Weekly reading – 20th march 2021

What I wrote last week

The economics of a credit card

Business

Hy-vee CEO shared how Covid shaped the company’s operations moving forward

Why Amazon Fresh stores will likely rock a few boats. As its competitors do more shipping from their own stores, Amazon can get on level terms in that sense with having more stores of their own in strategic locations. Plus, if they can get these cashierless stores to run properly, they will be able to cut back a significant line item on the Income Statement, paid employees!

How Trader Joe’s $2 wine became a best-seller

Telegram App Is Booming but Needs Advertisers—and $700 Million Soon 

The new Google Pay repeats all the same mistakes of Google Allo

Apple brand loyalty hits all-time high as Samsung loyalty dives

Austin Rief: How Morning Brew went from college newsletter to $75 million in 5 years

She Came to the US to Study With Only $300 in Her Pocket — Now She’s a NASA Director For the Mars Rover

What I found interesting

Does Atlantic Canada have a blueprint for rural revival in the post-pandemic era?

Facebook’s GDPR bypass reaches Austrian Supreme Court

Stats you may find interesting

BNPL grew by 215% year over year in Jan and Feb 2021. Total eCommerce spending reached $121 billion so far

As of February 2021, 45% of Square sellers accept online payments, up from 30% a year ago

56% of the people surveyed by AirBnb preferred domestic travel post-pandemic

How do credit card issuers make money? What are the main types of credit cards? A quick look into the credit card world

Launching a credit card product is similar to putting together a jigsaw. There are many pieces: how to appeal to customers, which customers are an issuer’s likely target, what a good experience looks like, how an issuer can make money and how a card can compete with existing products on a market. In this post, I’ll go over my thoughts on the economics of a credit card, the main credit card types that I see on the market (excluding those debit cards that have credit card functions), the appeal of Apple Card and how different cards compare to one another.

Economics of a card

An issuer essentially generates revenue from three main sources with a credit card: interest payment when customers don’t pay off their balance, fees (late fee, annual fee, cash advance fee, balance transfer fee, foreign transaction fee and others) and interchange. Interchange is a small percentage of a transaction that a merchant pays to a card issuer whenever a customer uses a credit card to pay. The more spend is accrued, the more interchange issuers generate. Interchange rates are determined by networks such as Visa, Mastercard, Discover and American Express. The exact rates depend on a lot of factors: the industry or category that a merchant is in, what type of card (high end or normal) is being used, regulations (Europe imposes a limit on interchange rates, unlike the US) and how a customer uses the card to pay (swipe, chip, mobile wallet, online, phone..).

On average, some categories such as Airlines, Restaurants, Quick Restaurant Services, Hotels or Transportation have an interchange rate somewhere between 2% – 3%. Other categories such as Gas and Grocery, especially at Walmart, Target or Costco usually yield a very low interchange rate around 1% – 1.4%. Any credit card that offers higher than 3% in cash back in a category likely loses money on that category as the interchange cannot make up for the reward liabilities. Issuers are willing to offer 3-5% cash back, knowing that they lose money on that front, because they are banking on the assumption that the money that they make up from other sources will offset that loss. Specifically, they are likely to make money on categories with 1%. For instance, if you buy clothes or pay for a subscription online or buy something from a Shopify store, your card issuer is likely to make at least 1% in interchange, after they give you 1% in cash back. Additionally, issuers that offer a rich reward scheme usually impose an annual fee to offset the reward liabilities and the signing bonus that they use to acquire customers.

Hence, cards with no annual fee offer a cash back between 1.5 – 2%. They can’t afford to go higher than that because the maths would unlikely add up. Cards that have an annual fee often come with high rewards and a big bonus. While a big bonus can be an attractive tool to acquire customers, it incentivizes short-term purchase bursts and unintentionally attracts gamers, customers who receive the bonus, cash it out and either become a ghost, if they don’t have to pay an annual fee, or close out the card for good. There are a lot of gamers and gamers aren’t profitable to issuers. However, issuers still dole out a big bonus and attractive rewards because they think that there are customers that stay for a long term and can provide the interest income and fees that issuers need.

Three essential types of credit cards

I call the first type of cards the “Everyday Card”. Examples of this category include Blispay and Citi Double Cash Back. These cards offer a standard rewards rate on every purchase category (1.5% to 2%) with no annual fee. There is usually a 3% foreign transaction fee and there is no signing bonus. What makes Everyday Card appealing is that customers do not need to remember the complex rewards structure. They can just “set it and forget about it”. It earns them respectable rewards on every purchase, even at Walmart.

The second type of cards is the “No Annual Fee With Bonus”. Examples of this category are Discover It Cash Back, Freedom Unlimited or Freedom Flex. These cards’ highest reward rate is usually 5% on a certain pre-determined category that tends to yield a high interchange rate. In some cases, this 5% rate can rotate every quarter, keeping it interesting for customers and making them locked in if they want to activate a preferred category. There is a signing bonus for new customers. Some cards reward customers with a few hundred dollars in a statement credit if they spend a certain amount in the first 90 days. This mechanism is designed to make customers locked in early. The issuers bank on the assumption that once customers earn their signing bonus, they will stick around to keep those rewards points alive. However, it’s not uncommon for customers to cash out their rewards and become inactive afterwards. 

