The Target Breach: what it means to card and mobile ACH payment:

In the aftermath of the Target Breach, David Heun at American Banker writes that ACH decoupled debit could be the big winner saying “security may have suddenly become the product’s biggest selling point.” He tiled the story, “Target’s Redcard Proves Less Vulnerable to Data Breach than Bank Cards”. Today Richard Crone, chief executive of consulting firm Crone Consulting LLC is quoted in PYMTS.com saying “Skimming the 16 digits on Target’s proprietary decoupled debit Redcard will probably not even be pursued by the fraudsters who captured that number because it can only be used inside Target”, he went on to say; “The proprietary Target card represents another reason merchants may want their own card because it can mitigate risk, too.”

National Payment Card Association is the leading provider of ACH decoupled debit card services at the POS and the world’s largest processor of mobile ACH transactions at the fuel pump. ACH decoupled debit is safer than legacy payment because the actual payment credentials are not being passed through the POS. Instead the consumer links their financial account to a card or phone as a psydo number/Token across our database. This process isolates the consumer’s financial data from the payment processing network. This differs from legacy payments where the payment credential is on the card; given the choice, “no one would pass actual payment credentials through the point of sale”, says Richard Crone

Retailers can lower their liability to payment data loss by implementing ACH decoupled debit programs. At the 2013 Pinnacle Users Conference in Dallas, I quote Gray Taylor; Executive Director of PCATS, where he said that ACH programs lower the retailer’s exposure to payment data liability. Retailers are rightly concerned about the liability associated with payment data loss. Target is not the first to be a victim of this crime and watching the media reminds me of, with my apologies to the family; Kitty Genovese.

The debate about payment data is hardly new, who can forget the transition to 3dez. Target has announced that stolen PINS are safe behind a processor based encryption key, one win in the data protection business. Proponents of EMV, and by its extension, those involved with NFC mobile payments will point to Target as another justification for their systems. Meanwhile thieves will work on new man in the middle attack strategies. As long as the payment credential passes through the POS and processing network, it will be a target for theft.

Mobile payment is impacted as well. Data security is also a consideration as the retailer evaluates cloud-based mobile payment or NFC at the POS. Some proponents argue that the payment data can be stored on the secure element and be safe. The growth of mobile payment will capture millions of users as consumers choose mobile payment. Retailers have a unique opportunity to lower payment liability by shifting consumers to card and mobile ach decoupled debit.

Lower fees get the headlines, but might not be the story. Why multiple unaffiliated networks is the real bombshell in Judge Leon’s decision.

Groucho Marx once said that “Politics is the art of looking for trouble, finding it everywhere, diagnosing it incorrectly and applying the wrong remedies.” Judge Leon might have been better served had he considered the wisdom in Marx’s thought before his recent ruling throwing out the current Fed’s implementation of the Durbin Amendment.

When Judge Leon threw out Durbin saying “The Board has clearly disregarded Congress’s statutory intent by inappropriately inflating all debit card transaction fees by billions of dollars and failing to provide merchants with multiple unaffiliated networks for each debit card transaction” he may have opened the legislation to a potential flaw that might just make implementation of Durbin impossible

In an August 13 article published in American Banker called “Damage to Banks from Debit Card Ruling Goes Beyond Lower Fee Cap”, Kevin Wack writes “Perhaps just as significant, but less discussed, the judge also ruled that retailers must be given the choice of routing each signature debit transaction, as well as each PIN debit purchase, over at least two card networks.” Kevin is correct, fees impact the economics of the transaction, but like the highs costs of implementing EMV, multi-homing has technical implementation costs far beyond the cost of the transaction. I covered this this issue in this blog, January 2011, “Who gets to choose? Durbin’s provision on “multi-homing” and the prohibition on network routing exclusivity” Here is the issue. I asked a well know expert this question: what makes multiple unaffiliated networks a complex requirement? His answer: “most retailer’s payment systems route transactions based upon the Bank Identification Number or BIN.  They do not have the ability to make different routing decisions if a PIN is present or not.  Additionally, a lot of smaller merchants do not have direct connections to networks but instead route the majority of their traffic to a merchant acquirer who then will determine how the card needs to be authorized based upon processing agreements that retailer has in place.  While the concept of allowing networks to compete for the same card traffic sounds attractive, from a practical matter it is far more complex.  And as raised in the most current legal opinion, the ability to route between non-affiliated networks needs to be at the transaction level, not the card level. “

I wanted a bit more granularity and so another source tells me that “Although most retailers do not connect directly to debit networks, there is nothing other than cost that prevents them from doing so. As EMV comes into the US domestic market and each Debit Issuer is tagged with their own network EMV AID(application identifier on the Chip), we may see more large scale retailers choosing to connect directly with their network of choice. A lot of stuff is up in the air right now. The next 10 months will be very exciting in terms of the number of changes coming to the debit networks above and beyond Judge Leon’s judgment. I doubt if the Federal Reserve or Congress will be able to keep up with everything that is happening in this space in the interim.”

