Transcript The Challenge Of Bank Card Interchange

The Challenge of Bank Card
Interchange
Steve Mott
Principal, BetterBuyDesign
December 2005
The Burning Questions
1. Where are we now, and how did we get to this
point?
2. What was the original rationale for interchange?
3. What’s the rationale now/how has that
changed?
4. Does the new “value proposition” hold water?
5. What new issues are forced into the open by
the emerging economics of interchange?
6. How are merchants and consumers reacting?
7. What are the resulting opportunities and
challenges?
2
1. Where are We Now?
Attacks on bank card market power and interchange have been piling
up since 2002
• Antitrust suits (allowing Amex et al to enter market)
• Wal-Mart suit settlement
• Merchant groups formed (Merchant Coalition,
Merchant Payment Roundtable)
• International challenges (Australia, EU, UK)
• May 2005 Fed conferences (KC & Chicago)
• Summer 2005 American Banker articles
• 4 of the 6 rumored interchange lawsuits this year
have been filed
• Congressional Inquiry in wake of Katrina/gas price
hikes
3
Banking’s Personality Challenges
In many respects, these challenges play upon some inherent weaknesses
• Banks tend to be terrible at communicating with one
another
• We’re worse at communicating to the outside world
(e.g., “ID theft”)
• We let the card networks do their talking for us
• We don’t know our own costs
• We don’t understand their
own economics (e.g., direct mail
solicitations, charge-offs, etc.)
• We rarely price on value, so
most products drop quickly to
cost-plus pricing
• We won’t talk about
interchange
4
Now it’s “Winner-take-all” Consolidation
On October 20, 14 interchange cases were consolidated by the same
court (and judge, John Gleeson) which certified the Wal-Mart suit
against Visa and MasterCard as a class action (Feb. 2002); 21 other
“potentially related” suits would be treated as “tag-along actions)
5
Scene After the Wal-Mart Suit Settlement
The Wal-Mart suit settlement was seen as a violent shock to the industry
6
Was the Court Satisfied with the Results?
But the results were disappointing to many—big retailers got the
benefits, but no structural change resulted
7
Guide to Some of the Key Lawsuits
Four of the six big interchange lawsuits rumored for this year have
been issued; these suits strike at the heart of interchange policies and
practices
Litigants
Complaints
Key Arguments
Nat’l Assn. of Conven. Stores
Nat’l Assn. of Chain Drug Strs.
National Cmty. Pharm. Assn.
Nat’l Cooperative Groc. Assn.
Eliminate collusion +
damages
Costs $232/year/
capita
3rd largest cost for
chain drugstores
Kroger, Albertson’s, Safeway,
Ahold, Eckerd, Maxi Drug, and
Walgreen
End price fixing and
barriers to negotiation
Kroger spends $350
mil. for 60% card
share; up 215% 5 yr.
Publix
Reduce high rates and
barriers to negotiation
Interchange for
premium cards: 2.9%
60% of txns.
Antitrust class-action suit
(Photos-etc./30 Min. Photo)
plus other CT. small firms
Set limits to banks’
ability to set “exhorbitant” fees
“Hidden tax” of 2%
Created credit card
interchange blog:
www.waytoohigh.com
8
Wheels of Justice Go Flat
While these developments might bring cheer to some, for those who
look for both fairer rates AND equanimity in marketplace, the courts
have proved somewhat disappointing
• Anti-trust suit permitting
banks to sell Amex &
Discover products
• $3.2 billion settlement of
“Wal-Mart” suit, rejecting the
“honor-all-cards” dictum of
the card associations
• Encouraged Visa/MC to
raise interchange to
“compete” with Amex rates
• Top 200 retailers got to
negotiate discount rates, but
smaller merchants got stuck
with more increases
9
Bad News from the U.K.