Discover’s signing bonus is designed to keep customers active during the first calendar year. They promise to match the cash back rewards at the end of the first year, but the bonus is a one-time occurrence and doesn’t repeat. This mechanism may keep customers active longer than what an outright statement credit does, but customers can always leave after the first year.

The last type of cards usually comes with an annual fee. Examples are Chase Sapphire Preferred or Bank of America Premium Rewards. Cards in this category come with a signing bonus after qualifying conditions are met and with a rich rewards structure. To offset expenses, issuers impose an annual fee. Customer acquisition may not be an issue with cards in this category, but will customers stay around after the signing bonus? Or are customers happy enough to pay a high annual fee every year? Also, these cards’ reward rate is high only in categories with higher interchange rate such as travel or dining. The rate is pretty light (1%) in other categories. While this approach appeals to a specific segment of customers, for customers that want “to set it and forget it”, does it still carry that same appeal though?

If you find credit cards complex and confusing, that’s normal because they are usually designed that way

Most credit cards can be pretty complex and confusing to customers. Let’s start with rewards. A tiered reward structure forces customers to mentally remember all the combinations of categories and rates. If customers have multiple cards in their wallet as they often do, it’s not an easy ask. Of course, there are folks that make a living in maximizing rewards, but that doesn’t work for the rest of us. In addition, it’s not always clear to customers how to categorize merchants. Merchants are categorized by Merchant Category Codes. These codes help issuers set up rewards and help networks determine interchange rates. MCCs are known in the banking industry, but to an ordinary customer, they don’t usually mean much. In some cases, issuers provide a list of qualifying merchants, but they can’t list all the available merchants and the practice is not ubiquitous.

Moreover, reward redemption can be a time-consuming process. Points or cash back earned in this cycle have to wait at least till the cycle ends before they are available for redemption. It can take longer in some cases, especially when it comes to signing bonuses. Here is a list of how long it takes for points to post at different issuers, compiled by Creditcards.com

 How long it takes to redeem the signing bonus?How long it takes to redeem spending rewards
Amex8-12 weeks after a customer hits the spending requirementWhen the current cycle ends
BofAAt the close of the billing cycle when the minimum spend is metWhen the current cycle ends
Capital OneWithin 2 cycles of when the spending requirement is metUp to 2 cycles
ChaseUp to 6-8 weeks after a customer hits the spending requirementWhen the current cycle ends
Citi8-10 weeks after a customer hits the spending requirementWhen the current cycle ends. With Citi Double Cash Back Card, it can take a bit longer if customers don’t pay in full
DiscoverWithin 2 cycles after a customer hits the spending requirementWhen the current cycle ends
US BankUp to 2 billing cycles after a customer hits the spending requirementWhen the current cycle ends
Wells FargoUp to 2 billing cycles after the qualifying period When the current cycle ends
Figure 1 – How long it takes issuers to let customers redeem rewards

The final point in rewards is that issuers tend to deceptively inflate the rewards by posting numbers in points, instead of dollars. Understandably, 100 points sounds much better than $1, even though they have the same value. Nonetheless, it creates an unnecessary level of complexity for customers to mentally convert points into cash, especially when the reward value is big.

Rewards aren’t the only source of frustration for credit card customers. Credit cards are essentially loans on which you may or may not have to pay interest. However, issuers hope that customers will incur interest and fees (as long as they don’t charge off). How often are fees prominently and clearly marketed as rewards? How often do you see in advance the potential interest payment if you don’t pay off your balance? Here is a study by Experian on the concerns that consumers have about credit cards

Consumer concerns about having a credit card
Figure 2 – Consumer concerns about a credit card

Apple Card is designed to do something different

Apple launched Apple Card in August 2019 in collaboration with Goldman Sachs. Customers can apply for an Apple Card right from the Wallet app, which is pre-loaded on an Apple device. The preloading is a significant advantage as customers don’t need to either load another bank app or search for a website and apply for a card. As soon as an application is approved, customers can use their Apple Card immediately either by holding your device near an NFC-enabled reader or paying online. With Apple Card, cardholders earn 3% cash back on purchases at Apple and strategic partners such as Exxon, T-Mobile, Walgreens, or Nike, 2% cash back on others purchases using Apple Pay and 1% cash back using the titanium physical card. The 2% cash back on other purchases can be appealing, but not every offline or online merchant allows Apple Pay.

The biggest selling points of Apple Card are transparency and simplicity. Take their no-fee structure as an example. There is no fee involved with Apple Card. No annual fee, no foreign transaction fee, no over-the-limit fee and no late fee. While Apple remains coy on cash advance fees, their special clientele may not use the mainly virtual Apple Card for this specific reason much. 

