I listened to a podcast about health insurance a while ago. Said, the podcast had someone who wrote a book about health insurance, say that insurance carriers offer things like gym discounts not to get people to be healthier but to attract healthier people to offset costs, basically to offset inverse selection.
Based on inverse selection, would anyone have insight into why credit cards give bonuses for people to sign up? I'd imagine they have it worked out where if they are giving $100 to sign up they know on average they will make >$100 back. Is it that simple? Seems to people I know people who can figure this out and never pay interest, but I'd imagine there is a large group of people I don't know/see who are paying for all the interest/bonuses?
$100 sign up bonus is ok. What is more amazing is those 0% interest transfer deals for 6-18+ months. That's a deal, especially if it is a $5K or $10K balance transfer (or more - I don't know the max).
https://www.fool.com/the-ascent/credit-cards/landing/best-balance-trans…
Inherently, I don't think CC providers aim to make the '$100 free then $100 back' offer per person. If you know how to play the credit card game, you can get SUBs on lots of cards, whether they have an annual fee or not. I think it's also a slight misconception that the AF is the way these providers get that SUB equivalent back, which could technically hold true, but also not the main source.
Their primary source of income seems to be as follows:
After all this revenue is calculated, I can only imagine a CC provider will mark up an advanced set of models, analyze their profit streams, and then figure out what the next promotional 'sweet spot' is - i.e., what's the most enticing offer they can market that will bring in new customers to offset the benefits they provide? Suddenly, you have a perfect combination of what you made, versus what you had to shell out in promotional offers.
Fun topic to think about.
Fair points.
I would say it isn't suppose to be a 1:1 transaction, as in, everyone who opens a CC pays back at least $101 in interest/fees. Could be for ever 10 cards they give out, 1 person pays $1,001 in interest/fees, so it would work out, plus they get the fee from retailers/restaurants. It's probably more 80-20, where 80% of the fees come from 20% of customers; I was looking for more if anyone had a break down or did work on it.
My other point, though I don't think I explained it correctly, was you'd think it would be more complex for CC companies. Effectively, if someone plays the game, meaning takes out a CC for the bonus, doesn't really use it past the required period and never pays interest, CC companies probably wouldn't want them as customers. So the companies would find a way to discourage these people from using the CC or taking the bonus money and running. For example, if someone was going to purchase a car cash, they could open a credit card, buy the car, get a bunch of points, then pay off the balance immediately. Doesn't seem like a good way for the CC companies to make money.
Citing this paragraph specifically, good points made by you here. I also didn't elaborate as well as I could have.
To be fair, I don't really know the answer. This is just my best guess. I'd agree with you that it can't be that simple - if working in our field has displayed anything, nothing is ever truly simplistic, and everything can be capitalized upon. However, put honestly? A large bulk of it could come down to CC issuers not believing everyone is a) savvy enough to take advantage of this, or b) honestly can't be bothered to go through the hassle.
I play the CC points game frequently, so I'd like to think from an anecdotal point I have this down. But the majority of Americans live in some form of credit card debt, and the numbers may just work out to the notion that issuers don't need to dissuade responsible cardholders from signing up. Maybe this is a cop-out answer, but I could see that working out off the top of my head.
I guess the thought process here can be correlated to your car purchase example - yes, it seems obvious to us that I could open a new Amex, buy an entire car, then have enough points to fly domestic anywhere I want for a couple of trips, but there's plenty of hoops to jump through there, and I really just don't believe the average consumer thinks like that. Who knows.
Regardless, an interesting topic. Would love to know more from somebody who works in this space!
Credit card companies mostly make money on interchange fees
Just FYI, it's "adverse selection", and yes, typically CC issuers know they will make the bonuses back through merchant fees or interest payments overall. Sometimes, however, it's a loss-leader to get someone involved in the brand. For example, Chase will offer high bonuses so you get a credit card with them, and then they will sell you on a Chase savings account, mortgage, auto loan, JPM investment account, etc. It's a relatively cheap way to get engagement.
Haha, thank you for clarifying that. I'm sure I'll be talking about this with people in real life, I need every advantage I can get to not sound like an idiot.
Loss leader is a too point too.
Lots of good insights in this thread, but think of upfront credit card bonuses as nothing more than a customer acquisition cost, which issuers will be more or less aggressive with as market conditions and company needs necessitate. No card issuer is seeking to earn back those customer acquisition costs through interest payment/late fees - that's a losing proposition. Those fees are a hedge against deteriorating customer credit quality, but would be a scary way to drive revenue.
Basic revenue model for card issuers is to earn money on interchange/merchant fees, annual cardholder fees, and to hopefully create cross-sell opportunities (expand revenue beyond card product and increase "stickiness" of customer). Basic calculus is that the notional volume of transactions (and associated fees), coupled with annual cardholder fees, will outpace the cost of cardholder benefits, rewards programs, and customer credit losses/defaults. Card issuers somewhat offset the upfront cost of any bonus with minimum spend requirements to earn the bonus (e.g. $1,000 minimum spend requirement to earn a $100 bonus might generate 2-4% of spend in revenue, lowering bonus cost to $60-80).
Key considerations for card issuers are modeling: 1.) expected spend, 2.) expected credit quality (i.e. will this cardholder make payments), and 3.) cardholder usage of benefits and rewards programs. While many issuers tout their rewards programs (Chase Ultimate Rewards, AmEx Membership Rewards, Citi ThankYou Points) as a plus for consumers, it takes a lot of work for a consumer to extract value from these programs which exceed the value you create for card issuers (hence, their profitability). Technically, outstanding point balances on these programs are recognized as a balance sheet liability by issuers (similar to airline miles), but many customers do not fully realize the value of those points or card benefits, which is ultimately what drives the delta in profitability for issuers (essentially, core earnings power from interchange/merchant fees represents baseline revenue, and managing the benefits/points programs and credit risk are the real drivers of delta).
This is a great comment, glad I followed this thread. My comment now looks weak in comparison, LOL.
You brought up something that I never even thought about - the SPEND requirements for points and SUB, and how those directly translate. When I got any sort of points-driven luxury card, I always remembered the little kickers of minimum requirements. I'm not sure what it is now, but w/ a referral I believe my original Amex Gold offer was 90,000 points contingent on me spending $4K within 4 months of opening the account. Now, if we take those points at face value, that's a $900 loss that Amex is initially incurring, but that doesn't account for any of the aggregate factors:
When put like this, pretty easy to see how they can offset that on the spot. This doesn't even take into account the massive APR that one would have to pay should they miss a payment, just the bare minimum baseline that they could expect. Suddenly, them offering 90K points doesn't seem like such a huge deal!
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