Defense of signature card interchange is going badly in other parts of
the world
• INTERCHANGE FEES TAKE ANOTHER HIT: The United
Kingdom's Office of Fair Trading, the government consumer
protection agency, today issued a preliminary ruling against
Visa's member banks, saying that the interchange fees banks
charge to process transactions are anticompetitive. The OFT
said Visa's multilateral interchange fee, which is applied to
consumer credit cards, charge cards and unduly high fee
being paid to card issuing banks by merchant acquirers
on every Visa transaction deferred debit cards in the UK,
leads to an "." The cost of these fees is being passed on to
retailers and ultimately to consumers,” the OFT added.
• In a statement, Colin Grannell, Visa UK's managing director,
said the card association does not believe its interchange fees
are unduly high. The preliminary finding wasn't unexpected in
light of the OFT's preliminary ruling last month that interchange
fees set by MasterCard's UK members were too high.
Source: Cardline, 2005
10
The Specter of Australia
Now, more than ever before, the specter of a fundamental change
looms in the U.S. If it goes the way of Australia, change could be
massive and consequences huge
• RBA concluded that credit card usage was artificially high due
to loyalty programs and interest-free credit—which were paid
for by merchants
• So interchange rates were halved (to .55%), with unexpected
consequences:
– Issuers shifted to Amex and Diners; charge-card growth surged
– Consumers got hit with surcharges for credit-card use
– Only a couple of new participants (Virgin Money, GE Money)
appeared
– Issuers lost $300 mil. in interchange, but profits went up 16% at
ANZ, versus the 40% drop they feared
– Merchants saved US$300 mil.; Australian CPI dropped 0.2%
• RBA has now set its sights on setting debit cards at par (free),
but large merchants—who receive interchange from issuers
on some EFTPOS transactions—are fighting this new effort
11
2. The Original Rationale
Credit cards are widely acknowledged as the most successful
consumer financial service product in the past half-century; the
original rationale addressed important societal goals
• Supported widespread, non-collateralized lending to
qualified consumers
– At efficiency levels better than merchants could provide
(including lower cost of money)
– With ability to use credit at any accepting merchant
– And get instant gratification for purchases
• Facilitated more efficient electronic purchases
–
–
–
–
Provided merchants with guaranteed payment
Provided end-to-end electronic processing
Moved consumers out of cash and checks
Reduced fraud and NSF risk
12
The Basics of Interchange
The idea was to compensate transaction parties for the work they did
Source: Diamond Cluster, 2005
13
Original Structure of Interchange
Although little is publicly available about interchange, it is possible to
piece together some cohesive theories on the original rationale and
structure; the structural components had clear purposes:
• Compensate issuers for costs of lending
• Compensate acquirers for merchant vetting and
processing tasks
• Recover costs of network development and
operation
• Manage costs of fraud, given guarantees provided
14
Key Premise: Support Electronic Purchases
With signature-based cards, consumers could afford to make a
purchase right away, or make a bigger purchase than they
otherwise would be able (or want) to make with cash or a check;
the first merchant who accepted the card would stand to benefit
from the resulting incremental sales opportunity by accepting the
cards
15
Original Premise: Mission Accomplished
So it’s easy to conclude that the original rationale for interchange has
been fulfilled
•
•
•
•
5 million accepting merchants
65-75% of consumers with at least one card
Cards now produce a third of consumer purchases
Fraud is well-contained and efficiencies of electronic
processing accrue to many
16
3. What’s Changed
But so much has changed since signature cards were introduced four
decades ago—especially in the past 10 years; although the card
networks have tried to morph these cards to fit all applications, there’s
no doubt that they’re getting long in the tooth—along with many of
their most loyal users
•
•
•
•
