This is the second in a two-part series looking at airline credit card deals. See this post for part one which explains how the ecosystem works.
The biggest US airlines are making billions of dollars every year thanks to their cobranded credit card deals with banks. Without those deals, the airlines are actually losing money which seems… bad. But could this whole setup possibly go away? If so, it’s going to have to come from Congress… which means it’ll never happen. There have actually been some efforts to kill this golden goose, though I remain highly skeptical of them.
On the surface, it is not hard to see what some of the arguments might be against continuing this arrangement, but only one makes any sense under scrutiny, and that seems like a longshot.
Let’s start with the primary argument that’s been used against these deals. In essence, if we lower fees charged when someone uses a credit card, that’s money that will go back to the consumer. Of course, if we lower fees, then the economics of the current cobrand arrangements won’t work, so the whole thing will fall apart. This is what happens in Europe where interchange fees are capped at 0.03 percent. That’s why we don’t see lucrative card deals across the Pond.
In a perfect world, the idea here is that when interchange fees drop, that’s money that gets returned to the consumer in the form of lower prices on goods. After all, the businesses will keep a higher percentage, so they can lower their prices and everyone is happy. Right? No, not right.
We actually have some real-world examples to show this. After the Great Recession, the Durbin Amendment to the Dodd-Frank bill limited fees on debit cards. One study of the impact was summed up this way:
Banks recouped a significant portion of their losses by charging consumers for products that they previously provided for free on the subsidized side of the two-sided market. The accelerated adoption of credit cards with higher interchange fees likely diminished—if not eliminated—merchants’ savings. These effects impede the regulation’s stated objective of enhancing consumers’ welfare through lower retail prices.
In other words, it became a lot harder to get a free checking account, because previously that was being subsidized by higher transaction fees on debit cards for those checking accounts. With the fees down, banks started charging fees directly to consumers to open the account. And in the case of debit cards, when the rewards that did exist started to disappear, people began shifting over to rewards credit cards instead. Those carried even higher fees than the debit cards. But even more damning is this from the University of Chicago:
The cost to merchants of taking payment on debit cards declined by more than $7 billion annually… while the effective cost to issuers of providing debit card services to consumers increased by a corresponding amount…. Did consumers gain more from cost savings passed on by merchants, in the form of lower prices and better services, than they lost from cost increases passed on by banks, in the form of higher prices or less service? We find that consumers lost more on the bank side than they gained on the merchant side. Our estimate is that, based on the expectations of investors, the present discounted value of the losses for consumers as a result of the implementation of the Durbin Amendment is between $22 and $25 billion.
Something is always subsidizing something else, and the market finds a way to equalize when new regulation comes into play. In this case, banks ended up finding ways to charge more for their services outside of the regulated fees. Then merchants didn’t give back nearly as much as hoped to consumers, so the consumers actually ended up losing money overall.
The last big attempt by Congress to address this issue on the credit card side of the house was the Credit Card Competition Act of 2023. This says that the real problem is the credit card networks like Visa and Mastercard. Credit cards are connected to only one network, and that gives them control over their fees more than would be the case if cards has a choice of networks. This would require the credit cards issued by the big banks to use at least two networks and one of them can’t be Visa or Mastercard.
Though the mechanism is different, the goal is again to reduce credit card transaction fees. And if that happens, it seems to put us right back in the same place as it did with debit cards.
I have to admit that I hate that this is the case. I’d like nothing more than to stick it to the banks. But banks are full of industrious people who find ways to make their profit margins one way or another. The real loser would end up being the consumer, not just in higher fees, but also in higher airfares. And that is a problem for Congress. The optics are not good.
This would have to lead to higher airfare. Remember, these big airlines are all losing money flying airplanes. If you take out the card revenues, they are going to have to figure out how to make money flying airplanes. That is going to mean higher fares are required, so they’ll cut capacity in order to make money. Right now, credit cards are subsidizing your airfare.
We can argue whether this model is right or not, but if you have to tell your constituents that what you support is going to raise fares and reduce airline capacity, it’s not going to go over very well.
