A dazzling array of credit card fees: evidence of an industry in transition.

Evans, Stephen T.

INTRODUCTION

In a well-documented article that appeared in Business Week, Emily Thornton explores a powerful social phenomenon with which all of us are all too familiar. The article entitled "Fees! Fees! Fees!" reminds us that "America used to be the land of the free. Now, it's the land of the fee" (Thornton, 2003). With methodical precision she identifies proliferating fees from a variety of industries and provides industry estimates of their financial impact. For example, hotel fees for such things as housekeeping bring in about $100 million per year (Thornton, 2003). The new "regulatory assessment fee" of 99 cents per month adds about $475 million in annual revenues for AT&T (Thornton, 2003).

Even governmental organizations use increasing fees to generate needed revenues, and "[c]ash-strapped states will pull in $2.6 billion in new revenues this year by raising more than 200 different fees on everything from fishing licenses to fingerprint processing to driving with new tires" (Thornton, 2003). But when it comes to expanding fees, "[n]obody beats the banks and other financial services companies ..." (Thornton, 2003). "Banks will get $30 billion this year from customers paying extra for bounced checks, using automated teller machines, and other added charges. Credit card issuers will rake in an estimated $20 billion in extra charges such as late-payment fees, which have been rising" (Thornton, 2003).

CREDIT CARD INDUSTRY

If a desire exists to generate revenues through the use of fees, the credit-card industry is the perfect industry in which to do it. "Eighty percent of all households have at least one credit card, (and) with well over one billion cards in circulation, the average household has about a dozen credit cards. About sixty percent of cardholders carry credit card debt from month to month, (and) the average credit card debt for households that carry a balance is more than $10,000" (Consumer Federation of America, 2003). Since 1997, credit card issuers have nearly doubled the amount of credit they offer to consumers, to more than $3 trillion dollars--about $30,000 per household. Revolving debt, which is almost entirely card debt, increased from $554 billion to $730 billion between 1997 and 2002" (Consumer Federation of America, 2003).

As a further evidence of the size and strength of this industry (and the potential for generating fees), the credit card industry reached a couple of major milestones in the year 2003. For the first time in history, "Americans bought more stuff in stores ...with cards than with cash" (Brooker, 2004). Also, the use of credit cards has now reached approximately "$2 trillion of transactions a year. That roughly calculates to 20% of the GDP" (Brooker, 2004). And considering the fact that the consumer segment of society is about 70 percent of the nation's GDP, it means that credit cards now account for about 27 percent of the total consumers' portion of our nation's economy.

THE UNDERLYING FORCES

In the credit-card industry (as well as other major industries), there is an interesting and powerful set of forces at work. On the one hand, stockholders, directors, and senior management continue to demand more profitability in consumer markets, but countering this is a wealth of information and sophistication that consumers have as they evaluate options and vote with their money. Because of increasing information that is available (including that which is contained on the Internet), consumers are more price and value conscious than ever before. With more comparison shopping, it makes it difficult for businesses to raise the stated prices for their goods and services. Consequently, many businesses have turned to fee-setting as a means of increasing revenues and profitability.

There is significance in the size and importance of the credit-card industry and in the motivating forces, but there is yet another reason why credit-card providers are among the elite in the successful use of fees and it relates to the nature and complexity of the process. If, for example, a car dealer, mortgage lender, airline company, hotel chain, or a variety of other businesses were to provide goods and services, the transactions would typically be well-defined events, short in duration, and easily understood, and the resulting documentation would be easy to evaluate and negotiate. But credit card processes are ongoing and usually involve many transactions, dates, and calculations each month, and the billing statements contain inadequate information. So there is room for lending institutions to "maneuver among the complexities."

In addition to the processes or mechanics, there are also powerful cultural, psychological, financial, and economic forces at work. All of these have a significant impact on the credit-card industry but are not fully understood, even by the experts. However, we turn to the academic literature to see if we can more fully understand these forces in the credit-card industry generally and more specifically in the fast-moving events that are taking place in the charging of fees.

LITERATURE SEARCH

In studies relating to the credit-card industry, by far the majority of attention has been given to interest rates, and there are few studies that relate directly to the setting of fees. However, the interest-rate studies do provide indirect value in understanding the forces at work. Perhaps the most significant study on credit-card behavior was done by Lawrence Ausubel in 1991. His paper, entitled "The Failure of Competition in the Credit Card Market," appeared in the American Economic Review and explored the reasons why the credit card industry seemed to show unresponsiveness to many of the economic forces that are so evident in other industries.

The lending industry had been deregulated more than a decade earlier, and yet it showed little responsiveness to interest rate changes in other industries. There was little evidence that barriers to entry, constrained inputs, significant sunk costs, or collusion were at work to thwart the workings of the free market (Ausubel, 1991), and yet the competitive forces did not seem to lower interest rates. There was possible explanation in the fact that consumers seem to make choices without taking into account the high probability that they might actually have to pay interest on their outstanding balances, so interest rates show a stickiness or inelasticity in their behavior relative to other financial markets (Ausubel, 1991). While less is said about fees, the same reasons might explain why competitive pressures are less influential in lowering or eliminating the fees.

A later study, also published in the American Economic Review, documented abnormally high profits in the credit card industry and suggested that credit-card customers face both search costs and switch costs, and that credit card providers do not cut rates because consumers are not responsive to rate cuts (Calem and Mester, 1995). While their focus was more on interest rates, the same findings may also apply to the setting of fees. Search costs and switch costs and the consumers' lack of responsiveness to fee changes may at least partially explain why fees seem to escape the competitive pressures allowing cardholders to set more of them and to set them at higher levels.

In another study published in the Journal of Political Economy, evidence was presented to show that cardholders live with higher credit-card interest rates because credit cards are a low-cost method of financing transactions and arranging short-term loans. Despite the large interest rates, they are actually rational consumers who live with the higher costs rather than pay the transaction costs associated with arranging traditional financing from other sources. Likewise, a rational investor may pay the higher costs associated with credit cards to avoid the costs of holding precautionary money balances that have higher opportunity costs (Brito and Hartley, 1995). These same findings are likely to apply to the charging of fees and to the raising of fees by credit-card issuers.

