Many credit card companies offer welcome bonuses to encourage consumers to sign up for credit cards. But should credit card companies offer welcome bonuses? What are the benefits, and the potential issues this practice may create? We will explore more on this topic below.
Arguments for why credit card companies should offer welcome bonuses
Everybody is doing it. If we don’t, then we will lose.
The battlefield of credit cards feels just like a prisoner’s dilemma. The prisoner’s dilemma is a game theory thought experiment that involves two rational agents, each of whom can cooperate for mutual benefit or betray their partner for individual reward.
Suppose we live in a world where welcome bonuses are not a thing. Under this circumstance, no credit card company will need to spend any money giving rebates to consumers.
But companies exist to make a profit. As such, there is an incentive (e.g., a less favourable quarter-end) for one company to start offering welcome bonuses to its customers. That one company will benefit hugely from this initiative. Now player #2 will join, and #3, #4, and soon after, all hell breaks loose.
Once all credit card companies start playing the game, they will find it difficult to retract their position. Consumers are already used to the idea of getting welcome bonuses, and those who stop offering them will lose.
Credit cards are just like any product. Of course, we should have it on sale to incentivize people to use the cards.
At the end of the day, credit cards are a financial product. From this perspective, it makes total sense for credit card companies to use whatever tactic possible to incentivize people to use their products, similar to how retailers have discounts for their products ranging from clothing to groceries.
Welcome bonuses compensate consumers for the monetary value extracted from us.
Credit card companies make billions of dollars thanks to the countless swipes happening every single day from you and me.
As consumers, we are essentially little machines who are helping credit card companies extract value from merchants (as ultimately it’s the merchants who have to pay for the credit card processing fees). When considered this way, shouldn’t consumers be compensated for our “work”?
Welcome bonus offers have led to some very fun stuff
Credit card churning can be a very fun hobby. It has also led to lots of successful entrepreneurial stories involving people teaching people how to use points to redeem for luxury flights.
Arguments for why credit card companies shouldn’t offer welcome bonuses
It can be good for the consumers. But for whom?
It is easy to see that consumers benefit from welcome bonuses. But the issue is, who exactly benefits from this action?
The answer is, the middle-upper-class consumers who are already financially savvy and who already enjoy many other privileges.
To begin, consumers who do not have a good credit score, or no credit score at all, will not be able to get any credit cards.
Once you become eligible to enter the credit card market, however, you will soon realize that credit cards have many tiers. At the beginner level, you have no-annual-fee cards. These cards have welcome bonuses, but the bonuses pale in comparison to those offered to mid-tier and premium cards.
These cards typically have higher rewards, but also higher fees. The mid-tier cards typically have an annual fee of around $150, and the premium-tier cards can have an annual fee of at least $500. As well, there is typically an income requirement for these cards. For example, Visa Infinite cards have a minimum income threshold of $60k, World Elite Mastercard $80k, and Visa Infinite Privilege $150k. The income threshold alone eliminates consumers who do not make a high enough income.
The issue is, that welcome bonuses don’t fall from the sky. It is a portion of the profit that credit card companies generate from merchants. Each time we swipe, merchants have to hand over a percentage to the credit card companies. To maintain profit margins, merchants will likely raise the prices of products. And everybody has to pay the same price, regardless of whether they use a credit card or not! It then becomes a vicious cycle that hurts people who may need money the most.
Therefore, the free flights consumers get to enjoy actually come from not just their own pocket, but also pockets of low-income households. Welcome bonuses may thus in part contribute further to income inequality. Those who may need the money the most could unfortunately become the victims of this pursuit.
Firms with less budget might lose the game
This is a familiar tale of a small fish who can’t compete with the bigger fish.
You may be well aware of the fact that local businesses, in many ways, cannot compete with large companies due to economies of scale. The same thing can happen with credit card issuers.
Welcome bonuses bring media attention. There are numerous threads on online forums discussing the best welcome bonuses, which in turn help promote these companies.
However, not all companies have a large enough budget to provide welcome bonuses. These companies, even if they offer superior customer services, are not able to achieve the same level of visibility as their larger competitors.
