Category: Economics

Great Read on the Anatomy of a Credit Card Rewards Program

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Anatomy of a credit card rewards program —

This is… far less incentive compatible for you, particularly if you decided that the business of manufacturing books-dollars was so lucrative that you could rebate more than the direct interchange revenue given mix effects. These users will have blended costs very close to your headline number, not to your modeled blended costs.

These users will even band into tribes, find each other on the Internet, and swap tips for exploiting poor, defenseless credit card program managers like yourself. The tribal elders will eventually run businesses, with names like The Points Guy, which eventually get quietly acquired by very sophisticated private equity firms. Those PE firms are betting that you continue paying generous per-signup affiliate commissions to Internet properties which send you new card users. You bet you will also paying tens of millions of dollars annually to Frequently Adversely Selected New Accounts Dot Com. And Redditors bet they will continue chortling that they have pulled one over on you, because haha, you’re not nearly as good as they are at fourth grade math or keeping spreadsheets.

There are some real great insights in this piece by an advisor to Stripe, a huge financial infrastructure provider and credit card processor. One that stood out to me was Chase going to Visa to create a new product to compete with American Express. We also talk about it a bit in the Patreon supporter part of the Dots, Lines, and Destinations podcast Episode 478.

One thing that is public but not well appreciated: Chase didn’t just decide to create an extremely lucrative-for-the-customer offering out of the goodness of their hearts and out of their own P&L. No, they pitched Visa on this idea. For too long, Visa, you have watched your competitor American Express outcompete every issuer in the Visa system for the best wallets in the world. They can do that because they can afford to, because American Express charges systematically higher interchange rates than Visa does even at its topmost tier. Visa, you should create a new tier where your not-exactly-chosen champions can try to spend those interchange dollars to give American Express a run for their money.

It’s definitely a long piece but well worth reading.

Cargo is Piling up Everywhere

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From NPR —

Soaring demand from Americans for everything from iPads to cars is leading to a surge in freight crossing the Pacific, hitting business owners such as Nephew.

When the cargo with his games finally arrived on the West Coast, the container was immediately emptied so it could be sent back to China for another load.

The games then continued on to Minnesota by truck, rather than rail, which would have been more economical. The final shipping cost was about $12,000, at least 50% more than the game maker had budgeted.

We are getting a lesson in basic economics in real time. Businesses are trying to meet increased demand but there is a constraint on the supply (the shipping companies) and so things get delayed and prices go up. When we look at something like lumber, which is mostly produced domestically, those prices are finally starting to normalize as supply starts to meet demand.

Browsing Instagram or TikTok and you will see people blame increased prices on Biden or the global cabal but in reality the prices you are seeing in stores have little to nothing to do with who is in the oval office and more to do with basic economic principles. Another example is the basic issue of getting empty containers where they need to be to carry more cargo.

From Bloomberg —

First there were the queues at the twin ports of Los Angeles and Long Beach, which left as many as 40 container vessels awaiting a berth in early February amid a flood of traffic. Combined volumes at the terminals hit a record of 1.9 million containers in May, nearly double the Covid-19 low in March 2020.

Part of the problem has been that containers aren’t in the right places. In global terms, trade enjoyed a remarkably short and sharp pandemic. By September last year, volumes were already running ahead of their seasonally adjusted levels in January and February, as demand for medical equipment and spending on durable goods picked up in rich countries.

Trying to make all those deliveries on time meant that many vessels started making their return journeys empty, saving a few precious hours that would normally be spent picking up vacant boxes to ship back to China. That’s resulted in a glut of containers in European and North American ports and a shortage in Asia, pushing freight rates to astronomical levels on export routes.

Containers are sitting empty at ports around the world and can’t be shipped back because the ships are trying their best to keep up with demand. Add to this, there is not a huge demand for U.S. goods in places like China, there is no reason to ship back empty containers on these boats and return the containers to pick up more cargo. Some of the predictions are that this could take years to correct. The empty containers need to get back into a normal rotation which relies on demand to return in certain parts of the world and ships need to reposition to carry all of that cargo.

If there is one thing that COVID-19 has taught me, it’s that supply chains are fragile. Everyone saw the ‘Great Toilet Paper Shortage’ as a problem but what’s sitting in ports right now and the rates to ship goods around the world are the real issue. And the unfortunate reality is that there is no way to speed the process of recovery up for shippers. It will happen as demand returns.