In an article that appeared more recently in The Business Lawyer, research data was presented that focused more on the credit-card providers than on the customers. The data showed strong evidence that the four major credit-card networks (Visa, MasterCard, American Express, and Discover) appeared to be competitive in some ways, but in reality the competition among the networks was almost docile. "Neither Visa nor MasterCard was seen to compete aggressively against the other. Moreover, both associations consistently increased interchange fees (the effective charge to merchants for handling transactions) in lock-step fashion for years" (Balto and Grube, 2002). Implied in this study is that when major networks are all charging fees and increasing them, the vendors and consumers have little opportunity but to go along with the decisions.

Aside from these few studies, there is little in the academic literature that provides significant insights directly on the charging of fees by the credit-card industry, but the reason is obvious. The charging of interest rates and the setting of these rates at high levels have dominated the industry and the academic research for several decades. The acceleration of credit-card fees within the industry is really a more recent phenomenon, so we turn our attention to this powerful new force.

CREDIT CARD FEES TO THE FOREFRONT

The reason that credit-card fees have moved to the forefront of the industry (and the forefront of academic thought) is because of a confluence of several major forces. To evaluate these forces, it is important to understand that interest rates were relatively high four years ago with the July 2000 federal funds rate at 6.54 percent, the prime rate at 9.5 percent, and credit-card rates hovering around 20 percent on average. As the federal funds rate and prime rate started falling in about December of 2000, the cost of funds for the credit-card issuers declined through 15 Federal Reserve rate reductions in the next couple of years. However, the interest rates that the issuers were able to charge their customers remained relatively stable, so the profits of credit-card providers increased significantly. Also important is the fact that the credit-card industry was still in the final stages of a decades-long growth stage.

Referring to the growth stage of the credit-card industry, there are some signs that it may be coming to an end. In 1960, for example, Bank Americard (Visa) was the largest credit card issuer with only 233, 585 cardholders (Brooker, 2004). In that same era, the advertising by American Express explained to potential cardholders that they were being offered cards because they were among the top 5 percent of the nation in finances and credit rating (Brooker, 2004). All told, there were fewer than one million cards in use in the early 1960s compared to a total that now exceeds one billion in America alone, so the quantity has increased by 1,000-fold during this growth stage. And instead of the top 5 percent being targeted by credit-card issuers, virtually every segment of society has been actively pursued by these lenders.

As the rates in other interest-rate markets remained low through 2002 and 2003, the interest rates in the credit-card market stubbornly inched downward which started squeezing profits, and with few segments of society left to turn to for growth, the credit-card providers began focusing more on the number of fees and the level of fees to maintain and enhance profitability. In 2004, we have seen the official rates in the banking industry starting to increase. The federal funds rate that has hovered around one percent was at about 1.4 percent as of July 1 and the prime rate has increased from 4.00 percent to 4.25 percent. This upward trend in the cost of funds will squeeze credit-card profits even further, so "the mice are hungry and are scurrying around looking for food."

PURPOSE OF THE STUDY

With the credit card industry at a crossroads and with an increasing emphasis on the charging of fees, the purpose of the study is (1) to identify what credit-card fees are being charged and how these compare to previous years, (2) to evaluate the amount or level of these fees and how they compare to previous years, (3) to form an opinion about the likelihood that these fees are being applied to customers and how this probability compares to previous years, (4) to search for clues about the impact that these fees are having on the profitability of the lending institutions, and (5) to use all of this information to form an opinion about whether the credit-card industry is moving from a growth stage to a shakeout or maturity stage.

THE EVALUATION PLAN

There is relatively little public data about the details of the fee-setting emphasis in the credit-card industry because the accelerated growth is a relatively new phenomenon, and financial intermediaries are less than forthcoming with much of the information. However, sufficient empirical data has been pulled together to complete an analysis in the five areas of emphasis mentioned in the previous paragraph. The data sources include (1) a wealth of articles that have been obtained, especially from business and financial publications, (2) academic journal articles (although less helpful for this study), (3) dozens of credit card statements that have been obtained, (4) dozens of interviews with banking employees and executives, and (5) advertising flyers that have been received from the national marketers of credit-card services.

As to the national credit card marketers, most American homes probably receive dozens of these each month (depending on the demographics of the family), and it is not difficult to save hundreds of these in a year's time. That is exactly what this author has done with well over 1,000 having been saved since 1996. There are over 4,000 credit card providers in the United States, but only about 20 of these remain active in national marketing, and the list has remained quite stable from year to year. Occasionally new companies join the ranks, but there are also some that drop off the list for a variety of reasons including mergers. Chase, for example, has been active in credit-card marketing for many years and has more recently merged with J. P. Morgan. This combined company (headquartered in New York) is now in the process of merging with Bank One (headquartered in Chicago), also one of the biggest credit card marketers. Likewise, Sears sold its credit-card portfolio to Citibank. In any case, the list of national marketers remains at about 20 each year depending on where one draws the line.

Advertising flyers for the year 2004 have been the most helpful for the analysis, and at least one was selected from each of what have been considered the top 20 companies. In some cases, where more than one plan was offered or where offers changed, an additional flyer was selected, and that resulted in a sample of 30 for 2004. Similar samples were taken from the years 1998 and 2001 so intervals of approximately three years could be observed. What has emerged has been a clear pattern of fee increases, and the details are described below.

THE FINDINGS

One of the first credit-card flyers that was reviewed from the year 2004 contained the following information on fee charges (identical to a flyer that was also received in the year 2003):

"Available Credit and Cash Advance Limitations: The initial minimum credit limit will be $250 and the following fees will be billed to your first statement: Annual Fee of $48.00, Program Fee of $95.00, Account Set-Up Fee of $29.00, monthly Participation Fee of $6.00 [$72.00 annually], and an Additional Card Fee of $20.00 (if applicable). If you are assigned the minimum credit limit of $250 your initial available credit will be $72 ($52 if you choose the additional card option)."

