Finance

How Do Credit Card Companies Make Money? How it started

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Thinking of how do credit card companies make money? How did credit card companies start? Or you need more information about credit card companies?

Credit card companies make money from interest, processing fees and fees charged to individual cardholders. And it’s not only cardholders who have to pay to use credit cards: Merchants pay for the privilege to accept credit cards at their businesses.

This article gives detailed explanatory answers to all your questions. Without further delay, let’s jump right in.

How do credit card companies make money?

Well, there are two types of credit card companies.

On one hand you have the issuers: the banks who essentially hand out the cards.

You also have the networks, who process these transactions, such as Visa or MasterCard. American Express and some others act as both issuers and networks.

  • Transaction Fee

One way these companies make money is by charging the retailer in the form of a transaction fee. This number is usually between 1 and 3%.

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Suppose at a given store, this number is 3%, that means if someone buys $100 worth of items using a credit card, the store keeps $97 and $3 is paid to the issuer and network.

These few dollars may not seem like much, but over time they add up. But why would a store do this? Why would they give up precious revenue? Two reasons.

No. 1: Customer convenience

Stores are in competition with one another and need to make their experience as easy and hassle-free as possible, or else customers will shop somewhere else.

No. 2: Impulse shopping

When not paying in cash, people tend to spend more since the money spent does not feel real. This of course is good for the store. More spending = more revenue. This is especially true if the money doesn’t even need to be paid back right away. This brings us to the other way these companies make money.

  • Interest

This is additional money paid when the balance owed is not paid at the end of the month.

  • Fees

The other way they make money is through fees. Fees for having the card. Fees for cash advances. Fees for paying late.

How Do Credit Card Companies Make Money?
How Do Credit Card Companies Make Money?

How Credit Card Companies Started

In New York City, 1949. A man by the name of Frank McNamara is out at dinner with his clients, when he realizes he left his wallet in another suit. His wife pays the tab but he comes up with an idea. What if nobody had to carry around cash or cheques, but instead, the bill could be charged to their name using a card.

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At the same meal, McNamara talks this over with the restaurant owner. The next day, he returns to the same restaurant and pays using a piece of cardboard with a signature. Diners Club, the first credit card is created.

The Diners Club card was good for a few restaurants and other establishments, and cardholders had to pay their bill at the end of the month. But the guys at Bank of America had a better idea.

Instead of making people pay their balance off at the end of the month, why not give them “free money”, at least for the time being. They’ll have to pay it off eventually. And by the way, you’ll have to pay more later, but enjoy yourself for the time being.

This card was called BankAmericard, but later became its own company: Visa.

What kinds of customers are they targeting?

How do they make the most money?

Their main source of profit are the customers with revolving debt. For the most part, they only make minimum payments, allowing interest to be charged and build up. They’ll pay it off later, but they’re also lining the wallets of the credit card companies.

The second source of profit are the people who pay in full, all of the time. The credit card companies don’t make their money from the cardholder but instead make their money here from charging the retailer 1 – 3% as a transaction fee.

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These types of customers aren’t a huge source of profit, but they add up. Like anything, there are people who exploit the system for free stuff, and there are even some people who will never pay anything.

Who do these companies seek out the most?

Who are they trying to lure in the most?

  • Uneducated population

Firstly, there is the uneducated population. Members of this group typically have little idea how the card or system works and treat the card as if it was not real money being spent. Credit card companies love them because they end up owing a lot of interest.

  • Unused credit card users

The second group that is targeted is composed of people who no longer use the cards because of credit card problems in the past. The companies give them lucrative and special incentives to try and bring them back.

Conclusion

Ultimately, a credit card company is a business, just like a restaurant, grocery store, or manufacturer, and as long as people keep using their services, they will more than likely make money. And a lot of it too.

That’s all for this article on how do credit card companies make money. I hope this article helps and until next time, thanks for reading.

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