The simplicity also goes into their daily cash back. Typically, cash back earned through a credit card can take weeks to be registered and redeemed. Points or cash back earned this cycle must wait at least till the cycle ends before they are available for redemption. With Apple Card, cash back is earned daily in Apple Cash. As long as transactions are posted, customers can see the earned amount reflected in their Apple Cash. In real money term not in points. This takes away an unnecessary step for customers to mentally convert points into cash. Furthermore, Apple Cash can be used at any time, either in a person-to-person transaction, in a deposit back to a checking account or to pay back the outstanding balance in Apple Card. 

In terms of transparency, Apple Card tells customers how much interest they are paying when making a payment. And their APR is on par with other issuers’. In the Wallet app, customers can determine how much of the outstanding balance they want to pay. Depending on the amount, Apple will let customers know in advance their interest so that they can make an informed decision. It is in contrast to what almost all other issuers do. 

Apple Card's flexible interest rate
Figure 3 – A simulation to show interests on Apple Card varies based on how much a cardholder can pay.
Source: Apple

Apple Card only works with iOS devices and Apple Pay can be a challenge for elderly or less tech-savvy customers. Nonetheless, no card is perfect for everybody and the transparency and simplicity can teach us a lesson on how to craft a good customer experience. Despite being available only in the US and all restrictions above, Apple Card’s portfolio balance grew from $2 billion in March 2020 to $3 billion in September 2020 and roughly $4 billion at the end of 2020. Not bad for a portfolio with one card that is restricted to iOS devices. 

Annual fee or no annual fee? Appealing and complex or straightforward and simple?

A good practice in positioning is to use a 2×2 matrix. In this case, I’ll look at Apple Card and the three main credit cards mentioned above through whether they are easy to use and whether they have an annual fee.

Credit card positioning
Figure 4 – A 2×2 positioning matrix for credit cards

Let’s look at the positioning chart above. On the top right corner, we have an ultra-luxury card such as The Platinum Card from Amex. This card’s annual fee runs up to $550 and while rewards rate can range from 1x to 10x, it is not easy to remember all the details or to redeem rewards. On its left side, we have cards such as Capital One Venture and Chase Sapphire Preferred. These cards’ annual fee is $95, lower than the Platinum Card’s. Similarly, the complexity of cards such as Chase Sapphire Preferred is still high. Capital One Venture has 2x rewards rate on every purchase, making it less complex to use for some users, but it’s still time-consuming to redeem cash back. 

Moving further left, there is Capital One Quicksilver. This card’s annual fee stands at $39 and it offers 1.5x on every purchase. It’s in the middle of the spectrums. On the “no annual fee” side, we have two groups. The first group features cards such as Freedom Flex and Discover It Cash Back. These cards offer a 5x reward rate, but it rotates every quarter and to some customers, that can add some complexity. The other group features cards such as Citi Double Cash Back and FNBO Evergreen. These cards have no annual fee and offer 2x on every purchase. Nonetheless, they still have a complex fee structure and a reward redemption process that can be improved.

The point here is that it’s very competitive on the top half of the chart. All these cards have their own unique selling points that appeal to different customer segments. What they do have in common is that their fees and reward redemption are pretty complex.

On the other side of the x-axis, there are Apple Card and Upgrade Card. Even though it’s straightforward to use Apple Card as there is no fee and cash back is earned daily, the use of Apple Card depends much on whether customers have an iPhone and whether merchants enable Apple Pay. 40% of mobile users in the US don’t own an iPhone and as discussed above, older and less tech-savvy customers may not find Apple Pay comfortable. Without Apple Pay, the titanium card itself earns customers a paltry 1% cash back. 

Upgrade Card is a credit card issued by Sutton Bank, a medium sized bank in Ohio with $500 million in assets, and marketed by Upgrade. There is no fee with Upgrade Card. Here is what the company claims on its website

Not all traditional credit cards charge fees. However, creditcards.com’s 2020 Credit Card Fee Survey found that the average number of fees per card is 4.5. For example, the 2019 U.S. News Consumer Credit Card Fee Study found that the average annual fee (including cards with no annual fee) is $35.23, the average late fee is $36.34 and the average returned payment fee is $34. 01. The Upgrade Card charges none of these fees. Over 90 percent of cards charge balance transfer fees and cash advance fees. The Upgrade Card enables you to transfer cash from your Personal Credit Line to your bank account with no fees.

Source: Upgrade

With Upgrade Card, customers earn 1.5% cash back on all purchases as soon as customers pay off balance. The 1.5% cash back rate is lower than what Apple Card customers earn using Apple Pay, but on the other hand, Upgrade Card is device-agnostic and doesn’t rely on any mobile wallets. Hence, it is more accessible. However, Apple Pay allows customers to earn and use rewards daily while Upgrade Card only allows customers to redeem rewards after they make full payments.