Market maturation
The shift to rewards to keep growth going
A force-fit for online commerce
Changing consumer behavior and merchant needs
for different ways to pay
17
Maturing into a Convenience Play
Consumer use of credit cards for lending has been flat for a decade,
while spending continues to rise
70%
35%
60%
30%
25%
50%
20%
40%
15%
30%
10%
Debt (LHS)
20
03
E
20
01
19
99
19
97
19
95
19
93
19
91
19
89
19
87
0%
19
85
10%
19
83
5%
19
81
20%
Spend (RHS)
Source: Federal Reserve, Nilson, Bureau of Census, Bernstein estimates
18
Interchange More Important to Issuers
16%
4%
12%
3%
8%
2%
4%
1%
0%
1993
1998
2003
2008E
Cardholders (%)
12.2%
8.7%
8.2%
7.1%
Merchants (%)
2.0%
2.0%
2.6%
3.5%
0%
Merchants Risk-Adjusted Return
(%)
Cardholders Risk-Adjusted
Return (%)
Merchant-side business is now producing a better return than the
cardholder side—naturally shifting emphasis to interchange
Source: Bernstein Analysis
19
Credit Cards Leverage Rewards
Bernstein Research estimates that 1% of interchange goes to
financing cardholder rewards—which mostly go to affluent nonrevolvers; Visa recently reported that 40% of cards would have
rewards by next year
30%
27%
75%
70%
25%
65%
20%
16%
60%
15%
55%
11%
10%
7%
50%
5%
45%
0%
40%
Q3 00
Q3 01
%GP Card Offers Carrying Rewards (LHS)
Q3 02
Q3 03
%GP Charge Volume on Rewards (RHS)
Source: Synovate, Bernstein estimates
20
Primary Purpose of Cards Drives Use
A large, but aging core group of credit card users regards rewards
as their primary motivation for paying with cards; debit card users—
a rapidly growing, younger group—want REAL pay-as-you go
control
21
Characteristics of Changing Consumers
New, emerging consumers are different than today’s transactors, and
will be extremely receptive to debit account products that they can
access from anywhere
•
•
•
•
•
The 18-34 age group is demonstrating a decided preference for debit
payments over credit (Forrester, 2004)
65% of college students have credit card debt; 50% charge them to the
limit; but a Nellie Mae study in 2004 reported that outstanding balances
had dropped 7% (from 2001) to a seven-year low of $2,169 per card, as
students weaned themselves from this product
This demographic is highly-evolved toward Internet use (e.g., 60% are
online bankers), and expect debit account access wherever they
transact
92% of high school graduates are Internet literate; Growing numbers
are registering for new payment types (e.g. PayPal web site reports
nearly 80 mil. accounts)
A new population “bubble” is moving through the marketplace with
unprecedented willingness to shop their primary debit account to
institutions who “get it” and offer the Internet and wireless services and
access they demand
22
Components of Debit Migration
Underlying the shift to electronic payments is a major migration to
debit- account products, away from the heretofore credit-card centric
consumer economy, to the tune of 40% of all payments by 2010
Proportion of Consumer Payments by Type
100%
80%
60%
40%
Shift to
Debit
Payments
20%
0%
1990
Stored Value
PIN debit
1995
ACH
2000
Sig-Debit
2005
Credit Card
Check
2010
Cash
Other
Sources: Nilson Report, Dove/ABA Study, BBD estimates
23
Debit Account Users: New Lifestyle
Debit card users are growing in number, and have clearly different
patterns for purchasing behavior—avoiding debt as much as possible
24
4. New “Value-Proposition”
The card networks have evolved their arguments for fostering
signature card use and keeping interchange high to a new set of
“value propositions”
• High interchange fosters innovation
• Providers are delivering new services, such as
charge-back protections for consumers
• Interchange pays for incentives to usage
• There are costs for guarding against fraud
• Payment guarantees can’t come free
• Use of electronic processing provides valuable
information
• End-to-end service can be cost-free (once interchange
is paid)
• The number of merchants accepting continues to grow
25
Innovation Track Record?
The bank card industry is not necessarily regarded as the seed-bed
of innovation; but then again, a BAI research study in 2001/2002
determined that there were only three “disruptive innovations” in
retail financial services in the past 40 years (monoline credit,
mortgage brokers and credit-scoring)….
