Effect of credit cards

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Effect of Credit Cards on consumption patterns
Introduction:
The one philosophy that has affected way of living in every country of the world is buy now pay later.
After inception, credit card has facilitated commerce a great deal and today it has become the most
vital component of business, banking and personal money management. until now the consumer
behavior research has only focused on understanding the antecedents of purchase, however, the effect
of the mode of transaction has not been extensively explored. The type of payment may put forth a
significant effect on individual consumer behavior because different systems of payment differ in
important economic and social characteristics.
It is an interesting topic to understand why and how people use credit cards? Do they use it for
convenience of paying all the cash at once and enjoy the float that is created in the mean time or they
use it for easy borrowing? One can begin to distinguish the different uses of credit cards by looking at
the effect they have on different measures of individual money demand. This also helps in
understanding buying and borrowing patterns of the consumer.
No significant work has been done in Pakistan that studies both the credit card's use as a method of
borrowing and as an alternative transaction medium. We have conducted this study as an attempt to
address this issue.
Use of credit card is more convenient for households because perhaps it is financially advantageous to
use credit card instead of cash. For small loans such that those for household items, money and be
easily obtained from banks without going into much hassle and similarly paying back is also not difficult.
For youngsters, it can limit their spending and also help parents keep a check on their child's spending.
Credit card is a great medium of transaction while travelling abroad. It helps get rid of carrying large
amount of cash and traveler's cheques. Objectives:
The objectives of this research are:
(a) to explore credit card ownership and usage practices in Pakistan, and
(b) to explore the relationship between credit card ownership and usage practices
The findings offer implications for researchers and consumers.
Credit Scenario in Pakistan:
All segments of consumer financing, including car purchase loan, housing loan and credit cards
business, witnessed a significant fall in the fiscal year ended June 2009, the State Bank reported in its
data released a day earlier. (THE NEWS- Tuesday 8th September 2009)
Various segments of consumer financing were forced to adopt a cautious approach as a result of slow
economic growth. These segments which grew rapidly just five years ago and had a potential to get a
large portion of the banks' financing lost their charm for the banking sector.
Till June 2009, the volume of consumer financing was Rs.359 billion as it fell by Rs.65 billion since
June 2008. As banks were already hesitant to loan the corporate and related sectors to avoid further
growth in their already elevated bad debts, consumer financing also had to receive a negative impact.
The fear also hit credit card growth and cautious banks slowed down their effort to spread the credit
business. The volume of credit card loan was Rs.44 billion until June 2008 and fell down Rs. 9 billion in
12 months to Rs.35 billion. As credit cards earn highest profit for the banks world over, this is a loss to
banking sector since the interest rate on credit cards was in the range of 35 to 40 percent per annum.
Problem statement:
We have defined the problem statement as follows:
Does the use of credit card affect the consumption pattern of consumers?
Literature review:
The development of controlled credit card network has allowed the use of credit card to expand and
become more persistent. This has been possible only because of the increased co-ordination between
credit card companies and merchants. Due to the reason, that credit card industry has become the part
of the complex system which makes travel services widely available to consumers, it has become
possible for the credit card companies to be familiar with the consumption habits of customers. When
consumers use credit cards to make purchases, extensive data about the transaction can be collected.
