Credit cards ; Electronic commerce ; Debit cards

Brye Steeves

English

Research Papers in Economics

ary Carol Garrity, owner of Nell
Hill’s Home Emporium and two other
shops in Atchison, Kan., is affected by
card reward programs as both a 
merchant and a consumer.
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RAs a shop owner of 25 years, Garrity has
seen an increasing number of patrons opting to
pay with their credit cards. She supposes the
incentives, such as the cash-back or travel
rewards tied to both credit and debit cards, is one
of the reasons driving this trend.
“I know it motivates me personally,” says
Garrity, who just recently started using two air-
line reward cards.
Her enticement: “My girlfriends who own
businesses get to fly first-class to Europe.”
A long-time cardholder but recent reward
card loyalist, Garrity is just the kind of con-
sumer that card networks are hoping to attract.
Research shows those with reward credit and
debit cards use them more exclusively than
cards that don’t offer rewards, and reward card
transactions often replace cash, check and non-
reward card transactions, says Fumiko
Hayashi, a senior economist with the Federal
Reserve Bank of Kansas City.
Hayashi recently analyzed the effects of
credit and debit card rewards on consumers’
payment choices along with Andrew
Ching, assistant professor of
marketing at the University
of Toronto.
“Capturing
new cardholders
is becoming diffi-
cult because most
consumers already
have both credit and
debit cards,” Hayashi
says. “Payment card
issuers, therefore, are try-
ing to stimulate their exist-
ing customers’ card usage by
providing rewards. It’s an
incentive for consumers.”
And it appears to be working. 
Enticing loyalty
Deborah Hamilton starts every
day with a reward, in addition to her
coffeehouse latte. 
ike so many of her customers, Mary Carol Garrity now charges
almost anything she can—including business expenses for her three
upscale furniture, home décor and giftware shops in 
eastern Kansas—to either her Visa or American Express credit cards. L
FALL 2006 . TEN 7
Charging Toward
ISSUERS OFFER CARDHOLDERS INCENTIVES TO ENTICE LOYALTYHer morning wake-up is Hamilton’s first
credit card purchase of the day followed by,
“Everything! Everything goes on the card,” she
says, which gets her that much closer toward
another Southwest Airlines ticket. 
With the exception of her mortgage and
car payments, although she tried, Hamilton
pays for all purchases big and small with her
Visa. And as a result, the single, 55-year-old
grandmother in Kansas City, Mo., racks up
five or six plane tickets a year. She’s traveled to
Napa Valley, Mexico, the Caribbean and the
Bahamas, among
other places. 
A “fanatical”
reward credit card
holder of 15 years,
Hamilton says only
death will part her
from her card. And
then her kids will
fight over her airline
points, she jokes.
It’s this loyalty
that card issuers are
striving to achieve
in hopes of gaining
users who would
have otherwise paid
with cash, check or
another card.
It’s been report-
ed that many card issuers that launched new
rewards programs have seen increases in spend-
ing on their cards. However, it is unlikely
reward receivers are simply spending more, but
are using their reward card in lieu of other pay-
ment methods, Hayashi says.
Footing the bill
Reward card issuers target middle- to high-
income consumers rather than low-income earn-
ers, who don’t qualify for high credit limits, or
possibly cards at all. As a result, low-income
earners may be affected beyond just rewards. 
Card programs and the merchant fee struc-
ture may distribute income from low-income to
high-income consumers, Hayashi says.
This is due to many merchants paying
higher fees to card issuers if their customers use
a reward credit card instead of a non-reward
credit card or other payment methods.
Merchants aren’t allowed to reject reward card
payments if they accept the network’s non-
reward card, nor can merchants price-discrim-
inate based on the payment method used. 
“As a result, the more customers who use
reward credit cards, the higher the merchants
may mark up their retail prices in order to off-
set higher fees,” Hayashi says. “Although
reward credit card holders are partly compen-
sated for higher
retail prices through
rewards, other con-
sumers aren’t.” 
Compounding
the cost of reward
credit card fees on
merchants, and pos-
sibly their customers,
Visa and MasterCard
recently introduced
interchange fees that
apply only to reward
credit cards. These
fees, which are a per-
centage of each trans-
action that the mer-
