Why Credit Card Rewards Models Are Getting Unsustainable

It didn't take long for debit card issuers affected by the Durbin amendment fee caps to cut back or eliminate rewards programs to recoup costs. Issuers now engaged in the increasingly competitive credit card rewards and loyalty environment may soon have to face that same decision.

With global pressure to decrease interchange rates for credit card transactions, it is not far-fetched to think U.S. issuers may see rates coming down within the next two years, said Brian Riley, principal executive advisor with CEB TowerGroup.

"If that happens, the programs we see today for cards and rewards are at risk," Riley said. He advised issuers to change their programs ahead of time to soften the blow to consumers.

Some issuers today offer lucrative signup bonuses and other costly features at a time when younger consumers are more inclined to apply for and use debit cards. It creates a complicated scenario for what a bank might want to do now to trim costs, and what the plan will be if regulatory changes reduce revenue.

Merchant-funded rewards programs are an option for issuers, and some represent a good model to follow while others struggle for adoption, Riley said.

The Plenti multi-merchant rewards program, managed through American Express but not tied to a specific credit card brand, is a new model that has some potential, Riley said. American Express does issue a Plenti credit card, but the general Plenti rewards card earns points for purchases with any card or cash to be redeemed at participating merchants. However, to lock in consumer loyalty, Plenti limits itself to one merchant partner per category.

Banks can keep customers interested in their credit cards by localizing merchant-funded rewards rather than offering only national brands, Riley said.

"Most anyone would certainly take $20 off at an Outback Steakhouse, but it would be more appealing if maybe the offer was for a well-liked local steakhouse," Riley said.

It will also be wise for banks to approach digital payment and commerce in a way that rewards shoppers for ongoing use, Riley added.

Apple, Samsung and Google all have designs on how they intend to incorporate rewards and loyalty programs into their mobile wallet services, whether bank partners are on board with that process or not.

"You have to give me a reason for using a mobile wallet and getting rewards, and it can't just be a conversion of the plastic card program into a digital program," Riley said. "It has to be more than that."

Chase may have had that in mind when partnering with Starbucks to offer a prepaid rewards card later this year, allowing Starbucks customers to redeem points at other merchant locations.

A legal ruling restricting interchange is not the only danger lurking for rewards programs. Some will simply become too expensive to operate even under today's standards, or fall by the wayside because of company mergers.

It's possible that consumers could lose one of the most popular rewards cards available in the American Express Starwood Preferred Guest Card when Marriott takes over Starwood, said Maria Schriber, community content and data manager at Wallaby Financial.

Marriott's card issuing partner is JPMorgan Chase, but a decision has not been made on whether Amex will remain the issuer of the Starwood card.

"The Starwood card does really well because it has more than 30 airline partners," Schriber said. "This is a card that many card geeks love, but it is a good example of a rewards program bubble."

Prior to pulling back its incentive, American Express offered a signup bonus of 35,000 points, or about $140 in rewards.

"It was interesting that it got that high, and showed how competitive it is getting," said Schriber, whose company provides an app and Web tools to help consumers determine which of their credit cards are best to use for each purchase to maximize rewards.

There are other examples of cards offering incentives that might be difficult to maintain if revenue circumstances change.

The Discover It card offers double cash back to new cardholders in the first 12 billing cycles, while Citi offers cash back when making a transaction and when the card user pays off the statement balance. Chase Freedom and Capital One Quicksilver offer cash back at 1.5%.

But banks are aware of the cost of doing rewards business, and many are implementing rules designed to cut costs by addressing cardholder churn, Schriber said.

"There is a whole set of card users who get a new card to earn points and travel the world, then cancel the card before having to pay the annual fees," Schriber added. "Credit card issuers are figuring out how to cut down on that."

Chase recently introduced the 5-24 rule, which means Chase will not approve a new credit card customer if that customer has opened five other card accounts, across all issuers, in the last 24 months, Schriber said.

"The issuers are quietly trying to cut expenses, while still attracting new customers," she added. "American Express has set up a rule that if you received a bonus to sign up for a new card before, you can't get that bonus again."

Regardless of what issuers decide to do to control costs or not be caught off guard by a regulatory change, they are all paddling along in the same boat.

"When you look at new offers today, 95% of all offers either have some cash back or credit," Tower Group's Riley said. "That's an expensive business model, and there's a horizon of about two years to think of how to re-engineer that process."