Marketing special report: The credit card trap

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By Sandra Arnoult

Credit card companies are reaping the benefits of increased online transactions, but airlines are studying the bill and calling for better terms as alternative forms of payment gain ground, writes Sandra Arnoult in Washington

Using the Internet to book flights and purchase ancillary services has been a boon to the airline industry, but everything comes at a price - in this case in the form of hefty credit card transaction fees. Airlines are therefore seeking ways to reduce these costs, secure improved reimbursement terms and offer alternatives to customers.

There is no one size fits all approach, so each airline is looking to find a solution with their credit card provider which suits its own operation. But they are also guarded about discussing their contractual arrangements. One major carrier declining an interview said it did not want to reveal information that its competitors would read about.

  (c) rex
 © Rex Features
"It's possible that airlines' contracts with credit card firms prohibit them from publicly discussing their details," offers Forrester Research vice-president Henry Harteveldt. "It's no secret that airlines are frustrated with the way credit card fees work and their relatively high costs. Some airlines may now pay more for credit card fees than for global distribution system fees."

While there seems to be consensus that airlines need to redefine their relationships with their credit card providers, there does not seem to be an easy answer. "The business challenge for airlines is: how can they provide consumers with trustworthy, easy to use payment options," says Harteveldt. "Credit cards are easy to use and they are trustworthy. The problem is we are wed to credit card usage."

The "typical cost" for an airline accepting a credit card charge is $7-10 per ticket, according to a recent survey of 70 airlines by management consultants Edgar, Dunn & Co. The highest cost is $14, while the lower end is $3. And although credit cards still account for the majority of ticket sales, Harteveldt says Forrester research shows 38% of travellers are placing fewer charges on their credit cards in an effort to "keep a tab on their spending and reduce debt".

"Most people probably don't even think of the cost of the credit card to the merchant accepting it," says Universal Air Travel Plan, chief executive Ralph Kaiser. UATP provides low-cost corporate charge card services which airlines offer to corporate account holders.

Kaiser explains that the type of card and where it is used can influence pricing. "Airlines share in some of the revenue streams those cards create, but they also have to pay the merchant fee. What airlines need to do is really understand the cost of accepting credit cards. It is complicated for sure," he says.

Airlines have long-standing relationships with their credit card providers. Some are designated as "preferred providers", while others have co-branded relationships, where the user is awarded points or mileage for each transaction. "Airlines sell miles in bulk to the banks," Harteveldt explains. "Banks buy the miles and then give them out for every dollar spent on a credit card." The question remaining is whether the cost of the credit card transaction offsets the revenue from these sales. "The airlines have to sit there and figure out which is really better for [them] as a for-profit business," notes Harteveldt.

In January, Air France-KLM launched a new co-branded American Express gold and silver card programme - but the card is by "invitation only" for a fee of €490 ($672). The cards are aimed at what Air France describes as "privileged American Express customers", and will feature concierge and insurance services and extra bonus miles awards.

American Express is said to have one of the higher rates among credit card providers. "The discount rate is set by industry and charge volume," says American Express. "The more business, the lower the rate." The company concedes that AmEx rates may be "typically higher, but it is because of the value we bring in terms of our card member base [which is] more affluent, brand loyal and high spending".


Brazilian low-cost carrier Gol offers its own VoeFacil credit programme, allowing customers to buy tickets directly and spread payments over up to 36 months. Chief executive Constantino Oliveira Junior says: "We finance the tickets to put more people in seats and expand the market. We stimulate the middle class with our product." Currently, only about 3-4% of Gol tickets are purchased this way, but Oliveira hopes to expand this total.

Local low-cost rival Azul is planning to launch a similar option, allowing passengers to pay the company over time, says founder and chairman David Neeleman. "Only about half of the middle class of 90 million people in Brazil have credit [cards] and most have a $500 limit. We'll see how that goes."

