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I don't understand. I read about half of the article and it doesn't explain how that works.

I mean money has to come from somewhere, I assume the tens of millions of credit card holders. But credit card holders do their usual spending, and in fact save between 1% and 3% on their monthly bills instead of paying more.

Unless.

- They increase their air travel frequency.

- They get addicted to collecting airline miles, because it gives them the feeling of free air travel.

- And as a result they increase their average spending (so no longer the 'usual' spending), and buy useless stuff, just so they can collect more and more miles.

Is that the real story or something more/different?




One way normal credit card companies makes money is this way: They charge the merchant a fee (1 to 4%), and in exchange they give a 1-2% cashback to the customer. They make profit on the difference.

With a deal with an airline, the company doesn't have to do the 1-2% cashback, instead they give 0 to the customer. The airline company will give them miles though. Now the airline company can say to the credit card company: "look these thousands of customers you have them only thanks to me, so let's split your profits from the merchant 50/50 (or at least give me that 1% cashback you don't have to pay the customer), plus at some point I'll have to actually offer a plane ticket to those customers who earn enough miles"

What a customer gets usually is something like 7 miles per dollar. Consumer website estimate[1] that in the best of case, a mile is equal to ~$0.01, so they're also saving money there. (Plus the money the credit card company give them is today, whereas the plane ticket might be in one year or more, so the present discounted value of that ticket is even less)

[1] https://thepointsguy.com/2017/04/april-2017-monthly-valuatio...


> What a customer gets usually is something like 7 miles per dollar. Consumer website estimate[1] that in the best of case, a mile is equal to ~$0.01, so they're also saving money there.

Your math is way off. If it's 7 miles per dollar spent on the card, that is 7% back by your math, compared to 1-2% cashback, this conflicts with "they're also saving money there."

With that math, you're saying that it's a great deal for the consumer. Perhaps the other things you mentioned still add up to being in the airlines favor, but whats really going on?


The marginal cost of a single passenger is fairly low to an airline. That's why they have blackout days, and restriction on where you can actually fly with earned credit-card miles... in order to make sure the cost of your flight is always to their benefit or at worst break even.


Most cards give you two miles per dollar spent, not seven. If you did get seven, then that carrier would value those miles even less than they currently do


Yep my bad for the 7 miles, see my reply to jessriedel below


This is a great explanation -- so clear. Now the article makes sense. Business magazines never seem to give straightforward explanations like the above, especially with topics like currency exchange, trade balances, or inflation. I suspect that business authors make processes sound mysterious and complicated to cover up the fact that they don't understand it themselves.


And tech magazines rarely give a straightforward explanation of why memory speed is important when talking about DDR5.

This is likely because they presume most of the readers reading a Bloomberg article about whether or not airlines are undervalued due to the revenue stream of their loyalty programs are passingly familiar with many of the core concepts.


> Consumer website estimate that in the best of case, a mile is equal to $0.01,

Can you give a source for this? I've definitely gotten much better value out of my miles than this (though not always). And I'm talking about normal coach fare, not wasting miles on first class tickets that only seems like a good deal because the list price is so exorbitant.


It's an average bloggers come up with based on potential and actual redemptions. They even do really dumb stuff like counting the face value of a seat nobody would pay cash for. Like "I got this $6,000 seat for 100,000 miles, so they were worth 6 cents per point."

What value you personally actually get out of miles is individualized and taking a valuation from a rando blogger at face value is incredibly stupid. Especially from bloggers like The Points Guy (which was linked), because they get kickback when you use their referral links to sign up for credit cards.

If you offered me the choice between 10 AA miles and 1,000 Delta miles, I'd choose 10 AA miles, no matter what bloggers say. I'll always use AA miles and I would have trouble doing anything with Delta miles.


Airline miles are fascinating.