There is, however, one argument that I think has legs to it. That’s the anticompetitive argument. Big airlines have big credit card deals that new entrants can never hope to ever match. So any new entrant is already playing with one hand tied behind its back. While eliminating the credit card deals would increase fares, it would make for a more competitive playing field for new entrants and potentially spur successful competition. (Yes, it’s a longshot, but it’s… something.) Perhaps there is some compromise in between that could require some sort of cross-subsidy. I don’t know.
I haven’t really heard people making this argument, but it’s the one that I think should be made. The big airlines have created a very significant barrier to entry into the industry through these deals, because they can keep fares lower. Someone should look into this, but there are no easy solutions. This whole construct has been built over decades, and it would be problematic to just have it disappear overnight.
23 comments on “Love ’em or Hate ’em, Airline Credit Card Deals Shouldn’t Disappear”
I hear what you are saying, but, as fees are capped on CC in Europe, it lowers the costs to the customer. In the States there is a very vociferous and growing segment of restaurant owners that are totally pissed off about the high costs to the merchant. As a result, they are now starting to charge their guests for paying with CC.
Just because CC give consumers points to use with airlines does not float everyone’s boat. We tend to get in a circular logic on points websites about the value of these points. Not much value if you travel infrequently. And, as you say, if you live in Europe, rates are much lower, as my wife, who has Finnish CC will attest.
I’m not buying your argument on Durbin. If a bank charges fees for having a standard account… then the market is open to competition for another bank (or a start-up bank) to offer an account with lower fees. Credit cards see very little real innovation – they function almost like a utility.
I know banks will find a way to ensure profitability… but when costs are difficult to observe or understand, it becomes much harder for John Doe to make good decisions that benefit him. Right now there is very little visibility on all of this… and that make anti-competitive practices much more likely to happen.
I see the bank-credit card-airline thing as a way to confuse customers into making poor decisions. A few will spend a lot of time looking for obscure loopholes and get a five star trip to Fiji for free… but in reality most airline credit card customers will be rewarded with shiny beads.
Agreed. The argument that “free checking” will go away is kinda amazing. I managed to open multiple checking accounts last year, and they all were free with very reasonable direct deposit requirements.
The question that has arisen for me re: airlines are unprofitable without credit card deals… Isn’t this revenue a source that then has costs when an airline has to deliver the service? You know, like the costs when people pay for a ticket with cash (or credit card)
This is really an accounting question as to if airlines are profitable without the credit card deals, and what if anything they have to carry as a liability from those.
The other question is, if someone can’t purchase an item with miles, will they just use currency? That is the other side of the equation, as to if airlines would be profitable without the airline plans.
This reminds me of an episode of Garfield & friends where he, Odi & John go to an exclusive shopping mall. When John attempts to pay with cash in a shop the salesclerk first reacts in horror & then sweet talks to him while the police are contacted. It’s all about the use of credit cards.
“The other question is, if someone can’t purchase an item with miles, will they just use currency? That is the other side of the equation, as to if airlines would be profitable without the airline plans.”
This leads to another question, would a consumer not make a purchase if they couldn’t pay with miles? And on the higher fares Vs less service debate goes, with fewer seats it makes each seat actually more valuable & therefore more profitable. In the current set up the seat becomes a lost leader of sorts as the credit card is where the real revenue is made.
I don’t have a credit card that’s tied into an airline. And I won’t, especially with Ed screwing his loyal flyers last year.
My question CF is what will happen when the airlines start to accept crypto? This business model will begin to take on water.
Angry Bob – I don’t have an answer for that one. I’m sure they’ll find a way to profit.
I think zooming out to an even bigger picture problem… rewards cards (not just airline cobranded ones) are a massive redistribution of wealth UP the economic spectrum.
Who do credit cards generate profits from? Lower & middle class folks who can’t pay off their full bill each month which results in basically perpetual interest and fees. Who gets the most benefits from credit cards? Rich folks who spend a lot but can afford to pay their full balance each month.
The whole system is basically an extraction of wealth from working people to the ultra wealthy. I’ve never been a Bernie Bro but I’m getting there…
You don’t need to agree with Burnie on everything, but listen to the bigger message & there’s a lot to like no matter your political worldview.
It’s not only rich people. It’s anyone who is responsible with finances and pays their bill every month. I’m not rich, but I’ll be vacationing in Hawaii next week and due to my points balance with Marriott, Alaska Airlines and JetBlue, I won’t be paying anything for flights or hotels.