(Adam Weaver - Passports to Pleasure': Credit Cards and Contemporary Travel)
Surprisingly, there have been very few researches to assess the correlation between credit card usage
and level of spending. However there have been many empirical and theoretical studies to explore
these closely related issues and simple observations have proved that people appear o spend more
with credit cards. (RICHARD A. FEINBERG- Credit Cards as Spending Facilitating Stimuli: A
Conditioning Interpretation)
This issue that whether credit cards promote spending or not is of great importance to economists, law
and public policy. If it can be proved that that credit cards make people spend more and save less or if
there is a long-term desire to increase personal saving, can cause regulation or even banning of credit
cards. (Elif Incekara Hafalir, George Loewenstein)
Another aspect of increased usage of credit cards is the matter of trust and distrust for the bank as well
as the users. Banks must very carefully think about substituting inter personal relationships with
technology while striving to motivate customers to adopt online banking, because the absence of
human contact may decrease trust in the mind of consumers. (Trust and Distrust in Online Banking:
Their Role in Developing Countries John Skip Benamati and Mark A. Serva)
Here the question arises that why should consumers use credit cards to finance purchases? The
answer to this is quite simple. Consumers want to maintain their life styles over their life time even
though their income and wealth may vary with time. Older consumers can utilize their past savings and
consume more than their current income. Similarly, young consumers who are expecting their future
income to be higher than their present income can borrow from future income to support present life
style. This process is also known as consumption smoothing. Through consumption smoothing, credit
card users are well able to maximize their life time utility. (The Effect of Credit on Spending Decisions:
The Role of the Credit Limit and Credibility Dilip Soman * Amar Cheema)
Credit cards offer both the advantages of convenient exchange medium and generation of revolving
credit. While the former is used by rich and high status card holders, latter is popular among low
income and socio-economic group. Therefore analyses of credit card use and user characteristics
should take both considerations into account. Evidences are found that incorporation of both elements
in the same model also changes the spending behaviuor as a whole and increases the spending of
consumers. (Credit Cards: An Interdisciplinary Survey GILLIAN GARCIA)
As a way of smoothing irregular consumption and income flows, credit cards compete with bank loans
and other forms of financing. They allow individuals to borrow amounts within their credit limit. When a
large amount of money is easily available the spending pattern also changes and results in more than
usual spending. (Consumer Rationality and Credit Cards Dagobert L. Brito and Peter R. Hartley)
Hypothesis:
Financial institutions issue credit cards which are used by consumers as a payment device and a
source of revolving credit. On the basis of main uses of credit cards, consumers have been defined into
two segments: users and revolvers. Convenience users use credit card as an easy mode of payment to
pay off their bills upon receiving the account statement. On the other hand, revolvers use cards as a
mode of financing and elect to pay interest charges on the unpaid balance. When consumers use credit
card as a mode of financing, credit cards compete with bank loans and other forms of financing. The
difference is in the ease and convenience of use and acquiring the credit where credit cards take
precedence over other forms in the short term. (Vathsala Wickramasinghe1 and Anurudh
Gurugamage-Consumer credit card ownership and usage practices: empirical evidence from Sri
Lanka)
Therefore, based on the above understanding it is proposed that:
H0: Use of credit card does not affect spending.
H1: Use of credit card increases the spending.
Methodology:
The methodology of our research is based on the research of Elif Incekara Hafalir and George
Loewenstein of Carnegie Mellon University in which they conducted a field experiment to measure the
impact of payment with credit card as compared with cash. We randomly changed some diners'
payment medium from cash to a credit card by giving them an incentive to pay with a credit card and
then observed the change in their spending behavior.
Sample size:
We selected a sample size of 50 participants to conduct our research; participants were selected from
five major areas of Karachi including Defence/Clifton, Gulshan-e-Iqbal, North Nazimabad and
Buhadarabad/Tariq Road to represent whole population.
Experimental design:
We chose to collect data using three types of techniques:
1. observation
2. questionnaires
3. in-depth interviews
Design 1:
For the purpose of observation, we chose five restaurants in different localities of the city and we
conducted waves of data collection with dinner time customers. The restaurants accepted both the
cash and credit cards which was a necessary condition to run the study. The restaurants offered a
broad selection of differently priced items, and had changing menus. The variety and range of prices
meant that diners could pay more or less for their dinner, so that if credit cards did promote spending, it
would be possible to observe such an effect.
There were 75 observations in total; we dropped 12 observations which were not usual dinner
purchases (e.g. purchase of a snack or a drink only). We also dropped 10 observations which included
participants who stated that they used cash but would have used credit card if it weren't for our
intervention in the treatment condition (which rewarded them for using a credit card). These people
might have chosen to use cash instead of credit in order not to disclose identifying information
(although we told them we would erase any identifying information on the receipts beforehand) or
because they felt manipulated. We excluded these people since the aim of the treatment was to induce
consumers to switch from cash to credit but not the other way around, although our results are barely
affected by including them. We also excluded 3 participants who had participated before.