For instance, I fly over 100,000 miles per year with one airline alliance which puts me in the highest earning category for earning award points. Essentially they give you a an 11x multiplayer of award miles for every actual mile (domestic, overseas is more complicated). At lower levels it may be be 9x or 7x, etc. That means the difficulty of earning miles scales significantly with frequency, which if course changes the value.

Now, rather then trying to figure out the price of a ticket and comparing it to #of miles spent, which is difficult because of black out dates, variable pricing, destination/date premiums, and a ton of other factors, I found out you can just buy gift cards.

Specifically, you can buy Amazon gift cards at about 15,000 points per $100 gift card. While not as fungible as USD, given my spending habits and Amazon's large selection, it becomes a pretty good stand in. That means for me, a mile is always worth around 0.006 cents at a minimum. At around 250,000 award miles a year that's around 1,600 dollars per year which isn't that bad. At the very least it's better then some random blogger picking a number based on ticket prices.


vmarsy added that link after I wrote my comment, and it clearly doesn't justify his use of the term "best case".


I added a link to my original post, it varies by companies, delta is estimated at $0.012 apparently those days.


I don't think "~1%" is a fair summary of that link, especially not "in the best case". You're trying to breakdown what happens to a 4% fee, and many of the airlines have miles valued at >2% at that link.

I also don't know where you're getting that 7 miles/dollar number from.


The 7 miles per dollar comes from the delta Amex marketing flyer sitting on my pile of mail, but I didn't look at the fine print, I got curious and looked into details : actually it's only 1 mile per dollar for usual purchases, you get one additional mile on "delta purchases", then you can get 5 extra more on money spent on flights itself. So yeah on average it's close to 1 mile per dollar, I can't edit the original post. So the math makes more sense with those numbers :)


There's a reason they're called Sky Pesos :)



What they sell miles for only gives you a soft upper bound on what miles are worth.


So in the end:

- more customers

- buying more useless stuff (to collect miles) that they would otherwise won't buy.

- making outrageous travel plans (using those miles) that they otherwise won't make (e.g., fly to europe over the weekend if you're feeling bored; or world tour for honeymoon).

on top of the usual:

- annual fee

- interest on credit card (missed monthly payments and/or lower-than-full payments)


And of course a bunch of those miles will expire, or some customers will never reach enough miles to make a flight. And at least in the past some airlines have had pretty high fees for redemption flights ("fuel surcharge") that might even cover most of the cost


Haven't most programs switched to miles not expiring? I know Delta has.


"I mean money has to come from somewhere, I assume the tens of millions of credit card holders."

No, the money comes from merchants.

When you charge something at a merchant (the seller) with a rewards card, the merchant pays a higher percentage fee to the card issuer for that transaction.

So when you sell things, and you accept credit cards, there is actually a fairly large variance in cost between different cards that your buyers might use ... it might be quite cheap for you if your buyer used a plain old visa card with no rewards ... and it might be 3-4x that fee if they use some crazy cash rewards super bonus miles card ...

That is where the money comes from.


The merchant takes this cost into account when setting prices. The money comes from the buyers.


In that case the cost burden is primarily from the buyers using non-rewards credit cards or cash with those merchants, since they are typically paying the same $ price without getting the utility of the credit card cost factored into whatever they are paying.

I guess a lot of people pay the same price for a product or service and don't use every aspect of it.


Cash has embedded costs as well. Precautions are taken against employee theft or robberies. Somebody with an armored vehicle is also getting paid to drive the cash to the bank at the end of the day and bring enough coins and paper currency in proper denominations so that cashiers can make change the next day.


That's right. But the merchants tolerate it because the people with high-end cards tend to spend more money per person compared to a bare-bones cardholder. On the miles cards, the merchant hopes to make out by getting larger sales, albeit keeping a smaller percentage.


It comes from the buyers as a group. But not everyone pays with a credit card, and not every card has the same fee to the merchant.


By this logic, nobody really pays for anything. The buyers get their money from their jobs, so is it employers that are really paying for miles?