In addition to the fees itemized in the previous paragraph, this lending institution also charges a minimum finance charge of $0.50, a transaction fee for cash advances which is the greater of $5.00 or 3% of the amount of the cash advance, a late payment fee of $25.00 each time the payment is late, an over limit fee of $25.00 each month the balance exceeds the credit limit, $25.00 for returned checks, a copying fee of $3.00 per item, an Internet access fee of $3.95, an "autodraft fee" of $11.00 for each payment requested through an autodraft service provided by the lender, a foreign currency transaction fee of one percent applied to foreign currency transactions, an express delivery fee of $25.00 for delivery of cards sent priority mail, a credit limit increase fee of $25.00 (which could be "as soon as 6 months"), and a voice response fee of $7.00 per transaction.

In addition to the 18 charges listed above, there are also a variety of interest rate arrangements mentioned by this national credit card solicitor (both explicitly and implicitly) that relate to balances carried forward, new purchases, cash advances, and penalty situations. And the customer who signs up for this credit-card service would be advised not to make a telephone call to complain about the resulting charges because $7.00 will be tacked on with each phone call (as referred to in the voice response fee).

From this and other credit card solicitations, a sampling of 50 fee charges (and in some cases their accompanying fee rates) has been assembled, and an alphabetical listing is shown as Exhibit 1. This list is derived from a review of all the credit-card solicitations that were sampled, and no single company had a list of charges that was anywhere near the total listing of charges shown in the exhibit. But the aggregate list that is shown could have been longer, especially considering the fact that most solicitors now have a multi-tier approach to fee charges. In other words, there are various fee or interest rate possibilities that can be applied depending on the credit rating and payment record of a given customer, and the customer is shifted from one level to another based on performance that is usually judged against very strict standards. And needless to say, the formula is usually established to increase the likelihood that fees and interest rates will be increased over time, and not decreased.

It is important to note that the number of fees and charges has increased over time. Although the sample sizes and types are not necessarily valid statistically, it is nevertheless interesting that an average of about 7.5 fee charges and associated rates were listed as categories in the 1998 advertising flyers, an average of about 12 categories were listed in the 2001 flyers, and an average of about 15 categories of fee charges and associated rates were contained in each of the advertising flyers received in 2004.

The list of fees shown in Exhibit 1 can be re-arranged in a variety of ways depending on the desired characteristics, but for this study it seemed most helpful to categorize the 50 fees and charges based on the eight categories that are itemized in Exhibit 2. Using this list, a variety of observations and comments will be made about each of the eight categories, and then a few of the specific fee charges and rates that are considered the "backbone" of the accelerating, fee-charging phenomenon will be evaluated in more detail.

OBSERVATIONS ON THE EIGHT FEE CATEGORIES

In evaluating the "fees for getting started" that are shown in list "A" of Exhibit 2, there might seem like few differences between some of them, but splitting hairs provides an opportunity to apply more charges and that is what is often done. In the sample that was described in the section entitled "THE FINDINGS," for example, notice that this company charges an account set-up fee of $29.00 and then a program fee of $95.00. Why there needs to be two charges instead of one is anyone's guess, but the guess is probably that it is an opportunity to apply another charge.

As to the "ongoing fixed fees" that are shown in list "B" of Exhibit 2, it is important to note that the "annual fee" is almost universally mentioned in all advertising flyers but few of the major card issuers actually apply it for two reasons. First, the mention of "no annual fees" has emerged as a major advertising message, and second, the fact that most competitors are not doing it makes it harder to do. A quick review of 30 major card providers reveals that eight of them do still charge an annual fee, but not one of the top ten does.

The "ongoing payment protection fee" and/or "rate" provide protection against "involuntary unemployment, total disability, hospitalization, or employer-approved family leave." The rate has edged up over the years from about 69 cents per month per $100 of coverage to about 85 cents per month per $100 of coverage.

An interesting thing about this arrangement is that it only eliminates or defers current payments, not the entire balance. Most credit-card plans only require about one hundredth of the balance to be paid each month anyway, so mathematically the plan requires the cardholder to pay nearly one hundredth of the balance each month for the privilege of waving about one hundredth of the balance each month under highly remote circumstances. It would be interesting to know how many cardholders actually think of the financial logic of this.

Exhibit 2
A Sampling of 50 Fees Charged by Credit Card Issuers
(Grouped into eight categories)
(Letters correspond to comments that follow)

A. Fees for getting started:
Credit review fee
Account set-up fee
Enrollment fee
Membership fee
Program fee
Initial card fee

B. Ongoing fixed fees:
Annual fee
Monthly participation fee
Payment protection fee
Payment protection rate
Unauthorized usage protection fee
Additional card fee

C. Main fees:
Unpaid balance fee (min. charge)
New purchases fee
Interchange fee (fin'l. intermediaries)
Cash advance fee
Balance transfer fee
Foreign currency transfer fee
Special purchases fee (gaming chips, etc.)

D. Main rates:
Unpaid balance rate (several levels)
New purchases rate (several levels)
Interchange rate
Cash advance rate
Balance transfer rate
Foreign currency transfer rate
Special purchases rate

E. Processing fees:
Minimum finance charge
Foreign fee (use of others' ATMs)
Service of account fee
Automatic payment fee
Payment by phone fee
Stop payment fee

F. Communication fees:
Copying fee
Autodraft fee
Internet access fee
Voice response fee
Mailed statement fee
Express delivery fee

G. Fees for account management:
Research fee
Credit limit increase fee
Overdraft advance fee
Overdraft advance rate
Closed account fee
Closed account rate

H. Penalty charges:
Late payment fee (several levels)
Over credit limit fee (several levels)
Returned check fee
Lost card fee
Arbitration fees
Legal fees

As to the "unauthorized usage protection fee" it is Federal law that cardholders cannot be held liable for more than $50 for unauthorized use of their cards. The financial intermediaries are required to take the burden of these situations. And yet, some card issuers have charged as much as a dollar or two per month--let's say $20 per year--for an unlikely need for protection against a $50 loss. The financial logic is equally puzzling.