So, Judge Leon concluded that the Fed must allow retailers the choice of two unaffiliated networks for each individual purchase — whether the consumer elects to make a signature or PIN debit transaction, never mind the costs or complexity of making it so. I come way feeling like Judge Leon clearly does not understand how routing actually works especially for small merchants.  He seems to believe there is a “Payments Genie” and that rubbing the lamp makes payments happen. The intuition is easy, but the way this actually works as a technical matter I think is a mystery to people.

The MasterCard/Visa settlement; an alternative point of view.

Opportunities are often difficult to recognize and they do not come with their values stamped upon them. It is often hard to distinguish between easy choices and those of opportunity; such may be the case with the retail industry’s reaction to the proposed Visa, MasterCard Settlement. As it stands today the proposed “Brooklyn” settlement has been rejected by nearly all retailer associations like; NACS, SIGMA, NGA as well as multiple retailers including large national and smaller local companies and even Senator Dick Durbin has added his disapproval to the chorus of rejection. It’s fair to say that the proposal is “Dead on Arrival”. Even so, I wonder if by refusing to embrace this settlement an opportunity is being missed.

With so much opposition to the settlement, how is it possible that an opportunity may be missed? The answer lies in the fundamental assertion that retailers can compete for the consumer’s method of payment steering them to low cost payment, rather than relying on legislative price controls or judicial action that seek to control the payments industry. Core to this belief is that there is significant competition in the credit card industry, it just happens to be between banks competing for consumers, rather than between retailers and banks competing for the consumers method of payment. There is nothing unusual about this model, it’s standard platform economics. The more end-users (retailers accepting cards and consumers with cards) on either side of the platform (MC/VISA), the more valuable and hence expensive the platform. This is why banks do not negotiate fees with retailers. Their mission is adding value to the consumer to carry and use their card for payment. The result is richer reward programs that add cost and drive the transaction fees higher. The retailer’s perception is a monopolist market, when in fact, as consumers we all participate in the very same economic activity.

In today’s rapidly evolving payment landscape consumers have many payment options. Surcharging creates an opportunity for the retailer to compete with the associations and promote low cost payment options. The challenge with surcharging is that it forces retailers to compete not just for the consumers purchase, but also for their method of payment and as a result some retailers may choose to use card payment as an economic advantage. Up until the proposed settlement this concept was merely theoretical because the card association rules prohibited the activity. While some retailers had experimented with cash discounts, the concept of charging for credit or debit card use has not been tested. The reason there is no information on surcharging is because it was prohibited by the associations operating rules. The Associations prohibited surcharging because it exposes the real cost of payment to the consumer and therefore allows the consumer to understand that using their card is not free.  This capability provides a powerful new tool for retailers to steer consumer payment choice.

Now armed with the tool needed to expose this cost, retailers are more concerned about the perception and customer services issues than the costs of payment. One retailer was quoted in NACS Online as saying he wants customers “impressed by the quality of products and services they receive” lamenting that surcharges for payment may appear to penalize them for the use of the card saying “it does not make for very good customer service”. This statement tends to suggest that the current costs accepting credit cards is acceptable, a suggestion that tends to explain why the opportunity presented by surcharging may be overlooked.

It’s unlikely that we will learn the answers to these questions in the near future. The industry is committed to seeking significant concessions that go beyond the proposed settlement which means the lawsuit is likely to move forward.  Stay tuned……

Surcharging for credit versus discounts for cash; why it makes a difference and how the consumer will react.

In the struggle between the Credit Card Associations and Retailers this week’s court decision reminds me of the old western film when two guys are fighting and the guy with the rifle runs out of ammo as the other guy’s gun is a few yards away. There is that brief moment when they both realize that the game has changed and now the race to the finale is upon them.  This week MasterCard Inc. and Visa Inc. along with some large banks settled what had become known as the Brooklyn case, setting the stage for retailers to pick up the gun and shoot first.

 The weapon that the Brooklyn decision has given the retailer is the ability to surcharge the consumer for the use of a credit card.  Surcharging is a tremendously powerful tool that has the ability to dramatically shift consumer behavior. Surcharging is fundamentally different than Discounts; understanding why, is the key for retailers wishing to leverage this decision. How powerful is surcharging?  Alphawise (Morgan Stanley Research) reports that “43% of consumers would be “very-likely” to switch from credit/charge cards to debit, cash or check if asked to pay a 1-2% surcharge by a merchant”. Further, “on average, those who said they would be “very likely” to stop using a credit card would shift about 67% of their credit purchases to other forms of payments”.

