Costco made headlines when it announced its split from American Express and its new relationship with Citi and Visa, which launches in June. It’s a big deal, mostly because the warehouse giant has had an exclusive relationship with AmEx for more than 16 years, offering its more than 80 million shoppers co-branded credit cards that can be used anywhere and earn special rewards for Costco purchases. The switch basically amounts to a business negotiation gone south: Costco wanted better terms than AmEx was willing to give. (Just after the announcement, AmEx’s stock fell 6.4%—its largest one-day drop since 2011.)
Such co-branded cards are becoming increasingly popular as both stores and credit card companies seek new ways to appeal to customers. In 2014, payments made with co-branded cards amounted to 31 percent of all credit card purchases in the country. But they're complex to structure, and require relationships across a range of institutions—which is why larger companies tend to be the ones that offer them.
A co-branded card relies on a relationship between the issuing credit card company (like Visa or American Express) and its marketing partner, which is usually a retailer (like Costco, American Airlines, or Best Buy, for example). A consumer often decides to sign up for the card because it’s offered by a store they frequently shop at or an airline they frequently use. The card works like a normal credit card‚ meaning that it can be used anywhere, for any purchase, and isn’t limited only to its branding partner. If used correctly, co-branded cards are a win-win-win for the credit card company, the retail partner, and the consumer—which is why they’re so popular. In 2014, 53 percent of American credit card users had a co-branded card—and 64 percent of them used those cards at least once a month.
Credit card companies like co-branded cards because they offer a built-in audience and a major sales channel. For example, if 81 million people shop at Costco, it’s likely that many of them will be interested in Costco-specific rewards. Without this incentive, many would likely opt for a different credit card, but they are encouraged to choose American Express instead. (Now, their AmEx cards are being canceled, and they’re all automatically receiving Visa cards. This is expected to impact 1 in 10 AmEx cards in circulation.)
But co-branded credit cards shouldn’t be confused with private-label credit cards that can be used only at the issuing store, like Target’s REDcard or the Victoria’s Secret Angel Card. These retailers work directly with payment processors to provide these cards. Co-branded credit cards should also not be confused with affinity cards, which, while very similar, are associated with a charity, association, or educational institution, rather than a retailer. The affinity partners get a cut of purchases made on the card, but there is no tangible reward for the consumer.
For their parts, retail partners like having co-branded cards because there are a lot of rewards in it for them, as well. Credit card companies pay a bonus to their partner or even to the partner’s individual salespeople every time a new customer signs up for the card (which means, for example, that a store’s employee might get a $100 bonus each time she convinces someone to sign up for their credit card). The retailer also does not have to pay a credit card fee when the co-branded card is used, and if the user pays interest or late fees to the credit card company, the retailer gets a portion of these, too. (And as we’ve seen, these can really add up.) Other fees can be negotiated with the card company, often to the retailer’s advantage. Perhaps most importantly, co-branded cards encourage users to spend more money, in hopes of gaining more rewards. According to MasterCard, co-branded cardholders outspend their non-branded counterparts by nearly $5,000 a year. The incentives for the customer mean more money for the retailer, too. The reward structures for retailers can vary greatly from credit card to credit card, especially as competition becomes greater. This was the impetus behind Costco’s decision to move to Visa, which was offering much better terms for the retailer.
And finally, the incentives for the customer are the reason co-branded cards exist in the first place. Using the card lets a user receive special discounts or accumulate points or miles that can be redeemed for additional purchases. Choosing a credit card often involves a careful weighing of the rewards. A small cottage industry now exists for websites that break down various reward structures for co-branded and regular cards. Though the rewards are often an appealing lure, customers should be cautious of the danger of using a co-branded card. The average APR on co-branded cards last years was 23.43%, while the average for regular credit cards was 15%. If you’re not diligent about paying off credit cards, the rewards won’t be worth the debt.
Co-branded credit cards are certainly a major contingent in the payment industry—but one that’s constantly changing. Competition for customers and retail partners is fierce, and more and more credit card companies are getting in on the game. What’s more, in an effort to gain a larger audience, more emphasis is being placed on term transparency and ease of use. Southwest Airlines is particularly lauded for making it easy to book a flight with points from the Southwest Rapid Rewards Visa Card rather than with money.
Once just the realm of the affluent, co-branded credit card companies are doing more and more to appeal to the middle class. A survey found that while households earning an annual income of $75,000-99,000 are most likely to want cash back rewards from their credit cards, households with a $50,000-$74,900 annual income are most likely to want miles rewards and point flexibility. To that end, mainstream retailers like WalMart and Red Roof Inn have recently begun offering co-branded cards in order to broaden their audience.
It remains to be seen whether the appeal to the middle class will pay off for credit card companies, especially as interest rates on co-branded cards continue to increase after the Federal Reserve increased its benchmark interest rates last year. Some experts fear that we’re on the verge of a breaking point, where the high rates won’t be worth it to customers anymore. And as retailers become more demanding about their terms—especially after witnessing Costco’s coup—credit card companies will be forced to respond.