The "main fees" that are shown in list "C" in Exhibit 2 are, along with the penalty charges of list "H," the main sources of fees that are charged by card issuers. Also note that the seven "main fees" each have a companion "rate" shown in the section entitled "main rates," identified as list "D." While all fees account for about one third of the revenues received by credit-card companies, the rates of list "D" are actually the main source of income and probably account for about two thirds of the net profits of these credit-card providers (Kouwe, 2003).

In the years before computerization was well-established in the credit-card industry, the merchants that accepted credit-cards in merchandising their products paid merchant fees that were, on average, perhaps three to five percent of sales.

With the advent of computerization, especially the point-of-sale terminals, charges are now levied between the merchants and the various credit-card organizations that use these massive systems. The payments for these services are known as interchange fees, and although they are paid by the merchants they are indirectly passed on to the customers.

Although the highly efficient computer systems can handle as many as 5,000 transactions in one second (Brooker, 2004), and with minimal costs, Visa and MasterCard have continued to charge around $1.50 for a $100 purchase (Economist, 2003). "Behind Visa and MasterCard are thousands of banks, many of them members of both associations, which continue to make big profits from their share of interchange fees" (Economist, 2003), and the "American public has been blissfully unaware of this hidden charge" (Economist, 2003). But in an out-of-court settlement last year, Visa and Master Card agreed to pay $3 billion in compensation to retailers and to lower their charges for certain payments" (Economist, 2003).

As to the "balance transfer fees" shown in list "C," these have often become necessary to prevent customers from taking advantage of the "zero interest rate offers" for a period of six months to a year and then transferring all of their balances to other credit-card providers to take advantage of other "zero interest rate offers." Although these balance transfer fees and rates were mostly unheard of five years ago, they are now fairly common with transfer fees typically being $5 to $10 or 3 percent of the transfer balance, whichever is greater.

As to the "main rates" that are shown in list "D" of Exhibit 2, recognition has already been made that these rates account for about two thirds of the revenue of credit-card companies, and only one additional observation will be made about the rates at this point. The reference to "several levels" that is shown next to unpaid balance rates and new purchases rates refers to the evolution to multi-tier pricing that has found its way into the credit-card industry. Five years ago there was little of it except an occasional reference to higher rate charges if accounts were not properly maintained. Now, virtually all major credit-card issuers have formally established processes for moving cardholders to higher rates if and when they fail to comply with a wide-range of criteria.

The mathematics of the practice makes it more likely that customers will be transferred to the higher rates than transferred back to the lower rates, and the practice has almost become a type of "permanent penalty." These multiple rates not only apply to the interest rates shown in list "D" but also to other charges including the late payment fees and over credit limit fees shown in list "H," the penalty charges list. As to the "regular" interest rates that are applied to unpaid balances, the average rate in the samples from year 2004 was 9.51 percent, but the high penalty charges sampled from the same year and for the same companies averaged 26.19 percent. There is obviously great incentive for these companies to move customers from the "regular list" to the "penalty list." and a major portion of the penalized are those, of course, who can least afford to be penalized.

The "processing fees" that are shown in list "E" relate to the payments that are made by customers. Most of these are self-explanatory, but the "foreign fees" may be an exception. These have nothing to do with foreign currency or with other activities outside of a native country, but the term has evolved within the industry to make reference to the use of ATM machines that are not owned by the financial intermediary that originated the credit card. Although the computers handle these financial transactions with speed, efficiency, and minimum cost, the process nevertheless provides opportunities for further charges. These foreign fees, along with the interchange fees, are under much scrutiny right now, and the arrangements are currently in a state of flux.

As to the "communications fees" that are shown in list "F," the autodraft fee is a coined word that refers to automatic payment systems, but the term is listed under "communication fees" because the process refers to the two-way process of inquiry and payment that takes place at the same time. What is interesting about all of the electronic payment processes that are included under lists "E" and "F" is that all of them are generally more efficient than the processing of payments received by mail or in person. And yet more frequent mention is made of charges for "automatic payments" or "semi-automatic" payments by phone. And, of course, the industry is doing as much as it can to encourage customers to use automatic payment systems because of the greater efficiencies and lower costs.

As to the "fees for account management" shown in list "G," the "overdraft fees and rates" refer to overdraft protection in both directions. On the one hand, when there are overdrafts in checking accounts (and even savings accounts) these can be covered by the credit-card account. In the other direction, on occasion there are payments made toward the credit-card balances when there are inadequate funds to cover the checks, and overdraft protection arrangements are available to cover these situations. But, of course, there are usually fees associated with these services, and financial intermediaries love receiving the fees.

Relating to the "penalty charges" that are shown in list "H," the late payment fees and over credit limit fees will be covered shortly, but reference is made to arbitration fees and legal fees that are sometimes enumerated in the fine print of credit-card under-standings. The subject is a negative one, so it is not likely to be covered in the "flashy" advertising materials, but contained in the documentation of one financial intermediary, for example, is the statement that "the Bank may take legal action (including collection action) against you and you agree to pay all collection costs whether or not awardable as court costs (including the cost of Bank staff) and reasonable attorney's fees (including those of salaried Bank employees)." Such a reference is likely to be covered in an oblique way in subsidiary documentation, and potential customers need to be aware of these potential costs.

RECENT BEHAVIOR OF KEY FEES AND CHARGES

As to the question of whether credit-card fees have been increasing, especially since the tightening of interest-rate profits that have been referred to, we now turn our attention to the five most significant fees of the industry and they are the (1) late payment fees, (2) over credit limit fees, (3) returned check fees, (4) balance transfer fees, and (5) cash advance fees. In the case of the late payment fees and over credit limit fees, the industry has increasingly turned to a multi-tiered approach with the amounts charged dependent on the balance in the accounts at the time of "infraction." As to the balance transfer fees and cash advance fees, these have been tied to "companion rates" that continue to apply to the balances after the money has been transferred. As to the returned check fees the evidence is that they alone remain largely as they have been in the past in the sense that a single penalty is affixed to a single event.