Retailers have some experience with offering discounts for cash or alternative payment discounts.  In the Convenience Store Industry, the per gallon discount for cash or merchant issued debit has been moderately successful. Some merchants like Savannah’s Parker Stores, are offering up to 10 cents off per gallon for consumers using their PumpPal card. These programs are reported to have captured between 5% and 25% of their consumer’s transactions.  But if Alphawise is correct, and Parker posts a price of $3.50 with PumpPal, and then ROLLS-UP the price of gas by 10 cents per gallon for the use of credit, then according to Alphawise’s survey results,  upwards of 50% of consumers appear ready to walk away from credit cards

The reason Surcharging is more powerful than Discounts is because of “Network Effects”. Network Effects are an economic term that describes the attraction of two groups of end-users across a “platform”. The reason the card associations have never allowed surcharging is because the economic principles driving a platform (two-sided market) state that only one side of the platform can be weighted with fees to the end-user.  An example of network effects is the Adobe PDF Reader. Almost all of us have the PDF reader on our computers, and it is free. The PDF writer on the other hand is expensive. The reason the writer is expensive is because so many people have the reader. If Adobe had charged for the reader it’s likely no one would have purchased it and as a result, the writer would be valueless. The same is true for credit cards, show the consumer the real cost of using their credit card and they are likely to find another way to pay.

The question is; will the Retailers react? Like our gun fighters, there is risk going for your gun.  Mike Schumann, owner of Traditions Classic Home Furnishing in Minneapolis was quoted in the WSJ saying that he is “hoping that surcharging will become commonplace, but that small firms will not lead the charge” adding that he might charge 2.5% to 3% if his competitors adopt the practice. During a call with a national home furnishings chain, the CIO wondered aloud how consumers would react to seeing an $80.00 upcharge for a major purchase. It’s a good question. But what does seem clear, is that in areas of every day spend, like gasoline and groceries, retailers have a new tool. We’ll have to see if they choose to use it.

 

New Bank fees set the stage for Merchant Issued Debit and Rewards.

The stage is set for an epic battle between the merchant community and the financial industry to win the consumers method of payment (MOP).  This week, BoA joined the list of financial institutions announcing either fees, or cut backs in consumer rewards programs, for debit card use .  Senator Dick Durbin sounded surprised when he said of BoA’s actions; “It’s overt, unfair” adding that “Banks that try to make up their excess profits off the backs of their customers will finally learn how a competitive market works”. Many in the industry had long predicted that this would be the immediate result of the regulation (see my June 13, 2011 Blog).  Regardless of the merits of the regulation, or the banks reaction to it, one immediate result is that merchants have the opportunity to steer consumers to a lower cost form of payment (debit): the question; will they be able to leverage this opportunity, or will the payments industry adjust their payments offerings steering consumers to unregulated forms of payment with higher fees i.e. credit, pre-paid cards, etc.

The pivotal decision for merchants is how to recapitalize the anticipated saving from swipe reform and use that money as an incentive for consumers to choose a lower cost form of payment.  Many merchants, particularly in the petroleum and grocery industry are already actively competing for method of payment by offering ACH decoupled debit card programs (merchant issued debit) or cash discounts. For these merchants, and vendors offering alternative payments  like PayPal or National Payment Card Association, the Durbin Amendment is living up to expectations providing them with a strong tailwind to the merchant and consumer.

Merchants are understandably cautious as they approach payment.  While technology, investment and ramp time look like the heavy lift, the real challenge is to understand the economics.  Traditionally merchants have relied on the bank and card associations to deliver payments.  During the lead up to regulation one argument was that; “there was no competition for payment”. Merchants’ successfully argued this point, irrespective of the intense competition between banks for consumers. What was missing from the debate is that the reason consumers use one form of payment over another is often rewards. These rewards had been paid by the issuers of the card using interchange fees (as much as 50%), and now with regulation, that funding source has disappeared.  Therefore merchants can provide consumers with the same incentive to use a low cost form of payment by offering merchant issued rewards.

Finally, there is a saying “He who enrolls; controls”. Issuance or enrollment is a critical question for merchants choosing to compete for MOP using rewards. Assuming that the merchant chooses to offer rewards for a specific MOP, which MOP should it be, cash, PayPal, Google, or perhaps a merchant issued debit card.  The smartest strategy might be a flexible approach to payment where rewards are based on the costs associated with the method of payment, regardless of whether the rewards are paid for by the merchant, or a 3^rd party.

