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A Growing Threat to Credit Card Profits

Consumers are infatuated with credit card rewards. Rising redemption rates suggest rewards are one of the most important features for card-carrying customers.

For credit card companies like American Express (NYSE:AXP) and Discover Financial (NYSE:DFS), reward programs have become an integral part of the business model. From cash back on purchases to airline miles, rewards programs incent spending, which in turn creates swipe fees and balances on which card companies collect interest.

On one hand, investors would like to see rewards spending grow. American Express spent roughly $1.8 billion on card member rewards last quarter, which brought in $4.9 billion of discount revenue from processing payments. Investments in rewards are lucrative, as discount revenue drives the business.

On the other hand, however, rewards have become a bit of a problem. Consumers are accustomed to receiving and redeeming rewards that the natural result is that customers demand more and more from their cards.

Rewards are here to stay
If you want proof of the permanence of credit card rewards, a quick walk through American Express' historical financial filings will tell you everything you need to know. In every report, the company publishes its "ultimate redemption rate," or the percentage of rewards it expects customers to actually redeem.

In recent...