Considering the late payment fees specifically, the samples of advertising flyers from 1998 show that the fees never exceeded $25 and were often less. By 2001, there were some, but not many, going over the $30 level, but many were at the $29 level. However, the samples from 2004 show that it has become almost universal to use a three-tier approach with a typical arrangement calling for a penalty of $15 for balances up to $100, $25 on balances of $101 up to $1,000, and $35 on balances of $1,000 and greater. There are some that are at $19, $29, and $39 respectively, so the fees have seen an upward trend in this category.

Having just covered the question of late fees, it is an appropriate point to discuss the question of grace periods since the allegation is frequently heard that grace periods are being shortened to increase the likelihood that customers will need to pay the late fees. One article, for example, stated that "[d]eadlines for paying bills have been shortened to as little as two weeks, and they're strictly enforced, producing more late fees" (Thornton, 2003). Another article stated that "[g]race periods are shrinking steadily to an average of 20.6 days from 27.8 days a decade ago" (Simon, 2004). Information contained in our samples for 1998, 2001, and 2004 did not substantiate these numbers. In fact, since 1998 the grace period has remained almost precisely flat with virtually 100 percent of the samples being between 20 and 25 days. Also, a quick review of the 30 most prominent credit card companies that are regularly shown in the Wall Street Journal showed that 100 percent of them are also between 20 and 25 days with one exception and that was at 26 days. Our conclusion is that the grace period has remained approximately the same in the last few years for national marketers and other large credit-card companies. If, in fact, the grace period is declining, it is probably happening among the smaller companies.

As to the over-credit-limit fees, the samples for 1998 never exceeded $25 and were often less. For 2001 the amounts were largely the same as the samples of the late payment fees with only a few going over the $30 limit but many at the $29 level. In the samples from 2004, it was interesting that there was almost no use of the three-tier approach that was used for late payments. Almost all the fees had gone up to $35 with a handful increasing to $39 per incident. The few exceptions typically have a standard of $15 on balances of $1,000 or less and $35 on balances greater than $1,000.

As already mentioned, the returned check fee, by tradition, seems to remain as a single payment for a single event. Why this is so is not quite clear, but there is not as much evidence that the amount is going up significantly. In 1998 the typical charge for a bounced check was $25, and in recent years the payment has more typically been $29.

In the case of fees for balance transfers, there is almost no evidence that such fees existed five or six years ago. But in the samples from 2001 it was almost universal for credit-card companies to charge the greater of $5 per transaction or 3 percent of the amount transferred, whichever was greater. In the 2004 samples, the 3 percent rate has remained almost rigidly in place as the standard, but there are some companies beginning to charge $10 per transaction (or 3 percent, whichever is greater).

As to fees being charged for cash advances, these have been in place for many years, even many decades. In 1998, the fees ranged from $2.00 to $5.00 with the average being at about $2.94. As to the applied percentage, all the samples were between 2 percent and 5 percent with the average rate being almost exactly 3 percent. In the samples from 2004 the cash advance fees were all either $5 or $10 with the average being about $6.50. As to the applied rates of 2004, 100 percent of them were rigidly fixed at 3 percent. In other words, current cash advance charges are, on average, about $6.50 or 3 percent whichever is greater.

PATTERNS OF PROFITABILITY AND THE NEW FEES

To fully understand the current profit picture in the credit-card industry it is useful to understand a little of what the profit pattern has been in past years. Prior to mid-1970s there were very few profits made in the industry, and frequent mention of that has been seen in the literature. For example, "between 1967 and 1970, Wells Fargo lost $7 million on its card business; Bankers Trust lost $10 million between 1968 and 1970 (and) in 1973 ...banks lost a total of $288 million on cards" (Brooker, 2004). This was largely true because the industry was relatively new and "dumb things" were being done. For example, there was little sophistication in how cards were given out or in decisions about who should receive them.

But the main culprit in lack of profitability was the lack of computerization in the processing of transactions. Most of the processing activities were manual both at the merchant level and at the credit-card-company level, and typical credit card transactions were taking about five minutes to process (Brooker, 2004). Also, some of the information was lost, some of it was unreadable, and many errors occurred in the manual processes. Gratefully, electronic credit-card processing systems developed in the 1970s got the processing time down to 56 seconds, and today's fast computers can process several thousand transactions per second (Brooker, 2004).

With the electronic improvements and with an increase in sophistication and understanding, card issuers moved into a profitable era particularly in the 1980s. For example, from 1983 to 1988, "the 50 largest credit card issuers earned from 3 to 5 times the ordinary rate of return for the banking industry ..." (Ausubel, 1991). Throughout the 1990s there was a continuation of this profitability. In a 1997 article, for example, one bank indicated that the credit-card business was among the most profitable business segments of the bank and made a return on equity of 34 percent (Zweig, 1997).

Moving into the 21st Century banks have continued to make money on their credit-card activities, and much of this has been because of the increasing interest rate gap previously referred to. One article mentioned that "Credit card profits continue to be significantly higher than for other bank lending activities. Bankcard profits increased in 2001 to their second highest level in the last five years (3.24% of outstanding balances). Growing profits were largely driven by the increasing "interest rate gap" between the benchmark rate set by the Federal Reserve which dropped significantly, and interest rates charged by card issuers to consumers. In 2001, the Federal Reserve cut interest rates by 4.75%, but major bankcard issuers cut their rates by only 1.35% on average" (Consumer Federation of America, 2003).

With the leveling off of the Federal Funds Rate and Prime Rate in 2002 and 2003, and with credit card rates inching downward, the profits started to be squeezed. As discussed previously, there is much evidence that banks have been turning to increasing fees to make up the difference. With these fee increases, much of the profitability is still being maintained. One article, for example, stated that "while the outlook for big business remains gloomy and the overall economy continues to disappoint, banks are enjoying one of their most profitable periods in recent history. The biggest reason: Loan-happy consumers have proven resilient in their ability to generate fee and interest income for lenders" (Reddy, 2003). Another article stated that credit-card issuers "saddled with lower interest rates and hungry for more income are raising fees at a faster clip. Income from late fees and other penalties could climb by $1 billion to $13 billion this year" (Simon, 2004).