As an incentive we told the customers that if they participated in our study, we will give them a special
gift pack. Upon their consent to participate in our study, we asked them to place the order again and
after they had their dinner, we took their receipts from them, canceled the credit card number and
stapled the receipt on a questionnaire. The participants were then asked to fill up the questionnaire and
return it to us before leaving; this is when we presented them a special gift pack.
Result:
After this exercise, we observed that 78% of the people increased their order from 8 to 20 percent.
Therefore, this would provide strong support for the prediction that credit cards make people spend
more.
Design 2:
QUESTIONAIRRE
CREDIT CARDS
16
Age:
* 18-25
* 26-35
* 36-45
Gender:
Male
Female
16
16
Education:
* Undergraduate
Graduate
Post- graduation
Yearly household income (Rs.)
* Up to 50,000
* 50,001- 75,000
* 75,001- 100,000
* 100,001-150,000
* Above 150,000
16
Q1. Did the promise of gift card affect your payment medium?
* Yes
* No
Q2 (a). Did you pay for anyone else's dinner?
* Yes
* No
Q2 (b). If YES, for how many people?
_________
Q3. Did you know what food you will buy before entering the restaurant?
* Yes
* No
Q4. Do you own a credit card?
* Yes
* No
Q4 (b) If yes, are you carrying your credit card right now?
* Yes
* No
Q5. Do you know the interest rate of your credit card?
* Yes
* No
* Not sure
Q6(a) Do you have an ATM card?
* Yes
* No
Q6 (b) If YES. Are you carrying it right now?
* Yes
* No
Q7. Have you participated in this study before?
* Yes
* No
Q8. Do you believe that the use of credit card increase your spending?
* YES
* NO
* NOT SURE
Q9. Reasons for obtaining credit cards
(Please rank form 1 to 12 according to preference)
Safety and security
Convenience
Ease of record keeping
Can be used to cover emergency needs
My family members' use of credit cards
To obtain incentives offered on credit cards
To keep up with colleagues and friends
To purchase items through the internet
Prestige
I was influenced by credit card promotions
To delay cash outlay
To help me make ends meet because I often run out of money
Results:
A large portion of our sample was of middle age and only 16% were between 18 and 25 years of age.
Among them 64% were males and 36% were females. 90% of the population is at least graduate.
All 50 participants agreed that the promise of gift affected their medium of payment and they were
motivated to use their credit cards because of our offer. 40% of our sample population also paid for
someone else's dinner also while the rest paid for themselves only.
Majority (58%) of the population did not know what they were going to order before entering the
restaurant while the rest had their minds made up before coming to restaurant.
42 people owned a credit card while the rest 8 were using either parents' or spouse's card.
Surprisingly, only two of the participants knew the interest rates of their cards while the rest were either
not sure or they simply didn't know. This shows that while using credit cards people do not much care
about the interest rate as compared to the convenience they get in having a credit card. Similarly only
64 percent people owned an ATM card out of which 84% (32) were carrying it with them. Still 64%
believed that use of credit card increases their spending. The reason might be convenience in present
and future spending as well as ease of record keeping.
When asked about the reasons to hold a credit card, the top most reason were convenience and
prestige. Some people also said that they used credit cards for easy record keeping and to cover
emergency needs. The younger audience had a reason to keep up with friends and family and also to
maintain their social prestige. Some also kept credit cards to delay future payments. However, since
purchasing through internet is not very popular in Pakistan therefore not many people were interested
in this benefit of credit cards.
Hence, through this survey we found out that a large number of Pakistan's urban population holds
credit cards because it is considered as a symbol of prestige and helps them gain high social
acceptance. Due to the convenience in its use, most people use credit cards for regular purchases and
through observation we have seen that using credit cards increases spending both in present and
future.
Design 3:
To gain in-depth knowledge about the subject, we interviewed an expert Mr. Shehzad Kharadi of Bank
Alfalah. The summary of discussion with Mr. Shehzad is as follows:
A perception of the perfect world is such that everyone would avoid too much credit and debt and would
not want to deal with the desperation of being unable to meet credit obligations but this isn't a perfect
world we are living in, and unfortunately these distressing situations are the norm for many people. If
someone finds him/herself in this position, or headed there, he/she should control of his/her spending
at that moment and should not wait until the situation is too dire that only a few options are left
available.