chant pays to the
card issuer, are higher
than non-reward
credit card interchange fees. The fees are the
same for reward and non-reward debit cards.
Accepting credit cards is increasingly chal-
lenging for a smaller business whose volume of
sales can’t easily offset additional interchange fees
like a chain merchant could, says Scott Baird,
manager of Georgetown Furniture, a family-
owned and operated furniture store in the west-
ern Missouri city of Liberty. 
“It doesn’t benefit the merchants at all,”
Baird says. “It’s kind of a deterrent. We appreci-
ate the business … but I would rather see some-
one use a check or the (store’s) finance plan.”
The majority of the store’s customers do
pay with a credit card or via the store-offered
finance plan, Baird says. It’s tough to say,
though, how many of those card purchases are
FALL 2006 . TEN 8
D eborah Hamilton 
starts every day with 
a reward, in addition 
to her coffeehouse latte.
Her morning wake-up 
is Hamilton’s first 
credit card purchase of
the day followed by
“everything!”FALL 2006 . TEN 9
tied to rewards and exactly how much that
costs Georgetown Furniture. 
“One percent here and 1 percent there—
it’s small, but they can add up,” Baird says. 
But Baird, an avid fly fisherman, loves his
personal card: a Visa with Cabela’s rewards. He
recently redeemed points for tackle from the
outdoor recreation mega store.
“It is difficult to say who actually pays for
these rewards,” Hayashi says. 
Even if reward card use is fully funded by
interchange fees, that doesn’t mean the actual
rewards are paid by merchants.  
Merchants may impose the cost of the inter-
change fees on their customers by raising prices.
If that’s the case, the customers are actually pay-
ing for the rewards. And how merchants and
their customers share the costs of interchange
fees depends on price elasticity of supply and
demand for goods and services, Hayashi says.
If credit card rewards are funded by interest
or finance charges, those card users are paying,
at least in part, for the rewards. For debit card
issuers, revenue is generated from both inter-
change fees and account holders.
Just like consumers, merchants and card
issuers are motivated by reward cards. Their
enticement: customer loyalty.
‘Cost of doing business’
The average consumer in the United States
has five to seven credit cards, says Ben Woolsey,
marketing director of CreditCards.com, a web-
site for consumers to research and compare
offers from leading card networks in the
United States.
Reward programs are driven by card com-
petition. By offering incentives, card issuers
build loyalty and extend the lifespan of the
card, which may offset the expenses of offering
the program.
To ensure consumers reach for their card
versus another form of payment, issuers are
offering countless reward programs as incentive. 
“Rewards have become a cost of doing
business” for the credit and debit card indus-
tries, Woolsey says.
Beyond airline miles and cash-back
PHOTO BY CHRIS SCHOENHALS
TO ACCUMULATE REWARDS, Deborah Hamilton
(right) of Kansas City, Mo., uses her credit card for
every purchase possible. It’s this kind of loyalty that 
card issuers hope results from reward programs.
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SFALL 2006 . TEN 10
options, these days, rewards range from mer-
chandise (Disney products and Starbucks cof-
fee, for example) to gasoline rebates (like the
Chase PerfectCard Platinum MasterCard) to
savings in a child’s college fund (like the Citi
Upromise Card.)
Rewards have increasingly become an
expectation by cardholders, who are more
savvy about receiving value in each transaction,
says Jennifer Schulz, vice president of con-
sumer credit products for Visa USA. 
“(Visa strives) to create reward programs
that are relevant to their customers’ interests
and lifestyles and ultimately foster customer
loyalty,” she says.
In the early 1980s, Visa introduced one
of the first mainstream reward programs, the
AAA Visa card. It wasn’t until about a decade
later that Visa, and other issuers, began 
partnering with merchants, which has result-
ed in significant growth in the reward card
market. Now, roughly half of consumers in
the United States have at least one reward
credit card of some type.
Many reward cards are co-sponsored by
merchants in an effort to offset the added
expense of accepting this type of payment
method while building customer loyalty,
Hayashi says. Often rewards are greater when
the card is used at the co-sponsor merchant’s
location. Additionally, the cardholders may
receive discounts or free merchandise from the
