cayenne92

I think everyone has a piece of the puzzle on how CVS profits from VR but are missing the obvious. What is the meat of their business-the pharmacy. Anything else they can sell is gravy. The Incomm deal has got be a great marketing item for them. Answer this question-where would you go to get prescription filled???

MsArbi

Deleted.

rdover1

Since the fee and card value are always split on the purchase, I'd speculate that there may be contracts in place so that interchange only applies to the fee, and not to the cash equivalent. Visa /MC / AMEX might agree to this as they would assume they get their IC fee when these cards are actually used as credit cards.

Just speculation that would explain how they keep the costs down as I don't see CVS losing over $100 in (3% of $5,039.50 less $39.50, assuming Incomm gives them all of the fee (which I doubt)) every time they let me buy $5k in VR.

lacuadra

Giftcards are a brilliant idea and come very handy when you want to give things that WILL be used. The merchants benefit as the number of returns diminishes dramatically. I remember the 80s and the horrible lines after Xmas just to return unwanted stuff.

InComm must be making a killing and seems to own this market in the biggest economy of the world. Wouldn't surprise me if a Bank or Blackstone is really behind all of this operation.

cbn42

In my opinion, the party that loses the most is the issuing bank (Metabank or US Bank, usually). This system was designed so that all parties would benefit. CVS would collect a $5.95 fee per card, remit part of it to Incomm, and keep the rest. Metabank would collect interchange fees when the card was used, take advantage of the float until it was used, and keep any unused funds that customers forgot about.

Then, the feds came around and threw a wrench into the plan by requiring PINs. Suddenly the card issuer started getting a flat fee of a few cents when the card was used rather than a percentage. Suddenly people would drain the card the day after buying it, so there was no float. Suddenly it became possible to spend exactly the amount on the card, so no more unused funds.

I really doubt CVS, or any retailer, is paying the standard 2-3% interchange fee on $500 or higher gift cards. That just makes no sense for any store to do. Even the most clueless management should be able to see the problem with that.

Agamemnon

The problem with that supposition, cbn42, is that banks are doling out miles, points, rewards, and even 2% cash back in categories based on VR Card MS at CVS, Safeway, etc.. Do you seriously believe that the "acquiring banks" in the interchange structure would receive sub-par interchange fees from CVS only to turn around and give a CC user 2% cash back (or miles equivalents, or more) on say $10,000 of MS per month, multiplied by as many as 100,000 or more MS arbitrageurs in the United States (who knows what the number is but it is not just a few thousand), year after year???

Banks are not dumb. They are cutthroats pushing debt peonage and trying to profit and financialize every conceivable human interaction. They do it with a smile, a handshake, and condescending slogans for the thoughtless multitude like "Citi Thank you Preferred. The card that rewards you for being you." I think not.

We are missing something. And it's not just academic. It is something that we can learn from immensely and something that may unlock the next MS arbitrage opportunity in this increasingly financialized economy.

MsArbi

Deleted.

atxtravel

You guys are overthinking this.

First, I HIGHLY doubt any store loses money on gift cards. These are not loss leaders like gas, which is a vital necessity and drives traffic to the convenience store. Evidence of that is CVS currently running a promo offering $5 worth of their extracare points for 2 gift card purchases. This is a not a product that can be marked up, hence it has no profit. Why would they even have it in their stores, let alone offer promos?

I suspect the business model for stores like CVS is a payment of fees by GC issuers for the floor space to promote the cards, and possibly some bonuses for higher volume of sales. I also wouldn't be surprised if the interchange fees is passed on to the issuer as well. It just doesn't make any sense for the store to even bother with these unless their cost of selling the GCs was nearly zero.

How the issuer of GCs makes money is the more interesting question. On a typical $50-100 card, the interchange fees they'd collect would be $1-3, hardly worth the effort if they had to pay manufacturing and distribution costs as well. Breakage might be a small factor, but many store registers will detect and use up small amounts when making a purchase, so it's not too difficult to use up the last few dollars. These cards don't expire for almost 20 years, so again, that's not a factor.

