Will Big Tech’s Entrance Into Cards Signal The Peak Of Credit Card Rewards? - Forbes

Retailers, big tech’s and fintechs are fighting back against cash-reward cards.

Attending a recent Yankees playoff game, I ordered a round of food and drinks and paid for it using cash back from my Apple credit card. It felt like we all got free hot dogs and beer.

Love of credit card rewards is as American as baseball, and in no other market do rewards hold as much sway as in the U.S., where consumers have been trained to believe that paying by plastic entitles them to a bonus — either in cash or in points. The result has been that rewards spending by the top five credit card issuers grew to $31 billion in 2018, up from $11 billion just three years earlier, according to new research from Accenture.

But the introduction of the cash-back Apple card may signal the peak of card rewards in the U.S. as the industry begins to deal with a less attractive volume-value trade-off.

For the moment, that trade-off is still working in favor of the payments industry, with North American bank payments revenue growing by $50 billion in the last three years to $300 billion. That growth trend is expected to continue, with projected growth of 4% through 2025, creating a $405 billion industry in North America.

If you look below the surface, North America is increasingly out of step with the rest of the global consumer payments industry, which is moving to high-volume, low-margin payments, many of which are moving over account-to-account payment rails rather than over the card networks. This has been stimulated by the move toward real-time payments in many countries, but also by the rise of QR-based digital payments systems in Asia. Recent estimates indicate that it costs a merchant only 0.5% on average to accept an Alipay payment, while credit card payments in the U.S. can still be over 2% for many merchants.

The pressure to move toward lower-cost payments isn’t going to come from consumers, as they see the benefit but not the costs of the current card-centric system. Instead, pressure is going to come from the merchants, as it is their high acceptance costs that are funding the free flights and cash-back payments beloved by the North American consumer.

We are already seeing merchants begin to favor debit over credit as a lower-cost payment mechanism, and favoring their own loyalty schemes rather than relying on those run by the card-issuing banks. For instance, Irving, a large New England gas station retailer, takes six cents off each gallon if customers pay with debit cards linked to their loyalty account, using the delta between debit- and credit-processing fees to incentivize customers to use the lower-cost option.

The migration away from reward-rich credit cards will also be driven by two other factors. The first is the belated development of real-time payments in the U.S. and the opportunity it provides for merchants to incent lower-cost payments that will be even cheaper than debit transactions. In the Netherlands, the vast majority of online consumer payment transactions are now completed via Ideal, a bank-owned network that enables direct account-to-account payments that don’t use the traditional card networks. This is also the trend in Scandinavia, where account-to-account direct payments are becoming the preferred consumer payment mechanism.

The second major driver of change will be the continued internalization of payments by major retailers to avoid having to pay merchant acceptance fees at all. Leading this internalization effort are firms like Starbucks, Walmart, Uber and Amazon, all of whom are providing meaningful incentives for consumers to switch their payments to prepaid accounts in return for either discounts or internal reward points. Take, for example, Uber Cash, where you transfer money from your bank account directly into your Uber Cash account and use it to get a 5% discount on rides and food. Similarly, Walmart’s MoneyCard gives customers 1% to 3% back at stores, online, and at some gas stations. Amazon is taking this idea one step further by extending its Amazon Cash product to other retailers, including GameStop and 7-Eleven.

In the current interest-rate environment, retail deposits don’t earn much interest, and so customers don’t mind holding small sums of money across a variety of payment accounts, even if they are not insured. But even the shift of relatively small amounts of spending scaled across a large number of users will create deposit fragmentation that makes it harder for banks to make money through traditional balance-sheet spread. With tens of billions of dollars sitting in PayPal, Starbucks and Walmart accounts, this deposit fragmentation is one reason why consumer bank liabilities have not risen as quickly as would have been expected in a period of robust economic growth.

As consumer payments move inexorably toward being instant, invisible and free, the traditional bank-card issuers are going to lose revenue. Some of that pressure will come from retailers incenting alternative and cheaper payment methods, and depending on how politics play out over the next few years, some of it may come from European-style direct regulation of payment fees. While overall the volume-value trade-off is still positive, Accenture estimates that North American banks will lose 11% to 15% revenue market share in the next three years; over the long run, the volume-value trade-off will turn negative and the consumer payments revenue pool will begin to shrink.

Long-term, North American banks need to start positioning themselves to take one of two paths. As fees continue to be driven lower, banks can compete in the low-margin, high-volume business of small payments and account-to-account transfers. In that case, banks need to focus on scale, and the evidence from Europe is that even as payment revenue per transaction falls, operating costs can fall even quicker, leading to higher profitability.

Alternatively, payments players in North America can focus on adding value to payments transactions in the form of non-card-based credit options, micro-insurance services and other add-ons that customers are willing to pay for.

At least in the short run, the serotonin hit that comes from getting “free food” at a Yankees game will continue to support the North American rewards-rich cards ecosystem. But over time, the link between payment initiation method, line of credit and rewards will be severed as merchants find ways to channel consumer purchases to payment methods that benefit the merchants more than the banks. In that world, traditional card issuers are going to need to get creative about how they maintain their fair share of the payments revenue pool.

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Will Big Tech’s Entrance Into Cards Signal The Peak Of Credit Card Rewards? - Forbes
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