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Credit Card Interchange Rates Just The Start Of Credit Card Wars

|About: Visa Inc. (V), Includes: AXP, CMCSA

Summary

Credit card companies have kept interchange rates rather consistent the last five years, keeping profit margins high.

Visa may have unleashed a new movement though, one where credit companies are willing to be very flexible and sacrifice profits to gain big retail customers.

Costco is a perfect example, investors should watch for similar deals and rising competition between the credit card companies.

Big dominant industries can crumble quickly, especially margins in these seemingly safe industries. It takes just one big company in any industry to undercut its competitor's prices to such a large degree that it causes a chain reaction. The end result will mean lower margins for the entire credit card industry.

During the last 10 years consumers have benefited from three such examples of large companies undercutting margins. In retail, Amazon.com (NASDAQ:AMZN) undercut prices on traditional brick-and-mortar retailer. This essentially caused those retailers to emulate Amazon's web based model with lower margins, or not and perish.

A second example occurred in the wireless market: T-Mobile (NASDAQ:TMUS) started a price war that Sprint (NYSE:S), AT&T (NYSE:T), and Verizon (NYSE:VZ) followed. The end result was reduced profit margins and lower earnings.

A third example is currently taking place in the broadband internet and TV industry. Google (NASDAQ:GOOG) (NASDAQ:GOOGL) Fiber is forcing Comcast (NASDAQ:CMCSA) and AT&T to not only increase internet speeds but lower prices as well. This will likely result in lower margins and reduced profits.

This scenario has played out many times before in numerous business sectors. Ultimately the majority of companies that end up on top are the ones who start the trend. Are the credit card companies the next industry sector to follow in these footsteps? It sure looks like it.

We have not yet seen definitive proof on a grand scale to confirm that a price war is near for credit card companies, but the signs are unmistakable that something is afoot. Recently, both Visa (NYSE:V) and Citigroup (NYSE:C) have taken unprecedented actions to exclude American Express (NYSE:AXP) in an attempt to gain exclusive rights to the wholesaler Costco (NASDAQ:COST).

American Express was the official credit partner of Costco before Visa and Citigroup jumped in with terms that were too good for the wholesaler to turn down. As of today, Costco pays American Express about 0.6% of each transaction on its cards. This relationship between American Express and Costco reportedly accounts for 20% of the card company's outstanding loans and 8% of total spending.

American Express will be losing out on that lucrative deal now that Visa has partnered with Costco for an interchange rate of less than 0.4%. Is this the first salvo in what could be a new price war in the now lucrative credit card industry?

Similar to Amazon and T-Mobile who sacrificed profits for higher revenue, Visa may not collect as high of fees from interchange rates, but it'll thrive in other areas. In fact, Visa may make nothing on the low set rate, as rewards are likely to cost more than the 0.4% rate it has set. However, Visa is likely betting that Costco will push these cards even harder to its customers due to its low fee commitment. Visa will then collect interest on credit card balances, which is where 80% of credit card revenue is earned anyway.

This means that Visa sacrifices on interchange rate, with the expectation to capitalize on higher interest payments from individual Costco customers. This low rate approach may be a road map and gain future market share from other large retail partners. It has the same makings of how price wars started in years past in other industries. The next question is where the competition ends? Will MasterCard and American Express eventually lower rates to 0.4%, or maybe even go lower? Might the high margin credit card business be the next industry to see profit margins cut in half, and its stocks to temporarily fall? Right now it's too early to tell, but is certainly important to monitor, especially for those investors who have a stake in one of these companies.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.