Water to be Traded on Wall Street as a Commodity

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From Bloomberg:

Water joined gold, oil and other commodities traded on Wall Street, highlighting worries that the life-sustaining natural resource may become scarce across more of the world.

Farmers, hedge funds and municipalities alike are now able to hedge against — or bet on — future water availability in California, the biggest U.S. agriculture market and world’s fifth-largest economy. CME Group Inc.’s January 2021 contract, linked to California’s $1.1 billion spot water market, last traded Monday at 496 index points, equal to $496 per acre-foot.

It seems these futures are tied to the spot price of water rights in California, measured against 10 acre-feet of water (roughly 3.26 million gallons).

To be honest I am not sure how I feel about this. At the end of the article there is a quote from a researcher saying that there is currently no way for people to manage their water supply risk. I think that has the situation sideways, commodity doesn’t help you manage risk, it helps you make decisions based on general risk.

Alaska Airlines purchases Virgin America

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The Wall Street Journal reports that Alaska Airlines has reached a deal to purchase Virgin America. The big news is the price paid.

Alaska Air Group Inc. said Monday morning that it had reached a deal to buy Virgin America Inc., winning a frenzied bidding war with rival JetBlue Airways Corp. The parent company of Alaska Airlines said it would pay $57 a share for Virgin, a 47% premium to Friday’s closing price, representing a total equity value of $2.6 billion. The Wall Street Journal had reported Sunday that Alaska won the bidding contest for Virgin, whose shares have risen lately on takeover speculation.

And investors are responding with a little bit of disapproval as well, with Alaska Airlines stock down around 5.5% at 10am Pacific.
Alaska Stock Price After Purchase Announcement of Virgin America

I am a little concerned that Alaska is paying a significant premium simply to gain gate space and landing slots at a few different airports, namely San Francisco. They are making the purchase at a time when Delta is still trying to grow their new Seattle operation and encroach further into Alaska’s dominant hub, yet they seem unfazed. The Alaska premium product is definitely not cut out to go head to head with some of the other premium transcontinental products and Virgin’s product is showing its age. How does Alaska plan to compete with better products on some of the more lucrative transcon markets (SFO/LAX-NYC, SFO-BOS)?

And all of this without taking into account two very different customer loyalty groups. Virgin is considered sleek and hip, while Alaska Airlines has a loyal following in the Pacific Northwest and Alaska. Merging those two cultures together while not losing customers will be key for Alaska to succeed. I wonder if the Alaska Airlines management team has a plan in place for doing just that or if they are going to call in the consultants to try and sort it out.

Lastly is the two very different airplane fleets. Virgin America operates an all Airbus A320 and A319 fleet while Alaska Airlines is Boeing 737s for their mainline operations. During the analyst call this morning it was mentioned that the Virgin America Airbus leases start expiring in 2020, so for the next few years, there will be a mixed fleet. The one possibility is that Alaska will use the Airbus fleet up and down the west coast since their capacity is a little less than what the 737s can hold and Alaska could run more frequencies to make up for that.

My general sentiment is that I had thought JetBlue would win the bidding war and build a larger west coast presence. This seems like a generally risky move for Alaska who up until this point has not needed financing to operate and they have grown very organically through the years. I worry that biting off more than they can chew could come back to haunt them in the next few years. I hope I am wrong, but the true test will be whether or not they are able to stay entrenched at Seattle-Tacoma International.

Quick Thoughts on the Starbucks Rewards Changes

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I am probably not the customer Starbucks wants using their rewards program. When I am in a city where there are not a lot of local coffee options, Starbucks is my backup. The blonde roast is drinkable and if it is not being brewed they are happy to make a pour-over of it. All of this to say, a lot of my recent work travel has not been close to local coffee shops, but Starbucks were readily available.

The recently announced changes to Starbuck’s rewards program are not going over well.

Under the new plan, the “stars” that are stockpiled to earn free drinks and other rewards are awarded at a rate of two stars for every $1 spent. Currently, customers earn one star per visit. But it will take 300 stars to get to the company’s Gold status, up from 30 stars, and it will take 125 stars for a reward, instead of 12.