26
New Services: Charge-back Protection
In the model of disruptive innovation, established market participants
tend to add services that users don’t necessarily need in order to keep
value (and prices) rising; in the case of zero liability and other chargeback protections, the industry has trained a generation of “free-riders”
who routinely repudiate transactions—more or less at will—at exactly
the moment that the industry needs to encourage more consumer
responsibility and accountability for online security
27
Network Operations Costs
Certainly, the costs of running the payment card networks has
continually come down with the benefits of digital technology
• Visa just finished a two-year upgrade of the Direct
Exchange Network, which can do real-time
authorizations for less than $.05
• Network costs through Private NetworkVPNIP
evolution have reportedly dropped by more than one
order-of-magnitude
• Fraud costs are at an all-time low
28
Fraud is at an All-Time Low
Card fraud in the banking systems continues to drop, and bank costs
for risk management are stable; so this factor doesn’t drive
interchange, either
29
High Cost of Sig-Card Risk Management
Saddled with the liability for fraud, online merchants manually review 1
in five transactions, and block 4-5 good orders for every bad one—on
top of fraud and charge-backs (especially “friendly” fraud); the situation
for smaller merchants who can’t afford elaborate risk management
systems is much worse
Industry Costs for Sig-Card Risk Management ($ mil.)
$12,000
$10,000
$8,000
$6,000
$4,000
$2,000
$0
2003
2004
2005
Manual Review
2006
Blocked Orders
2007
2008
Fraud
2009
2010
Charge-backs
Source: BBD Projections from RTD Business Model
30
Back-Shop Costs = 2 x Interchange
The net result is that even the best and most competent online
merchants are paying twice what they pay in interchange just to riskmanage anonymous signature card transactions
Costs as % of $ Volume
4.5%
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
2003
2004
2005
2006
Interchange
2007
2008
2009
2010
Risk Management
Source: BBD Projections from RTD Business Model
31
Meanwhile, Charge-offs Have Soared
In fact, true fraud pales in comparison to the industry’s somewhat
self-destructive penchant for extending credit beyond the logical
ability of incremental users to pay
Visa/MasterCard Fraud vs. Non-fraud Charge-offs
20
02
20
01
20
00
19
99
19
98
19
97
19
96
19
95
19
94
19
93
Non-fraud
Fraud
19
92
19
91
40000
35000
30000
25000
20000
15000
10000
5000
0
Source: Bank Technology News, March 2004
32
Merchant Vetting?
And poorly-vetted merchants fuel charge-backs while generating high
interchange
33
Competing Merchants Forced to Accept
With so many merchants accepting cards in today’s environment,
competitors are forced to join-in or risk missing sales
?
