Payments 3.0: The Delicate Balance of Closed-Loop Cards

As banks and merchants fight over interchange regulation in Washington, the real struggle is in shoppers’ wallets, phones, and Web browsers.

Last month, I wrote about how merchants use discounts, surcharges, and direct bank payments to influence consumer behavior. This month, we’ll look at another tool that merchants can use to manage payments costs: gift cards and other closed-loop cards.

The most-cited case of a successful closed-loop or gift card program is that of Starbucks, which had more than $1.5 billion loaded onto its cards in fiscal year 2023, according to its annual report. Because of this, analysts sometimes describe Starbucks as a bank, but that is a misunderstanding of the program.

The reality is companies like Starbucks, Walmart, and Apple are not looking to become banks. They want to bring customer dollars into their ecosystems without being a bank. This helps them manage payments costs, and understanding the cost of a transaction reveals how.

In a post on its Web site, the payments processor Fiserv describes the transaction fees that merchants might pay, including processing and authorization fees, network fees, and interchange to issuing banks—made up of a flat fee plus a percentage of the transaction— among other charges.

JPMorgan Chase lists out prices: to accept a transaction at the point of sale, a merchant will pay 2.6% of the transaction plus 10 cents, and 2.9% plus 25 cents per online transaction. So let’s use the Chase numbers to do a back-of-the-envelope analysis. I do not know whom Starbucks works with for payments processing, so this is just for illustration.

If a person stops at Starbucks each workday of the month and pays with a credit card every time, the company pays a percentage of each transaction plus a flat fee for each of those roughly 20 transactions.

But if they convince a customer to load a Starbucks card, they can reduce the interchange to the cost of a closed-loop transaction and eliminate the fixed fees. Even if that card is loaded with a credit card, the savings could be substantial.

Using the Chase numbers to illustrate this, let’s assume a 25-cent online fee to load a closed-loop card versus a 10-cent-per-transaction point-of-sale fee for credit cards. The savings from moving to the Starbucks card from a credit card would start at $1.75 per customer per month. At Starbucks’ volume, that starts to add up quickly.

Two things help Starbucks succeed. The first is that their customers have a high volume of purchases. Second, they offer rewards. The frequent visits are not something every merchant can duplicate. People buy only so many televisions, for example. Rewards are open to all merchants, but carry risks.

A generous rewards program tied to gift card loads can lead to shoppers trying to double dip by loading up gift cards with credit cards that pay high rewards. This can become costly if the cards are bought through resellers where the merchant needs to offer a discount to get their cards into a card mall or rewards program, for example.

The math around gift cards is further complicated by unredeemed cards, which often escheat to state governments looking for an extra source of revenue disguised as consumer protection.

This may seem like a zero-sum game, but new payments bundles could open opportunities for new partnerships among merchants, card networks, and banks. Super apps that integrate closed-loop wallets, rewards programs that offer closed-loop options, and direct bank loads into closed-loop wallets are a few of the possibilities.

Success will come to innovations that balance the interests of merchants, payments providers, and, most important, shoppers.

—Ben Jackson bjackson@ipa.org