* * *<\/p>\n
We started the banking profit model by saying that profit was equal to total revenue less bad debts, less capital holding costs and less fixed costs.\u00a0 This remains largely true.\u00a0 What changes is the way in which we arrive at the total revenue, the way in which we calculate the cost of interest and the addition of a two new costs \u2013 loyalty programmes and fraud.\u00a0 Although in reality there may also be some small changes to the calculation of bad debts and to fixed costs, for the sake of simplicity, I am going to assume that these are calculated in the same way as in the previous models.<\/p>\n
\u00a0<\/strong><\/p>\n Revenue<\/strong><\/p>\n Unlike a traditional lender, a card issuer has the potential to earn revenue from two sources: interest from customers and commission from merchants. \u00a0The profit model must therefore be adjusted to cater for each of these revenue streams as well as annual fees.<\/p>\n Total Revenue\u00a0 =\u00a0Fees + Interest Revenue + Commission Revenue<\/p>\n = Fees + (Revolving Balances x Interest Margin x Repayment Rate) + (Total Spend x Commission)<\/p>\n = (AF x CH) + (T x ATV) x ((RR x PR x i) + CR)<\/p>\n Where\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0AF = Annual Fee\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0CH = Number of Card Holders<\/p>\n T = Number of Transactions\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 PR = Repayment Rate<\/p>\n ATV = Average Transaction Value\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 i = Interest Rate<\/p>\n RR = Revolve Rate\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 CR = Commission Rate<\/p>\n Customers usually fall into one of two groups and so revenue strategies tend to conform to these same splits.\u00a0 Revolvers are usually the more profitable of the two groups as they can generate revenue in both streams.\u00a0 However, as balances increase and approach the limit\u00a0the capacity to continue spending decreases.\u00a0 Transactors, on the other hand, seldom carry a balance on which an issuer can earn interest but they have more freedom to spend.<\/p>\n Strategies aimed at each group should be carefully considered.\u00a0 Balance transfers \u2013 or campaigns which encourage large, once-off purchases \u2013 create revolving balances and sometimes a large, once-off commission while generating little on-going commission income.\u00a0 Strategies that encourage frequent usage don\u2019t usually lead to increased revolving balances but do have a more consistent \u2013 and often growing \u2013 long-term impact on commission revenue..<\/p>\n Variable Costs<\/strong><\/p>\n There is also a significant difference between how card issuers and other lenders accrue variable costs.<\/p>\n Firstly, unlike other loans, most credit cards have an interest free period during which the card issuer must cover the costs of the carrying the debt.<\/p>\n The high interest margin charged by card issuers aims to compensate them for this cost but it is important to model it separately as not all customers end up revolving and hence, not all customers pay that interest at a later stage.\u00a0 In these cases, it is important for an issuer to understand whether the commission earnings alone are sufficient to compensate for these interest costs.<\/p>\n Secondly, most card issuers accrue costs for a customer loyalty programme.\u00a0 It is common for card issuers to provide their customers with rewards for each Euro of spend they put on their cards.\u00a0 The rate at which these rewards accrue varies by card issuer but is\u00a0commonly related in some way to the commission that the issuer earns.\u00a0 It is therefore possible to account for this by simply using a net commission rate.\u00a0 However, since loyalty programmes are an important tool in many markets I prefer to keep it out as a specific profit lever.<\/p>\n Finally, credit card issuers also run the risk of incurring transactional fraud \u2013\u00a0 lost, stolen or counterfeited cards.\u00a0 There are many cases in which the card issuer will need to carry the cost of fraudulent spend that has occurred on their cards.\u00a0 This is not a cost common to other lenders, at least not after the application stage.<\/p>\n Variable Costs = (T x ATV) x ((CoC\u00a0x IFP) + L + FR)<\/p>\n Where \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 T = Number of Transactions\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 IFP = Interest Free Period Adjustment<\/p>\n ATV = Average Transaction Value\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0CoC =\u00a0Cost of Capital<\/p>\n FR = Fraud Rate<\/p>\n Shorter interest free periods and cheaper loyalty programmes will result in lower costs but will also likely result in lower response rates to marketing efforts, lower card usage and higher attrition among existing customers.<\/p>\n \u00a0<\/strong><\/p>\n The Credit Card Profit Model\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0<\/strong><\/p>\n Profit is simply what is left of revenue once all costs have been paid; in this case after variable costs, bad debt costs, capital holding costs and fixed costs have been paid.<\/p>\n I have decided to model revenue and variable costs as functions of total spend while modelling bad debt and capital costs as a function of total balances and total limits.<\/p>\n The difference between the two arises from the interaction of the interest free period and the revolve rate over time.\u00a0 When a customer first uses their card their spend increases and so does the commission earned and loyalty fees and interest costs accrued by the card issuer.\u00a0 Once the interest free period ends and the payment falls due, some customers (transactors) will pay their full balance outstanding and thus have a zero balance while others will pay the minimum due (revolve) and thus create a balance equal to 100% less the minimum repayment percentage of that spend.<\/p>\n Over time, total spend increase in both customer groups but balances only increase among the group of customers that are revolving.\u00a0 It is these longer-term balances on which capital costs accrue and which are ultimately at risk of being written-off. \u00a0In reality, the interaction between spend and risk is not this \u2018clean\u2019 but this captures the essence of the situation.