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By accepting American Express (Amex), you offer your customers a greater range of choices in making payments and thereby increase your revenue. Note that Amex cards account for approximately 24% of the total dollar volume of credit card transactions in the US, the highest of any card issuer.

The typical credit card business model

When a consumer makes a purchase using a credit or charge card, a small portion of the price is paid as a fee (known as the merchant discount), with the merchant keeping the remainder. There are typically three parties who split this fee amongst themselves (see: How does credit card payment processing work):

  1. Acquiring bank: the merchant's bank. It processes all credit card transactions for a merchant and credit's the merchant's account for the amount charged, minus any fees.
  2. Issuing bank: the bank which issues the consumer's credit card. This is the bank consumers pay for their credit card purchases. The issuer's share of the merchant discount is known as the interchange fee.
  3. Image of a Costco Amex cardNetwork: the link between acquiring banks and issuing banks. These banks have relationships with a network, rather than with each other, for fulfilling card purchases. This allows a card issued by a community bank in Peru to be used at a shop in Denver, for instance, without requiring the banks to have a direct relationship with each other. The two largest networks in the world are Visa and MasterCard.

The average merchant discount in the United States is 1.9%. Of this, approximately 0.1% goes to the acquirer, 1.7% to the issuer, and 0.09% to the network.

Most Prime and Superprime card issuers use the majority of their interchange revenue to fund loyalty programs like frequent flyer points and cash back, and hence their profit from card spending is small relative to the interest they earn from card lending.

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How American Express differs

Image of an Amex cardAmerican Express typically plays the role of all three parties above, keeping the entire merchant discount. In recent years Amex has begun authorizing other banks to either acquire or issue on Amex's behalf, primarily in countries where Amex would otherwise have little or no presence.

Amex also has historically charged a higher merchant discount than Visa or MasterCard. The size of the premium can differ significantly: in the US, Amex charges 66 basis points more (2.56% vs 1.9%) than rivals Visa and MasterCard, while in Australia Amex charges more than twice as much as Visa or MasterCard due to Australian interchange regulations.

Amex uses this higher discount revenue to invest in rewards programs that provide a higher payout than competing programs. TheseImage of the American Express Tower in New York City more substantial rewards programs, in addition to a premium brand and a reputation for superior customer service, allows Amex to attract a disproportionate share of affluent consumers. Amex then uses its strength with affluent consumers to justify charging a higher merchant discount rate, implying that if a merchant does not accept Amex cards he will lose affluent customers. This business model creates a self-reinforcing loop.

Due to what Amex calls its "spend-centric strategy", card spending and fees are responsible for 70% of Amex's card profit, vs. 10–40% for other issuers. Amex also tends to make more money from annual fees than other issuers do.

One tension in Amex's business model is acceptance, a volume vs. margin trade-off. Because Amex charges a higher merchant discount fee, it is not as widely accepted as Visa or MasterCard. Amex's business model depends on having a higher discount fee, however, making it difficult to lower it. The company has to strike a balance, keeping its fee low enough to attract sufficient merchants, but high enough to fund rich rewards and drive its business model. In countries where Amex charges a small premium, like the US, it has near-parity acceptance, but its card rewards are not significantly more substantial than those of its competitors. In countries where it charges a large premium, its cards often have a much higher rewards payout than competing cards.

Many banks fund their lending, both card and otherwise, through deposits. Without deposits, however, Amex has historically funded its lending through outstanding travelers cheques (which function like non-interest-bearing deposits), the wholesale funding markets, and securitization. As travelers cheques have declined in popularity since the rise of ATMs, Amex has begun seeking traditional deposits through online high-yield savings accounts. The freeze in wholesale funding markets and securitization during the financial crisis of 2007–2010 caused Amex to accelerate these deposit-raising efforts, and also caused them to decrease growth in lending.



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