19 May 2015
A new EU regulation coming into force soon will change the credit card system fundamentally. The times we know (and appreciate) about earning huge amounts of loyalty points through credit cards might soon be over.
Back in March, the European Parliament voted to cap credit card charges paid by retailers to 0.3% of the transaction value. Once the Council of Ministers will have formally endorsed that decision, it will come into effect some six months later, so probably in late 2015/early 2016. Third party payment systems American Express and Diners Club are granted an additional grace period of three years before the rules will apply to them as well.
These fees, also known as interchange fees, are capped in other countries such as the US, Canada or Australia as well, but the EU caps will be much lower than anything else in place.
The intention by governments of capping these fees is to reduce the bills for consumers. The changes in the EU are expected to save consumers 6 billion Euros a year – although it can be safely assumed that the largest piece of that cake will be retained by merchants to increase their margins.
These are the facts, but what are the wider implications? First and foremost, credit card schemes will simply have no commercial room anymore for any extravagant services like loyalty schemes as we know them today. Buying one mile from an airline to give it to credit card holders for each Euro spent will no longer be commercially viable and airlines won’t be willing/able to lower mileage prices to maintain that value proposition. Actually a big share of these 6 billion Euros is now going to airlines across the continent, awarding valuable miles to their frequent flyers. And it looks like these sums will basically be redistributed from frequent flyers/airlines to merchants, questioning nevertheless the sense of this well-intended measure.
Since the use of credit cards will continue to be convenient, safe and popular with frequent travellers being prime users of these cards, there is no question of seeing credit card schemes linked to loyalty programs disappear completely. But there will be changes in their value propositions, in form of lower mileage earning rates, higher card fees and/or higher interest rates – all of them meaning deterioration in the value proposition from a consumer perspective and increasing the annual spend threshold from which it is really worthwhile to opt for such a credit card. Credit card companies and their issuing banking partners are therefore well advised to develop quickly creative ways to counterbalance that development by compensating the losses at the level of the loyalty currency in other areas – or they are at risk of even accelerating the development of new alternative payment systems, e.g. mobile ones.
And unlikely it might look at first glance, this situation risks having a global impact rather than being a regional issue confined to the European borders. On one hand, it can be a motivation for other governments to look into their respective regulations and secondly, these caps also apply to foreign cards for transactions in Europe. These would, of course, usually only represent a small fraction of their total card spend, but it can have an impact on their overall economics nevertheless.
But the big losers here are ultimately the airlines with their Frequent Flyer Programs. Even in Europe, there are some larger programs now generating 30-50% of their total revenue from miles sold to credit cards. It might be a low margin, but a high volume business, generating the necessary cash flow to support the business. This volume of business in terms of mileage sales won’t be maintainable anymore – and can’t be easily replaced by other partners since the transaction volumes even with large hotel or car rental partners are well below the typical credit card performance.
Nevertheless, there might be a chance in these changes, too: By losing an important part of this ancillary business, Frequent Flyer Programs may rediscover their true reason of existence: to create loyalty among their airline’s customers. FFPs and airlines shifting their focus in that direction and jointly managing that challenge can definitely make up for all the losses incurred from decreasing credit card revenues – but this is a somewhat more cumbersome task many airlines have basically refrained from so far in favour of the long hanging fruits. And while credit cards used to be the cherry trees of the loyalty business – you get these long hanging fruits year after year without too many efforts -, even cherry trees have a limited life expectation and die at one point, not producing anything anymore.
The next months risk being busy for many players in the finance/loyalty area in Europe, all aiming at addressing their individual challenges. The market balance is going to shift for sure, but who will emerge as winner from this new situation, which many considered as worst case scenario, is a completely open question. Historical merits etc. are no longer of any value. Everybody has to start again from scratch on a white page of paper now.