Edgar, Dunn & Co director Pascal Burg suggests this could be an option for budget carriers in emerging markets. A recent survey performed by Edgar, Dunn & Co revealed that 47% of respondents already issued their own credit cards under a private label or in conjunction with UATP.

Some airlines are considering imposing a surcharge for online credit card purchases. But while this may recover costs and raise some sorely needed cash, it could also evoke the wrath of consumers and regulators alike.

Ryanair's decision to levy a £5 ($8) debit or credit card charge surcharge per passenger, per journey sparked the ire of the UK Office of Fair Trading. "On some level, it's quite puerile, it's almost childish," OFT chief executive John Singleton said in an Independent newspaper interview. "This is just playing silly games at the margins of it all and we might or might not go running after something like that." But Ryanair was unapologetic, pointing out that consumers can avoid the fee by using a prepaid Mastercard. "If that's the worst they can accuse me of, guilty as charged," says Ryanair chief executive Michael O'Leary. "Essentially [he] said it's not illegal."

Ryanair maintains it wants to make flying affordable for everyone - and everyone may not qualify for a credit card. Until December, it had an agreement with Visa Electron. While it still accepts payment from that prepaid card, it has struck a new agreement with prepaid Mastercard. That agreement will be reviewed in three years. "We wanted to move to a card that was more widely available," Ryanair explains. "This [prepaid Mastercard] is a universal card - everyone can get this card. A lot of people out there still need to travel and they can't get a card." The airline would not discuss the terms of the exclusive agreement between Ryanair and Mastercard.


Finnair in November followed in the footsteps of KLM and Air France by placing a surcharge on credit card payments for online ticket sales in the Netherlands, where the practice is permitted. It may expand the surcharge fee in other markets, where the competition also uses surcharges. "As long as there is a legal and technical possibility, we will consider it within the EU," Finnair vice-president for global sales Petri Schaaf confirms.

Shifting the focus to Australia, Qantas applies a surcharge on all Internet sales in its home market and other carriers say they are keeping their eye on this possibility. Lufthansa, too, says it may consider surcharges, adding: "We are closely watching current developments in markets like the Netherlands or Scandinavia."

In the Edgar, Dunn and Co survey, Burg says 71% of respondents expected the use of airline surcharges to become more widespread over the next three years. It is difficult to assess how widespread this practice will become because each country has different rules governing the imposition of additional fees for credit card use, says Burg. For instance, surcharges are not imposed on credit card airline ticket purchases in the USA.

Tied directly to credit card purchases is holdback policy, whereby credit card companies retain a certain amount of ticket revenue to ensure they will be covered if the airline goes out of business and customers demand refunds on their purchased tickets. "You've got to put yourselves in the shoes of the financial community," says Marc Rosenberg, an aviation and travel consultant and former vice-president of sales and product distribution for Air Canada. "On a pure business level of success and failure of airlines, it's not a good record. They need to provide coverage. You can't fault them for their attitude."


When US carrier Frontier Airlines declared bankruptcy in 2008, it blamed some of its financial plight on the holdback practice of its creditors. Bankruptcy enabled the US carrier to re-negotiate terms of its agreement.

Meanwhile, Republic Airways Holdings acquired Frontier in October 2009 - and effectively inherited what it considers an untenable holdback policy. It is attempting to renegotiate its agreement for Frontier, and a second acquisition, Midwest Airlines. Financial analysts with Raymond James say if Republic is able to reduce its holdback by 50%, it could provide an additional $60-90 million in liquidity. "We have a 100% holdback for Visa and Mastercard. We are negotiating a single, long-term credit card," says Republic chief executive Bryan Bedford. "But I don't have a high degree of confidence we will see those holdbacks substantially diminished."

Slovakia's SkyEurope complained last summer that €10 million in ticket sales was being held back by credit card acquirer E-Clear UK as the airline was going under. The financial firm agreed to continue releasing money from credit card sales based on the flow of revenues to provide it with ongoing liquidity, but the airline ended service in September 2009.