34
Result—Higher Cost of Doing Business
The result is all merchants face a higher cost of doing business
35
5. Economics Force the Issues
Meanwhile, the economics of bank card usage are forcing serious
examination of the underlying cost structure and pricing rationale
• Interchange only goes up (unless you’re a national
retailer with negotiating leverage)
• But other digital processing businesses demonstrate
the value to society of open competition
• Signature cards are decidedly the most expensive
way to transact in the merchant space
• High interchange accrues mostly to the benefit of
Issuers (not Acquirers)
• Industry concentration has polarized
relations/bifurcated strategies
36
Interchange Rates Trends
For most merchants, interchange just keeps rising; for select
merchants with negotiating power, some relief came in early 2004
Interchange Cost for $50 Transaction
$2.0
$1.8
$1.6
$1.4
$1.2
$1.0
$0.8
$0.6
$0.4
$0.2
$0.0
1997
1998
1999
2000
2001
2002
2003 Aug-03 Jan-04 Oct-04 Apr-05
VISA-Credit
MC-Credit
VISA-SigDebit
VISA-Interlink
Interlink-Threshold 1
STAR
VISA-SigDPerf
Source: Visa, MasterCard, Corporate Reports and Bernstein estimates; BBD additions
37
Bank Card Interchange Rates
Rising interchange has been a fact of life since the early 1990s; in a
recent report, Morgan Stanley predicted an average rate of 1.85% by 2010
VISA/MC Interchange as % of Purchase Volume
2.0%
x
1.8%
1.6%
1.4%
1.2%
1.0%
0.8%
0.6%
0.4%
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
1975
1974
1973
1972
0.0%
1971
0.2%
Source: Nilson Report, May 2005
38
Telecommunications Counter-Example
International calling prices dropped from $1.34 a minute in 1980 to
$.21 in 2003, spurring a hefty increase in demand
Source: FCC
39
Telecommunications Counter-Example
Basic long distance services are experiencing normal declines in
price expected for a maturing service
[D]
40
Enormous Stakes for Merchants
It takes unusual market power to keep interchange rates rising in a
period of digital network efficiencies; for the world’s largest retailer the
stakes are enormous—about $750 million in 2002 and more than a
billion by 2007 that would otherwise drop to the bottom-line
Estimated Card Acceptance Cost at Wal-Mart
30%
10%
% of Sales by Card
25%
8%
7%
20%
6%
15%
5%
4%
10%
3%
2%
5%
1%
0%
Card costs as % of Pretax Income
9%
0%
1991
1998
Credit card
1999
Sig debit
2002
PIN debit
2007
Card costs
41
Source: Bernstein Research
Credit Cards Provide the Bulk of Fees
It’s easy to see why the card industry is so protective of
interchange; credit cards generate the vast bulk of merchant fees
paid to FIs vis-a-vis all other payment types
Merchant Fees Paid, by Payment Type ($ bil.)
$25
$20
$15
$10
$5
$0
Cash
Check
Credit
Card
Offline
Debit
Online
Debit
ACH
Sources: FMI, Paymentech, NDPS, Nilson
Report, ATM/Debit News, PiperJaffray, BCG
42
Total Costs for Each Average Ring
Factoring in all the transaction costs, signature cards remain the most
expensive way to transact
Transaction Cost Per Average Ring ($)
$1.40
$1.20
$1.00
$0.80
$0.60
$0.40
$0.20
$0.00
Cash
Check
Bank/Acq.Fees
Credit Card
Tender Time
Offline
Debit
Deposit Prep.
Online
Debit
ACH
Transport
Indirect
Sources: FMI, Paymentech, NDPS, Nilson
Report, ATM/Debit News, PiperJaffray, BCG
43
Proportions of Each Ring Amount
And when ring amounts are factored in, the signature debit card
product emerges at even more expensive than credit cards
Transaction Cost as a % of Each Average Ring ($)
3.0%
2.5%
2.0%
Weighted
Average=
1.29%
1.5%
1.0%
0.5%
0.0%
Cash
Check
Credit Card Offline Debit Online Debit
Fees
Processing
ACH
Other
Sources: FMI, Paymentech, NDPS, Nilson
Report, ATM/Debit News, PiperJaffray, BCG
44
Bank Card Revenue—2002-2004
Looking at bank card revenue components from an industry level,
interest remains the big driver—although merchant interchange is
becoming more important
Bank Card Revenue ($bil)
120
100
80
60
40
20
0
2002
Interest
Cash-Adv.Fees
2003
Interchange
Annual Fees
2004
Penalty fees
Enhancements
45
Source: Credit Card Management
Card Revenue vs. Demographics
Between 40-60% of revenue—mainly in the form of penalty interest
rates and fees—is derived primarily by saturated marketing of cards
