If any company deserves accolades for giving away a host of free offers to its customers, it’s the one that’s been doing it with credit cards for more than 60 years: American Express Co. (AXP). As one of the biggest credit card companies in the world, American Express generates revenue from transactions occurring at partner merchants, as well as through annual member fees and interest income. Few other corporations can offer such a wide array of cash rewards, flights, theme park admission, rental cars, hotel upgrades, and gift cards, all in exchange for you doing absolutely nothing. Nothing short of buying stuff that you presumably would have bought anyway, that is. American Express doesn't even add your personal information to an invasive and all-encompassing database, in the manner a tech giant might. With all this giving, it might be difficult to surmise how American Express remains a profitable company, yet it delivered more than $40 billion in revenue and nearly $7 billion in net income in 2018—according to its last annual report.

American Express was founded in 1850 as a freight forwarding and mail service company. Just a few years later, the company expanded into the financial services industry by offering a money order component. It launched its first charge cards in the 1950s and has since gone on to become one of the best-known credit card companies around the world. Besides credit card services, American Express also offers a host of other digital products as well.

On June 27, 2018, American Express benefited greatly from a Supreme Court ruling which stated that vendors can't nudge customers towards using one type of debit or credit card over another. American Express typically charges higher fees, making it in merchants' best interest to urge customers to use other cards.

As of June 16, 2019, American Express enjoys a market cap of $102.85 billion. From 2017 to 2018, it saw growth of revenues (net of interest expense) of 9%; for 2018 its return on average equity was 33.5%.

American Express' Business Model

American Express divides its operations into three large segments: Global Consumer Services Group (GCSG), Global Commercial Services (GCS), and Global Merchant and Network Services (GMNS). Broadly, the company earns revenue from two major sources: cardholders and merchant partners. Among cardholder revenues, American Express earns money from interest on outstanding balances, card fees, conversion fees, and more. The largest portion of the company's revenue, however, is discount revenue derived from transactions occurring at partner merchants around the world.

Key Takeaways American Express earns most of its money through discount revenue, primarily represented by earnings on transactions that take place with partner merchants.

The company also generates revenue from cardholders through annual membership fees, interest on outstanding balances, conversion fees, and more.

American Express has a "spend-centric" model aimed at growing the number of overall transactions on its cards through special offers and relatively low fees.

American Express' Cardholder Revenue

One of the main reasons the entire business model stays viable is that American Express has tens of millions of cardholders who don’t understand how it works, demonstrating this by failing to pay their bills on time. As with all credit cards, outstanding balances tend to generate massive interest and late fees, which spells larger revenues for the issuing company. We won’t explain the basics of how credit cards work right here, but the late payers make it easy for the rest of us to ride free. With 114 million American Express cardholders charging about $1.2 trillion in 2018, that’s a lot of revolving credit.

There’s more to American Express’s strategy than just collecting interest from tardy customers. For one thing, the company is unusual among credit card issuers in that it charges cardholders just for the privilege of possessing many of its cards. Annual fees can reach up to $550 for American Express’s publicly available cards and $2,500 for its legendary, but very real, invite-only Centurion card. The company does offer several free co-branded and entry-level cards.

American Express also generates revenue from other fees, including member delinquency fees and foreign currency conversions.

American Express' Merchant Revenue

Most of American Express’s gross income is categorized as “discount revenue,” better known as merchant fees. Famously, American Express earns money by charging high merchant fees, higher than those its competitors charge (although in March of 2018 the company announced it would reduce its merchant fees to the lowest levels in 20 years, according to the Financial Times). As to why merchants willingly accept American Express and thus pay the high fees, the average American Express cardholder is relatively wealthy; the company focuses on its premium space. It’s worth the increased fees to get said customers in the door. Since the company’s self-perpetuating cycle of cachet allows it to charge merchants more than MasterCard Inc. (MA) and Visa Inc.(V) do, and since American Express’s comparably affluent cardholders buy more goods and services than their cohorts closer to the mean, it’s worthwhile for merchants to court American Express.

In the past, the majority of American Express cards charged no interest. You had to pay your bill in full every month, or else the company would close your account and send a collection agency after you for the balance. This stands in blatant contrast to the modus operandi of other credit card companies, which charge interest high enough to keep cardholders beholden for decades. American Express had a different strategy—hook the merchants, not the cardholders. (With the advent of American Express’s Blue Cash and related cards, now the idea is to hook the cardholders too.) The percentage of each transaction is tiny, but a tiny percentage multiplied by more than $1 trillion in annual charges is enough to turn a more-than-handsome profit.

Future Plans

In its 2018 annual report, American Express indicated that it had focused on four strategic initiatives over the prior year: expanding its leadership in the premium consumer area, continuing to grow its commercial payments segment, improving its global, integrated network and continuing to focus on its digital offerings. The company is likely to continue to develop these goals into the future as well. Particularly since announcing the reduction in merchant fees in March of 2018, American Express has signaled that it may be revising its business model to keep fees across the board lower in an effort to boost the overall number of transactions.

Key Challenges

For all of its success, American Express still lags behind its major competitors, Visa and Mastercard, when it comes to the number of partner merchants. For the customer, this means that you're more likely to find that you're not able to pay for something with the American Express card than you would be with a card from one of its rivals. Though American Express has reduced its merchant fees, these remain higher than some other credit card companies, which may be a barrier to wider merchant acceptance. However, American Express has some advantages as well: as both an issuer and a network, it is able to provide a more streamlined, predictable service than Visa or Mastercard, neither of which typically issues its own cards.