Did you ever wonder how and why credit card companies give such valuable sign up bonuses? Do you fear this is all coming to an end soon? Well I took a look at the numbers below. You'll be surprised by my findings.
I stumbled upon this document by the consultancy Edgar Dunn & Company.
It was published in 2007 before the financial crisis but I believe that most numbers are still spot on for our calculation below.
What the study basically says is:
– rewards credit cards users have higher average spend with $1,119 for co-branded Airline credit cards
– they also keep a higher revolving balance (they should not!) with $3,023 for co-branded Airline credit cards
– they are usually the ones with the lowest risk profile for a bank (low default ratio)
Given the average numbers above we can also deduct what a credit card company sees in revenue per card:
a) Merchant charges
Let's assume a very conservative 1.75% for Visa/Mastercard and 2.5% for American Express.
b) Financing charges
Let's assume 15% APR on average
c) Consumer defaults
Let's assume less than 1%.
d) Miscellaneous fees
Annual fees, Foreign exchange fees etc. come to $150 year per card
$234.99 (Visa/MC) / $335.70 (AMEX) in merchant charges
$453.45 in financing charges
$150 in MISC fees
minus $30 in default
This makes a handy profit of $808.44 for Chase/Citibank/Barclays etc. and $909.15 for American Express per card/ per year. Now this is before all marketing costs and staff that banks have as a major cost factor. But this is certainly high enough for a sign-up bonus of $400 or more since most consumers will keep their card for the second (not fee free) year. Since it's not (yet) public what banks pay for frequent flier miles we can only guess it's less than 1 cent per mile.
Please note that I rely on several assumptions for this. If you have more sophisticated numbers I'd be happy to hear them!