to the next-to-lowest quintile—who can least afford them
Card Revenue vs. Demographic Group
120
100
80
Penalty Fees
Interchange
NonRevolvers
60
40
Paycheckto-Paycheck
(Don’t
qualify for
cards)
Interest
20
0
Revenue
Demographics
Source: CCM, plus BBD projections
46
Bank Card Expenses/Margin—2002-2004
Meanwhile, charge-offs vastly eclipse fraud and other typical
network costs; and the costs of cardholder rewards (part of
“operations/marketing”) and billions of unproductive direct mail
solicitations generate the bulk of industry costs
Bank Card Expenses ($bil)
$120
$100
$80
$60
$40
$20
$0
2002
Cost of Funds
2003
Chargeoffs
Opns/Mktg
2004
Fraud
Taxes
Net Margin
Source: Credit Card Management
47
Card Costs vs. Demographics
A substantial portion of marketing expenses now go to rewards, which
mainly go to non-revolvers; charge-offs of debt mainly accrue to the
next-to-lowest quintile, who now use credit cards for day-to-day living
Card Costs vs. Demographic Group
$120.00
$100.00
NonRevolvers
$80.00
$60.00
$40.00
$20.00
$0.00
Opns/Mktg
Paycheckto-Paycheck
(Don’t
qualify for
cards)
Chargeoffs
Interest
Costs
Demographics
Source: CCM, plus BBD projections
48
Non-Revolvers Get a Free Ride?
Non-revolvers tend to produce the lowest profits for Issuers, and
are mainly relied upon to drive interchange revenue; but merchants
don’t see benefits from serving these customers—particularly at
premium-card interchange rates—since they can afford to pay by a
variety of means
49
Industry Revenue/Income by Participant
By far, the vast portion of industry revenue and profit accrues to the
Issuers; in fact, acquirer margins have been regularly squeezed
Industry Revenue/Income by Participant ($ bil.)
$100
$90
$80
$70
$60
Indust. Rev.
$50
Oper.Income
$40
$30
$20
$10
$0
Issuer
Acquirer
Network
Iss.Proc'r
Sources: FMI, FirstData/Concord,
EFT Report, PiperJaffray, BCG
50
Smaller Merchants Foot the Acquirer Bill
SMEs generate the bulk of revenues and fees for acquirers
Merchant Acquiring Revenue ($bil.) Breakout
$4.00
$3.50
$3.00
$2.50
$2.00
Sales/Service
Processing
$1.50
$1.00
$0.50
$0.00
National
Local
Total
Nat’l
Local
Total
Txns (bil.)
11.3
7.5
18.8
$ Vol ($T)
$0.71 $0.47
All-in fee
13bp
60bp
Proc’g/txn.
2.5¢
11¢
Sales/svc.
$0.06 $0.27
$1.18
32bp
6¢
$0.14
Source: Bernstein Report 4/2003
51
Concentration in the Card Business
Concentration in issuance has growth markedly; today, eight FIs control
92% of transactions; so the debate over interchange mainly affects a
handful of institutions—but threatens the entire industry
52
FI Concentration: Online
The handful of companies that dominate credit cards don’t serve the
entire marketplace, though--e.g., the online marketplace; serving this
marketplace fully with the right products will require many participants
100%
90%
80%
70%
Top 10
Next 40
Next 2450
Next 5500
Non-FI
60%
50%
40%
30%
20%
10%
0%
% of Fis
% of CC % of OLB
% of
BillPay
% of ACH % of DDA
Source: Various Research Reports
53
The Specter of Cannibalization
Banks are frozen from moving to non-card payment innovations by
the challenges of product cannibalization
Financial impact of converting to:
Payment
Method
Net Income
ACH
Online Debit
Offline Debit
Credit Card
$1.25
($1.31)
N/A
N/A
Offline Debit
$0.30
($0.36)
($0.25)
--
Online Debit/
POS check
$0.05-0.06
($0.11)
--
$0.25
ACH
($0.06)
--
$0.11
$0.36
Check (net
of fixed
costs)
($0.46)
$0.40
$0.51
$0.76
Source: Dove Consulting, from VISA Discussion Documents, Faulkner&Gray, Nilson Reports, NACHA, FDIC, BCC Study, Industry Reports
54
Prisoner’s Dilemma
From an enterprise standpoint, weaning an institution off of high
interchange might make perfect sense—except to the card business
units
55
Merchant Concentration: Online
In a similar vein, large merchant strategies conflict with small merchants
100%
90%
80%
70%
Top 10
Next 40
Next 50
Next 300
Next 500K
60%
50%
40%
30%
20%
10%
0%
% of etailers
% of
Purchases
% of
Repeats
% of Fraud % of Costs
% of
Shoppers
Source: Various Research Reports
56
6. Consumer and Merchant Needs
• Consumers are clearly shifting to a debit-account
payment preference
• Efforts to extend card usage to applications where
