Advertiser Disclosure

Pointwise is part of an affiliate sales network and receives compensation for sending traffic to partner sites, such as MileValue.com. This compensation may impact how and where links appear on this site. This site does not include all financial companies or all available financial offers. Terms apply to American Express benefits and offers. Enrollment may be required for select American Express benefits and offers. Visit americanexpress.com to learn more.

Introduction: Are Credit Cards A Scam?

We take it for granted that credit cards are part of our daily life, but that hasn’t always been the case. I’m not talking about pre-1958, when the BankAmericard was launched by bank of America as the world’s first credit card, but as recently as 2000, it was checks that accounted for more than 40% of non-cash payments, while credit and debit cards were used for half as many transactions.

Today, the story is much different. In 2021, card payments accounted for a whopping 77% of non-cash payments. And with a much bigger share of the market, credit cards suddenly seem far more sinister.

Here’s what it looks like: Credit cards give you rewards, so consumers are convinced to get credit cards. Merchants want consumers to shop at their store, so they’re forced to pay the credit card processing fees (around 3%). Because almost everyone is using a credit card, merchants then raise prices by about 3% to make up for the 3% they’re paying in fees. This costs consumers billions of dollars a year because everything costs 3% more than it should, just so credit card companies can collect their fees from the average American.

Congressmen on both sides of the political spectrum are pushing a shiny new bill called the Credit Card Competition Act (CCCA), which will force credit card companies to allow multiple payment networks to be used on any given card.

As it stands today, if a merchant accepts a Chase Visa card, they’re stuck paying Visa’s transaction fees. The idea is that by forcing each credit card issuer, like Chase, to allow more than one payment network on each credit card, there will be more competition among the payment networks to lower their transaction fees (because the merchant will just pick the cheaper one), causing the transaction fees to go down, and ultimately saving consumers around 3% on everything.

The Credit Card Competition Act: The Real Scam

If it were that easy to save consumers 3% on everything, then I’d be all for it, but the truth is that this line of thinking is wrong on 2 critical levels:

1. The Credit Card Competition Act actually reduces competition and choice for consumers. It only increases competition and choice for the merchants.

Consumers, who today can choose between any one of thousands of credit cards with a huge selection of perks and rewards, will be left to choose from only basic cards that offer the same miniscule rewards and benefits that European credit cards do (since credit card transaction fees are capped in much of Europe). If that were the cost of reducing the price of everything by 3% then it might be worth it, but that couldn’t be further from the truth.

A white paper published by the International Center for Law & Economics analyzed legislation like the CCCA that was passed in different countries around the world, and found the following results (it’s worth reading this section in its entirety):

“One of the primary justifications made by legislators and regulators for introducing caps on interchange fees is that these fees drive up the merchant discount rate [the fees a merchant pays to accept a payment type], which in turn leads merchants to raise the prices of goods and services offered to consumers. For example, an oft-cited 2010 study estimated that low-income U.S. households pay on average an additional $21 per year on goods and services due to credit-card interchange fees and card rewards. To arrive at this number, the study assumed that interchange fees are fully passed through to consumers in the form of higher prices.

“However, the only reason the overwhelming majority of merchants would pass on all cost savings is that they believe their consumers would otherwise buy their goods and/or services elsewhere—in other words, it assumes the merchants have zero market power. While that might be true for retailers of gasoline and diesel, it is unlikely to be true for retailers of less homogenous goods and services. Most retailers have some degree of pricing power because of the idiosyncratic nature of the products they sell and the way in which they are sold (which can include factors such as location, expertise of the staff, the way products are displayed, among others). Indeed, the evidence for cost passthrough in general indicates that, while cost increases are often passed through at rates of around 90%, cost decreases are typically passed through at much lower rates.

In addition, a 100% pass-through rate would imply that merchants would reap none of the benefit from a reduction in interchange fees. As such, they would have no incentive to lobby for such a change. Since some merchants do lobby for reduced interchange fees, it seems highly likely that they enjoy some degree of pricing power in their given markets and are thus able to pass through less than 100% of the reduction in interchange fees.

