One of my assignments as an investment analyst was to study Aeroplan, Air Canada's loyalty reward program.
The airline had just carved Aeroplan out of the company and floated it as a separate business on the stock market.
It's a complicated business at first glance. For example, CIBC offered the extremely popular Aerogold Visa card. You spend money using the card and you get Aeroplan points. What is actually happening, though, is that CIBC is buying the points from Aeroplan and giving them to you. When you were ready to cash in your points, Aeroplan shelled out to buy a flight from Air Canada, if that's what you chose, or a frying pan or mixer etc. if you preferred something else.
It didn't take me long to realize what a great business Aeroplan and loyalty programs in general are. They make lots of money by relying on a key human instinct: our love of the deal. It also made me realize consumers should avoid things like loyalty programs and other selling gimmicks.
The perception of a bargain makes us completely irrational. How many times have I had a conversation with a female friend that goes something like:
"Do you like my new dress? I got if for 60 per cent off."
"How much was it?"
"So you saved $133?"
To which I would answer, "You should have bought 10 of them and saved $1,333, then you could have taken your savings and bought 10 pairs of shoes at a big discount and done it all over again."
And that's when it sinks in.
Credit card loyalty programs are similar: They are only an illusion of value. Aeroplan makes a lot of money. Who ultimately provides those profits? People who collect Aeroplan points. You and me. We're not really getting a free flight. We pay for it.
My local grocery store accepts Air Miles and also has an in-house card that gives discounts on goods and gasoline. Most people see that as a bargain, but it's not. We pay for it one way or the other. I compared prices between that store and another store that has no loyalty offerings and found the prices were at least 10 per cent lower in the store with no program. That's not a scientific study, but it's not hard to believe, is it?
It's not just loyalty programs, either. Furniture stores that sell you a couch you don't have to pay for until 2014 or whatever are selling you a fantasy. You are paying more for that couch -- a lot more. That chain's profit margins are going to be higher than a no-frills chain's.
Banks used to offer GICs that are linked to the market's return but guarantee the principal. (They're not too popular now because of the market turmoil.) I know from banking friends that this was a particularly profitable line of business. In fact, insurance -- this product was effectively an insured investment -- is often overpriced. Travel insurance, for instance, is very expensive. It doesn't seem that way because most people weigh the cost of the insurance against what they'd have to pay if something went wrong and they didn't have insurance. But that leaves out a crucial piece of the equation: the probability of needing insurance, which is extremely low. It's not that insurance is a bad idea; it's just that it's easy to overpay.
A twist on insurance is the extended warranty. Never, ever buy an extended warranty. Companies make far greater profit margins on these than on the products they sell -- often 90 per cent. In fact, some retailers make the bulk of their profits selling warranties.
If something is going to malfunction, it is likely to happen before the regular warranty expires.
In short, use your head. There's nothing for free in this world. When it looks free, it's often actually more expensive than if you just bought it.
Fabrice Taylor is an award-winning financial journalist and analyst and author of the President's Club Investment Letter. Email him at: