October 9, 2008
Store Cards Costing Customers More in Interest
By Bernice Hurst, Managing Partner, Fine Food Network
At a time when more shoppers are trying to decide how to stretch their money, one seemingly obvious decision is reducing the amount paid each month on credit and store cards. What not everyone realizes, however, is that making minimum payments means interest is paid first and the debt itself doesn’t get very much smaller.
Julian Knight, in the UK newspaper The Independent, examined store cards and pronounced them “a very expensive way to shop.” Although he agreed that they may seem convenient at the till, he quotes Michelle Slade of financial information firm Moneyfacts, who says that “The combination of high interest rates – up to 30 percent – and the requirement only to make a monthly repayment of four percent or less of the balance outstanding means that even relatively small debts can hang around for 15 years or more.”
According to Moneyfacts, store card interest rates – already more than three times the level of the ‘best buy’ credit cards – are also set to rise further. Mr. Knight explains that experts attribute this both to banks operating the cards and retailers needing to maximize profits during the current economic squeeze.
David Kuo, of financial advice website Fool.co.uk, told him that banks are getting to charge more in interest in exchange for giving retailers the credit they need to maintain stock levels.
Card issuers make their profits when customers pay only the minimum necessary. Moneyfacts’ sums demonstrated that customers can end up paying more in interest than they initially spent.
All this is in spite of a Competition Commission decision last year that card providers must be more transparent about interest rates exceeding 25 percent so that consumers are aware of what will happen if they stick to minimum payments.
Edward Simpson of the Finance and Leasing Association (FLA), which represents the store card industry, maintains that the Commission’s instructions have ensured that customers are getting a fairer deal than in the past with more transparent rates. He also pointed out that “the actual level of debt on these store cards is actually quite small compared
with credit cards, loans and mortgages, and the average sum owed by customers
is only £156.”
Discussion Questions: How do you think the U.S. financial crisis will impact store credit cards? Will interest rates on store cards increase? Will consumers cut back on using store cards?
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By my way of thinking, plastic in the drawer is not the same as cash in the drawer. Many consumers are not fully cognizant of all of the ramifications surrounding a credit card transaction, and they especially are not aware of what these transactions actually cost the retailer when they go bad. The only advantage to offering a store branded card that I can see is if the credit provider is the party assuming any loss if the customer fails to pay their bill on time, if at all.
If the bank is assuming the risk, and the customers only pay the minimum required, will it be enough to replenish the coffers to purchase new inventory and cover operating expenses? As retailers, we need to turn inventory to make a profit. If that inventory is purchased on credit, based on the presumption that the customers will also pay for what they purchased on credit, are we really making any money? Or are we just re-distributing bank notes around the market. Sort of a robbing Peter to pay Paul type of situation?
In truth, the only party making any profit when the bare minimum is paid on an account is the credit provider. As long as the principal balance is not paid off, the provider will continue to profit. But when a retailer assumes the risk, that principle that is not being paid off is basically paramount to a freezing of your dollars available to buy, thus forcing the retailer to rely on credit to replenish inventory – which then costs the retailer money, slowly eating away at an already slim profit margin.
I process more and more applications that are rejected, and fewer people buying large ticket items in my work, largely because available credit is drying up. The only sensible way for a retailer today to offer credit is to partner with a large credit bank offering a Visa or MasterCard type of program. Things are going to get much worse before they get better in retail. We need to maximize our potential before it is too late. Plastic money costs way too much, and in more ways than you can imagine.
Put me in both camps: the use of store credit cards will increase probably in direct proportion to the default rates.
The last comment in my chain from the boutique store owner is interesting to me. When I was at Sears we had customers who would finance just about anything on their store card because that was the option they had available to them. I think we will see increased use of store cards from those least able to afford them as they use these cards to bridge their financial emergencies–needless to say the bad debt on this will get worse before it gets better.
Today’s discussions are focusing on the profitability (or not) of the cards, but as a shopper, I only use my store card for one reason: to enjoy the benefits of the stores’ loyalty programs and for the recognition on-site as a loyal customer. I would urge retailers to not let the accountants own this dialogue (they are the guys who closed your restaurants and painted over your show windows, remember?) but consider cards a loyalty program in the style of the travel industry.
As a boutique store owner, I can say that we’re seeing a good increase in the use of our store credit card. Our customers seem to be scrounging for ways to continue making their purchases while their other sources of funding are drying up. Fortunately, we immediately sell that receivable at an 8% discount so we’re not exposed to the risk of default. So long as we’re getting an extra 8% of sales as a result of offering credit, we’re doing okay with it. Customers are probably going to want it more and more as we get deeper into crisis, they just may not thank us in the long term when those 20% rates hit them. Caveat emptor, though.
Retailers understand that cards drive loyalty and sales. Furthermore, it’s the only envelope we know consumers will open when we market to them.
Interest rates won’t deter customers with desires. The limitation is our ability to understand their new sensibilities so that we can craft messages that create desire.
I have heard the same comments regarding credit cards and the financial crisis as Doron. I was at a financial conference last week and several people indicated that the credit card exposure is much greater than the sub-prime exposure. Credit card debt has been packaged and resold the same as mortgage debt.
Fortunately, many of the retailers that have branded credit cards don’t actually have the exposure to them. The credit card is really a private label or license with a financial institution taking most of the risk (and a good portion of the profit).
Credit card use is already down. However, that trend may not hold with the oncoming holidays. My prediction is that it will and the cut back in store card buying will be greater than the actual drop in retail sales. We are not just in an economic downturn. This is a true financial crisis that the media will continue to highlight into December. And, as long as the crisis remains front and center, many people will, out of intelligence or fear, not extend the use of their credit cards until they see a safe tomorrow.
Store credit card use will be down among the responsible and the consumers that know that they just need to do without if they can’t afford it. But store credit card use will be up among the ones that don’t have any cash and they continue to use the card, pay the minimum and eventually default. Fortunately, this is not the majority.
Generally, the limits on store cards is less. Visa and Mastercard routinely give us limits of $25,000 or $50,000. Store cards max out at a few thousand, so it doesn’t take much to hit the limit and spending will cease. So I see the use of store cards going down. While retailers make a nice profit when consumers make only the minimum payment, they make no profit when consumers make no payment. As times get tough, paying cash for groceries will get priority over making a store card payment.
In as much as all consumers are hearing and watching all the scary news about the financial crisis and the certain downturn in the economy, most consumers do not truly understand “what happened” and how “it” will ultimately impact each and every family in this nation. Credit cards will be one example of the fall out. It’s all part of a very dynamic chain of events.
Most retailers have brains enough to avoid a significant amount of bad debt. Those getting burned now are learning a quick lesson. Unless something changes dramatically on the regulation front, credit card programs will still be big profit centers for retailers.
Anecdotally, I’ve heard from some supermarket operators that lately they’ve been seeing less use of credit cards than before. And an analyst who now handles a small part of my vast investment holdings (yeah, right) told me yesterday that in August, total credit card charges were the lowest in many years.
Store credit cards have always been structured in a way that consumers end up being the biggest losers in the transaction. Interest rates are exceptionally high and payment terms are a bit deceptive in the sense that making the minimum really doesn’t make a dent in the principal. If retailers increase their rates, they will only be shooting themselves in the foot.
I was speaking to a friend of mine who works for a major credit card company and he was hinting that the subprime defaults on houses is only the beginning and we will see huge credit card defaults in the near future. Raising rates and making it more expensive will only increase defaults as consumers give up paying into an ever increasing black hole of debt.
We really need to think of the consumer and the current environment we are treading in.
Anyone who finds this to be a mystery should not be allowed to shop (or drive or leave their houses for that matter). People like to blame everyone but themselves for their financial mess. Whatever happened to living within your means?
I do believe there are a lot of people who understand the concept of paying interest but then chose to ignore it. Then I suppose there are those people who just don’t get it. Either way, this recent bailout could be viewed as a wake up call to spend within your means. There should definitely be full disclosure and unfortunately, there needs to be more regulation to keep companies from taking advantage of the American tax payers.