In short, when legislation like the CCCA have passed in other countries, they haven’t reduced prices by nearly as much as they were advertised to. Instead, merchants largely charge the same amount, and keep the extra money for themselves, either as extra profit or to invest more in their business. Regardless, this money currently ends up with the consumers in the form of rewards, but with the CCCA, it would end up with the merchants.

This is why lobbying groups like the National Retail Federation (NRF), who represent retailers (aka merchants), so strongly support the CCCA. They say things like “Every time a card is swiped, a Wall Street bank profits off small businesses and consumers”. The key to figuring out if they’re being honest is by looking at the data. As we’ve discussed, the data tells a different story. Here’s what a more accurate headline would say: “Every time a card is swiped, a Wall Street bank gives the consumer a roughly 2% discount off the purchase price, and keeps roughly 1% as their reward for doing that. The retailers and merchants are out 3%”

When you realize that the NRF works for retailers/merchants, it becomes painfully obvious what they’re trying to do: fight for the retailers, not the consumers: they would have no incentive to get this bill passed if retailers actually passed all the savings onto the customer, since then the bill wouldn’t have any positive effect on retailers.

While you can make the argument that I’m biased because Pointwise is compensated by the bank when people open credit cards from our links, our whole business model depends on us earning you the most money possible, so you trust us and keep coming back*.* The NRF’s business model is to earn the retailers and merchants as much money as possible, so they keep paying them membership fees.

The Truth: Credit Cards. A Brilliant Win-Win.

There’s one more critical error in the line of thinking that lowering credit card fees is good for consumers:

1. The entire credit card ecosystem actually creates value for everyone involved.

You might think that’s impossible because of the fees added, but once we address the incentives for the four participants in the ecosystem (merchants, consumers, credit card companies, airlines and hotels), you’ll realize quickly that it really is best for everyone, even those merchants who are lobbying hard to eliminate these fees. Let’s start with them

The Merchants

Merchants are in the business of selling stuff or services. They profit when more people buy their stuff. They reason they put up with credit card fees today is because they know it generates more business for them than they’d have if they didn’t accept credit cards.

Merchants also benefit from the more predatory side of credit cards: about 40% of credit card users had credit card debt at some point last year. Had those people not had credit cards, they would have purchased fewer things, and merchants would be worse off. The credit card companies are therefore providing a service of real positive value to merchants by expending consumers easy-to-access credit. If at any point credit cards weren’t profitable for merchants to accept, they just wouldn’t accept them. No one’s forcing them to. But they’ve made the decision that accepting the payment forms that consumers like, and that gives consumers access to more money to spend at their stores, is actually a net positive for their business.

So why are they lobbying against credit cards? If you look at what they’re lobbying for, they’re actually not lobbying against credit cards. They’re lobbying in favor of effectively forcing credit cards to lower their fees . In other words, they know credit cards help their business, they just don’t want to pay for them if they don’t have to. And if they can spend some money on lobbying to convince the government that credit card fees increase prices for consumers, then they’ll happily take the extra money and not pass it back down to the consumer, as studies mentioned above have shown.

Make no mistake: credit cards help merchants more than they harm them, or they wouldn’t accept them. Credit cards, as they are today, are a net positive for merchants.

Consumers

Consumers benefit the most from credit cards. Using the right credit cards when checking out (see Pointwise to find your best card), a consumer can easily earn 2-5% back on every transaction of theirs, which is often more than the merchant even paid for the transaction! And because many of these rewards come in form of points that can transfer to hotels and airlines, if you use the points correctly, it’s not uncommon to get 2 cents per point instead of 1, earning you 4-10% on every transaction.

Granted, it’s not easy to do that, but it’s getting easier by the day. Tools are coming out every month making it easier to earn the most points on the spending you’re already doing, and making it easier to redeem those points for maximum value. If you don’t believe me, I’m happy to personally help you find great uses for your points. Just download Pointwise, and once you go through the onboarding, head to your profile and click on “Call a Founder.”

