Docstoc

Efforts to Expand Sales Using Reward Programs

Document Sample
Efforts to Expand Sales Using Reward Programs Powered By Docstoc
					Efforts to Expand Sales Using Reward Programs



                      Conference on
        Payment Markets: Theory, Evidence, and Policy
             University of Granada, June 2010


                      David Humphrey
                Florida State University, USA
    Outline

•    Motivation:
     Contrast earlier and current merchant reward programs.

•    Covering:
         Stamp rewards
         Cash rewards (deep discount stores)
         Card rewards.

•    Interchange fee caps.

•    Compare estimate of card costs with merchant fee changes.

•    Speculate on future of card reward programs.
    Stamp Rewards


•   Stamp rewards (1890s) initially given to customers who did not ask for store
    credit. Later applied to all payment methods.

•   1 stamp for each $.10 of sales (S&H Green Stamps most popular stamp).

•   Stamps were pasted into books: 1 book = 1,200 stamps = $120 in sales.
    Books used to redeem rewards.

•   Most popular from 1930s to 1960s.

•   More popular in US than Europe.
    Stamp Rewards

•   In 1960s:
         Over 60% of US households collected stamps
         3 times more stamps were issued than all postage stamps in mid-1960
         Reward catalogue was largest publication in US
         $825 million in rewards in one year in 1960s
         Over $10 billion in rewards total.

•   Since almost all merchants gave stamps (gas stations, supermarkets,
    department stores, etc.), the stamp market became saturated.

•   In a saturated market, merchant sales or market share benefits from offering
    stamps no longer exists. Giving stamps becomes a defensive measure.

•   Merchant cost base rose but no longer have any net sales benefit.
    Stamp Rewards

•   Stamps almost disappeared in inflation/recessions of 1970s.

•   Merchants cut costs to retain margins. By 1999, only 100 stores still offered
    S&H stamps.

•   Merchants replaced stamps with store-specific, “preferred customer”
    loyalty/reward programs which were less expensive.

•   Stamp programs (green points) still exist at some Internet websites.

•   Other reward arrangements: dish sets and wigs when deposit funds in a non-
    interest deposit account for 1 year.

•   Supermarket in Florence, Italy, gives loyalty points for small gifts.
    (After 9 months of shopping, only close to getting a flashlight.)
    Stamp Rewards


    Reward examples:

•   A JVC noise-cancellation headphone (actual cost $46.99) requires 43,000
    green points from spending $430,000.
    (value = $.001 per point)

•   AMEX requires 385,000 points for a 46” flat-screen TV (actual cost around
    $570) and took one person 5-6 years of card spending.
    (value = $.0015 per point)
    Stamp Rewards

•   Near death of stamps came when:

       1. Almost all merchants offered stamps, so no longer have any
          sales benefit to giving stamps;

       2. Merchants faced strong pressure to cut costs during recessions
          of the 1970s; and

       3. Merchants had control over whether to offer stamps or not and
          almost all dropped stamps in favor of cheaper store-specific
          “preferred customer” rewards.

•   1 and 2 exist now for network credit cards in the US.
    3 does not since networks, not merchants, control reward values and
    consumers control card use.
    Cash Rewards (Deep Discount Stores)

•   Deep discount pricing not possible due to resale price maintenance laws.

•   Manufacturers set minimum (sometimes maximum) resale prices to protect
    their base of small retail stores from chain store competition.

•   US Sherman Antitrust act--resale price maintenance contracts:
     – Illegal per se before 1930s
     – Mostly reversed during Depression to protect small merchants from
       chain stores and called “fair trade” laws
     – 1968 Supreme Court ruled most resale price maintenance illegal per se.

•   UK legislation (1964) makes restrictive resale price maintenance illegal.
    Cash Rewards (Deep Discount Stores)

•   Before 1968, due to resale price maintenance laws, there were only a few
    discount stores and these were organized as co-operatives. Consumers paid
    a membership fee to shop there.

•   After 1968, no longer needed co-operative legal structure. Discount store
    volume took off. Includes general merchandise (WalMart) and specialty
    stores (Best Buy, Toys-R-Us, Home Depot, etc.).

•   Result: many, many smaller merchants went out of business, unable to
    compete with very low prices and large selections.

•   Discount stores have own store card but also take network cards.
    “Double reward” of low price + card rewards.
    Store and Network Card Rewards

•   Store credit cards:
     – Long history of providing store credit—now with a card
     – Expands sales (for credit needing customers)
     – Ties customer to store (store cards are merchant-specific).

•   Network credit cards in the beginning:
     – First adopted by merchants catering to travelers in 1950s (hotels, restaurants)
     – Assures merchant gets paid (eliminated bad checks and having to
       accept/carry cash).

     Greatly expanded to many different merchant types:
     – Volume rises as rewards induce consumers to use cards
     – Sales expand only when a limited number of merchants accept network cards.
    Store and Network Card Rewards

•   Network credit cards in a mature environment:
     – When almost all merchants accept network cards, there is no sales or market
       share benefit to a merchant. Accepting becomes a defensive measure.

U.S. data                          2000                      2010
                                   Bank     Store            Bank     Store
# of cards (mil)                   455      597              563      513
Purchase Value ($ bil)             768      120            1,330      121
Debt outstanding ($ bil)           480       92              672       93

•   Network card purchase value 11 times store card value in 2010. Adds greatly to
    merchant cost base. Hence merchant complaints.
    Interchange Fee Cap (Rochet-Tirole model)
•   Tourist Test:
     – Interchange fee ≤ cost of non-card payment alternative.
     – European Commission may use as guideline for network credit card
       interchange. Debit cards not covered since few have rewards.
     – Cash costs differ by transaction value, probably are not lowest cost overall.