I found it very confusing, too. In particular, the headline makes no sense at all -- ultimately the "miles" they sell are for the very same "seats". Framing it as though the "miles business" is distinct from the "flying business" is nonsensical.

What I think it's getting at is: airlines are increasingly selling their services (i.e. seats on planes) indirectly, via loyalty programs instead of directly, via ticket sales.

Selling via the loyalty programs has benefits probably because consumers over-value the miles they receive, because (a) some portion of the miles will expire or never be redeemed, and consumers don't internalize that fact, (b) the airline collects from from the bank as soon as the issue the miles, but they don't have to pay for the seats until some point in the future, and (c) they can take advantage of some psychological factors/gamification by encouraging people to earn "gold" or "platinum" status, etc.


Importantly however, and what is being noted, is if I use my Delta credit card, Delta has an income stream whether or not I'm flying. Eventually, someday, perhaps those miles will be used for seat, but it's a different revenue stream that's likely not perfectly correlated.


Right, and that's what I was trying to get at when I mentioned that "some portion of the miles will expire or never be redeemed", but I guess it should be emphasized since it's the main benefit to the carriers.

If you have a Delta credit card and you never redeem the miles, the rational thing for you to do would be to switch to a credit card with a different rewards program.

The reason you'd keep using your Delta credit card is because you anticipate that you will redeem the miles for air travel later. The value of the miles still ultimately derives from their "flying business".


    > ultimately the "miles"
    > they sell are for the very
    > same "seats"
No figure to support the following claim, but I'd expect 50% of miles to expire without being redeemed.

But also: I recently stayed at the Conrad Rangali "for free" having accumulated enough points. Food, a small upgrade, transfer to the island, etc conspired to add an extra $5,000 of spend on a five night stay. Don't underestimate the upsell!


Well, yeah. It's the Maldives.

I've used points for five-night stays at the Conrads in Seoul and Tokyo without having a single dime on my invoice at checkout.


I have not escaped any points stay without additional spend, and I suspect that makes me the much more typical case than you.


At a resort, I expect you're right.

But in an urban setting? What is there to spend money on at the hotel that isn't better off-property? Especially at Hilton properties where anyone with enough points for a redemption at least has gold status and gets free breakfast and likely lounge access.


112 nights in Hilton properties last year, about 20% redeemed. I eat at the hotel restaurants a lot because it's convenient (and occasionally good — Trianon Palace probably having the best Hilton restaurant), I generally get them to book my airport transport because it's convenient, I often raid the minbar for water because it's convenient, and I usually have room service at least once.


The headline reflects airline's point of view, not consumers'. The money quote on credit card subdivision: "it accounts for more than half of all profits for some airlines, including American Airlines Group Inc., the world’s largest"


It's not about the amount of the money. It's more about the nature of the money, liquidity and risk.

One of the ways to look at it is that banks pay to attract stable, low-risk customers. They're losing money on each individual cards, but they gain money in the long run buy attracting high-income people who will continue to spend during an economic downturn.

Most of the modern economic system is not about making money out of thin air, but about managing risk.


The banks pay the airlines for miles cardholders earn.


Yes. But how do banks make money? Surely they're not paying airlines for miles and distributing the miles free-of-charge to their card holders out of the goodness of their hearts. What are they getting in return? Either what I said above or something more/different (annual fees is another possibility?).


Annual fees, interchange fees, misc fees (late payment, etc), and interest.

Same way banks make money off the rest of it's cardholders.


To be clear: the interchange fees (~2.7%) paid by the merchants are the cost that is always there and completely covers the kickbacks to the consumer. The other things are certainly money makers, but they may or may not be negligible depending on the card and the consumer.


Interchange fees dont go directly to bank providing the card afaik. Visa/Mastercard network take a cut, I recall reading 0.25% on CC in Europe? Then the merchant bank takes a cut (merchant services and shouldering last man standing chargeback/fraud risks - hence why sometimes merchants pay 4%+) and then hmm anyone else?? I doubt any more than 1% is remitted to the bank providing the card given I know some physical retailer (small) paying ~1.4% in UK.