According to the book The Anatomy of The Swipe, medium sized banks are essentially unregulated and can charge a higher interchange rate than big regulated banks. Hence, it’s very likely that Upgrade Card’s interchange rates are higher than those of cards issued by the likes of Chase or Capital One. The higher interchange rates can help offset rewards liabilities and generate revenue.

In fact, I am surprise to find no product like Upgrade Card from big banks. I suspect it would take a huge investment in infrastructure by legacy banks to offer the Daily Cash feature that Apple Card has. But legacy banks can essentially waive all fees like Upgrade Card does. While the likes of Chase, Discover or Capital One have more expenses than a smaller platform like Upgrade, they also have more popular brand names than Upgrade; something that would help tremendously in customer acquisition.

In summary, the credit card world is highly competitive. If an issuer follows the conventional way of launching a credit card, it will surely have a lot of competition and little to differentiate itself from competitors. In the upper half of Figure 4 above, I do think all the concepts and variations of rewards and economics have been tried. To be different, an issuer has to think differently and appeal to customers more with a superior customer experience (easy and simple to use) and less with complex features.

Where debit meets credit – This debit card features credit card benefits

I came across an interesting startup called Point, which offers Point App and Point Card. Point App is a mobile wallet application from which you can apply for and manage your Point Card. Point Card is a debit card that offers benefits similar to those of a credit card. Benefits include 5x points on subscriptions such as Netflix, Spotify, Hulu and some others, 3x points on food delivery & ride share, 1x points on everything else, no foreign transaction fees and more. Instead of banking on your missing your payments, Point makes money from interchange fees which are a small percentage of your spend and a subscription fee. In order to use Point Card, a customer must pay $7/month or $5/month on an annual plan.

I think this card will be helpful to those who are conscious of their budget and interested in credit-card-like benefits. 47% of Americans carry credit card debt that amounts to $890 billion in total in Q1 2020. Failure to make payments on time results in a high interest which often comes in the range of 13% – 26%. Further inability to make payments repeatedly will put a revolving customer in a vicious cycle as in that case, compounding interests work against him or her. I work for a bank and a credit card issuer and let me tell you: we want you to be delinquent on your credit card debt. It’s a significant source of revenue and profit to issuers. With Point Card, the risk of delinquency is taken away as you can only spend money that you actually have. There is no temptation to make impulsive purchases on credit and break personal budget.

Point Card may not make sense for every one, though. I mean, if you are willing to pay a few bucks a month to have a cool-looking debit card and some nice features that mimic those of Apple Card, by all means. If you want to break even on a $5/month annual subscription at 1x points redemption rate, you’ll need to spend at least $500/month for this investment to make sense financially. If a family puts all utilities, car insurance and subscriptions, and other discretionary expenses on a Point Card, it can easily exceed $500 while the family can avoid the risk of delinquency.

I do think it’s an interesting concept that can appeal to a group of consumers. As a fan of personal finance, I want to see more folks in control of their own finance and stay away from the temptation from card issuers. I hope that as Point scales and continues to be nimble without a big budget in marketing as well as physical branches, it can offer more rewards to attract more customers.

Cobranded Credit Cards and Apple Card

In this post, I’ll try to deduce the reasons why Apple and Goldman Sachs decided to collaborate on Apple Card. What follows in this entry is my deduction from available information and based on my experience working in the credit card industry. First, I’ll touch on the concept of cobranded credit cards and what brands and issuers often get out of a partnership. Second, I’ll talk a bit about Apple Card. Last, I’ll give my thoughts on why Apple and Goldman Sachs may benefit from their relationship. These are my own thoughts only and if you have any thought or material that can contribute to the topic, I’ll appreciate it that you share with me.

Cobranded Credit Cards

You probably have seen a few cobranded credit cards before at popular stores or when you fly with domestic airlines

Source: Google Images

So, what exactly do brands and issuers get for working on cobranded credit cards?

Every brand wants to establish as close a relationship with consumers as possible. One of the popular methods is through a credit card with exclusive benefits. However, brands would be subject to a lot of regulations if they issued credit cards on their own. There would be also a lot of expenses that’d go into servicing accounts. No brand wants that extra burden in addition to running their own business. That’s why they need financial partners.

To compensate an issuer for bearing the risks and operational expenses, a brand usually takes care of the cost of exclusive brand-related benefits. For instance, shoppers receive 5% cash back at Target when they use Target credit cards. I don’t know the exact detail, but my guess is that Target will be responsible for most of the cash back, if not all. Additionally, brands can assist issuers with acquisition costs. Issuers spend thousands of dollars, if not much more, every year to acquire new customers. Brands have an already established relationship with their customers, brand awareness and financial resources that can help issuers in this regard.

On the other hand, issuers are responsible for dealing with financial regulations and servicing accounts. That’s why issuers try to sign as many partners as possible to leverage economies of scale. A small number of partners wouldn’t make operational expenses justified.

