition inside Visa and Master can be described as product differentiation.
  • 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
    • 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
    Product Differentiation
    • 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
    • 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 …
    Dimensions Along Which Payment Cards Differ
  • AT & T
    • Nature of business : Telecommunication
    • Benefits offered
      • Telephone calling card
      • Discount on AT & T calling
      • Extended warranty
  • General Motor ( GM )
    • Nature of business: Auto motor industry
    • Benefits offered
      • Credit toward buying a car
      • Getting discount in changing a new car
    • 3. Service Fees (con’t)
    Dimensions Along Which Payment Cards Differ * American Express Green Card has no limit $2 - $4 min Cash Advance Fee (in $) 2% - 4% min Cash Advance Fee (in %) $20 - $29 Late Fee $0 - $88 Annual Fee Variation (Min – Max) Service Fees
    • Amount of Credit Provided
    Dimensions Along Which Payment Cards Differ
      • 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.
    • Interest Rates in 1998
    Dimensions Along Which Payment Cards Differ From 20 to 30 days Grace Period Prime rate + fixed rate (from 2.9% to 11.55%) Fixed interest rates range from 13.99% to 18.9% Interest Rates Variety
  • Finance charges dominate bankcard issuers' revenues
    • I. Product Differentiation
      • Heavy Marketing
      • Difficult for consumers to learn about and compare alternative card products
    Implications
  • Paradox of Credit Card Lending
    • Credit card lending is a very competitive market
    • According to Economic t heory , 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 ) .
    • 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 ?
  • High and Sticky Interest Rate
    • Credit card interest rates are usually higher than interest rates on other types of consumer loans
    13.5 Twenty-four-month personal loan 7 Home mortgage loan 8.7 Forty-eight-month automobile loan 16 Credit Card Interest rates (percent%) Types of consumer loans
  • 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
  • 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 c redit card loans are not secured by assets .
      • Adverse selection
  • 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
    • A nnual fees fall
    • Total price remains the same.
  • 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 <10% of the average price
    • Profit made
      • Nature of business
      • Product differentiation
    • 3. Service Fees
    Dimensions Along Which Payment Cards Differ Trend of Service Fees Charging 0 3 6 9 12 15 18 83 84 85 86 87 88 89 90 91 92 93 94 95 96 Year $USD Service Fee Annual Fees
  • 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
      • AT&T sold its increasingly unprofitable credit card operation to Citibank
  • 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!
  • Biases in Accounting rates of return
    • Reason
      • Initial high fixed investment or high risk
      • Examples
        • Credit card industry
        • Oil industry
  • Case: Discover card
  • 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