<\/p>\n Profit = Revenue \u2013 Variable Costs \u2013 Bad Debt \u2013 Capital Holding Costs \u2013 Fixed Costs<\/p>\n = (AF x CH) + (T x ATV) x ((RR x PR x i) + CR) \u2013 (T x ATV) x (L + (CoC\u00a0x IFP)) \u2013 (TL x U x BR) \u2013 (TL x U x CoC\u00a0+ \u00a0\u00a0TL x \u00a0\u00a0(1 \u2013 U) x BHR\u00a0x CoC) \u2013 FC<\/p>\n = (T x ATV) x (CR \u2013 L \u2013 (CoC\u00a0x IFP) -FR) \u2013 (TL x U x BR) \u2013 ((TL x U x CoC)\u00a0+ (TL x (1 \u2013 U) x BHR\u00a0x CoC)) \u2013 FC<\/p>\n Where\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0AF = Annual Fee\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0CH = Number of Card Holders<\/p>\n T = Number of Transactions\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 i = Interest Rate<\/p>\n ATV = Average Transaction Value\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0TL = Total Limits<\/p>\n RR = Revolve Rate\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 U = Av. Utilisation<\/p>\n PR = Repayment Rate\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0 BR = Bad Rate<\/p>\n CR = Commission Rate\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 CoC = Cost of Capital<\/p>\n L = Loyalty Programme Costs\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 BHR = Basel Holding Rate<\/p>\n IFP = Interest Free Period Adjustment\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0FC = Fixed Costs<\/p>\n FR = Fraud Rate<\/p>\n \u00a0<\/strong><\/p>\n Visualising the Credit Card Profit Model\u00a0\u00a0<\/strong><\/p>\n Like with the banking profit model, it is also possible to create a visual profit model.\u00a0 This model communicates the links between key ratios and teams in a user-friendly manner but does so at the cost of lost accuracy.<\/p>\n The key marketing and originations ratios remain unchanged but the model\u00a0starts to diverge from the banking one when spend and balances are considered in the account management and fraud management stages.<\/p>\n The first new ratio is the \u2018usage rate\u2019 which is similar to a \u2018utilisation rate\u2019\u00a0except that it looks at monthly spend rather than at carried balances.\u00a0 This is done to capture information\u00a0for transactors who may have a zero balance \u2013 and thus a zero balance \u2013 at each month end but who may nonetheless have been restricted by their limit at some stage during the month.<\/p>\n The next new ratio is the \u2018fraud rate\u2019.\u00a0 The structure and work of a fraud\u00a0function is often similar in design to that of a debt management team with analytical, strategic and operational roles.\u00a0 I have simplified it here to a simple ratio of fraud: good spend as this is the most important from a business point-of-view, however if you are interested in more detail about the fraud function you can read\u00a0this article<\/a>\u00a0or search in\u00a0this category\u00a0<\/a>for others.<\/p>\n The third new ratio is the \u2018commission rate\u2019.\u00a0 The commission rate earned by an issuer will vary by each merchant type and, even within merchant types, in many cases on a case-by-case basis depending on the relative power of each merchant.\u00a0 Certain card brands will also attract different commission rates; usually coinciding\u00a0with their various strategies.\u00a0 So American Express\u00a0and Diners Club who aim to attract wealthier transactors\u00a0will charge higher commission rates to compensate for their lower revolve rates while Visa and MasterCard\u00a0will charge lower rates but appeal to\u00a0a broader\u00a0target market more likely to revolve.<\/p>\n The final new ratio is the revolve rate which I have mentioned above.\u00a0 This refers to the percentage of customers who pay the minimum balance \u2013 or less than their full balance \u2013 every month.\u00a0 On these customers an issuer can earn both commission and interest but must also carry higher risk.\u00a0 The ideal revolve rate will vary by market and depending on the issuers business objectives but should be higher when the issuer is aiming to build balances and lower when the issuer is looking to reduce risk.<\/p>\n Source: https:\/\/blegrange.wordpress.com\/2010\/10\/11\/a-generic-credit-card-profit-model\/<\/a><\/p>\n <\/p>\n","protected":false},"excerpt":{"rendered":" A Generic Credit Card Profit\u00a0Model Probably the most\u00a0common credit card business model is\u00a0for customers to be charged a small annual fee\u00a0in return for which they are able to make purchases using their card and to only pay for those purchases after some interest-free period \u2013 often up to 55 days.\u00a0 At the end of this … Continue reading A Generic Credit Card Profit\u00a0Model<\/span><\/a><\/p>\n","protected":false},"author":1,"featured_media":1756,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[25],"tags":[32,37,26,54,46],"class_list":["post-1754","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-bookmarked-articles","tag-analytic","tag-banking","tag-data","tag-data-mining","tag-retail-banking"],"_links":{"self":[{"href":"https:\/\/mintea.blog\/index.php?rest_route=\/wp\/v2\/posts\/1754","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/mintea.blog\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/mintea.blog\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/mintea.blog\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/mintea.blog\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=1754"}],"version-history":[{"count":3,"href":"https:\/\/mintea.blog\/index.php?rest_route=\/wp\/v2\/posts\/1754\/revisions"}],"predecessor-version":[{"id":1760,"href":"https:\/\/mintea.blog\/index.php?rest_route=\/wp\/v2\/posts\/1754\/revisions\/1760"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/mintea.blog\/index.php?rest_route=\/wp\/v2\/media\/1756"}],"wp:attachment":[{"href":"https:\/\/mintea.blog\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=1754"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/mintea.blog\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=1754"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/mintea.blog\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=1754"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}![\"Diagram,](\"https:\/\/mintea.blog\/wp-content\/uploads\/2022\/01\/diagram-funnel-chart-description-automatically-g.jpeg\")
<\/p>\n