In the UK they also market you for $. They ain't sending you that exclusive "loyal VIP customer" introduction/bonus offer for virgin wine, or some fitness club, or breakdown out the goodness of their heart..Which is probably another nice earner on top of everything else


The European rules to limit transaction fees seem to have removed almost all cashback cards from the UK.

There are still some [1] with introductory cashback, or very limited cashback, but nothing like the 2-3% ones that used to exist.

I'm not sorry to see them go -- charging all customers an extra 1.5% (or whatever) in order to give a savvy few cashback isn't fair.

[1] http://www.moneysavingexpert.com/credit-cards/cashback-credi...


>anyone else??

Credit card partners!

So if you get your favorite sports team's credit card, they get a cut.

http://www.doctorofcredit.com/everything-you-ever-wanted-to-...

There's even a Linux credit card (not kidding) https://www.linuxfoundation.org/offerings/linux-credit-card



Page 10:

> Standard Interchange Reimbursement Fee, All Other Products [besides Visa Signature Preferred / Visa Infinite]: 2.70%


Very few merchants pay that, notice how there are dozens of segmentations on that page? They have general retail and general e-commerce, your business will slot into one of those two categories worst case. If your merchant processor doesn't put you in one of those two, they are not the sharpest tool in the shed.

Most of the stores I work with average around 0.83% to 0.85% of credit card/debit card volume going to transaction fees, with processor pricing hovering between $0.10 a trans and 10 basis points to 25 basis points.


This is not what I've heard from the handful of store owners I've spoken with. Do you know if data about industry-wide averages rather than the folks you work with?


> This is not what I've heard from the handful of store owners I've spoken with.

Are you well versed in interchange? Have you seen there merchant processing statement? What was their average ticket, Visa/MC/Amex/DC breakdown, total volume, and pricing (basis points, trans fee, plus hidden fees)?

If your a restaurant, you are going to take many more premium cards. My example is from grocery, where debit cards are common, and the retailers are extremely aggressive and sue companies like Visa on a quarterly basis.

>Do you know if data about industry-wide averages rather than the folks you work with?

Lololololol, that is a good one! No, this is an extremely fractured industry with literally hundreds of players, operating using pyramid scheme brainwashing tactics, and in ACN's and CDS's cases, as actual pyramid schemes (the latter pushed via a church).

Industry players don't share, and there are contracts & regulations preventing First Data, Tsys & Elavon from aggregating and distributing that type of info about their ISOs portfolios. Akin to the firewall in Investment Banking between analysts and bankers, it isn't about to come tumbling down.

What I can tell you is running a bit below 1% cost is fairly common in the supermarket vertical. Restaurants and other retail trend higher, due to their poor lobbying power, but still you should be well within 2.5% if not 2% if your clientèle aren't all exclusively using top tier cards and you aren't processing through some racket like Card Data Services where your fellow parishioner sold you payment processing that is 150 basis points over interchange.


Right, so "Most of the stores I work with average around 0.83% to 0.85%" is not very representative. I'm pretty happy with my initial characterization, whose roughness I emphasized with a tilde. Thank you for the interesting comments about the industry.


Interchange fees charged per-transaction by Visa/MC/Amex.


Correct. Merchants pay about 2% on credit card charges. The other big earnings stream for banks are finance charges on cardholders who carry a balance (ie, borrow money from bank).


Every cardholder who uses their card borrows money; carrying a balance is a matter of not paying it back within the grace period, but you are borrowing money either way.


Most attempts at pointless pedantry are incorrect. In this case, I have at least one credit card where I've put down a deposit of twice the spending limit of the card. At no time am I in debt to the bank, or borrowing money to them. Yes it's a credit card, not a debit card.


That's called a "secured card."

Anyways, you were still borrowing money they just had you put up collateral first. You were still in debt to the bank, the fact they were holding collateral for the debt is irrelevant.