Issuers also have to compensate partners for leveraging their brand names. Agreements between issuers and partners vary on a case-by-case basis, but I wouldn’t be surprised if an agreement featured:

  • An issuer pays a partner for each new acquired account and a smaller fee for a renewal
  • An issuer pays a partner a fixed percentage on total purchase volume
  • An issuer pays a partner a fee when accounts make the first purchase outside partners’ locations

What do issuers get in return?

Issuers, of course, keep all financial charges and fees such as annual fees, cash advance fees or late fees. Besides, issuers can generate revenue from interchange fees. In every transaction, a merchant bank which works with a merchant has to pay an issuing bank which issues a credit card to the consumer who shops at the merchant a small fee for accepting credit cards as payment. Payment networks like Visa or Mastercard act as a middle man between a merchant bank and an issuing bank, and decide how big the fee, which is called interchange, should be. What I just describe is a gross simplification of what transpires behind the scenes in a couple of seconds or less in a transaction. There is a lot more to it. Essentially, for the sake of simplicity, just imagine that for every transaction, an issue bank receives 2% of the transaction volume in interchange fees. So if an issuing bank handles $1bn in transaction a month, that bank will get $20 million in interchange fees. Lastly, as mentioned above, issuers can also leverage partners in terms of acquisition costs.

IssuersPartner Brands
Responsibilities– Service accounts and handle regulatory compliance
– Bear risks of charge-off
– Compensation to partners 
– Additional rewards expenses as selling points to consumers
– Assistance in acquiring new accounts
Benefits– Financial charges and fees
– Interchange fees
– Marketing leverage from partners’ outreach
– Deepen relationships with customers
– Compensation from issuers
Table 1

Apple Card

Apple Card is an Apple-branded credit card issued by Goldman Sachs. You can only apply for an Apple Card via your wallet app on Apple-produced devices such as iPhone or iPads. The Card is so synonymous with Apple that you can barely hear about Goldman Sachs.

Apple reportedly will offer monthly payment plans for iPads and ...
Source: The Verge

Apple Pay’s selling points include:

  • No fees
  • Simple application process
  • Premium look and feel
  • Unlimited 2% cash back when you pay with Apple Card using your Apple Watch or iPhone
  • 3% cash back from select merchants such as Uber, T-Mobile, Nike, Walgreens, Duanereade and of course, Apple itself
  • Security as each transaction must be verified either by Touch or Face ID
  • Apple and Goldman Sachs promise not to sell consumer data with a 3rd party for marketing purposes

What’s in it for Apple and Goldman Sachs in launching this Apple Card?

Goldman Sachs isn’t know for consumer banking. It’s known for its investment banking business. Apple Card is the first attempt at consumer banking from the renowned company. As the issuer, Goldman Sachs (GS) will have to deal with all regulatory and security challenges while bearing the risk of charge-off. They will also take part in servicing accounts, but the work is shared with Apple as Apple Customer Service agents handle upfront communication with users. Since Apple Card has no fees whatsoever, what GS can benefit from this collaboration, I allege, include

  • Interchange fees
  • Insane marketing power from Apple and its global footprint in the form of millions of installed iphones
  • I imagine that if this collaboration succeeds, GS will want to sign more partners to achieve economies of scale, leveraging what they learn from operating Apple Card

Apple allegedly wants to launch Apple Card for two reasons: 1) to deepen relationship with users, to motivate them to buy their hardware more 2) to generate more service revenue. As a technology partner, I don’t imagine Apple will have to deal with fraud, regulatory or security concern. In exchange, Apple provides marketing outreach and technical assistance in incorporating Apple Card into its ecosystem. Additionally, from what I read, customers who need technical assistance will reach out to Apple Customer Service agents. Hence, that’s also what Apple brings to the table. Also, the company may allegedly be responsible for Apple-only rewards and interest free payment plans when customers buy Apple products. In terms of rewards with 3rd parties such as Nike or Uber, I can’t find any relevant information. If I have to guess, my money will be on Apple taking the bill for extra rewards as well.

Goldman SachsApple
Responsibilities– Service accounts and handle regulatory compliance
– Bear risks of charge-off
– Compensation to partners 
– Market Apple Card to users 
– Offer technology to make the card work with Apple Pay and its devices
– Help service accounts 3% cash back on Apple products and services
– Interest-free payment plan for customers when buying Apple products
Benefits– Interchange fees
– Leverage marketing power from Apple and its footprint
– Deepen relationships with customers
– Compensation from Goldman Sachs
Table 2

According to Apple, the number of transaction through Apple Pay has grown substantially since it was launched. As of Jan 2020, the annual run rate for Apple Pay reached 15 billion transactions. Not all Apple Pay transactions are through Apple Card. The card debuted only in August 2019. Since Apple doesn’t offer details on Apple Card transactions, let’s run some scenarios by assuming that the annualized transaction count for Apple Card is 500 million to 2 billion. If average ticket size (dollar amount per transaction) ranges from $20 to $60, the transaction volume will be as follows

