Credit card companies are amazing. Not only do they now offer cards with no annual fees and low teaser rates, they even give you a a rebate for 1 percent of everything you buy. Get an American Express card through Fidelity and you can get 2 percent of your purchases rebated to your investment account. Discover offers 5 percent on selected categories of purchases - groceries, gasoline, travel, clothing - depending on the month and the season. Can 7 percent be far behind?
Of course, you may be wondering, as I did, where the credit card companies come up with all the money for these rewards and rebates, which are now a feature on half of all credit cards in active use. At first blush, the money appears to be coming from retail merchants, who are paying ever-escalating fees for the privilege of swiping your credit card through their registers. But according to a wide range of government and private economists, ultimately it's you, the consumer, who is paying for those rebates, as merchants raise their prices to cover those additional costs. When all is said and done, all that's really happening is that the credit card companies are taking money out of your left pocket, setting aside a hefty fee for themselves and putting what's remains back in your right pocket.
Steven Pearlstein is a Pulitzer Prize-winning business and economics columnist at The Washington Post.
Only it's worse than that. Because while everyone pays the higher retail prices necessary to cover the "swipe fees," only those with rich rewards cards actually get the kickback. In effect, they are subsidized by those who pay those higher retail prices with cash, debit cards or standard-issue credit cards.
To understand how we got to this point, you need to understand the unique economics of the credit card business.
Credit cards are a "network" business, one in which everyone benefits when there are more customers using the same network. Cardholders prefer cards that are accepted by more merchants, and merchants prefer to take the cards that have the largest number of cardholders. So once one card company begins to get a lead, it's difficult for the others to catch up or enter the fray. The result is that, in most network industries, all the business winds up in the hands of very few companies, at least until some new disruptive technology comes along. Certainly that's the case with credit cards. Visa, MasterCard and American Express now account for more than 90 percent of the market. And with that much concentration comes the power to charge higher prices than would be possible in a market with many competitors.
The other unusual characteristic of credit cards is that it is what economists call a "two-sided market," where firms compete both for merchants and cardholders. In the industry's early years, more of the revenue came from cardholders as companies competed to get more retailers into their networks. Keeping merchant fees low was an essential part of that strategy, and card companies made up for that by charging card holders annual fees and high interest rates on unpaid balances.
Over time, however, the competitive dynamic changed. Once consumers began using credit cards to make a majority of their big purchases, merchants realized that they simply couldn't stay in business if they didn't accept all the major credit cards. At that point, the credit card companies had the upper hand, allowing them to push through fee increases with relatively little drop-off in merchant participation.