Peak spending periods point to credit card interchange compression

Insights from a recently released white paper indicate that analyzing card usage during peak spending periods can tell an interesting and actionable story to issuers. The white paper can be downloaded in its entirety here.

PSCU recently applied its Member Insight suite of analytic tools to analyze 290 million credit and debit card transactions conducted during the holiday period by members of its Member-Owner credit unions. The analysis looked closely at the transactions to gather insights into how credit unions can elevate their cards to top-of-wallet status before, during and after peak spending periods.

The research showed that, with almost 12 percent growth, credit cards outperformed all expectations for the 2016 holiday season. The main driver of spending growth was card growth. PSCU Owner credit unions grew their overall credit card base by 3.6 percent going into the season, coupled with 7 percent more cards actively purchasing during November and December.

The second, and more significant, contributor to the holiday spending story was more spending per card. On average, credit cardholders spent $100 more during the two holiday months than they did last year. More transactions per active account drove the incremental spending per card this holiday season.

A New Dynamic at Play

For card issuers, strong spending growth is a positive sign because, all things being equal, interchange income should rise commensurately. Interchange is a function of spend multiplied by the rate set for that merchant or merchant category. Interchange yield, or the effective earning rate, is a simple ratio of interchange earned divided by spend.

The data analyzed from the 2016 holiday season could be an early indicator of a new dynamic at play: an emerging pattern of credit card interchange compression.

In 2014 and 2015, data pointed to some minor volatility in credit interchange yield, but generally a stabilized picture, which follows the traditional yield pattern we have observed for many years. With the 2016 holiday season, we began to see a material reduction in yield – 0.16 percent or 16 basis points. Interchange is priced through a complex matrix of rates by merchant category and merchant size, and applied to each individual purchase transaction. Changes in the ‘spending mix’ across merchant categories often create some fluctuation in yield. For example, high dollar volume at merchants with lower interchange pricing can depress overall yield.

The emerging story of credit card interchange compression is isolated to merchants that benefit from significantly higher spending during peak shopping periods. There may be others, but the high spending volumes at these merchants shine a spotlight on where the rate compression is concentrated.

Two notable merchants – a large mail order retailer and a discount warehouse – are driving the preponderance of rate compression due to special interchange pricing arrangements between those merchants and Visa and Mastercard, the card brands that set credit card interchange rates. By delving into the backstory on each, two main strategies surface: scale and card acceptance. These are not necessarily new merchant strategies – we saw indications of both when debit card interchange was compressing. What is new is that these same strategies are now surfacing in credit card interchange.

While holiday spending helped us identify the rate compression drivers for credit card interchange, this is not a holiday-related issue. The merchant level rate reductions are here to stay. It is difficult to predict what the future will bring, but this may well be the start of a growing trend.

The big question is how do we get in front of the trend? What are the effective counter-measures? Here are three strategies to consider:

1. The top counter-measure is persistent card program management and attention to the classic P-A-U strategies: Penetration for more cards; Activation through consistent campaigns; and Usage promotion. Programs supported by PSCU’s Advisors Plus consultant group experience above-average growth. Whether you do it yourself, or with the help of a trusted partner, active card management pays off.
2. Best practices around peak spending periods should always be considered. Increasing credit lines on qualified accounts for the holiday period and early summer (for back to school) is a solid approach to keeping your credit card top-of-wallet through peak spending periods. In addition, planning balance transfer campaigns a month or two after a peak spending interval can capture competitor card balances to grow interest income. While not directly attacking interchange compression, more cards, more transactions and growing interest income can more than offset the effects of credit card interchange compression.
3. There is a growing sentiment around buying local and frequenting independent merchants to support the local community. This movement aligns with the credit union mission from a messaging perspective – and purchases at those merchants would not compress yield. At the local level, credit unions can develop incentive programs with merchants or leverage the Small Business Association’s “Small Business Saturday” concepts all year long.

Applying a strong analytic approach helps set strategy to adapt to changes in the business environment. More than 300 PSCU Owner credit unions regularly use the CUSO’s powerful suite of Member Insight analytics tools to extract actionable insights from their card and transactional histories to make informed adjustments around optimization strategies for growth and profitability.