Costco slashes credit card fees to near nothing

Costco (NASDAQ:COST) has accomplished something other retailers only dream of: It has reduced its credit card acceptance costs to almost nothing.

As Costco moves to replace the current arrangment it has with American Express, the wholesale retail club has struck a deal with Visa and Citigroup that almost entirely eliminates the acceptance costs, sources told Bloomberg Business. Comparatively, Costco currently pays 0.6 percent per transaction to AmEx.

Though Costco will still pay small fees on the Visa cards it accepts that are issued by other banks, the fees will be offset by incentives from Citigroup and Visa.

Spokespeople at Costco, Visa, Citigroup and AmEx declined to comment.

The Costco partnership is highly desirable because the wholesale club only accepts one card brand, so it has more leverage in its negotiations with financial firms. American Express said it could not agree to the same conditions that Citigroup and Visa accepted and ended a 16-year relationship, which expires in March 2016. At that time, Visa will become the exclusive card network at Costco, while Citigroup will issue the credit cards co-branded by Costco.

"The numbers didn't add up," AmEx CEO Kenneth Chenault told investors. "We couldn't accept their financial terms or their contract terms, some of which would have meant taking on more risk than we were comfortable with."

Although they won't charge Costco the customary interchange fees, Visa and Citigroup may profit if customers carry loan balances and pay interest. The financial firms will also benefit when consumers use the cards in other places that do pay higher card acceptance fees.

All large retailers have fought the fees banks and card issuers charge them when accepting credit cards. However, cards remain very popular with shoppers in spite of security breaches, and especially ones that offer incentives, such as cash back, airline miles or other point-based rewards.

Banks that issue Visa cards will need to evaluate the revenue equation at Costco, where Visa has set the interchange rate for cards other than Citigroup's at 0.4 percent. The Federal Reserve Bank of Kansas City's 2014 study reported that the average credit card interchange fee on Visa's network is about 2 percent.

Lisa Ellis, an analyst at Sanford C. Bernstein & Co., told Bloomberg Business that about 80 percent of credit card revenue comes from interest on balances and other fees, but banks rely on the interchange fees for the rest. Most cash-back rewards, such as the co-branded card AmEx offered, return 1 percent to 2 percent of transactions to consumers, she said.

For more:
-See this Bloomberg Business article

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