 Annualized Apple Card Transactions
             500,000,000                         1,000,000,000                2,000,000,000 
$20$10,000,000,000$20,000,000,000$40,000,000,000
$40$20,000,000,000$40,000,000,000$80,000,000,000
$60$30,000,000,000$60,000,000,000$120,000,000,000
Table 3

Interchange fee rate varies depending on numerous factors. However, if we assume that the rate is 2% of purchase volume, based on the scenarios above in Table 3, GS would receive the following as interchange fees

Annualized Apple Card Transactions
             500,000,000                         1,000,000,000                2,000,000,000 
$20$200,000,000$400,000,000$800,000,000
$40$400,000,000$800,000,000$1,600,000,000
$60$600,000,000$1,200,000,000$2,400,000,000
Table 4

As you can see, the more Apple Card transactions, the bigger the interchange fees for GS. Given that Apple has legendary marketing prowess, an installed base of millions of devices and rising demand for contactless payments, the numbers may even grow bigger in the near future.

On Apple’s side, it is reported that Apple takes 0.17% cut on each Apple Pay transaction. In terms of Apple Card transactions, I think the cut will be even bigger, but won’t be bigger than GS’ interchange fee rate. Since we assume that GS receives 2% in interchange fee rate, let’s say Apple receives somewhere from 0.2% to 1% on purchase volume. How much would Apple receive, using the lowest purchase volume for each scenario of transaction count (first row respectively in Table 3)?

 Annualized Apple Card Transactions
             500,000,000                         1,000,000,000                2,000,000,000 
0.20%$20,000,000$40,000,000$80,000,000
0.50%$50,000,000$100,000,000$200,000,000
1%$100,000,000$200,000,000$400,000,000
Table 5

A few days ago, Apple and Walgreens announced that new Apple Card customers would receive $50 bonus in Apple Cash after spending at least $50 at Walgreens using the card. The promotion is valid till the end of June. It signals to me that 1) Apple wants to acquire more customers for Apple Card and 2) Apple may also receive a fee whenever a new customer comes on board. I don’t imagine $50 bonus would be paid for Walgreens or GS. Why would they do so when there is no sustainable benefit? If Apple shoulders the cost of the acquisition bonus, or at least most of it, it will likely not make financial sense to just rely on fees from card purchases to recoup the investment.

In sum, I hope that the information I shared and my thoughts are useful in helping you understand more about the credit card world that is complex yet fascinating. I spent quite some time thinking about the collaboration between Apple and Goldman Sachs as the presence of a tech giant and an investment bank in the consumer banking area is quite interesting. There isn’t much information out there so I would love to learn from whoever has useful information to contribute to the topic at hand.

Disclaimer: I own Apple stocks in my personal portfolio

Complexity of credit card data

This entry is just a little bit of what I have experienced after more than one year working at a bank. By no means am I trying to imply that I am an expert in credit card data. Not even close. This is simply to shed some light or pull the curtain a little bit into the world of banking. It’s also a way to put into writing what I have learned or think I have learned so far.

Lost and stolen

One reality that makes compiling and analyzing credit card data complicated and tricky is that people lose their cards or have them stolen all the time. When that happens, banks issue new cards to customers with totally new account numbers. On the front end, customers don’t see any change. New cards just work like old cards. However, on the back end, it’s a totally different ball game. If an analyst like myself wants to analyze performance of cards, especially accounts that have a complicated history, such as spend, balance and profit history, a reconciliation of all the account numbers associated with the original account number can be daunting and easily lead to mistake.

Tricky balance between risk and profit

If you are like me who uses cards regularly and pays off balance every month to avoid financial charges, you are not a profitable customer to credit card issuers. To make money off customers, issuers usually charge interests on late payments and fees such as annual fees, foreign transaction fees, over limit fees. No late payments mean no financial charges and no profit. On the other hand, customers who are usually late on payments and accrue balance are usually the riskiest bunch. Such customers, as we call revolvers, are more likely to charge off and cost issuers money. As a result, issuers must find a sweet spot between risk and profitability. Having the majority of customers under 680 FICO can lead to higher profitability, but also higher risk at the same time. Acquiring great credit customers poses a lower risk, but also a lower chance of profitability.

One popular practice in the credit card world is balance consolidation. In a layman’s term, it is an offer allowing customers with a balance at a higher interest rate to transfer the balance to another account at a substantially lower rate which can be 0% for several months. This offer appeals to credit trapped customers who are likely to be late on payments, but want to avoid interests. By taking on more accounts and balance, issuers take on more risks, but balance consolidation may not always lead to higher revenue and profit.

Ambiguous definition

Sometimes, metrics in the credit card world may not be as straightforward as they sound. For example, if a customer calls to close a credit card, but chooses to pay balance in installments instead of one big payment, is that credit card considered closed or still open with an outstanding balance? When discussing “active” accounts, are we talking about “balance active” (having balance > 0) or “debit active” (having net purchase which is comprised of purchases minus refund > 0)? When discussing spend per account, are we talking about spend per account or spend per “debit active” account only? Those are just a few examples on top of my mind. There are plenty more cases where a question, straightforward as it may seem, is really not.