Stars will now be earned based on spend instead of number of transactions, meaning people who buy the expensive Frappuccinos will earn more stars than someone like me who orders a grande coffee. I am sure this is specifically targeted at a customer like me who earns 12 stars by ordering coffees and then redeems (or has someone else redeem) an expensive drink. Or worse, the person who orders a coffee and a pastry but in separate transactions to earn two stars and then redeems for something expensive.

Are the Starbucks changes aggressive? Yes, but just like in the airline mileage earning and redemption world you have to remember: Pigs get fat and hogs get slaughtered. Starbucks could have probably made some rules changes that simply limited the number of transactions per day to something reasonable (2 per day maybe?) but they decided to go fully revenue based. The revenue based rewards are quickly becoming commonplace across tons of different industries as a way to “reward” someone for their spend rather than their loyalty. The thing to remember is that spending more to earn a reward usually is not beneficial to you mathematically. Well, unless you’re buying the office coffee on a corporate card; Then you’re making out like a bandit.

In the end, this probably will not change my habits when it comes to Starbucks. If there is no local option when I travel, I will visit Starbucks. And that’s probably exactly what Starbucks wants. Spending habits stay the same but the number of rewards will decrease.

Index for Airline Fares – May 2014

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The Bureau of Labor Statistics released the May consumer price index summary yesterday and within it was a piece of data that has gone somewhat unnoticed.

The index for lodging away from home rose 2.0 percent and has increased 4.0 percent over the last three months. The index for airline fares rose sharply in May; its 5.8 percent increase was the largest since July 1999.

And…

The index for all items less food and energy has risen 2.0 percent over the last 12 months; this is the highest figure since February 2013. The 12-month increase in the shelter index reached 2.9 percent in May, its highest level since March 2008. The index for airline fares has increased 4.7 percent over the span, and the medical care index has risen 2.8 percent. Indexes that have risen more modestly over the past 12 months include apparel (0.8 percent), new vehicles (0.5 percent), and used cars and trucks (0.2 percent).

Airline prices are on the rise and with oil prices likely to rise in the coming weeks there will be little relief. But hey, consolidation is a good thing. Right?

Why UPS Trucks Don’t Make Left Turns

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I am a sucker for this kind of, in Jeopardy terms, potpourri. Priceonomics has a short piece on why UPS trucks do not make left turns. The most telling part:

UPS engineers found that left-hand turns were a major drag on efficiency. Turning against traffic resulted in long waits in left-hand turn lanes that wasted time and fuel, and it also led to a disproportionate number of accidents.

UPS even has a page describing the practice of no left turns and they expand on the above idea.

What we found: A significant cause of idling time resulted from drivers making left turns, essentially going against the flow of traffic. From there we explored routes where these turns were cut out entirely, and then compared data.

The use of data to make a decision that goes against logic is what I love. UPS leadership was experimental enough to say “we are going to implement this and see if it works” and then study the results from that test. There are a number of very large companies that I have worked with that would immediately balk at this idea. They almost go through stages of grief (sans depression) with ideas like this.

  1. Denial – the companies claim the data is wrong or that it is flawed
  2. Anger – the workers who are responsible for causing the data become upset that someone found out about their poor work habits
  3. Bargaining – to get out of making a change, people start tossing out different ideas, none of them good
  4. Acceptance – “I guess we’ll just have to do it”

Then there are the companies who do the complete opposite. They implement a terrible idea based on bad data, or their understanding and interpretation of good data, and it blows up in their face. Once that happens, they become very adverse to ever trying a new idea again. We need new ideas backed by data and I think it’s awesome that UPS took their data and made some interesting choices that have paid off.

Debunking United’s anti-Hobby Arguments

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Tory Gattis with the Houston Chronicle debunking United’s stance regarding international flights from Hobby Airport →

What they are pretending will happen is that the fares and number of passengers on any given route are static, and that by splitting them with SWA, they will have to cancel IAH flights (because there aren’t as many passengers to fill their planes – SWA is “siphoning them off”). What happens in reality is the famous “Southwest effect”: SWA reduces fares, UA matches, and demand increases because the price dropped (simple supply-demand curve economics). SWA does not have to actually have lower costs than UA to reduce fares (although they do), they simply have to be willing to give up some of the fat monopoly profit margins UA currently enjoys on those routes. Even if their costs are exactly the same as UA, fares will come down and demand will be stimulated. This terrifies UA, of course, because not only do they lose the fat monopoly profit margins, but they have to offer more flights to meet the demand surge, pulling planes from elsewhere (either that or just cede market share to SWA). Of course, Houston wins all the way around: lower fares and more service.

