How american Express makes money?

American Express- The most prestigious of all the credit cards.

Visa, Mastercard everybody has those, but only a select few have American express. In 2019, there were about 3.3 billion visa cards out there, over 2 billion Master cards but only 114 million American Express cards. That is 29 Visa cards and 17 Master cards for every American Express card. And that’s because they are not as concerned with volume as doing a lot of things differently.

So, does profitable business means the more extensive sale of their products?

Visa and Mastercards are issued by banks, but American Express handles most of them by themselves. You can now get them from Bank of America, but 70 million were allocated by themselves. Possibly because they are not only offering a charged card but something more. So it is not fair to compare them from the number of cards, but as a premium brand, they are not concerned with how many cards they issue but how much money they make from each card. That can be a more telling statistic because it is significantly higher for American Express. That is because despite having a lesser number of cards, American Express has higher revenue than Visa or Mastercard, even higher than both of them combined. Though they aren’t widely used, they have their own system in place that’s working differently. They call it “spend-centric”. I will talk about it later but what I would like to talk about first, is the evolution of this company because they didn’t start by providing credit cards. They go back a 100 years before even credit cards existed.

Evolution of American Express

In the 1840s, Express services were thought to be a promising new industry. An express service is- paying someone to transport something for you. Due to the pricing and logistics, you typically use it for smaller, more valuable things. The first one in the US was founded in 1839, and by 1840s; there were a bunch of them and notably located in higher population areas like New York City. In 1850, 3 of these bigger ones in New York decided that competing with each other was being harmful, and it would be so much better if they joined forces. There were some big names here such as Henry Wells, William Fargo and John Butterfield, who combined their separate express companies into one larger one called the American Express.

Up until this point, all of the most famous cities in the country were in the east and mostly in the North-east. So logically, those were the areas they served. But they actually formed American express during the California Gold Rush for the first time. People were making out their way in big numbers, and San Francisco was soon become the first big city out there. Henry Wells and William Fargo, the first president and Vice President of American Express, saw some opportunity there. This was their chance to offer their services in San Francisco before anyone else, and if the city kept growing like it did, they would likely grow with it. Now, the rest of the company wasn’t crazy about the idea. They thought it was too risky and American Express would be better off focusing on the eastern city. The board of directors basically said that the two could go and do whatever they wanted, but the company would stay right there. And this was what happened. The two went out to San Francisco to start a separate company, and we can all see how it eventually turned out.

I think I should make this clear that they stayed with American express while simultaneously running both companies. Through the rest of the 1800s, American Express continued to grow, either merging with competitors or making deals with them, with what territories they would serve, making deals with railroads and other transportation services. The civil war was good for their business because everything had to be shipped everywhere. The point is, the cities were getting bigger, the population was growing, and American Express was able to set up a system that allowed them to take advantage of this rapidly growing demand.

How did they enter financial services?

Henry Wells remained president until he retired in 1868, that’s when William Fargo took over until he died in 1881. He was then replaced by younger brother James Fargo which is actually when the company thought of entering the financial services.  The year after he took over, American Express launched its first money order. It was intended to be a cheaper, safer and more accessible version of what the US post office had introduced over 20 years earlier. They sold quite a bit of them mainly because there was a high immigrant population that was buying money order to send back money to their families. Since it turned out to be so successful, they followed up on it 9 years later when they introduced their first traveller’s cheque. I think the success of those played a part in them getting involved in the Travel business a few years later.

We can see how they started by delivering stuff but slowly progressed into somewhat related businesses. It was a good thing that they did too, because during  World War I in 1918, the government took over everyone’s express operations. American express was then reduced to only banking and travel. Had they not made those moves, I am pretty sure that that would have been the end of them. That’s how they existed for the next few decades, a relatively small company mostly known for their money orders and travellers’ cheques.