                  Merchants:         credit card > debit card > check > cash
                  Banks:             credit card > debit card > cash > check
                  Consumer:          cash > check > debit card > credit card

         Overall Cost Rank:          cash > credit card > check > debit card
         Overall Unit Cost:          $1.49      $1.16      $1.07     $.90

•   My preference: apply a cost-based cap—transaction cost without rewards since
    this deals with the hidden cross-subsidy and card overuse (Australia and Spain).
     – If rewards remain, they would be paid for by the card user, not the merchant
         (principle of “user pays” balances costs with benefits).
Interchange Fee Cap (Rochet-Wright model)

•   Convenience user:
     – Due to rewards, cards overused by convenience users.
     – Apply tourist test to cap interchange fee (so merchant is indifferent).

•   Credit user:
     – When store credit cost > network card credit cost, add merchant net
       credit savings to tourist test value.
     – Raises interchange cap.

     – When store credit cost < network card credit cost, subtract network
       card net extra cost from tourist test value.
     – Lowers interchange cap.
    Cross-Subsidies

•   Both store and network cards involve cross-subsidies among consumers.

•   Store credit card:
     – Corte Ingles gives free parking when use card in store.
     – Corte Ingles accepts network cards, but need to pay for parking.

•   Network credit card:
     – Obtain airline miles when use for purchases.
     – Cross-subsidy is to network card user from all other consumers.

•   Magnitude of cross-subsidy is quite different. Network card purchase
    value is 11 times store card value.
 Payment Scale Economies
25.0
           U.S. Cents per
           Transaction
22.5


20.0


17.5
             1987 (Blue)
15.0


12.5


10.0


 7.5
                                   1995 (Red)
 5.0


 2.5                                                                                   2004 (Black)

       0    1000   2000     3000   4000   5000   6000   7000   8000   9000   10000 11000 12000 13000 14000 15000




 • Predicted unit payment costs versus payment transaction volume.
       (Bolt and Humphrey, 2007)

 • OC/TA ratio fell -34% for 11 European countries over 1987-2004.
   Fell by -50% for Spain (-52% for Germany, 0.0% for France).
     Payment Scale Economies

                                         Cash                 Card
Norway 1994-2001
d(payment costs)/d(volume)                                      0.43

Netherlands 2002
Marginal Cost/Average Cost                0.37                  0.39

Belgium 2003
Marginal Cost/Average Cost                0.25                  0.39

U.S. 2005
d(payment costs)/d(volume)                                   0.31 – 0.39

Netherlands 1997-2005
Bank Data, Econometric Model                                 0.27 – 0.31

Sources: Gresvik and Øwre (2002); Brits and Winder (2005), Table 4.3; Quaden (2005),
Table 3; First Annapolis Consulting (2006); Bolt and Humphrey (2009).
    Payment Scale Economies

•   Spain 2002-2009
     – POS card transactions rose by 105% (terminals by 73%).
     – Can estimate change in unit or average cost from just change in POS
       transactions and Spain’s payment scale economy value (.30).
     – Estimate that average card costs fell by 36% (5% per year over 7 years).

•   “Consultations” in Spain reduced merchant discount fee by 52% over 2002-2009
    (from 1.59% to .77%). Fee also fell 21% during 1999-2002.

•   Appears that realized scale effects are being passed on to merchants in Spain.
    Not done in other countries.
     Future of Network Card Reward Programs


•   Recall near death of stamp rewards came when:

       1. Almost all merchants offered stamps, so merchants no longer
          received sale/market share benefits;

       2. Merchants faced strong pressure to cut costs during recession; and

       3. Merchants had control over offering stamps and almost all dropped
          them in favor of cheaper store-specific rewards.

•   1 and 2 exist now for network credit cards in the US.
     Future of Network Card Reward Programs

•   Merchant network card purchase value 11 times store card value.

•   Merchant costs rise but have no control. Network cards control value of
    rewards (raising merchant costs) and consumers control card use due in
    part to rewards.

•   Cards experience substantial scale economies but merchant fees in most
    countries are stable rather than falling with volume growth.

•   If remove card rewards, two studies suggest card use would fall but have
    little effect (-1%, -4%) on network card market share due to “habit
    persistence” (Simon, Smith, and West, 2010; Ching and Hayashi, 2010).
       Future of Network Card Reward Programs
•   Court cases and proposed state/federal legislation are focused on returning
    control of merchant fees to merchants.

•   Political power trumps economic issues. As 10 largest US banks receive 80%
    of the $48 billion in credit card interchange fees, merchants will ultimately
    prevail:
     – Challenging & overturning “honor all cards” rule
     – Legislation requiring negotiation of interchange fees
     – Legislation giving FR authority to impose cost-based interchange fees
     – Legislation permitting minimum value for card use and discount for cash.
         (last 2 items are now law in Vermont, except enforcement is at state level)

•   Possible cheaper payment instrument with no interchange fee:
     – Consumer-initiated electronic check at POS or via Internet for bill payments
     – Makes checks 100% electronic; big cost savings in B-to-B payments

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:14
posted:8/13/2011
language:English
pages:20