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This story appears in the January 2009 issue of Cards&Payments.
The rising cost of managing credit and debit card rewards during the current economic downturn is giving card issuers another reason to explore merchant-funded rewards. Issuers view the concept as a way to help offset the expense of directly funding rewards and to boost customer retention and card use.
With coalition-based or merchant-funded rewards, groups of merchants team with card issuers, processors or independent merchant-network operators to provide discounts and cash rebates when cardholders purchase specific products or services from participating merchants. Part of the merchant rebate goes to the cardholder as cash or as a cash equivalent, and a portion goes to the issuer to help cover the cost to administer the program.
An estimated 80% of credit cards offer some type of rewards. And as debit card use continues to grow, debit rewards also are on the rise, analysts say.
Issuer-funded debit rewards programs grew from 5% of U.S. card issuers to 19% between 2006 and 2008, according to the 2008 Debit Issuer Study U.S.-based Oliver Wyman Group conducted for the Pulse electronic funds transfer network.
During the same period, the percentage of financial institutions offering debit rewards that also offered some form of merchant-funded rewards grew to 23% from 11%, the study found.
Coalition-based rewards vary widely in their structure and scope, but the concept has existed for years in Europe, primarily as a customer-retention tool. Citigroup in 2004 adopted a broad, coalition-based program called ThankYou Network that rewards customers for using multiple Citi products and services, including credit and debit card use and banking. Participants also earn rewards by making travel and merchandise purchases through Citi's merchant partners.
A growing number of card issuers and processors are now developing their merchant-funded rewards programs specifically for credit and debit cards.
U.S.-based card-industry players, including Fiserv Inc., late last year unveiled UChoose Rewards, a merchant-funded rewards program six banks are piloting. And SunTrust Banks Inc. recently announced it will augment its points-based, issuer-funded card rewards this year with merchant-funded rewards administered by Vesdia Corp. for credit and debit card use. Access Development Corp., which has administered merchant-funded rewards for Zions Bancorp since 2005, also says it is in talks with several other banks interested in launching their own merchant-funded rewards.
Though the sluggish economy, which has boosted the cost to administer and fund card rewards, is one factor driving greater interest in merchant-funded rewards, the specter of declining interchange revenue brought on by industry and legislative pressure worldwide is another.
Merchant acquirers pay interchange to card issuers to cover their cost to provide card programs. They then pass the expense on to their merchant clients as part of the discount rate. U.S. retailers claim they ultimately pay approximately $42 billion annually in interchange. A good chunk of interchange helps fund issuers' reward programs but does nothing to benefit retailers, merchants complain.
Lawmakers last year introduced the first-ever U.S. legislation to regulate credit and debit card interchange. Although the Credit Card Fair Fee Act did not reach Congress for a vote, observers believe the bill will resurface this year.
"A legislative reduction in interchange fees would force card issuers to seek alternative funding for their rewards programs and, as a result, many are already exploring the possibilities surrounding merchant-funded rewards," says Terry X. Xie, a director with U.S.-based Mercator Advisory Group. It is still early too in the evolution of merchant-funded rewards for U.S. credit and debit cards to predict how widespread they will become, he notes.
'An Enhancement'
Analysts and industry insiders also caution that merchant-funded rewards are not a panacea for card issuers' burdens surrounding rewards programs.
"Merchant-funded rewards tend to enhance consumer involvement with rewards programs, and they reduce some of the cost burden," says Lars Holmquist, chief marketing officer for Vesdia, which administers merchant-funded credit and debit rewards for Citi, Citizens Financial Group and SunTrust. "But they ought to be viewed as an enhancement to existing rewards programs, not a substitute for them."
Many card issuers mistakenly believe merchant-funded rewards will eliminate the burden of issuer-funded programs completely, notes Kelly Passey, Access Development executive vice president of loyalty. "Merchant-funded rewards can provide tremendous value to card issuers, but there are still costs to be borne and they take a lot of work," he says. "You don't just turn it on and your problems are over."
