New Tech Players Crafted Different Plays in the Card Game — Part 1

The Card game always attracts players with money and ambition. Las Vegas card rooms have seen new entrants such as Andy Beal, a wealthy banker from Texas, challenging the card sharks that grind at the table for a living.

Today, a similar scene is playing out in the world of bank cards. There are several new deep-pocketed players, with earnings from Silicon Valley, eager to book some winning sessions in the games traditionally played by bankers.

Why do these tech companies enter the old game now?

Actually, why not? The poker table never stops seeing the influx of smart young players with money. What else do you need to play in the game, other than chips and a chair?

However, each of the young guns seems to bring a different game plan to the table.

Apple: Credit Card

Apple joins the credit card table with its Apple card. While the play looks fancy with a sleek card design and close ties with its own mobile wallet and devices, the game itself is nothing new.

Back in the day, department stores operated their own credit card portfolios to help sales. Later, the banks formed partnerships with retailers to take over the tasks of card issuing and servicing, so retailers could focus on the core retailing functions such as merchandizing. That was well before the concept of “banking as a service” became popular.

Previous Apple Card

Actually, before the hype of the new Apple Card issued by Goldman Sachs, Apple had already partnered with Barclays to issue a Barclay Visa with Apple Rewards, with additional financing options available for Apple devices. As a rewards point card that allowed the cardholder to redeem points like an Apple or iTunes gift card, it did not receive as much of the media spotlight as the new version.

Needless to say, the Barclay Visa with Apple Rewards was a goner with the launch of the Goldman-issued Apple Card. Retailers do change card issuing partners, just as Costco switched from Amex to Citi, and Walmart changed from Synchrony to Capital One.

On Apple’s website, a Barclaycard Financing Visa is still available, which provides special financing on purchases made at Apple for up to 18 months. As time passes, it would come as no surprise if Goldman Sachs takes over the sales finance business from Barclays as well. The industry has seen Amex and Citi offer transaction-level installment loans on credit cards.

The Profit Model

So, how does Apple profit from the credit card game?

First, private label credit cards help retailers grow sales. There are always customers who cannot afford big-ticket items. With the special financing plan offered via card, such as deferred interest or long-term equal pay, customers can acquire merchandise with a more manageable monthly payment plan.

According to a study sponsored by GE Capital, whose spin-out Synchrony is the largest private label credit card issuer, a private label credit card can boost retail sales by 39% to 89%.

This value proposition works especially well for big-ticket items with high profit margins, such as mattresses and furniture. Apple’s electronics fall into this category as well. The offer of 3% cash back is enticing for customers to pull out the Apple card and get that latest iPhone right now, while Apple enjoys the 37% profit margin on the sale of another new device.

If the Apple Card can help boost sales by 10% over its previous Barclay version, that is nearly $12 billion on top of the $115 billion US sales in the previous 12 months. With the 37% profit margin that Apple enjoys, that translates into a $4+ billion incremental gross profit.

Also, the use of private label credit cards avoids the interchange fees that retailers pay to card networks such as VISA & MasterCard. For a retailer to accept a regular VISA or MasterCard branded credit card, it needs to pay a 1.5%-2% Interchange Fee. Although apparently not a large amount on its own, interchange fees add up quickly for any retailer with sizable transactions.

In addition, for cardholders who carry the card balance into the following month instead of paying it off, financial interest can be charged. Adopting the co-branded card (dual card) model, the Apple Card can be used both in Apple stores and outside the store via the MasterCard network. The out-of-store purchases will generate additional interchange fees paid by merchants. For financial interest and interchange fees, usually the retailer can receive a good portion from the card issuer under the partnership agreement.

The form of the payment to the retailer could include a bounty payment per new account opened in-store, a rebate of in-store interchange fees, a royalty on out-of-store purchases, revenue sharing or profit sharing, or a combination of some of the forms above.

Each contract between retailer and card issuer is different. However, if Macy’s (who has $25 billion in annuals sales and 46% in credit sales) can receive about $750 million a year from its card partner Citi, then Apple (who has annual sales of $115 billion in the U.S. and an estimated 10% in credit sales) should be able to pull in a similar number from the Apple Card deal.

With the back-of-the-envelope calculations above, it seems that Apple can book close to $5 billion from the card deal, mostly from growth of sales, and the rest from credit card fee incentives.

That is almost 10% of growth on top of Apple’s annual profit of $55 billion. A pretty nice winning from the card game, especially considering that Apple needs to grow its new revenue streams as the flagship iPhone sales slow down.

Apple Ecosystem

From a strategic perspective, Apple wants the card to engage Apple fans further within its growing ecosystem.

At stores where Apple Pay is not yet available, there is a physical Apple Card to use. Where Apple Pay is available, Apple hopes that the 2% cashback would encourage more Apple Card customers to use the mobile wallet, which will help pull in another 0.15% of the transaction value.

Over time, more Apple Cards would encourage more merchants to accept Apple Pay, which in turn would stimulate the issuance of more Apple Cards and sales of more Apple devices. This is certainly the self-propelled ecosystem Apple hopes to achieve.

(To be continued)

Disclaimer: The author does not have investment interest in any company mentioned in the article. All opinions are his own.