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Jamie Dimon, the CEO of JPMorgan Chase, told the attendees at an investor conference that the new Sapphire Reserve credit card is "doing great”. At the same time, he notes that one negative aspect of its popularity is the high cost of acquisition. In the fourth quarter, the card will reduce the company’s profits by roughly $200 million. To the passive observer, these two statements may seem at odds. The cost for this single credit card seems astronomical, yet senior officers view it as performing well. The answer: user behavior. In the end, cardholders will likely bring down the overall maintenance cost of this product. The Reserve, like many other rewards credit cards, can be profitable for the issuers. On average, cardholders will not be using all the rewards and benefits their cards offer to their fullest potential.
Banks can typically expect to make 2% of every transaction through merchant fees. Issuers usually offer reward cards with a mix of rewards across categories. Some exceed that 2% mark, giving the cardholder more than the bank earns on a purchase, while other hover closer to 1%. In the example of the Chase Sapphire Reserve, consumers can earn 3 points per dollar on travel and dining at restaurants. When translated into actual value, those purchases produce a return for consumers that well exceeds 3%. When you throw in the massive sign-up bonuses that come loaded with the product, it’s understandable why someone might wonder how banks can make their money back on these investments. However, all other purchases produce rewards between 1%-1.5%, depending on how the points are redeemed. While some individuals are likely to use the card in a way that's highly profitable for them, the bank is counting on the average user averaging sub 2% returns. The hope is that most of these new accounts will stick around. The big risk in this approach is the new users simply churning and burning through it. That means they cash in on the bonus, and then cancel their account.
The point of a diminishing average reward can be best understood by looking at the earnings report for Discover Financial Services, one of the nation's biggest credit card issuers. Their flagship credit card, the Discover it, can provide users with 5% cash back in categories that change each quarter, up to the quarterly maximum. All other purchases earn just 1% cash back. In theory, if most people used the Discover it optimally, the issuer would be hemorrhaging money. However, over the last 6 quarters, the average rewards rate has never exceeded 1.21%.
This doesn't even account for those Americans who earn the maximum number of rewards, and then choose to not use them. A recent survey by the American Institute of CPAs found that "While a majority of Americans (58 percent) say that using their credit or debit card to earn travel reward points makes financial sense, few of them are actually taking advantage of those perks to save on their hotel and airline costs."
Credit Cards as Lead Generators
For many banks, credit cards are more than a simple cash-grab on interest charges and interchange fees. They may also serve as a gateway drug to the other services offered by a bank. Once you are in the bank’s database, they can market you offers on their checking and savings accounts, investment accounts, or even mortgages and personal loans. This, in turn, can help them generate revenue in those other fields.
Some banks take this concept to the extreme, locking their best products to account holders. For example, certain banks offer 2% cash back credit cards. On paper, these don’t make sense. However, such cards are only available to those who already have an investment account opened with the bank offering them.
Be the Outlier
While the average cardholder is likely getting below-average rewards from their credit card you don’t have to. Using your card optimally requires very little effort. Follow these steps to make sure you are the outlier who gets to take advantage of lucrative incentive programs, instead one of the masses that brings costs down for the bank.
- Identify where your card is strong or weak. It’s very tempting to simply put all your purchases onto a single credit card without thinking about reward categories. However, the truth of the matter is that some cards are better used at certain shops and retailers than others. For example, you may want to use one credit card when shopping for groceries and another when ordering things online. Take the time to figure this out, before you apply for your next card.
- Identify the best use for your points. Today, most credit cards allow you to use rewards on a number of things – cash back, travel, gift cards, etc. However, not all these redemption options are equal. Some will be better than others from a value standpoint. Take the time to quickly find out what is the best use case for your points. An easy way to do that is to divide the dollar value of a prize by the points needed to get it. This will get you a per-point value. Use it when comparing your options.
- Actually use your points. As we mentioned earlier in the article, many people simply sit on their rewards and never actually use them. The truth is that reward points are likely to decrease in value over time. Loyalty programs are constantly being devalued by companies. Therefore, the points you’re accumulating won’t grow in value over time. The only way to actually get something out of them is by using them. Avoid hoarding, and use your rewards whenever you can.