All told, the evidence is clear that there is an acceleration both in the number of fees being charged and in the level of these fees, and the increases are, at least for the time being, offsetting the squeeze that is taking place in interest rates. Consequently, the profitability is still largely there, but perhaps there is evidence of a "watershed" shift taking place in the life-cycle of the industry, and we turn now to that subject.

EVIDENCES OF AN INDUSTRY LIFE-CYCLE SHIFT

General business theory usually makes reference to at least four major stages in the life cycle of each industry--the introduction stage, growth stage, maturity stage, and decline stage. (With more refinement, some lists put a shakeout stage between the growth stage and maturity stage.) Characteristics of the growth stage include an increasing number of customers, fast-growing sales, especially big profits for the early innovators, rising profits for other participants (with some decline later), an increasing number of competitors and competition, increasing varieties (or variations) in the product offerings, and heavy advertising costs.

Characteristics of the maturity stage include a large saturation of customers, a leveling off of sales, profits declining to more normal levels, fewer participants (because of bankruptcies, mergers, etc.), an intensification of competition, fewer product innovations, less "awareness" advertising, but an increase in specific promotional costs. Many of these traits seem to be characteristic of the credit-card industry at the present time. For example, as to customers it was previously mentioned that in the 1960s there were about one million credit-card customers in the United States. Now there are over one billion cards in the United States alone (with many customers having more than one card). And instead of cards being held primarily by the top five percent of the population economically, they are held by virtually every segment of the population.

Reference has also been made to the 4,000 plus credit-card issuers (with the number remaining fairly constant in recent years) and the fact that the number of large, national credit-card marketers has remained fairly stable at about 20. All these statistics are indications of a possible shift beyond the growth stage, but what about profits? "Credit card issuers are fighting over fewer customers, who have less debt. And lower interest rates on the debt that customers do have are squeezing profit margins of credit card lenders. For example, even though growth in new accounts and increased charge volume lifted BankOne's total credit card balances 12 percent in the first quarter, the bank's profit margin shrunk. The credit card division's poor performance explains why ..." (Reddy, 2003).

Other articles give evidence of the increased competition, declining profitability, and increasing promotional costs: "People are going after each other's market share by offering interest rates that don't look profitable ..." (Simon, 2004). "People familiar with the deal say MBNA will use a chunk of its fees to offer consumers new reward programs" (Sapsford, 2004). "Fees are becoming increasingly important as interest rates have dropped, putting pressure on the margins that banks make on credit-card debt. The banks have to make up the revenue they lost" (Kouwe, 2003).

Notice the reference to fees in the previous paragraph. The evidence that has been presented shows that fees are accelerating both in number and in amount. These fees are not just another source of income but represent the need to fill a significant income gap that has been created by interest revenues inching downward, interest costs inching upwards, promotional costs that are increasing (reward programs), and competition that is increasing for a customer base that has now been largely tapped.

All these characteristics are signs that the industry growth stage is largely past, but there is not yet sufficient evidence to conclude that the industry is fully in a maturity stage. It is more likely that it is now moving into a shakeout stage (that precedes the maturity stage). The reasons for this conclusion are the following: The number of credit-card providers has not yet contracted significantly which is typical of a maturity stage. The number remains at about 4,000 with about 20 national marketers. Credit-card sales are continuing to increase (although increasing at a slower pace). Credit-card profits, although not as robust, still exceed the average profits of other banking services. And finally, there is still significant opportunities overseas (including China that is beginning to discover "plastic").

All in all, it is the conclusion of this study that the industry has been moving from its growth stage to a shakeout stage, but not yet to a maturity stage. A summary of the life-cycle findings are shown in Exhibit 3 that follows:

SUMMARY OF KEY FINDINGS

With reference to the purposes of the study, evidence has been presented on the significant transition taking place in the credit-card industry, particularly relating to the charging of fees. But the study has gone one step further in using the accumulated evidence on fees to identify where the credit-card industry is in its product life cycle. The findings have included the following:

(a) The number of fees being charged by the industry has approximately doubled within the last six years. Although not statistically significant, survey data shows that the number of fees identified in the advertising flyers of 1998 has gone from an average of about 7 1/2 fee categories mentioned in each flyer in 1998 to about 15 fee categories mentioned in each flyer in 2004. A sampling of 50 of these fee categories was shown in Exhibits 1 and 2.

(b) "Late-payment fees" and "over-credit-limit fees" have increased from an average of less than $25 in 1998 to "probably" over $30 at the present time. The reason the word "probably" is used is because most credit card companies have adopted more complicated mathematical formulas and the data is harder to compare.

(c) In reference to the more complicated formulas, it was almost universal in 1998 to advertise one late-payment fee and one over-credit-limit fee, but it is almost universal now for companies to apply a scale with higher fees for higher credit-card balances. But almost certainly the scales have been designed to increase the company revenues.

(d) Although there is frequent mention in business publications about the lowering of grace periods to increase the likelihood of late payments, evidence could not be found to support this theory. Virtually 100 percent of the samples from both 1998 and 2004 showed grace periods between 20 and 25 days. Likewise, the top 30 credit-card providers regularly listed in the Wall Street Journal continue to fall within this range. It is possible that smaller companies (not included in the samples) have been lowering grace periods.

(e) Charges for returned ("bounced") checks have almost universally remained a single fee (as opposed to a scale of fees), and the amount of these charges has increased from approximately $25 per returned check in 1998 to about $29 per returned check in 2004.

(f) "Balance transfer fees" was basically a non-existent phenomenon in 1998, but with credit-card holders now "jumping around" to take advantage of "zero-interest grace periods" companies are regularly charging balance transfer fees that average $5 to $10 per transfer or 3 percent of the transfer amount, whichever is greater.