Recent history has demonstrated that the consumer will not think of the consequences and continue to use credit until he is no longer able.
As long as it is done responsibly, credit will always be a profit center. I’m hopeful the current crisis will lead to better lending practices since in the long run it will benefit the company and the consumer.
Store-based credit cards have always featured sky-high interest rates. Lending profits can be much greater than merchandising profits. Credit losses? They’ll soar if unemployment soars. The great riddle: folks who need credit are the risks. Hard to make money lending if you don’t lend to those folks.
I believe we will see a decline in store card use by prudent, educated shoppers. However, I also believe there will not be an overall decline in the use of store credit cards due to the number of people that are already over their heads in household debt.
As the holidays approach many consumers will reluctantly dust off their store cards and head out to do the shopping they previously said they weren’t planning to do. Some people will just throw caution to the wind and buy for themselves, while others will be thinking of their friends and family that “deserve” holiday presents. Overall store card usage will go up before it goes down.
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By my way of thinking, plastic in the drawer is not the same as cash in the drawer. Many consumers are not fully cognizant of all of the ramifications surrounding a credit card transaction, and they especially are not aware of what these transactions actually cost the retailer when they go bad. The only advantage to offering a store branded card that I can see is if the credit provider is the party assuming any loss if the customer fails to pay their bill on time, if at all.
If the bank is assuming the risk, and the customers only pay the minimum required, will it be enough to replenish the coffers to purchase new inventory and cover operating expenses? As retailers, we need to turn inventory to make a profit. If that inventory is purchased on credit, based on the presumption that the customers will also pay for what they purchased on credit, are we really making any money? Or are we just re-distributing bank notes around the market. Sort of a robbing Peter to pay Paul type of situation?
In truth, the only party making any profit when the bare minimum is paid on an account is the credit provider. As long as the principal balance is not paid off, the provider will continue to profit. But when a retailer assumes the risk, that principle that is not being paid off is basically paramount to a freezing of your dollars available to buy, thus forcing the retailer to rely on credit to replenish inventory – which then costs the retailer money, slowly eating away at an already slim profit margin.
I process more and more applications that are rejected, and fewer people buying large ticket items in my work, largely because available credit is drying up. The only sensible way for a retailer today to offer credit is to partner with a large credit bank offering a Visa or MasterCard type of program. Things are going to get much worse before they get better in retail. We need to maximize our potential before it is too late. Plastic money costs way too much, and in more ways than you can imagine.
Put me in both camps: the use of store credit cards will increase probably in direct proportion to the default rates.
The last comment in my chain from the boutique store owner is interesting to me. When I was at Sears we had customers who would finance just about anything on their store card because that was the option they had available to them. I think we will see increased use of store cards from those least able to afford them as they use these cards to bridge their financial emergencies–needless to say the bad debt on this will get worse before it gets better.
Today’s discussions are focusing on the profitability (or not) of the cards, but as a shopper, I only use my store card for one reason: to enjoy the benefits of the stores’ loyalty programs and for the recognition on-site as a loyal customer. I would urge retailers to not let the accountants own this dialogue (they are the guys who closed your restaurants and painted over your show windows, remember?) but consider cards a loyalty program in the style of the travel industry.
As a boutique store owner, I can say that we’re seeing a good increase in the use of our store credit card. Our customers seem to be scrounging for ways to continue making their purchases while their other sources of funding are drying up. Fortunately, we immediately sell that receivable at an 8% discount so we’re not exposed to the risk of default. So long as we’re getting an extra 8% of sales as a result of offering credit, we’re doing okay with it. Customers are probably going to want it more and more as we get deeper into crisis, they just may not thank us in the long term when those 20% rates hit them. Caveat emptor, though.
Retailers understand that cards drive loyalty and sales. Furthermore, it’s the only envelope we know consumers will open when we market to them.
Interest rates won’t deter customers with desires. The limitation is our ability to understand their new sensibilities so that we can craft messages that create desire.