Apple to apple comparison

A performance analysis needs a benchmark to compare against. To analyze a cohort of accounts, it’s important to find another cohort that is as similar characteristically as possible to the one at hand. The challenge is that there are multiple elements to consider such as acquisition channels, vintage (when accounts were opened), cashback or rewards cards, FICO, credit bureau segments (more on this later), brands that cards are associated with (FCA, Delta Airlines, Walmart…) and so on. If the task is to perform an analysis on the same set of accounts over time to test the effect of an offer, seasonality needs to be considered. Obviously, consumers spend more during holidays. So, comparing spend in Dec to spend in Feb isn’t really a fair one.

External data

Issuers work with agencies such as Acxiom to acquire demographic data. To my best knowledge, issuers send account information such as addresses and names to Acxiom to match up with their demographic database such as household income, net worth, how likely they have a mortgage, how likely they have children, how they are etc…Such information is sent back to issuers for future marketing purposes. One of the challenges arising from this practice is that an account can have more than one user. Joint accounts can have two users whose demographic profile can be different. In that case, a decision has to be made as to which profile should be used and data needs to be handled with care. Otherwise, it would lead to double accounting.

Issuers can work with credit bureau agencies for credit score and other information. An individual banks with multiple corporations and has multiple cards with different issuers. It’s helpful to know how big of a customer’s wallet share your issuer makes up. For instance, it’s helpful to know how much a customer allegedly tends to spend in a year and the percentage of that spend goes to your issuer. The same goes for all credit card balance and revolving balance. Agencies such as Experian receive data from different issuers and return their estimated data back to issuers for marketing purposes.

Another challenge is that between the time when data is sent to external data partners and the time when data is sent back to issuers, accounts can be lost or stolen. Reconciling that change can be problematic.

I have worked intensely at my current company for the past year. It’s really satisfying to learn how data works, what goes under the hood, what the nuts and bolts are and what can be done to help the business. There are a lot to learn and do such as

  • How to optimize the acquisition process? How to get the best response rates for Direct Mail, an important practice in this industry
  • How to encourage spend?
  • How to balance risk and profitability?
  • Who are the “best” customers?
  • How to use data to improve customer experience
  • How to improve interchange?
  • How to predict charge off?
  • How digitally engaged are customers?

I hope this entry has been helpful somewhat. If I miss anything or any point is incorrect, please leave a comment. I hope I’ll learn more and be able to share with you in the near future.

Contactless and card penetration trend from Visa.

In this post, I want to share with you what I found while I was doing some research on credit card trends.

Tap to pay

  • As of March 2020, one in three card present transactions by Visa is tap to pay, up from one in four a year ago (1)
  • In 2019, excluding the US, 55% of Visa transactions were contactless (1)
  • In the US, there are 145 million contactless credit cards in circulation and Visa expects that the number will reach 300 at the end of 2020 (1)
  • 17 out of the top 25 issuers are fully issuing tap to pay cards. 8 out of the top 10 merchants are accepting tap to pay. 60% of all in-store transactions in the U.S. are now taking place at terminals that are enabled for tap to pay. (1)
  • Globally, tap-to-pay has resulted in 20% life in card transactions. (2)
  • In the US, tap-to-pay cards led to plus 4 more transactions per month and $160 increase of spend per month (2)
  • “CEMEA now has the highest tap to pay penetration of any Visa region. 2 of our CEMEA countries, Russia and Georgia, are in the top 10 tap to pay countries in the world. Georgia is, in fact, number one, with an incredible 96% tap to pay penetration.” (2)
  • 77% of active terminals in South America are contactless-enabled. Tap-to-pay penetration was doubled in one year. Chile and Costa Rica have a leading 50% contactless penetration
  • “For example, on transit for London services, we saw double the transactions and 70% higher growth in spend by tap to pay transport for London users versus those not using tap to pay. In New York City, Visa is partnering with Chase to promote tap to pay in and around subway stations that are contactless enabled. As a result, Visa has crossed 4 million taps within the MTA system and contactless payments will be accepted system-wide by the end of 2020.” (2)’
  • In Asia Pacific, tap to pay penetration increased from 29% in 2016 to 41% in 2019. Post activation, tap-to-pay card saw 3.8 times more transactions and 1.8 times more spend per card. Specifically, tap-to-pay cardholders made 3.9 times more transactions at fast food restaurants and 2.3 times more at supermarkets and grocery stores
Source: Visa