sponsoring merchant, such as Target. Both
incentives may cause cardholders to shop there
rather than at competitor stores such as Kmart
or Wal-Mart. 
Small merchants might not be able to
issue co-branded cards, but may join issuers’
reward programs by offering discounts on their
merchandise to increase sales and gain cus-
tomer loyalty. 
Because all merchants who accept cards
pay higher fees for reward cards anyway, it may
be advantageous for individual merchants to
partner with a card issuer, Hayashi says. 
Collecting rewards 
Cars with license plates from states all
around the Midwest circle the block surround-
ing Mary Carol Garrity’s main store in down-
town Atchison. Shoppers—mostly women—
are eager to get inside Nell Hill’s, the eclectic
“home emporium” Garrity named after her
grandmother. 
Inside, customers make their way to the
cash register, knickknacks in one hand and
their plastic card in the other. 
After his wife, Jo, selected a few things for
their kitchen back home in Topeka, Ken
Edwards paid for her purchases, like he does
for the majority of their purchases, with a
Discover reward credit card.
When choosing their credit card, one fea-
ture was most important to the Edwards cou-
ple: Discover’s cash-back reward program.
“Well, you can always use cash,” Ken says,
adding that as long as it’s convenient and
Discover offers this reward, he’ll use the card.
There are several factors to consider when
choosing a reward program debit or credit
card, Woolsey says. Cardholders need to con-
sider terms of the rewards, interest rates, annu-
al fees and other member benefits. 
MARY CAROL GARRITY (LEFT) helps customers make
furniture selections for their homes. As a seller of large-
purchase items, Garrity sees most of her customers pay
with credit cards.
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RMany cardholders don’t realize
some conditions of reward programs
can negate the rewards the cardhold-
er receives, Woolsey says, adding it’s
the reward aspect that often affects
consumer behavior. As a result, cardholders use
their cards exclusively in hopes of maximizing
their purchases. 
Hayashi’s research shows reward programs
entice both credit and debit card holders alike. 
The choice to use a reward credit card versus a
reward debit card is often a matter of prefer-
ence, just like the type of reward program cho-
sen. A possible determinant of consumer pay-
ment choice is using a debit card to avoid car-
rying a balance on a credit card, or reduce
interest costs on a credit card balance. 
Consumers who carry a balance on their
credit cards use debit cards more often, and those
who don’t tend to use credit cards more often.
Regardless of whether a debit or credit card
is used, consumers with either a reward debit or
reward credit card use this card more exclusively.
And consumers who receive rewards from both
debit and credit cards distribute their transac-
tions more equally between the cards.
There are distinct groups, in addition to
income levels, who most use reward card pro-
grams, according to Hayashi’s research. 
Generally, female consumers tend to use
debit cards more frequently than male con-
sumers, while Asian-Americans use credit cards
more exclusively. Younger consumers use both
credit and debit cards more often than older
consumers, as do those with higher education.
The credit card market will eventually
reach a saturation point—again. After a large
number of high-income earners hold reward
cards, issuers will target first middle- and then
low-income earners, Hayashi predicts. 
“Right now, issuers are competing for con-
sumers,” Hayashi says. “And this will keep
increasing rewards.”
FALL 2006 . TEN 11
COMMENTS/QUESTIONS are welcome
and should be sent to teneditors@kc.frb.org.
T
FURTHER RESOURCES
PAYMENT CARD REWARDS PROGRAMS AND 
CONSUMER PAYMENT CHOICE 
BY FUMIKO HAYASHI AND ANDREW CHING
www.KansasCityFed.org/TEN
BY BRYE STEEVES, SENIOR WRITER
R ewards have 
increasingly become 
an expectation by 
cardholders, who are 
more savvy about 
receiving value in 
each transaction.
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KEN EDWARDS OF TOPEKA, Kan., pays for his wife’s
purchase with his cash-back reward card. He says as long
as he gets rewards, that card will be his preferred pay-
ment method. 

Charging toward rewards : issuers offer cardholders incentives to entice loyalty

http://www.kansascityfed.org/publicat/TEN/pdf/Fall2006/ChargingForRewards.pdf

Charging toward rewards : issuers offer cardholders incentives to entice loyalty

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