I have heard the same comments regarding credit cards and the financial crisis as Doron. I was at a financial conference last week and several people indicated that the credit card exposure is much greater than the sub-prime exposure. Credit card debt has been packaged and resold the same as mortgage debt.
Fortunately, many of the retailers that have branded credit cards don’t actually have the exposure to them. The credit card is really a private label or license with a financial institution taking most of the risk (and a good portion of the profit).
Credit card use is already down. However, that trend may not hold with the oncoming holidays. My prediction is that it will and the cut back in store card buying will be greater than the actual drop in retail sales. We are not just in an economic downturn. This is a true financial crisis that the media will continue to highlight into December. And, as long as the crisis remains front and center, many people will, out of intelligence or fear, not extend the use of their credit cards until they see a safe tomorrow.
Store credit card use will be down among the responsible and the consumers that know that they just need to do without if they can’t afford it. But store credit card use will be up among the ones that don’t have any cash and they continue to use the card, pay the minimum and eventually default. Fortunately, this is not the majority.
Generally, the limits on store cards is less. Visa and Mastercard routinely give us limits of $25,000 or $50,000. Store cards max out at a few thousand, so it doesn’t take much to hit the limit and spending will cease. So I see the use of store cards going down. While retailers make a nice profit when consumers make only the minimum payment, they make no profit when consumers make no payment. As times get tough, paying cash for groceries will get priority over making a store card payment.
In as much as all consumers are hearing and watching all the scary news about the financial crisis and the certain downturn in the economy, most consumers do not truly understand “what happened” and how “it” will ultimately impact each and every family in this nation. Credit cards will be one example of the fall out. It’s all part of a very dynamic chain of events.
Most retailers have brains enough to avoid a significant amount of bad debt. Those getting burned now are learning a quick lesson. Unless something changes dramatically on the regulation front, credit card programs will still be big profit centers for retailers.
Anecdotally, I’ve heard from some supermarket operators that lately they’ve been seeing less use of credit cards than before. And an analyst who now handles a small part of my vast investment holdings (yeah, right) told me yesterday that in August, total credit card charges were the lowest in many years.
Store credit cards have always been structured in a way that consumers end up being the biggest losers in the transaction. Interest rates are exceptionally high and payment terms are a bit deceptive in the sense that making the minimum really doesn’t make a dent in the principal. If retailers increase their rates, they will only be shooting themselves in the foot.
I was speaking to a friend of mine who works for a major credit card company and he was hinting that the subprime defaults on houses is only the beginning and we will see huge credit card defaults in the near future. Raising rates and making it more expensive will only increase defaults as consumers give up paying into an ever increasing black hole of debt.
We really need to think of the consumer and the current environment we are treading in.
Anyone who finds this to be a mystery should not be allowed to shop (or drive or leave their houses for that matter). People like to blame everyone but themselves for their financial mess. Whatever happened to living within your means?
I do believe there are a lot of people who understand the concept of paying interest but then chose to ignore it. Then I suppose there are those people who just don’t get it. Either way, this recent bailout could be viewed as a wake up call to spend within your means. There should definitely be full disclosure and unfortunately, there needs to be more regulation to keep companies from taking advantage of the American tax payers.
Recent history has demonstrated that the consumer will not think of the consequences and continue to use credit until he is no longer able.
As long as it is done responsibly, credit will always be a profit center. I’m hopeful the current crisis will lead to better lending practices since in the long run it will benefit the company and the consumer.
Store-based credit cards have always featured sky-high interest rates. Lending profits can be much greater than merchandising profits. Credit losses? They’ll soar if unemployment soars. The great riddle: folks who need credit are the risks. Hard to make money lending if you don’t lend to those folks.
I believe we will see a decline in store card use by prudent, educated shoppers. However, I also believe there will not be an overall decline in the use of store credit cards due to the number of people that are already over their heads in household debt.
As the holidays approach many consumers will reluctantly dust off their store cards and head out to do the shopping they previously said they weren’t planning to do. Some people will just throw caution to the wind and buy for themselves, while others will be thinking of their friends and family that “deserve” holiday presents. Overall store card usage will go up before it goes down.