What Mr. Gattis fails to mention is that Southwest has, in recent years, been less likely to lower their fares significantly over a long term when entering new markets. This was brought up by the city council when reviewing the Houston Airport System study, which, oddly enough, heavily favored Southwest. City council questioned the mentioned fare numbers due to their extremely low prices, something like $150 for Houston to Cancun. When the Houston Airport System and Southwest folks were put on the spot, they could only offer a rebuttal along the lines of “that is what we forecast in five years”. Unless Southwest expects fuel prices to plunge in the next five years, those numbers are unattainable. I cannot seem to find a mention of this anywhere on Mr. Gattis’ blog.

I do think that United’s arguments are a bit of posturing, but what do you expect? I do not think that demand will necessarily increase out of Houston if Southwest gets its way, simply because prices probably will not go down that much. Southwest will start flights at some rock bottom rate and two weeks later they’ll be close to matching what United has. Where Southwest will win out is one-way fares and last minute and walk up tickets.

The difference with “siphoning off” passengers in Houston versus say, New Orleans, is that Southwest is not sure they could fill the planes out of New Orleans, but they feel they could out of Houston. What Southwest is effectively doing is moving closer and closer to the legacy airlines by creating more and more of a hub-and-spoke system. If they wanted, Southwest could easily start international flights from any airport in the U.S. and in fact other airlines have done that; United offers seasonal service from Austin to Cancun, Raleigh-Durham to Cancun, etc. Instead, Southwest does not want to incur the costs of paying for immigration and customs officers at all of these airports, instead they want the city to split those costs with them.

I’ll end this by saying I do think international flights from Houston’s Hobby Airport are inevitable. The push for them is just too persistent for it not to happen. What I don’t understand is this anti-United sentiment. I read and hear comments about “losing the hometown airline” and if that is what is fueling this rage against United then it is in poor form. United still has one heck of a presence in Houston and it will continue to stay that way for a long time. Just as Mr. Gattis said, it’s about free markets, and that’s why United moved to Chicago, they have a better office/building agreement up there.

Delta Wants to Buy a Refinery

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Delta Bid for Trainer Refinery Gaining Momentum (philly.com) →

When I first saw the news that Delta Airlines was looking at the former ConocoPhillips refinery in Philadelphia I had to do a double-take. An airline running a refinery is just that strange. At first I thought it was a move by Delta to stir up the market a bit but this most recent news makes me think the Atlanta based airline is very serious about buying the facility.

The Trainer refinery is configured to produce a higher yield of jet fuel – about 13 percent of its output, or 23,000 barrels a day (966,000 gallons). Delta could ship the fuel by pipeline or barge to New York, where it has a large presence at LaGuardia and JFK airports.

Delta would ostensibly receive all of the jet fuel from the facility, but would probably swap much of the gasoline and diesel for jet fuel in other locations near Delta hubs.

I am still trying to understand where Delta thinks they will save the money. They will still be buying oil at the market price, the difference now is that they will be a refiner of said fuel. Refining crude oil is not a “value-add” process, it is a necessity. You can’t fly a plane on crude oil.

“The objective would be to achieve a 10 percent price reduction on a large portion of its fuel needs – which, if were achieved, would represent significant savings,” reported Linenberg, the Deutsche Bank analyst.

How? How are they planning to achieve that much of a reduction? Are they simply offsetting their fuel costs by selling the jet fuel on the wholesale market? If so, then how are they financing the operation of the refinery? Refineries are not cheap to operate and certainly not cheap to maintain. As stated earlier, oil companies do not view them as moneymaking facilities but rather, as necessities to compete in the market. The margins in refining are so small that it is hard to make money from fuel alone. Now, maybe if Delta is going to sell chemicals from the facility they can make the revenue that the article hints at.

I would love to have a sneak peek at Delta’s game plan. They must have some kind of strategy up their sleeve to make this work, but they’re going to wait to make it obvious to the rest of us.