I'm willing to bet their main goal with these is to generate large quantities of low-cost float money, which they then use to conduct more lucrative financial transactions. It's like a bank that offers free checking for keeping a certain minimum, except GC issuers don't have the cost of running many branches and ATMs. They have statistical models that predict how quickly the average user drains the account. This would explain why they even bother with $500 GCs. They want to encourage large deposits.

Even if they pay the 2-3% interchange fee, on a typical small load their activation fees probably cover most of the costs. They would tolerate more of a loss on higher value loads, with the expectation that on average those cards would last much longer and give them more money to play with.

kcblakely

Agree.
I'm betting that breakage is a *HUGE* factor. Losing cards, throwing away the last few cents - on the scale we're talking, that's gotta be big.
I agree. This is huge as well, altho I'm betting not as big as breakage, IMHO....

atxtravel

I would normally agree with you about breakage being a big factor, except with such far off expiration dates, they can't count breakage as pure profit right away. For the next 18 years, the few $ left over just fall under the category of average float, and their models predict how long that money lingers.

I'd be curious to find out how many heavy MS people are out there. I wonder if we're just a blip, or starting to seriously alter their expected performance on the cards.

Lemma

The expiration date on the cards is just there because it's necessary to have something in that field for the card to go through. If you still have money on the card when it hits, they will send you a replacement (for a fee). But even for GCs that don't expire, i.e. store GCs, they are allowed by GAAP to claim the breakage as revenue on their books after a certain period of time goes by such that on average, a GC that has gone unredeemed so long has a remote chance of ever being redeemed. This issue, though, is why US Bank (and other GC issuers, though I don't think Vanilla) have started imposing a monthly fee after the card has been active for 6 months until the balance drains to zero. Read the T&C on the back of a US Bank GC the next time you buy one.

I think this scenario is highly unlikely both because the stores probably don't have the technology to tell the banks what is being purchased and because the CC issuing banks would not want to accept such a low interchange fee, both because of the risk involved in processing transactions (which is at least as high for these transactions as for normal purchases and probably higher because they are similar to a cash advance) and because of the rewards they were paying out. If this were the case, we'd probably see the CC issuing banks refuse to pay rewards for these transactions. If they had the raw data to not charge IC fees for part of a transaction, they'd have the raw data to do this and a strong incentive to do so.

I get mine filled at Kroger now that variable load GC don't earn fuel points anymore, because the fuel points they give me for doing so are more valuable than 50 cents of ExtraBucks. But I'm inclined to believe the CVS manager who told me that GC/VR are basically a break-even proposition for them, which they offer to bring people into the store. I don't think they are losing money on these products, though. They wouldn't have raised the limit to 5k/day if that were the case.

Sounds like we're in agreement then. I misunderstood your original post about gold. I agree gold is generally a poor investment (though in a diversified portfolio, it may make sense to have a small (maybe a few percent) share in gold since although it has a low average real return and high volatility, it tends to move in the opposite direction from many other assets). The worst as far as the peddling by profiteers goes, though, is the ads telling you to buy gold coins. They sell those things at a huge markup relative to the bullion value, and convince people to roll over their IRA funds so they are often losing 50% of their retirement savings overnight when they put it in these coins.

Right, my comment about people who can't get credit cards was about VR, not GC. In the case of VR, the issuers of the cards we load them to are probably losing money, which is why they often try to shut us down. They don't have the ability to do that with GC, which are anonymous. As far as GC are concerned, the question is why they don't stop offering the $500 cards. CVS may not break down their data with that much granularity, and I'm guessing Incomm pays them enough that they break even on the IC fees, but the prepaid card issuers probably do break down their data that way since prepaid cards are their whole business. While the number of people who MS is small, the quantities they do are large (the people who aren't heavy hitters can just stick to VR), so it could be having a large effect on their bottom line if they are breaking down their profits by card denomination. The question is how many people buy $500 GCs for non-MS purposes. I don't think it is common to give GC that large as gifts, certainly not in comparison to the amount that are bought for MS. As I hypothesized, if enough people buy them to hide assets from the taxman, court judgments, or an ex-spouse, they could be making enough money on the float to outweigh the losses from us. Interesting hypothesis about the IPO investors, though.

