Why do credit card companies charge annual fees for certain cards?

OK, to make money…i get that. But is that it? Is it to make it appear more “exclusive”? It seems that alot of people looking for a new card may skip the one with an annual fee and go with a no fee card that perhaps offers slightly less cash back or whatever. It seems like they’d make up in interest payments whatever they’d lose by dropping the fee on certain cards and open it up to anyone credit worthy.

Can anyone explain.

And yes, one of my cards is an Amex with an annual fee. The higher cash back % offsets the fee in my case.

I listened to a podcast on this topic a few months back. This one: Inside the Mysterious World of Credit Cards (with Patrick McKenzie) - Econlib

The gist of the answer is what you said: to make money. Annual fee cards tend to come with the best perks and those perks aren’t free. Annual fees are one of many revenue streams and credit cards need a mix of them in order to limit how easy is to “game” the rewards, which apparently is becoming a bigger problem with the internet and communities dedicated to figuring out how to maximize that. Keep in mind that plenty of people don’t even pay interest on their credit cards. For those accounts, the merchant fees alone may not be enough, especially if the card is only being used for whatever product mix maximizes the return to the card holder.

On the flip side, a few weeks ago I read a WSJ article about how the high fees on some cards is part of their allure. The exclusivity is cause being a perk to a certain segment of customer. The article had this cheeky quote:

The cards’ allure “can lead to behaviors that you can’t justify” based on function alone, said Derek Rucker, a marketing professor at Northwestern’s Kellogg School of Management. “That’s where the math doesn’t have to make sense,” he said.

Paywalled, probably.

As previously said, the fee is to partially cover the cost of the benefits of a premium card, which can include not only rewards but benefits like extended warranties. I happily pay an annual fee on one of my credit cards because it accumulates my preferred airline points, and that alone makes it worthwhile. Over the years it’s brought me free flights and free merchandise worth far more than the cost of the card.

To make it the card you use. People typically have multiple credit cards, and if it’s free they don’t mind keeping an extra on the back burner. But if you get them to pay an annual fee, they want your specific card to use (not to have as a backup), and that’s worth the perks associated with it which further incentives that is the card to use.

The other reason, on the other end of the spectrum is someone can’t get a card without a fee due to poor credit, so has no choice.

There may be special cases like this, but that’s not what we’re talking about here. In general, credit cards with fees are premium cards with high credit limits and extra perks.

My premium credit card is the Amex Aeroplan Reserve which runs me CAD$600/yr. It’s a super premium card which comes with things like elite Air Canada benefits and a heavily discounted companion fare. I just booked a flight to San Francisco for a business trip that was about $1000, my wife is coming with on the companion ticket for $250.

I have a half-dozen premium cards totaling thousands of dollars in annual fees. I don’t carry a balance on any of them. The only money they make is the transaction fee charged to the business accepting the card, and my annual fee. What’s in it for me? The perks associated with the cards (hotel/rental car status, lounge access, free upgrades, etc.) are well worth the price of the card once other credits and cash-back benefits are factored in. $200 off a hotel here, $300 off a plane ticket there, free Netflix, free Apple TV, etc. All of that can be subtracted from the annual fee. Sometimes the free stuff surpasses the annual fee, in which case, the elite status and lounge access comes at no cost at all.

Sometimes the Card Companies overshoot, and the cash-back credits and other perks are worth way more than the annual fee. Chase lost $2 Billion on the Sapphire Reserve in the first 5 years. I loved that card. $550 a year was a steal considering everything it offered. No surprise at all that they lost money. They’re increasing the fee to $795 in a couple months. Updating their benefits and perks as well.

I would have to think long and hard before I got a credit card with a $795 annual fee.

You have to work the numbers. I run significant business expenses, typically $20K/month, through my card. That gives me ~$4000 a year in value without including any of the other benefits

When the airlines started charging to check bags I got an offer for an American Airlines credit card with a $99 annual fee. Among the benefits was free checked bags on American Airlines flights charged to the card. Since I regularly flew AA several times a year, the annual fee more than covered the cost of checking my bags. Plus, there were bonus miles and credits which over the years have gotten me free flights and upgrades. I think I’ve gotten my money’s worth.