(g) "Cash advance fees" have been in effect for many years with a dollar amount charged or a percentage amount whichever is greater. The percentage amount has remained very stable at almost exactly 3 percent, but the dollar amount has increased from approximately $2.94 in 1998 to about $6.50 in 2004.

(h) In broad terms, the credit-card industry was not generally profitable before 1980. Since 1980 it has been highly profitable, but an increase in the number and level of fees is what has been keeping it profitable in the last couple of years. An inching down of interest revenues and an inching up of interest costs is putting a squeeze on "interest-rate profitability."

(i) The accelerating fee charges are more than a passing trend or an operational phenomenon. They are more of a long-term, strategic trend in the industry. The trend is a "watershed shift" in an industry that is becoming increasingly crowded and competitive.

(j) The evidence is that the industry is moving out of the growth stage of its life cycle, but it is probably not yet moving into a maturity stage. It is more likely moving into a significant shakeout stage.

MAJOR CONCLUSIONS

The two major conclusions of the study are that (1) fees being charged in the credit-card industry are accelerating both in number and in amount and (2) this acceleration is evidence that the industry is moving from a growth stage to a shakeout stage in its life cycle.

REFERENCES

Associated Press (2003, April 16). Banks miss expectations despite strength in retail. As shown in The Mercury News.

Ausubel, Lawrence M. (1991). The Failure of Competition in the Credit Card Market. The American Economic Review, 81(1), 50-81.

Ausubel, Lawrence M. (1997). Credit Card Defaults, Credit Card Profits, and Bankruptcy. American Banker, LJ 249.

Balto, David A. & Brian K. Grube (2002, May). The Visa-Master Card decision and its implications for high-tech markets. The Business Lawyer, 57(3).

Berlin, Mitchell & Loretta J. Mester (2004). Credit card rates and consumer search. Review of Financial Economics, 13(1), p. 179.

Bhandari, Shyam B (2002). Some ethical issues in computation and disclosure of interest rate and cost of credit. Journal of Business Ethics. 16(5), p. 531-535.

Bianco, Candy A. & Susan M. Bosco (2002). Ethical Issues in Credit Card Solicitation of College Students--The Responsibilities of Credit Card Issuers, Higher Education, and Students. Teaching Business Ethics, 6(1), p. 45.

Bird, Edward J., Paul A. Hagstrom, & Robert Wild (1999, Winter). Credit card debts of the poor: High and rising. Journal of Policy Analysis and Management. (18(1), p. 125-133.

Brito, Dagobert L. & Peter R. Hartley (1995). Consumer rationality and credit cards. The Journal of Political Economy, 103(2), p. 400-433.

Brooker, Katrina (2004, February 23). Just One Word: Plastic--How the rise of the credit card changed life for the FORTUNE 500--and for the rest of us. Fortune, p. 125-138.

Calem, Paul S. & Loretta J. Mester (1995), Consumer Behavior and the Stickiness of Credit-Card Interest Rates. The American Economic Review, 85(5), p. 1327-1336.

Cargill, Thomas F. & Jeanne Wendel (1996, Winter). Bank credit cards: Consumer Irrationality versus market forces. The Journal of Consumer Affairs. 30(2), p. 373-389.

Carow, Kenneth A. & Michael E. Staten (2002, Summer). Plastic choices: Consumer usage of bank cards versus proprietary credit cards. Journal of Economics and Finance. 26(2), p. 216-232.

Chu, Kathy (2004, April 29). Card Upgrades Could Result In Higher Fees for Customers. Wall Street Journal (Eastern Edition), p. D.4.

Consumer Federation of America (CFA) (2003). Facts About Consumer Credit Card Debt and Bankruptcy. P. 4.

Foust, Dean (2004, January 12). The Power Behind the Plastic; First Data's grip on payment processing and debit cards threatens Visa and MasterCard. Business Week, p. 38.

Green, Jeffrey (2003, July). The foreign-fee feast. Credit Card Management, 16(4), p. 33.

Grieb, Terrance, Charles Hegji, & Steven T. Jones (2001, Fall). Macroeconomic factors, consumer behavior, and bankcard default rates. Journal of Economics and Finance. 25(3), p. 316-327.

Gross, David B. & Nicholas S. Souleles (2002, February). Do Liquidity constraints and interest rates matter for consumer behavior? Evidence from credit card data. The Quarterly Journal of Economics. 117(1), p. 149.

Guseva, Alya & Akos Rona-Tas (2001, October). Uncertainty, Risk, and Trust: Russian and American Credit Card Markets Compared. American Sociological Review, 66(5), p. 623-646.

Hallinan, Joseph T. (2004, April 21). Wells Fargo & Co., Bank One Report Surge in Profits. Wall Street Journal (Eastern Edition), p. A.8.

Hallinan, Joseph T. (2003, October 22). Deals & Deal Makers: Big Banks Report Strong Gains, Led by Wells Fargo, Bank One. Wall Street Journal (Eastern Edition), p. C.5.

Hamilton, Robert & Mosahid Khan (2001, July). Revolving Credit Card Holders: Who Are They and How Can They Be Identified? Service Industries Journal, 21(3), p. 37-48.

Hoffman, Stuart G. (2003, October). Another day older and deeper in debt ... American Bankers Association. ABA Banking Journal, 95(10), p. 84.

Kara, Ali, Erdener Kaynak & Orsay Kucukemiroglu (1994). Credit card development strategies for the youth market: The use of conjoint analysis. The International Journal of Bank Marketing. 12(6), p. 30-36.

Kouwe, Zachery (2003, July 23). Credit-Card Issuers Raise Late Fees; Banks Also Cut the Time For Sending Payments, Making Charges More Likely. Wall Street Journal (Eastern Edition), p. D2.

Kulasekaran, Sivakumar & Sherrill Shaffer (2002, Nov/Dec). Cost efficiency among credit card banks. Journal of Economics and Business. 54(6), p. 595.

Mantripragada, Krishna G & Haragopal Banerjee (1992, Summer/Fall). Credit Card Interest Rate Caps Do Not Make Sense. Review of Business, 14(1), p. 19-24.

