If the market doesn’t punish you for bad profits, Uncle Sam might.
Wall Street is scrambling to understand the financial implications of the Obama administrations new policies towards credit card companies. Reading the definition of revenue sources that will be restricted in the future, it reads awfully like a list of classic bad profits. According to the Wall Street Journal (subscription required), the credit card companies most affected are those who rely on “… portfolios that are skewed toward late-payment fees, over-limit fees and penalty repricing”. Yup. Sounds like bad profits to me. Sounds like they are getting what was coming to them.
But hold on.
If this practice was so bad, why did the market not simply take care of the issue? The argument for government involvement is usually around market failure; why did the armies of detractors of these credit card companies not bring them to their knees? Faced with such disaster, wouldn’t the executive leadership eliminate this scourge of their business?
From our studies in the credit card space, we do know that these practices create detractors, churn and low profits. One plausible explanation of the industry failure to self-address, is the absence of players who have chosen to capitalize on an alternative competitive strategy. In the airline industry, one airline charges for bags and another instantly responds with advertising that it is “bag charge free”. This has not happened to the same degree with credit cards (although I would welcome examples to the contrary). It’s plausible that the segment of customers who are being hit with these bad profits are either so unattractive that the high NPS players don’t want them, or they self select bad profit providers through lack of financial understanding (hence the argument for regulation around opaque rules by the issuer).
At a more macro level, the response to Blockbuster Video’s “late fees” was the creation of Netflix. If existing competitors don’t want to eliminate bad profits, sooner or later new entrants will. It would be ironic if the US government’s efforts to eliminate bad profits simply displaced new entrants into the market.