Agamemnon

I respectfully disagree.

Think in order to learn.
Learn in order to earn.

There is a delicious irony at work here. The financial system is specifically designed to be non-transparent. The last thing a bank (or any financial service provider) wants is for customers to understand the system and to be able to make informed decisions. Less profits for them. The interchange system is a labyrinth with different players, different minimum IC fees, different merchant codes (MCC), different IC fee tiers (MC has 240), etc. It is getting more complex all the time.

MS arbitrageurs are leveraging this lack of transparency to enter the loop and squeeze out a spread between the IC fees and the CC rewards. It may be that just as we do not see the whole merchant/issuer/interchange loop, some of these players do not see our whole arbitrage loop. They may suspect it is going on, but cannot grasp its extent. E.g., The CC bank may know a CC holder is doing MS, but the VR issuer may not. As a previous poster stated, it may be that MS skews the profits from activation fees, breakage, etc.

All is fair in love and war.

mithrin

Before you discount the number of people buying the "$500" GCs for other purposes--remember that they aren't actually $500 denomination cards. They are $20-500 cards. What if you want to give someone a $75 GC? You can either give a $25 and a $50 (and pay both fees, force receiver to keep track of two cards), or get a variable load for $75. Same goes for any other $ amount that isn't exactly equal to a fixed amount card that the store carries and is in stock.

Sure, not too many will load the full $500 outside of MS, but there is a market for the variable load capability of the card. Also, there will be a small niche for $500 cards for the "MS lite" crowd. That's how I describe people who either or both:
1. Go for sign-up deals on CC, and when normal spending doesn't get them enough spending, stock up on GC to shift future spending into the window. They would spend down the prepaid cards through normal use--yielding plenty of interchange fees and some float for the issuer.
2. Use prepaid cards to shift spending into bonus categories. Buy $500 variable card at a bonus location, and spend it down at non-bonus locations. If they get 5% on the variable card - 1% fee - 1% earnings that alternate purchases would have earned anyway = 3% boost to earnings.

They won't buy in nearly the volume of the MS crowd, but there will be more of these types (I was one myself before the PIN change happened).

As to the granularity. While I'm sure that the issuers collect separate data on each denomination of GC, they may or may not be mining the variable load GC data to separate out by initial load amount. If they don't then the $75 loads get lumped in with ours and muddies the waters for them. Since not a single issuer has lowered the variable load limit from $500, it seems that they either don't see the MS effects (MS usage is low compared to totals, or they aren't analyzing by purchase amount), or they don't care about the MS effect (see it--but its small enough to ignore, or tolerate it because of the increase to their volume numbers).

particlemn

i wonder if the variable cards are a marketing ploy on thoses who dont pay attention, they see a card that can be loaded to 500 for 4.95 and think thats a really low fee less that 1% and then load it with 100 and pay the 4.95 fee thinking its a great deal casue its just 4.95 on 500.

ragnarkar

When you use MS to get points to get a free (or almost) free seat on an airplane, there's now 1 less seat on that plane. Now let's assume you wouldn't have made this trip if you didn't have the points you gained from MS. So Demand for seats is still the same but the Supply has shrunk.. -> ticket prices will go up.

Thing with airlines is that unlike other widgets, there's no way to increase the supply of airplane seats in a short period of time (the supply is relatively inelastic.) So prices will rise as airlines, like most businesses, are fundamentally greedy and will charge as high of a price as possible as long as it maximizes profits.

Say there are X seats available on a particular route among all participating airlines, and demand is X at the current prices. Now suppose due to MS, the supply of seats is now only 0.9X but demand is still X. The airline will raise prices until demand is now also 0.9X.

Conclusion: the losers in MS are the people who regularly pay for their seats and rarely/never use points.