It's like if I had a fedora collection worth $30,000 and I go to the pawn shop and they give me a $10,000 loan and hold my Fedora collection as collateral for that loan.


Forgive me if I'm missing something obvious, but what exactly is the point of a secured credit card - how is it really different from just paying in cash?

(I'm from .au, where secured credit cards apparently don't exist, but I've read about the concept on the internet in the American context)


It's to build credit.

So if you have no history of paying back loans the bank doesn't want to loan you money unless you put up collateral. You use it to build up a credit history without risk of default to the bank - if you default they keep your collateral.

Secured cards aren't intended to be used long term. They are only for when you don't have a history (or poor history) of paying back debts. Many (most?) secured cards automatically convert to a non secured cards after a while, like six months or so.


Thanks. Interesting to know - I wonder why banks over here don't think they're particularly necessary. (I got my first credit card, unsecured, when I was still an undergraduate working part-time and receiving government welfare payments...)


> Thanks. Interesting to know - I wonder why banks over here don't think they're particularly necessary.

I suspect that there are probably regulatory or other systematic differences that make them not worth offering; while they are sold here as ways to build credit they don't seem to actually be necessary to that purpose. Even without credit cards, most people seem to be able to build a history of having and paying financial obligations that will result in sufficient credit to qualify for regular (if low-limit) credit cards in a reasonable period of time without secured cards.


My card was issued somewhere I have no credit history. The point of the card is to have access to a credit card -- with its benefits -- without needing to borrow from the bank.


It's nothing like that, as money is fungible and fedoras are not. I suppose you'll tell me that if I prepay my credit card to a positive balance, and spend that money, I'm also borrowing?


Yes, money is fungible which makes it seems like a nonsensical dance ("can I borrow $10? here's $20 collateral.") but I promise you, it's exactly that. As silly as it sounds you really are borrowing money with money as collateral. The money you borrow even comes with an interest rate and you get charged interest if you don't pay the balance in full (only minimum)!

If you weren't actually borrowing money then it wouldn't effect your credit score, full stop.

For example, read the terms for Discover's secured card:

https://www.discovercard.com/application/securedApplicantTer...

>If you are in default under the Cardmember Agreement or the Account is closed for any reason, you authorize us at any time(s) to withdraw all or any portion of the Funds from the Security Deposit Account and apply them to reduce your Obligations. Any such application of Funds will not constitute any part of the Minimum Payment Due under the Cardmember Agreement. You will continue to be responsible for making payments as required under the Cardmember Agreement and for repaying any outstanding Obligations.


> Most attempts at pointless pedantry are incorrect.

That wasn't an attempt at pedantry (ironically, it was actually abbreviated to avoid pointless pedantry; the original draft had "of conventional credit cards who have not paid on the account in advance of spending" after the "cardholders".)

> In this case, I have at least one credit card where I've put down a deposit of twice the spending limit of the card.

As a sibling comment and it's descendants point out, using such a secured card is still borrowing money in the same way that using an unsecured card is, and still subject to interest charges on the debt if not paid within a specified time just like unsecured cards. That you are putting up collateral to limit the banks default risk (and typically getting a better interest rate on any carried balance than anyone without excellent credit would get on an unsecured card because of that) doesn't alter that fact.

> At no time am I in debt to the bank, or borrowing money to them.

Yes you are; the bank just has possession of some of your property and a right to seize ownership of that property, as well as the possession it already holds, in the event of default on the debt. This is similar to what happens when you borrow money against property at a pawn shop.


its just arbitrage.

airlines sell a mile at an average of 1 cent, banks charge merchants 3.5 cents for every dollar.

consumers can win if they pay their credit card off on time. many of them are able to churn by putting business travel from their employer on their credit card and getting it reimbursed in time.

banks can win double and triple if consumers don't pay their credit card balance completely one time, just once.

since the credit card aspect was already there whether there were good loyalty programs in existence or not, its actually a decent ecosystem!




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