For example, I have been a long-time user of Home Trust Preferred Visa, but I honestly haven’t heard very much discussion about it. I think it may be because this card doesn’t offer a welcome bonus. But if you are an occasional international traveler or someone who is looking for a simple card, this is the perfect card. It has no annual fee, no foreign exchange fee, and you earn 1% on every purchase in Canadian dollars. To me, this card is so much better than other no-foreign-exchange-fee cards that charge an annual fee, and so much simpler than all the other credit cards that offer different cashback percentages on different categories. Some of the premium cards only offer 0.5% cashback, and yet they receive so much more media attention.
It promotes an unhealthy obsession with luxury travel
Nowadays, there are many YouTube and online stories on how to use points to travel for free. While these efforts certainly have their benefits (e.g., ad money for the content creators, entertaining viewers, etc.), they can inadvertently promote an unhealthy obsession with luxury and luxury travel.
I am not saying luxury travel is bad, but the thing is, only a very small segment of the population can rack up enough points to travel the world using points alone. These people typically are consultants/lawyers who travel constantly for work and whose companies reimburse them for the expenses. Or they may run a small business and have lots of business expenses.
For most of us, traveling around the world flying business/first-class constantly is most likely unattainable. Although we might have one-time expenses, such as a wedding or a home renovation project, for which we could benefit from large welcome bonuses, but that’s likely a once-in-a-lifetime. Yet these videos make it seem so easy to just put expenses on your credit cards, earn welcome bonuses and travel for free. Viewers may try to use similar tactics only to spend money they don’t have, buy things they don’t need, and worse, miss paying their bills and therefore are forced into paying 20%+ interest.
Welcome bonuses can lead people into grey areas such as manufactured spending
People who naturally don’t have a high enough spend may be incentivized into participating in activities such as manufactured spending to hit the minimum spend for welcome points. By using these tactics, you are “spending money” on your credit cards only to cash the money back into your pocket through another means.
Is it ethical? I find it questionable.
I just finished reading Risky Business: Why Insurance Markets Fail and What to Do About It. It is a very interesting book on the insurance industry (I know, how can insurance be interesting!). In the book, the authors noted several examples of why selection problems can lead to the demise of a service altogether. This is because by raising fees, only customers who need the service the most (i.e., the most expensive ones to serve) will remain.
I can’t help feeling that the same pattern can be applied to the credit card industry.
If you have been paying attention to the credit card landscape in the last few years, you have probably noticed that welcome bonuses have been harder and harder to get: instead of spending $1000, now you may have to spend $5000. Instead of first-year-free, now the annual fee is not waived.
But this gradual decline in benefits may only end up retaining the most dedicated credit card churners – i.e., the customers who are most expensive to serve.
Let’s do a simple example.
Suppose a credit card company offers an FYF (first year free) credit card with a 50k welcome bonus after you spend $1000. This is relatively achievable, so a lot of people will sign up. But not all those who sign up will achieve the $1000 spend threshold. As well, many may find the card useful, so they will keep the card even after the first anniversary.
Now, the credit card company realizes that it spent too much on welcome bonuses, and therefore, they increase their conditions. Instead of spending $1000, now you have to spend $3000 to get the welcome points.
This time, the people who know that they have no way of achieving $3000 will not get the card at all. Your customer pool thus becomes smaller. But the pool will also become more expensive to serve, because all the experienced credit card churners will continue to sign up for the card and get the welcome bonus.
If you make it even more difficult to get the welcome point, more people will self-select out, but the people who remain will be the most tenacious people who are determined to get the welcome bonus. The company’s payout will be a lot closer to 100%, vs. perhaps 50% if you set your limit lower. The game thus becomes more and more expensive to play, for both the consumers and the credit card issuer. Ultimately, only the most expensive players will remain in the game.
As an individual consumer, I see both sides of the coin. I have personally benefited from welcome bonuses and have enjoyed the perks, but I can also see why this can be a problem, and how it widens the gap between the rich and the poor. I am curious to see how this industry will evolve in the future.