they don’t fit (e.g., bill payments) are failing
• Merchants have good reason to want additional
payment options for their customers
• So they are dabbling in alternative payments—
looking for better product functionality at justifiable
rates
• Real-time debit alternatives appear to be the
direction the industry is most likely to take
57
Consumers Need Payment Flexibility
There is growing evidence that consumers are frustrated with
today’s payment products, and are trying non-bank alternatives
• Studies continue to show that more and more consumers want to
pay for purchases with their ATM debit cards (or ACH
equivalents) to get more control and pay-as-you-go option
• Up to half of adults can’t buy a $250 basket on the Internet with
credit cards (don’t have them, or are maxed-out)
• Online billpayment continues to be horse-race between bank
and biller models
• Stored value demand for online loading, top-off and account
management capabilities is growing rapidly
• Micropayments users are constrained by lack of viable and costeffective means of payment
• Consumers—not just those living paycheck-to-paycheck—
proving quite willing to pay $1-3 for convenience payment
alternatives
58
Merchants Demand Better Options
Meanwhile, merchant demands for better alternatives to expensive
signature-card payments online are reaching a crescendo
• Groups like the Merchant Payment Roundtable (representing
56% of eCommerce revenue) are actively pursuing real-time,
good-funds guaranteed payment alternatives for online
purchases
• The Merchant Payment Coalition is researching a merchant
payment network for POS
• A cottage industry of Billing Service Providers has arisen to
help billers gain access to debit networks for payment (including
PINless debit, STARChekDirect, etc.)
• Stored value processors are rapidly plumbing-in eDebit
capabilities for transactions—on top of loading and top-offs
• Digital content providers are tweaking stored value and other
debit-account solutions to get per-transaction pricing under $.20
sig-card minimums
• Remittance and convenience payees are increasingly willing
to accept account transfers, direct debits, PINless alternatives,
and ACH to cut transaction costs and speed payments
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Merchants Benefit from Multiple Options
Evidence is beginning to surface demonstrating the benefits of
multiple payment options—led by PayPal and BillMeLater
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PayPal—Instant Credit, with Interest
By default, PayPal is offering very convenient online “banking” via
an increasing array of merchants
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Instant Credit Online-BillMeLater
Example
Other “instant credit” models are gaining traction as well, producing
both incremental demand and lower interchange costs
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Debitman Model
Debitman remains an interesting test of merchant experimentation
blended with provider ingenuity; Pay-by-Touch is another vendor to
watch
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Merchant Interchange
Debitman introduces the notion of “merchant interchange”, providing
an incentive for solving the issuance challenge
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7. Opportunities and Challenges
The movement to a debit-account centric payment society from a creditaccount based one carries substantial political baggage
• A contrarian’s view makes the case for more
thorough examination, debate, and disclosure
• The financial services industry itself appears ready
to change—if only to avoid calamity
• Industry polarization could thwart consensus to
move forward with appropriate networks
???
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A Different Point-of-View
Aite principal Gwenn Bezard claims there are five ”misconceptions”
about interchange that need greater understanding in this debate
•
Interchange is only one part of the total cost of acceptance—acquiring
fees are the other big cost;
– in countries like France, for example, where the debit interchange is lower,
the acquiring fees make total cost about the same as in the U.S.