We’ll get into how it’s possible that this phenomenon exists shortly, but the fact of the matter is:

1. Consumers can easily earn at least 2% back on every transaction, which is more than the merchants would discount prices if credit card processing fees were lowered.

2. Consumers can often earn more in value than the credit card processing fees even cost the merchant, actually creating new value for the consumer.

Credit Card Companies

This category consists of everyone from credit card issuers (Chase, Bank of America, etc), to credit card networks (Visa, Mastercard, etc) and credit card-issuing fintechs (Bilt, Robinhood, etc), each of whom benefits from the ecosystem in slightly different ways.

Where they all benefit is from the credit card processing fees charged at the point-of-sale. This is charged to the merchant, not the consumer, and the merchant’s recognize that it’s worth it for them or they wouldn’t pay it, and consumers can easily have most of that fee passed down to them by using the right card, which is more than the merchant would pass down to them if these fees were lower. Not all of these fees go back to the consumer, and what’s left over is kept by these middle-men,

But let’s not forget that even with what’s left over, the credit card companies still foot the bill whenever there’s fraud, not the consumer, and have other costs as well. They’re making money, as they should because they’re operating an ecosystem that benefits everybody involved, but they’re not making 3% on every transaction, not even close.

The credit card issuers and card-issuing fintechs also benefit from three other sources of revenue:

1. Annual fees and late fees charged to the consumer

Annual fees are only charged if your credit card charges an annual fee, and you, as a consumer, should only pay those if you get more value than the annual fee in return. Late fees can be avoided by setting up autopay, which I highly recommend.

2. Interest payments from the consumer

You’re only billed for interest if you don’t pay off your credit card in full every month, which should almost never be the case.

3. Cross-selling other products to the consumer

This is another way credit cards benefit everyone involved. By offering advantageous terms on a credit card, a company can entice you to become a customer of theirs, and then introduce you to their other products, and you can decide if you’d like them. Regardless, you get the advantageous terms on the credit card regardless.

Credit card companies do benefit from this system, but a large portion of their fees go right back to the consumer’s pocket, and a large portion of their fees can be easily avoided. What they keep, they deserve, because they’ve created an ecosystem that benefits everybody involved. They are not bad guys on Wall Street taking advantage of you, like the merchant lobbies would have you think: they’re providing positive value to every type of stakeholder they interact with.

Airlines & Hotels

One of these things is not like the other - and between credit card companies, merchants, and consumers - airlines and hotels are the misfit of the group. What are they doing in this ecosystem other than their role as just another merchant? The answer is that airlines and hotels are the symbiotic key that makes it possible for consumers to earn more value in rewards than merchants pay in transaction fees, due to a simple concept called price discrimination.

My AP econ teacher, Dr. Arnold Kling, had a saying he loved: “Price discrimination explains everything.” Airlines and hotels, and their relationship to the credit card world, could not be explained better by any other concept.

As many of you know, airlines and hotels often have partnerships with credit card rewards programs that enable points to be transferred, often at a 1:1 ratio, from the credit card’s points currency to that of the airline or hotel. Using the credit card points currency directly for cash back, or even travel, is often only worth 1 cent per point, but Airline and hotel points can frequently be used for closer to 2 cents per point, and sometimes even higher. Sometimes these points which technically have a “cash value” of 1 cent per point can be transferred to an airline for a business or first class flight at a value of 5-10 cents per point, which is worth several times what the credit card company collected in fees from the transactions that earned you those points!

These redemptions are made available by the airlines and hotels because they think it’s unlikely they’ll sell those same seats or rooms to a cash buyer, so instead of letting it stay empty and they’ll earn nothing, they’re okay earning something and having someone stay there. But they have a problem: who do they give these discounted rates to? Lowering the price of the tickets or room would cost them more revenue than it would earn them because most last-minute bookings are people who really need to get where they’re going, so they’re willing to pay more. Discounting their rate would just be costing the airline or hotel money because they’re willing to pay the full rate! Furthermore, the airline or hotel can probably get away with charging them even more, because their dates are less flexible and they have to go there. That’s why cash prices for airlines and hotels tend to go up the closer you are to the date of the booking. So the airlines and hotels need a way to get something from the unsold inventory, without lowering the prices for the last-minute, largely business travelers, who are willing to pay more. And that’s where points redemptions come in.