Scottish carrier FlyGlobespan also raised a similar complaint, claiming £35 million was withheld by E-Clear. The airline shut down in mid-December. The issue is now in court, with E-Clear initially claiming it needed to hold on to the cash for six months in order to pay any refund claims. But a new wrinkle was added when E-Clear indicated that it, too, was on the edge of collapse and there was no money to cover Globespan's claim.

"Airlines sometimes complain that if someone buys a ticket today, it will be paid seven days later by bank or credit card companies," Burg says. "If you have a strong balance sheet and you are a profitable airline, you should have a better deal to be paid back."

AirTran chief executive Bob Fornaro says, "For us, we want to make sure our holdback relationships are balanced and longer term. What we'd like to do is see some change in some ways these rates are negotiated."

American Express maintains that holdbacks are determined on an individual basis on level of risk. "Our business model is direct relationships with our customers - individually negotiated contracts with individual merchants." But some carriers fare better than others when it comes to holdbacks.

JetBlue's senior vice-president treasurer Mark Powers says it maintains a "very close relationship with Visa and Mastercard. Your credit card processor is your largest, unsecured creditor and we currently have no holdback. We treat this creditor with the utmost respect and transparency."

Meanwhile, AirAsia director and co-founder Conor McCarthy says while merchant fees in the carrier's market are higher than in other parts of the world, there is no holdback with its credit card processors. As for credit cards that will not offer favourable terms, he says: "You can agree not to do business with cards that simply have too high a cost. It's a question of being able to say no."


Edgar, Dunn and Co's Burg says there is growing airline acceptance of alternative forms of payment (AFOP). In its survey, 63% of respondents said they accept AFOPs, representing debit cards, bank transfers and e-wallet transactions. Half believe that AFOPs - such as PayPal, U-Cash, PaySafe or AirPlus - will represent more than 10% of total airline ticket sales within the next three years.

Lufthansa began offering PayPal as an alternative for customers in the USA in August 2009. "We are planning to implement additional payment options worldwide in 2011," says Lufthansa global head of sales and marketing Marcus Casey. "The advantages of additional payment options would include more potential customers, an increase in revenue, and lower transaction fees in an effort to remain competitive and ahead of the curve."

PayPal offers advantages over traditional credit cards by allowing members to send money directly from their bank account, eliminating the need to share financial information online. It is an eBay company and has been available to airlines since 2005. "PayPal's processing fees are typically lower than most credit card processing services," says the firm. It charges a flat fee, ranging from 1.9-2.9% plus $0.30, depending on how much is processed through the account each month.

PayPal claims to have an active user base of over 80 million accounts. "While we can't discuss specific numbers, we continue to experience a high level of success with our airline partners." In addition to Lufthansa, PayPal's list of airline clients includes many of the largest US carriers, including American Airlines, Delta, Southwest and JetBlue.

"The more alternative payments we can accept, the more revenue we get to keep," explains UATP's Kaiser. "Getting to keep more of your money is a huge part of the business." UATP processes all of PayPal's airline transactions under a partnership between the two companies. But it is no easy task for airlines to reset their credit card practices.

Burg says the 70 carriers Edgar, Dunn and Co surveyed were quizzed about their key concerns. "Operational complexity" caused by the adoption of alternative forms of payment, surcharging and the issuance of credit cards was one of the top three responses.

"It's a web of complexity that makes it quite challenging to make any significant change in the short term," says Rosenberg. But he insists that airlines keep trying. "Vendors will continue to increase their rates. You always have to look for alternatives. If you can develop strong alternatives, it gives you a little bit of leverage - or a lot - in dealing with your vendors. It's not black or white - it's not something anybody can change overnight."

Harteveldt agrees that credit card providers and airlines need to change the way they do business. "Credit card companies have no choice. They had better realise the writing is on the wall. Airline executives have placed fixing their credit card agreements on top of their list of things to do. If the credit card companies don't realise this they will wake up and realise what happened to this marvellously lucrative side of the business."