– The merchant service charge (MSC) for credit cards is lower in the U.S.
on average than in all but three countries surveyed (e.g., same as UK, but
higher only than France and Denmark)
•
High interchange is not the result of a lack of competition
– Multiple card networks in the U.S. (vs. single networks in many foreign
countries) tend to bid up interchange as networks seek more bank
customers
•
Issuer contention that interchange is necessary to develop networks
and new products is “simply wrong”, however;
– Most issuers make the most money on outstandings
– Many debit card networks overseas have developed thriving networks
with much lower interchange
– Interchange is a negligible factor for exploding stored value card use
Source: Aite, 2005
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A Different Point-of-View (cont.)
Further examination and scrutiny should go a long way to balancing
out some of the furor
• High interchange doesn’t foster innovation
– Prepaid card markets are exploding, and interchange is a
negligible factor (though FI pricing weighs against them)
• Regulatory relief, such as interchange caps, haven’t
worked completely as expected in countries that
have tried it
– e.g., Australia, consumers pay more though merchants
have halved Interchange costs
– rather than push for regulatory relief, merchants in the US>
would be better off backing electronic networks they control
(e.g., Debitman—a similar system in Germany now handles
53% of the debit traffic with NO interchange)
Source: Aite, 2005
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Roadmap to The Opportunities
Those these recommendations are antithetical to the closed and
defensive approach of the bank card associations, there IS a way
forward
• Acknowledge differences in strategies and stakes between the
big card issues and all other FIs; ditto for merchants
• Find an independent arbiter (Fed?) to referee examination of
costs and value in-depth among ALL stakeholders
• Debate the issue and positions openly and ingenuously
• Start the process of rationalization before merchants abandon
bank networks/products en masse, and pricing plummets
• Return to making money the old-fashioned way: By earning it
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Consequences of The Challenges
The stakes of this debate have become enormous—most especially
for the biggest card issuers, who far and away have the most to lose
• Amex civil suit plus 47
interchange suits
• Possible interchange
decline
• Absolute volume loss to
merchant-controlled
networks
• Exacerbated split between
the big bank and all other
FIs
• One estimate of the
expected value of settlements/damages: $15.4 bil.
• $11 bil. out of $24 bil., if
restructuring a la Australia
happens (Morgan Stanley)
• Up to 20% of current card
volume, or $400 billion
• “Big 8” lose support from
rest of the industry; all other
FIs support rival products
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Potential Reduction in Interchange
Lower interchange is probably inevitable, and the least of our worries
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Tragic Irony: Fight Over Value-Pricing
Ironically, this battle is over one of the few banking products that
haven’t simply devolved to commodity, cost-plus pricing; “value” has
conflicted with the notion of “market power” in this debate
Checking Accounts
Savings Accounts
Investment Accounts
Check deposits
ACH
Commercial lending
Prepaid cards
Online banking
Online bill payment
etc.
Signature cards
Wire transfer (SWIFT)
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Consequences of Getting it Wrong
So maybe, just maybe, the industry should seize upon the opportunity
for getting the interchange issue right, and use that model for
reexamining all other banking products—moving the industry toward a
defensible balance of costs and value, toward a new era of customer
relationships, where FIs are respected, rather than vilified, for the true
contributions they make for secure transacting—before it’s too late…
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Steve Mott’s Contact Coordinates
This presentation represents a portion of a growing body of research
and analysis by BetterBuyDesign. Please don’t hesitate to contact
BBD with any questions, comments or further interests!
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Steve Mott
BetterBuyDesign
dba CSI Management Services, Inc.
1386 Long Ridge Road
Stamford, CT 06903
(o) 203.968.1967
(f) 203.322.1012
(c) 203-536.0588
email: [email protected]
website:www.betterbuydesign.com
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