Facing the factors that give you the urge to spend more than your income can be uncomfortable, but if
one can't face them, he/she may never get control of their spending and debt. An important aspect
here is that if you are always trying to pay off debts on the past purchases, how will you get things
which you want in your future?
One negative aspect of using credit cards instead of cash is that you tend to spend more because you
don't feel like you're spending real money. The pleasant feelings you experience when you purchase
the item are disconnected from the unpleasant or painful feelings of making the payment when you get
the credit card statement. Studies have revealed that most people are much less likely to buy, or less
willing to spend as much, when paying with cash as opposed to credit cards. Try leaving your credit
cards at home. Pay with cash, check, or a debit card.
To get control of your spending and your credit card debt, you need to examine what money means to
you. Make an effort to notice how you interact with money and what beliefs and attitudes you have
about money.
Studies also show that people with low self-esteem engage in more impulsive spending and buying
things they don't need. Remind yourself daily that money or a lack of it doesn't determine who you are.
Your worth as a person has nothing to do with how much money you have. Once you truly believe this,
and money is no longer connected to your sense of self-worth, you open up the psychological barriers
that were keeping you from wisely handling the money you do have and limiting your ability to make
more.
If psychological factors influence your spending, credit reduction programs are like using perfume to
cover body odor: they will treat only the symptoms, not the root cause. Working on the psychological
aspects while taking steps to reduce debt will greatly increase your chances of long-term success.
Conclusion and Implications:
The purpose of the current research was to enhance the understanding of consumer credit card
ownership and usage practices. We applied quantitative as well as qualitative data collection and
analysis techniques to capture the dimensions investigated in this study.
It is expected that the findings of this research will lead to more development of this area as a field of
investigation as the methodology is based on western research but the findings are purely according to
Pakistani market. Furthermore, this study can also help banks to apply strategic decisions in
developing and applying marketing strategies. This will also help consumers make informed choices on
competitive credit card offerings.
It was found that customers have three broad motives for using credit cards which are:
1. Payment in lieu of cash for routine transactions for the sake of convenience.
2. To maintain their social status.
3. As a mode of short term financing.
Whatever may be the reason, use of credit cards encourages consumers to spend more than their
current income by providing an easy option of money availability.
Limitations and Future Research:
We believe that this study and its results are worthy of note as it has been conducted under controlled
conditions, we also believe that, even beyond the usual cautions, it is important to take account of
limitations of this study and of reasons why the results should be treated with caution.
The first is that the experimental manipulation operated by inducing people who would not have
naturally paid for lunch with a credit card to do so. Someone who is induced, by the prospect of a gift
pack to pay with credit, when they otherwise would have paid with cash, might feel manipulated and
determined not to spend more than they would have with cash. Thus, it is difficult to generalize these
results to people who choose on their own to pay with credit card. This effect works against showing a
spending-enhancing effect of credit cards, even if such an effect exists.
The study is confined to a convenience sample of 50 individuals living in Karachi metropolitan area,
people living in other cities of Pakistan were not a part of this research. Individuals having one credit
card were taken into account. However, the influence of possessing multiple credit cards by an
individual has not been explored. This study had not explored credit history and credit card debt to
identify factors influencing the amount of, and changes in, consumer debt held by households.
The findings suggest that credit cards could result in a higher level of purchasing expenditure and
purchasing item volume, however, it is not clear whether high spenders incline towards credit card
usage. Therefore, cause and effect relationship between credit cards and spending has yet to be
adequately explored.
Overall, issues involved with possession, utilization, the repayment of credit card debt and lifestyle
outcomes are numerous, and a single study cannot be expected to address them all. Research is
needed to complement the findings.
This study shows that it is possible to conduct a randomized field experiment to examine the impact of
credit card use on spending. We hope that it is only the first of many studies that finally bring us to a
definitive answer to this important question.