There has been a fair amount of discussion recently in the payments trade publications about the Consumer Credit Card Competition Act (CCCA). This is proposed legislation that would take a Durbin Amendment-esque approach to credit card interchange fees. The general thrust of the legislation is to require/allow merchants to have a choice about which network a credit transaction could be routed through on a given plastic. So when I buy my candy bar at the gas station with my credit card that may have a Visa logo on it (and possibly other logos), the merchant could route the transaction through a network other than Visa. There is a lot to work out with that idea, but part of the fear issuers (especially large ones) have about it is that rewards programs could be impacted as the profitability of card programs may decline.

Whether the CCCA comes to fruition or not, it offers the opportunity to ask the question: How is your credit-card rewards program doing? Cards are sometimes so profitable that many institutions treat them like fire-and-forget programs. Institutions are sometimes unaware of the opportunity they are leaving on the table due to basic analytic lethargy about such programs. Should a threat to card programs and their profitability actually materialize, it would be nice to know the profit thresholds of your program before then.

One of the first questions you should investigate is how profitable the card program is. What is the average profit each card generates? An even more fun question is: How much profit does each card relationship engender? A nice profit model can be found in a study from 2016 on the role of points redemption in card and card-relationship profitability.¹ I recommend that model highly. It looks oddly familiar to the profit model that Raddon uses in its Performance Analytics program. The author of that study investigated whether points redemption is a bad thing or not. Could you answer that question for your institution, not just in general terms like, “Yeah, we like it,” but in specific terms like, “The average customer who redeems 2,000 points a year is worth $20 to us in relationship profit, but the customer who redeems 10,0000 or more points on average is worth $560 per year in profit”? What that study found (and it is a little dated) was that customers who redeemed the institution’s median number of points per year (roughly 10,000 points in this case) were worth roughly 2 times more in card profit and 3 times more in relationship profit than those not redeeming, and those who redeemed twice the median for that institution were worth a bit more than 2 times in card profit but roughly 5 times in relationship profit. (All the cohorts investigated in the study are listed in Figure 1.)

Figure 1: Comparison of card-account profit and relationship profit averages based on quantity of rewards-points redemption

Card holder vs relationship profit

Source: Journal of Financial Services Marketing, 2016 

It seems odd that someone who redeems points a lot would be worth more. An example might be illustrative. Let’s say an institution’s blended interchange income per card is 174 bps (basis points, 1.74 percent). A traditional rewards program grants one point per dollar and allows redemption at 1 cent per point. This means that a cardholder who redeems 100 percent of their points is only worth 74 bps in interchange versus the non-redeeming blended rate of 174 because a full percentage point of interchange is spent on point redemption. It seems difficult to understand how that cardholder could be more profitable. On its face, when two cardholders have the same volume but one redeems and the other does not, the non-redeemer must be more profitable at the card level. The loyalty generated from redeeming points, though, encourages more usage and redemption, leading to higher card profit on average.

However, the real magic happens in the relationship profit. I heard the card executive of a major bank recently say that he looks at card-first bank relationships in the same way as indirect-auto relationships. What?! That is not the experience of most community banks and credit unions. That executive was quite negative about the card from a relationship development standpoint. Loyalty wizardry happens when a cardholder redeems all the time. Such activities, through some unexpected, ethereal magic, make customers more valuable with other products. It is likely that if you have a cardholder who is redeeming a high number of points each year, that customer’s checking account will be more profitable. There is a higher likelihood that the customer has more products overall. In a recent Raddon Performance Analytics report, data show that while checking (which is a good relationship product) typically has a services-per-household cross-sale number of 2.59, those with a credit card have a services-per-household number of 3.33.

Another brilliant study done on cards asked whether cards were an antecedent or consequence of customer loyalty.² That is nerd-speak for whether the credit card leads to more products or the card gets adopted after other products have already generated loyalty. This study (which is also dated) found that the number of non-credit-card accounts and non-credit-card transactions for a cardholder were statistically significantly higher following credit card adoption after 12 to 18 months. This supports the notion that card adoption is a generator of loyalty. Additionally, it seems that card adopters already had a significantly higher level of (non-card) transactions prior to credit-card adoption, suggesting that loyalty may precede card adoption. So in essence, it is both a loyalty generator and a consequence of loyalty, which means these programs should be well managed.

Thus, rather than ignoring redemption behavior, we might want to encourage it. Maybe treat it like a loan-to-deposit ratio. When a customer is redeeming too little, prompt them to redeem; when they are humming along redeeming a lot, then save your marketing dollars until they fall back below the threshold. Where does that threshold lie for your institution? You will have to do the research. My bet is there will be a jump in relationship profit at about the median level of redemption and another quantum leap somewhere around two times the median. But every institution is different. What you will learn about your card program’s profitability and impact on your customer base will be astonishing as you do the research to answer just this one little question.

So whether the CCCA becomes law or not, it doesn’t hurt to know your card program well enough to plan for either scenario. If it passes, then you will have the data for strategic countermeasures. If it does not, then you will be well armed to ensure that no low-hanging fruits of opportunity are going unharvested. 

Sources:

¹ Leavell, J. P. (2016). Point redemption matters: A response to Murthi et al. (2011). Journal of Financial Services Marketing 21(4), 298–307. doi: 10.1057/s41264-016-0013-2

²Leavell, J. P. (2015). Credit card adoption: Antecedent or consequence of banking-service loyalty. Paper accepted for the August 2015 Marketing Educator’s Conference of the American Marketing Association, Chicago, Illinois.