Management Fees
Successful merchant-funded rewards usually require extensive participation from the card issuer, including adding merchants' logos to statement mailings and to bank Web-site communications, Passey says.
The issuer cost to operate merchant-funded rewards varies. Most administrators charge card issuers a fee to manage the programs, and fees vary based on the program's scope. But most merchant-funded rewards operators say program fees are more than offset by merchant rebates. The spread, however, depends on the success of the program.
Before making any rewards changes, card issuers should adopt more-robust data-analysis tools to measure program costs and results, Xie says. "One of the dilemmas issuers face, especially with debit card rewards in a changing economy, is determining whether higher card-usage is actually a result of a rewards program," he says. "This is especially important to know when a merchant-funded rewards program is added."
Fiserv Inc. joined forces with the coalition marketing company Affinity Solutions Inc. for its new merchant-funded rewards program. Bridge2 Solutions handles reward redemptions.
The program enables cardholders to earn rewards both for credit and debit card purchases through hundreds of national, online and local merchants. In most cases, customers must spend a specific amount with merchandise partners to achieve rebates that range from 1% to 25% of the sale. The average rebate is about 5%, says Andy Brown, Fiserv vice president of product development.
Customers can redeem their rewards for items featured in UChoose Rewards' online catalog or for cash back. Rewards include tickets for travel and entertainment and approximately 6 million other merchandise items.
Fiserv's financial institutions clients can customize Fiserv's program in a variety of ways so card issuers can set their own point-value rates for card usage. Issuers also can determine whether PIN-based, signature-based or both types of debit trigger rewards.
"Many card issuers that want to promote debit card usage heavily are getting the best results by using a traditional points program in combination with a merchant-funded rewards program," Brown says.
Central Pacific Bank of Honolulu conducted a UChoose Rewards pilot earlier this year with its Visa check card customers. UChoose is Central Pacific's only debit-rewards program, and it is too soon to quantify results, a bank spokesperson says.
Citizens Bank in 2007 added a merchant-funded component to its points-based, issuer-funded debit card rewards. Through the newer merchant-funded program, customers can earn up to 10 points for every dollar spent at participating retailers through a program Vesdia administers.
Participating merchants include Eddie Bauer, Golfsmith and Legal Sea Foods. Customers can redeem their points for a variety of cash-equivalent rewards available through an online catalog.
The program is meeting its goals, a Citizens spokesperson says, declining to elaborate or specify how many consumers are participating.
Card Spending Up
But Vesdia says that, in a sample of 10 million consumers enrolled in all of its reward card programs attached to a merchant network, cardholder spending at participating merchants increased by 37% during the first half of 2008 compared with the same period the previous year.
Results from other merchant-funded rewards programs vary. Citi's ThankYou Network has reduced cardholder attrition by 50% since its introduction, according to Nancy Gordon, executive vice president in charge of the program.
Zions Bank, whose merchant-funded rewards program is more localized and mature, has helped reduce cardholder attrition by 26% over three years, while new-account acquisition has risen 7% annually, a bank spokesperson says. Zions also reports an 11% lift in the average debit card transaction at participating merchants compared with the bank's overall average debit transaction.
Customers participating in Zions Cash Rewards can earn rewards on purchases with credit or debit cards through more than 200 national online retailers, including Target Corp. and Wal-Mart Stores Inc. More than 1,500 local retailers, including restaurants, also provide rewards.
Zions requires cardholders to hit a certain spending target to get a discount. "Just giving people a certain percentage off on routine transactions doesn't benefit the bank or the merchant," Passey says.
A typical Zions offer is $5 off each purchase of $30 or more. The average reward Zions members receive on each qualifying transaction is $4.25, which equates to about 9% based on the average transaction amount. Program participants receive their rebates as cash deposited into their checking accounts or as a credit to their credit card accounts.
Merchant-funded card rewards remain relatively new, and although they vary considerably in design and scope, they may help issuers retain customers and increase card use. But successful programs require ongoing investment, marketing support and data analysis. CP