American Express’ entry into the credit card industry

But in the 1950s everything changed. Now, this was the time, when credit cards were thought to be a promising new industry and up until this point, there were no large-scale widely accepted cards. In 1950, the Diner’s Club card practically changed the game. It was accepted by multiple entertainment providers and ensured the potential for a product like this. It wasn’t long before various banks across the country started introducing their own regional cards. 1958 was when American express first entered the market with its first travel and entertainment card. This got popular so quick that 500,000 people possessed it within its first 3 months and I think we can say that this was the main reason, that throughout the 1960s, their income grew 10 times larger.  And then the introduction of their famous green card and corporate cards helped propelled them to the next level. American express transformed into one of the most respected and valuable brands on the planet. They had a great slogan to it which you probably heard of – “Don’t leave home without it”. It’s direct and straightforward and became the most popular sayings for a long time.

The habit of using credit cards and paying the loan on time

I mean this credit card business helped them so much that over the next few decades they were able to acquire all these other financial businesses. They have since sold them, but at one point they bought an insurance company and brokerage firm. Today my perception is they are mostly focused on their Gold and Platinum cards. I want to get a look at their platinum card as it very well represents how they do their business. First of all its called “Platinum card”. Platinum as a metal is uncommon, valuable and flashy, much like how American express would like to be perceived. But beyond the name, this card costs $550 just to have it. Most cards don’t cost anything or if it does its typically not this much. I see this as reflective of their business because they generate a revenue of $4 billion/ year from the card fees. It’s a big part of their model. Another aspect of the platinum card is that there is no interest rate as the full balance has to be paid at the end of each month. The idea is unlike every other provider, American express actually wants you to pay your bill on time. And for many of their cards like the platinum, it’s actually a requirement. Looking more into this card, you can earn 60,000 membership reward points after use of your new card to make $5000 in purchases in your first 3 months. This is the core of their business. Any seller who accepts a credit card has to pay for the ability to do it.

So how does American Express earn?

In comparison to Visa or Mastercard, American Express generally charges a much higher rate. If you want to buy something from Flipkart or Amazon using your visa card that’s typically cheaper for Walmart, than if you were to use your American express. Since Flipkart or Amazon has to pay them typically high value per transaction every time you use it. They want you to use it. The more you use your card, the more money American Express makes. So offering deals that motivate you to spend $5000 in 3 months is reflective of their overall plan. This is where they make most of the money by the way, and that’s why it’s called “spend-centric”. So, the obvious question would be why would the sellers then accept American Express? Most people don’t have them anyway, so why bother if it costs more. Well, that happens because historically, people find it challenging to find places that accept it. But nowadays, it’s better than it used to be.

They say that in the US, it’s accepted by just about the same number of merchants that accept Visa. The reason they want to accept it is because of the prestige. The people with American express cards tend to be wealthier. They have higher credit scores, I mean, why would you pay the $550 annual membership fees if you don’t plan to use it? More affluent people tend to spend more money. So, the advantage of Flipkart or Amazon is that it will attract bigger spenders to their business. They will be giving American Express a larger percentage of the more massive bill. So, it should work out for everybody. Then, of course, the benefits. That is why people want to get a platinum card. You saw the reward points, and there are a ton of benefits, (visit their website as I don’t want to sell you a credit card). But for many people, these benefits outweigh the cost. Can you see the system in place and how different parts work with each other?

Their most prestigious card is the “Centurion”, also known as the American Express black card. If you have one of these, then you must have a lot of money because it is not easy to get. I think this makes it a little bit far even for American express. First off- They have to offer it to you. You can’t openly apply for it like every other credit card in the world. Nobody knows the criteria for it, but you have to spend $100,000 on your other American Express cards. Once you get invited, you have to pay $5000 initiation fee to get it followed by $2500/ year to keep it. Obviously, you need to be very wealthy to get this card, and it’s an extreme example of how American Express conducts its business.

I will ask you- do you have any of the American Express credit cards? How has been your experience while using it? Let me know in the comment section. And last but not least, did you learn about American express’s history and how they work? We often think the luxury market doesn’t work or is running a lot of debt, but the business of American Express gives a reality check. Astonishing for a 170-year-old company standing apart, isn’t it? And for those who are still using the Visa or Mastercard, are you thinking of making a switch?

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