Plus many people spend with money they don’t have (ie credit cards) and then don’t pay of the balance. Not only has this, as other comments have suggested, caused an increase in spending (the merchants get paid their money) but credit card companies are making a killing off of interest and fees. With an average rewards credit card APR hovering around 19.4 percent thats a whole lot of money to throw around by the company. Take 1 percent out (as that is the most popular reward back amount) and hand that to the rewards program and those that pay off their balances in full get the rewards free and those who don’t simply put the ‘rewards’ right back into the system through interest plus the other 18 or so percent their still paying.

Rewards programs really pay for themselves and the most likely scenario is that companies take a fraction of different incomes they earn (say 0.2 % of merchant fees and 0.8% from interest payments and late fees) to ‘pay out’ 1% back rewards.

Say a merchant has $1,000,000 in sales of which $500,000 is paid w/ CC. The merchant pays 2% of $500,000 ($10,000) to the CC companies. This $10,000 is 1% of their sales so they raise prices by 1% to pay this cost.

A person with a 1% cash rewards card would therefore about break even in this scenario, as the reward offsets the rise in prices. A person paying in cash on the other hand would be 1% poorer, in order to subsidize the use of CCs by other patrons.

It then follows that a CC user only comes out ahead with a reward if sales volume is less than half CC and lose money if its more. Of course, people that pay in cash lose money in all scenarios but lose more as CC volume goes up.

You really have to hand it to the CC companies, they have applied game theory principles masterfully. If no consumer used credit cards then prices would be lower. CC companies provide an incentive through “rewards” to use them. But the “reward” is only a reward if a few people use CCs. And once CC use becomes dominant people still have an incentive to use them because they will lose less by getting a “reward” than if they paid in cash.

First: Just because things cost less to the retailer doesn’t mean you get a discount: They just keep the 2% for themselves because the product is still worth the same amount to you.

Second: the credit card companies create more demand (people can buy with money they don’t have), which creates more supply, which lowers the prices. I wouldn’t be surprised if the credit card industry lowered retail prices and increased retailer profits.

However, they also bankrupt the consumers’ futures in the process.

Thank you for your comments. Most businesses accept credit cards because there’s an army of transactors demanding on using credit cards and getting their rebates and miles. Industry stats I read said 1/3 of all credit card users are Transactors and they generate 1/2 of the transaction volume. I don’t think the industry would be pursuing the Transactors’ business if they merely break even on them. The DOJ document I quoted in the post showed Transactors are indeed profitable to the card companies.

Also, although 2.5% may be the merchant processing fee for a rewards card, many people do not have such cards. I did soem google-ing and found 3 businesses that quoted their average merchant processing fees. They were 1.6%, 1.71%, and 1.75%. Using 1.7% and the 80% cc usage you used, the price comes out to be 1.36%. If I have a cc with 1% cash back + 3% at grocery and gas, it prolly comes close to 1.36%. To that you can tack on the convenience of the grace period.

So, I’d say that I, along with many Transactors, am probably about breaking even vs. what it would be like in a world without credit cards.

p.s. wikipedia says 2%, but i’m leaning toward the ‘real’ merchant results.