Being able to have one price for points and one price for cash means that they can offer a more attractive points rate because they know people are looking for those deals, but they can keep the cash rate high in case someone comes along willing to pay that. By booking with points, you’re signaling to the airline or hotel that you’re a less-urgent, more flexible customer who’s very price sensitive, so they’ll set the points value at whatever they can to make sure the booking is filled by someone. By booking with cash, you’re signaling that you’re a less flexible, less price sensitive customer who’s willing to pay whatever it takes to get on that flight, so they charge them much more. This is called price discrimination.

It also helps the airlines and hotels maintain their brand value. If a first class, Delta One seat from NYC to London costs $4,000 cash, they don’t want to publicly offer it for $500, since then people will wait to book it when the price goes down, and they’re less likely to ever think it’s ever worth the $4,000. But if they let you book it for 50,000 points, which you can transfer from many American Express credit cards, now you’ve paid $500 worth of points for a $4,000 ticket. It’s okay if you think it was never worth $4,000, because you’re not the type of person that would ever pay the $4,000. They just can’t lower the list price so that the people who would pay $4,000 don’t think it’s a $500 flight.

Not to mention Delta, in all likelihood, won’t even get $500 from American Express when you transfer 50,000 to book that flight. That’s because credit card issuers have deals with these airlines to purchase a minimum number of points from them over the course of a year, which guarantees the airline or hotel revenue. In exchange for that high minimum order, the airline or hotel gives the credit card issuer a discount on the points, so they usually aren’t paying a full 1 cent per point for a Delta point. This is how they can afford to give us all these points back and still make so much money. 2% for us might only cost the credit card issuer a small fraction of that because of these deals.

Those of who who fly Delta are probably shouting at your screen right now, pointing out that you can’t actually book that flight with Delta for 50,000 points. That’s true. And that’s just more price discrimination. Delta is popular enough that enough people look to book flights on Delta with points, that they don’t discount their own bookings that much with points. But they still want to fill the plane, so they open cheaper redemption options to their airline partners, so that they can offer the cheaper tickets without diluting their brand. The ~50,000 point offer only exists when they need to lower the price that much, and they offer it through Virgin or KLM: so you transfer your points to Virgin or KLM, and book the Delta One flight there. This way, the countless people who look at Delta’s points pricing won’t see the discounted prices, and their brand won’t be diluted. So by booking through a 3rd party, they know you’re an even more sophisticated deal hunter, so they’re willing to give you a lower price, because you would never pay more. Once again, price discrimination.

There are entire blogs and companies devoted to helping you earn and redeem points for maximum value, but the takeaway you should get from this section is that it makes perfect sense how consumers can get more value from credit cards than it cost the merchant in credit card fees, thanks to airline and hotel partners.

In Conclusion

Credit cards, as they are today, without the CCCA, epitomizes a real, symbiotic relationship where everyone does better because credit cards exist:

• Merchants do better because more people buy their stuff, and those people don’t have to worry about fraud while doing so.

• Consumers do better because they can easily earn 2% back on everything (and in many cases way more), which would not trickle down to them if credit card processing disappeared. Just remember to pay off your cards in full every month, and make sure you’re using the cards that are best for you.

• Credit card companies do better because they make whatever’s left over after they’ve given the consumers all their rewards. They compete with all the other credit card issuers on who can give the consumer the best rewards. That’s the most important competition in this industry, and it most certainly is not a monopoly, like the NRF wants you to think.

• Airlines and hotels do better because they’re able to sell their unsold inventory at a steep discount, but for much more than $0, without hurting their brand.

Today’s credit card industry is a real win-win-win-win.

——

Editors Note: The opinions expressed in this article are solely the author's and do not reflect the views of any bank, credit card issuer, hotel, airline, or other entity. This content has not been reviewed, approved, or endorsed by any of the organizations mentioned.