Mayer, Robert N. & Cathleen D. Zick (1996). The cost of "free" credit card benefits. Consumer Interests Annual, 42, p. 161-166.

Moskowitz, Howard, Dorit Cohen, Bert Krieger & Samuel Rabino (2001, December). Interest and reaction time analysis of credit card offers: Managerial implications of high level research procedures. Journal of Financial Services Marketing. 6(2), p. 172-189.

Mosler, Warren (2003/2004, Winter). Credit cards and interest rates: theory and institutional factors--a critical view. Journal of Post Keynesian Economics, 26(2), p. 303-307.

Parloff, Roger (2004, February 23). The $50 Billion Card Game. Fortune.

Reddy, Anitha (2003, April 16). Consumer Loans Boost Bank Profits. Washington Post, p. E01.

Roman, Monica (2003, April 14). The Oh-So-Popular Sears Card. Business Week. 3828(40), p. 40.

Sandler, Andrew L. & Molly A. Meegan (2000, Jul/Aug). Credit card issuers beware: Consumer issues present the next regulatory and enforcement risk for the industry. The Banking Law Journal. 117(4), p. 329-338.

Sapsford, Jathon (2004, January 30). Card Deal Adds A New Avenue of Competition. Wall Street Journal (Eastern Edition), p. C.3.

Scholnick, Barry (2000, June). Regulation, competition and risk in the market for credit cards. Canadian Public Policy, 26(2), p. 171-181.

Shimp, Terence A. & Margaret P. Moody (2000, April). In search of a theoretical explanation for the credit card effect. Journal of Business Research. 48(1), p. 17-23.

Simon, Ruth (2004, March 31). Credit-Card Fees Are Rising Faster; As Economics of Industry Change, Issuers Seek to Boost Income From Penalties; $35 Late Charge.

Wall Street Journal (Eastern edition), p. D.1.

Sinkey, J.F., Jr. & R. Nash (1997). On Competition, Risk, and Hidden Assets in the Market for Bank Credit Cards. Journal of Banking and Finance, p. 89-112.

Spors, Kelly K. (2004, May 2). Tip of the Week: Cancel Card, Keep Freebies. Wall Street Journal (Eastern Edition), p. 1.

Spors, Kelly K. (2004, April 25). Starting Out: Nursing a Debt Hangover From College. Wall Street Journal (Eastern Edition), p. 3.

Stango, Victor (2000, August). Competition and pricing in the credit card market. The Review of Economics and Statistics, 82(3), p. 499-508.

Stauffer, Robert F. (2003/2004, Winter). Credit cards and interest rates: theory and institutional factors. Journal of Post Keynesian Economics, 26(2), p. 289-301.

Stavins, Joanna (1996, Jul/Aug). Can demand elasticities explain sticky credit card rates? New England Economic Review, p. 43-54.

Stavins, Joanna (2000, Jul/Aug). Credit card borrowing, delinquency, and personal bankruptcy. New England Economic Review, p. 15-30.

Steindl, Frank G. (2000, Summer). Credit Cards, Economization of Money, and Interest Rates. Journal of Economic Education, 31(3), p. 271-279.

Toh, Kevin G. (1996, March). Are credit-card late fees "interest? Michigan Law Review, 94(5), p.1294.

Thornton, Emily (2003, September 29). Fees! Fees! Fees! Business Week, p. 99-104.

Warwick, Jacquelyn & Phylis Mansfield (2000). Credit card consumers: college students' knowledge and attitude. The Journal of Consumer Marketing. 17(7), p. 617.

Yu Hsing, Jo-Anne Gibson, Tin-Chun Lin & Dawn Wallace (2003, September).

Determinants of credit card rates and policy implications. International Journal of Management, 20(3), p. 395.

Zweig, Phillip L. (1997, October 27). The New Stars of Finance. Business Week, p. 122-125.

Exhibit 1
A Sampling of 50 Fees Charged by Credit Card Issuers

 (In alphabetical order)

Account set-up fee Legal fees
Additional card fee Lost card fee
Annual fee Mailed statement fee
Arbitration fees Membership fee
Autodraft fee Minimum finance charge
Automatic payment fee Monthly participation fee
Balance transfer fee New purchases fee (charged to
 vendors)
Balance transfer rate New purchases rate (several
 levels)
Cash advance fee Over credit limit fee (several
 levels)
Cash advance rate Overdraft advance fee
Closed account fee Overdraft advance rate
Closed account rate Payment by phone fee
Copying fee Payment protection fee
Credit limit increase fee Payment protection rate
Credit review fee Program fee
Enrollment fee Research fee
Express delivery fee Returned check fee
Foreign currency transfer fee Service of account charge
Foreign currency transfer rate Special purchases fee (gaming
 chips, etc.)
Foreign fee (others' ATM
 machines) Special purchases rate
Initial card fee Stop payment fee
Interchange fee (electronic
 processing) Unauthorized usage protection
Interchange rate (electronic
 processing) Unpaid balance fee
Internet access fee Unpaid balance rate (several
 levels)
Late payment fee (several levels) Voice response fee

Exhibit 3
Characteristics of the Industry Life Cycle

 (With an emphasis on the credit-card industry)

Indicators: Growth Stage: Shakeout Stage:

Credit-card customers Rapidly increasing Saturation
Credit-card sales Fast-growing Slower growing
Interest rate behavior Very inelastic Inelastic, but less
 so
Interest rate levels
 (regular) High Declining slightly
Interest rate levels
 (penalty) Very high Remaining high
Fees and other charges Average Increasing in number
 and level
Profits (Innovators) Big profits Profits becoming
 more normal
Profits (Generally) Rising then Leveling off,
 leveling off declining for some
Competitors (Number) Increasing Some decline with
 mergers
Competitive options Many Fewer
Competition Increasing Intensifying
Product quality Increasing Maintaining to
 improving
Product variations Increasing Some increasing
"Awareness" advertising Heavy Average
Specific promotional
 costs Average per unit Increasing per unit