Card Penetration

  • On average, an American makes 12 cash transactions a month. 55% of all transactions under $10 were made in cash (2)
  • In daily segments such as gas or supermarkets, card penetration stood at 60% for the US (2)
  • Retail digital spending has grown at CAGR of 23% since 2016, yet it still only makes up 14% of global retail spending (2)
  • Cash and check penetration remains at 92% for Sub-Saharan Africa, excluding South Africa (2)
  • “The macro trends are incredible. It (Sub-Saharan Africa) has the fastest-growing population among major regions, double the global average and half of sub-Saharan Africa is under 18 years of age. It has 46 countries, and 6 of which are in the top 10 fastest-growing economies in the world. The market is still greenfield. Cards have only penetrated 3% of PCE, and 2/3 of the population does not have a bank account. Yet Africa is home to nearly half of all mobile money users. Sub-Saharan Africa is mobile first. People use their mobile phones daily to make and receive payments. This opens immense, immediate and long-term opportunities for Visa.” (2)

References

  1. Visa Inc at Wolfe Research FinTech Forum (11th March 2020)
  2. Visa 2020 Investor Day

Disclaimer: I own Visa stocks in my personal portfolio

Today I learned – 1st Jan 2020

US lags behind the world in tap-to-pay

The latest annual report by Visa wrote:

Contactless payments—or when a consumer taps to pay at checkout with a contactless card or mobile phone—continues to see strong adoption around the world. In 2019, excluding the United States (“U.S.”), tap to pay had surpassed 50 percent of face-to-face transactions that ran over the Visa network. This is up from less than 30 percent just two years ago. There are now more than 50 countries where tapping to pay represents at least a third of all domestic face-to-face transactions processed on our network, up from 35 countries at the end of last fiscal year.

The U.S. is starting to catch up to this global adoption rate. In 2019, U.S. financial institutions began issuing contactless cards to customers nationwide. There are now more than 100 million Visa contactless cards in the U.S., and we expect that number to grow to 300 million by the end of 2020

Contactless payments can also open up new payment experiences, such as transit. Transit continues to be an important use case for introducing consumers to the benefits of tapping to pay. In 2019, Visa helped launch contactless transit solutions in cities around the world, including Belarus, Edinburgh, Florence, Manchester, Miami, Milan, New York, Rio de Janeiro, Singapore, São Paulo and more—making it easier for people to get around while reducing operating costs for private and public transport operators.

Visa’s 2019 Annual Report

In July, Apple CEO Tim Cook said the following in its earnings call

In the United States, in addition to a successful integration into Portland’s transit system in May, we’re beginning to rollout of New York City transit and will launch in Chicago later this year. In China, Apple Pay launched the payment card for Didi the world’s largest ride hailing provider.

As I’ve said before, transit integration is a major driver of a broader digital wallet adoption, and we’re going to keep up this push to help users leave their wallet at home in more and more instances.

Source: Seeking Alpha

While iPhone and Apple devices are wildly popular in the US, a recent study reported a low adoption rate of 9% of Apple Pay among Apple-device owners. It’ll be interesting to see how transit helps with the adoption of Apple Pay and, as a result, contactless payment in the US. In Omaha, to the best of my knowledge, there is no contactless payment at Walmart. Adoption at such a chain that attracts traffic like Walmart will definitely increase the use of tap-to-pay.

US seemed to have a bigger cash transaction on credit card than the rest of the world

While studying the reports from Visa and Mastercard, I noticed something quite interesting. The US seems to withdraw more cash from credit card each time than the rest of the world. The figures from Visa and Mastercard are pretty similar, signaling a true pattern. The following data is from Visa and Mastercard in the quarter ended Jun 30, 2019.

 Cash Volume ($ billions)Cash Transactions (millions)Average Cash Ticket
US1415$933.33
International49223$219.73
Source: Visa
 Cash Volume ($ billions)Cash Transactions (millions)Average Cash Ticket
US1010$1000.00
International41190$215.79
Source: Mastercard

Amazon Secured Credit Card for those with low credit profile

Amazon partners with Synchrony to offer a secured credit card to those who have a low credit score. Normally, a low credit score results in a rejection of a credit card application at a financial institution due to default concern; which, in some real-life cases, can lead to significant trouble. With the Amazon Secured Credit Card, potential customers put in an amount of money that serves as collateral and their credit limit. Customers then gradually build up credit profile by being financially responsible before graduating to a better credit card.

I think it’s smart of Amazon to implement this initiative

They can tap in a new customer segment

It’s hard to imagine that folks with low customer score can be Prime members and Amazon’s profitable segment. Yet, after years of exploiting the higher customer tier, Amazon will likely need to widen the customer pool for growth and more than 11% of the population in the US is a sizable segment to appeal to.

This will increase switching costs and customer loyalty

Amazon Secured Credit Card comes with 5% cash back on purchases like the ordinary Store Card. A pretty competitive cash back rate on every purchases. Convenience, a variety of choices and generous cash back can definitely encourage purchases on the Seattle-based company’s website.

More customers and purchases mean more vendors and advertisers

Vendors who wish to appeal to low-credit-score customers will want to get on the e-commerce platform if there is enough demand. Advertisers will be willing to pay to put their products, services or brands in front of the new customer segment, in addition to the existing customer base.