Credit card reward programs are like grocery coupon promotions. Try to find coupons and comply with their terms to reduce the hit of name-brand markups. I long ago quit that game.
I moved my shopping to Costco and Aldi. Good quality at reasonable prices every day, all over the store. We don’t have an airline like that at the moment.
I just use the Fidelity credit card that rebates 2% on everything.
You can argue that if credit cards did not subsidise airlines, then air fares would have to rise and airlines would cut back on flight frequency. That subsidy however comes from consumers paying more on day-to-day spend, and smaller businesses having a harder time (and potentially having to shut down due to lack of profits) because they have to charge more to customers to pay an airline sales tax. A sales tax does two things (amongst others) – it increases prices and it also reduces consumer activity. The airlines getting the credit card subsidy are large highly profitable corporations – they are not running Essential-Air-Service flights to remote airports. Which is more important to John Doe – the local Mom-and-Pop business or the air fare ? If you grant a big subsidy to airlines… then the money has to come from somewhere else. Better to have each sector of the economy standing on its own merits – and transparency for all.
CF – consider a person who signs up for Essential Travel Planning with Crank Concierge at US$125 per person. Let’s assume it’s two people travelling, so it’s a US$250 fee. Think about how much profit you probably make on that fee. Now realise that if credit card fees are about 2.9%+$0.30 per transsaction instead of 1.5%, you are paying an additional US$3.75 to subsidise an airline beyond what the bank needs on its own. Now multiply up by the number of customers Crank Concierge gets per year. You happy with paying that subsidy to airlines ? If credit card fees were lower…. you might see a few more customers with a slightly lower fee, or you could afford to maybe give (even) better service to customers, pay your staff slightly more or have a bit more money for you and your own family.
Yes, banks and airlines do need to make a profit. But why does Cranky Concierge need to charge higher fees to subsidise the airline ?
Anon – As a merchant, of course I’d like lower fees. But I can tell you that there’s no way I’m passing that on to customers. Even if I wanted to pass it on, I probably wouldn’t. We want a price that rounds. If I saved 2%, I’m not going to change the $125 price to $122.50. So if the goal is to benefit the consumer, that’s not going to happen.
It never trickles down. Never…
When do we get to see a Cranky Flier co-branded card?
> …in Europe where interchange fees are capped at 0.03 percent
0.3%, not 0.03%
On a related point, the UK Supreme Court will hear a case next week relating to commissions around auto loans and vehicle financing. It is expected to find in favor of the banks involved, but it decides in favor of the customer bringing the case then one side effect could be that the banks/finance companies have to say up front how much money they are giving a co-brand partner (i.e. the airline, retailer, etc.) per card sign-up. Don’t think it’ll extend to the price per point/mile purchased though.
So, in other words, it’s only the likes of Breeze/Allegiant/Sun Country/(maybe) Frontier, that are actually making money off of flying??
#respect
Airlines are unlike other passenger transportation institutions in that they’re nominally expected to make money in the US. Other such entities—roads (except some toll roads), rail, public transit, and airports themselves—aren’t expected to make money and are subsidized and regulated accordingly.
I suspect those other modes work like that because people have a strong idea of what a trip from point A to B is worth, with some leeway for experience/comfort/amenities. Transportation is a tangible service, and the customer’s perception of its value is aligned closely enough to the true value, i.e. the cost to the institution providing the trip, that the institution can’t charge much of a premium for it.
With cobranded credit cards, airlines shift the perceived value of their entire product ecosystem. The tangible value customers have of the transportation service is obfuscated by the murkier but generally higher value customers associate with credit card and mileage awards, which is driven by psychology. Without them, airlines will be even more indistinguishable from one another—both as business models and in their customer product offerings—than they are today.
In the last few years, was tempted to go on the JetBlue bandwagon via their paisley program where I had accumulated a block of points. Then B6 whittled down their service to my airport to just two flights a day. Yuck ?!!!
This happen just as I was ready to sign up for their Barclays card. Saved myself some grief.
Based on the above, I’ll stay a free agent looking for the better deal as opposed to making irrational choices just to accommodate deflated value miles.
Cranky – small typo on the capped interchange rates for credit cards in the EU. You have the rate capped at 0.03 percent. It’s capped at 0.30 percent (30 bps)