Wow. That is a lot of spending. I typically charge about $2,000 monthly. And looking at the Chase Sapphire Reserve benefits, I see Doordash credits here, StubHub credits there. The common denominator is that these may cost Chase little or nothing to include. On the other hand, the credit cards directly affiliated with particular airlines involve billions in payments from the card issuers to the airlines to buy all of those airline miles. At this point, the airlines might make more money from their affiliated credit cards than they do from actual passengers buying tickets.

To be much worse. Enshittification strikes again. I’m canceling mine before the next annual fee.

For me the good ones were the primary rental car insurance, travel and medical insurance, previously Lyft Pink discounts, travel rewards (especially great during covid when they let you apply it to groceries instead), and Priority Pass for lounges and free airport food for two. Much of that has gotten enshittified though (Priority Pass was always too good to be true, and it’s a total tragedy of the commons crapshoot now. We’d also get two free meals from multiple restaurants at every airport we laid over at, to stock up for the plane and the next few days.). Their revised card is retargeted for the moderately rich who think spending a grand a night on a hotel is loose change. The old one was used and abused by value conscious middle class travelers – who were probably never a very profitable segment. The loss leader days are over, I guess. Too bad.

The main target audience for those sorts of cards are business owner/operators. A friend of mine has a credit card affiliated with an airline and another affiliated with a hotel. He runs very close to $100K/month total through the two cards just on normal business expenses. And always pays the balance in full when due.

He has not paid for airfare nor a hotel room for years. But always travels first class and stays only in luxo suites wherever he goes. Which is at least monthly. He can’t begin to use up his points and miles as fast as he earns them.

Those card issuers love him to pieces since they get their schweet schweet 3% vig on all those $100K of purchases every month.

I’m kind of surprised that the merchants he’s doing business with don’t insist on a lower cost payment option.

Some have. But the nature of his supplier’s industry is online ordering. Imagine Amazon deciding they didn’t take credit cards. How else are you going to pay and how are they going to deal with deadbeats who don’t pay (or slow-pay) their bills?

Just as we’ve talked in the past about how cash is not a costless option for retailers due to security and loss concerns, A large online business taking checks from legions of small businesses isn’t costless either. Even paying the CC companies’ 3% vig from their sales can be cheaper than all that other rigmarole.

Now what will upset this happy applecart is the increasing prevalence of credit card surcharges. Around here they are rapidly becoming the norm at restaurants and are spreading to ordinary B&M retail. If online merchants, whether BtoB or BtoC, begin breaking out CC surcharges as a separate line item, that’ll shake up a lot of these cozy deals.

There are lots YouTube channels run by guys (it does seem to be mostly guys) who talk about various credit cards and their point and rewards, and how you can use them so that you can take fabulous luxury trips for nothing, and they pretty much all agree that the recent changes to the Chase Sapphire Reserve have “ruined” it.

Ironically, it’s most likely the increasing prevalence of those very YouTube channels, which teach people how to take advantage of those cards to extract the maximum possible value from their rewards structures, that have made the cards less profitable for their issuers, and caused them to increase the fees and scale back on the rewards.

Yeah. A heck of a lot of good deals depend on only a smallish fraction of people who have access to the perks actually using them.

But a gym that sells memberships where 100% of the members work out every day or an “all you can eat” buffet where everyone fills their plates 10 times with the most expensive stuff can’t stay in business with the expected price and performance for the customers and also the expected profitability for the company. Something’s gotta give.

Social media / youtubers / the points guy are all serving to make it much more likely that a much higher fraction of cardholders squeeze most or all the juice out of their cards.

The Sapphire Reserve is still worth it to me for the travel benefits–as mentioned above, specifically the travel insurance and primary car insurance. Have you priced travel insurance since COVID? Yeesh. We’re heading to Fiji in 6 weeks for a couple weeks of diving. Not cheap, and you run the risk of an expensive medical evacuation if something goes wrong. We have never paid a cent of interest to Chase, so the fee is all they get.

There should be other, cheaper cards that offer travel insurance without the luxury perks of the Reserve, though. Will have to find one…

I looked. Really low coverage limits, like a couple grand. CSR is $10k per person per occurrence with a $50k annual limit. And that’s if you put ANY part of the travel on the card, not all of it.