Competitive opportunity in a post Durbin world: richer debit rewards as the unintended consequence of the $10 billion exclusion.

Dozens of articles have been written about the impact of the Durbin Amendment on the payment card industry, with nary a positive comment in the mix. The focus has been on the punitive impact that the legislation will have on both financial institutions and consumers. The consensus has been that banks will lose significant revenue and that consumers will see more bank fees as costs are shifted to make up for lost interchange revenue. This article takes a different approach and looks at the new market opportunity hidden in the bill, the opportunity for smaller financial institutions to launch aggressive debit reward programs fueled by higher interchange fees.

Under Durbin’s “reasonable debit fee requirement,” there is an exemption for banks and credit unions with assets under $10 billion (this includes 99% of all banks and credit unions). This means that Visa and MasterCard can continue to set the same debit interchange rates that they do today for small banks and credit unions.  Those institutions would not lose any interchange revenue that they currently receive; in fact they could receive even higher rates. Many experts writing on Durbin have concluded that this exception will be meaningless because the networks will be unable to accommodate multiple fee structures and as a result, while exempt, interchange fess on those financial institutions will suffer along with their larger brethren.

The argument is that the required costs and effort, such as network IT changes to accommodate multiple interchange fees, make this outcome unlikely. The recognition that business pressure from small banks and credit unions on the networks, Congress or the Fed could leave the networks with little choice but to develop a two tiered fee structure may alter this conclusion. A few weeks back, TCF, an issuer whose business is above the $10 billion exemption, filed a lawsuit stating, “the thousands of banks exempted from the amendment will be free to continue to charge retailers the current debit-card interchange rate and recover all their cost plus a profit. This will result in an irrational competitive disadvantage for banks like TCF that are subject to the new regulations.” It appears from TCF statements that the idea of 7000 smaller financial institutions issuing a new class of richer debit reward cards seems not only plausible, but probable, and a real threat to their business. The focus on the challenges associated with creating a network pricing schema that allows for multiple interchange rates, rather than discussing the market dynamics, is missing the business opportunity.

The reason this will happen is that the payment card industry is a two-sided market. Durbin treats the payment industry like a utility, but this analysis is mistaken. Durbin and its proponents have argued that the payment card industry lacked competition. This falsity, propelled by an active merchant lobby, found resonance in Congress. In reality, the payment card business is a highly competitive marketplace. It just happens that the competition is between financial institutions fighting for a larger share of the consumer market. The result of this competition is higher fees to those wishing access to the market.  Durbin seeks to upset this market, ignoring the two-sided market economics driving consumer demand.

Consumers will move their purchasing to whatever product provides the most incentives. Merchants will accept the business from any large group of consumers, and Durbin does not allow merchants to discriminate by issuer on a network. What this means is that smaller financial institutions will introduce richer debit rewards programs attracting larger shares of consumers who will then shop at retail locations using those cards. Retailers will not turn customers away because payment method would be become a factor in the consumers choice of retailers, something no marketing department will allow.  This is the result of network effects, and they are the unavoidable economic reality driving the industry. The resulting competitive dynamic is in play: issuers will want to try to drive up fees on the merchant side of the market, delivering greater rewards on the consumer side. Consumers will look for low-fee banking services and richer rewards that are supported by these programs. As a result, millions of consumers will gravitate from the 90 or so issuers affected by Durbin to the 7000 who are excluded. This looks like opportunity.

The real question is how long it will take the networks to code the system to handle multiple prices for issuers. I’d be surprised if the work was not already well underway and available not long after the Fed sets its rates. Durbin will have closed the door on the top 90 issuers, essentially putting them at a competitive disadvantage. But in closing that door, the way has been cleared the remaining 7000 financial institutions to develop their debit rewards business. In many ways Durbin did for the network what they could not do themselves; i.e Durbin eliminated the power of the major issuers and opened the market to the smaller financial institutions.

The TCF lawsuit has been both ballyhooed and scoffed at.  No matter the outcome in court, the case will have an impact on the industry. If Durbin passes all of its legal challenges, the irony may be that the consumer will benefit as a result of richer rewards programs from smaller issuers, and merchants will see card acceptance costs rise taking no comfort knowing that they won a battle but lost the war.

“Reasonable and proportional”, is issuance and the cost of reward programs a part of the “incurred payment processing costs”?

Lost in the debate over interchange fees and the Durbin amendment is a focus on how payment card products reach the consumer. One of the key points of the amendment is to mandate that the interchange fees on selected debit transactions be “reasonable and proportional to the cost incurred in processing the transaction” Merchants have taken the position that as the volume of transactions have increased, the economies of scale and overall effectiveness and efficiencies of the payment processing network have improved, and therefore the cost of transaction processing have gone down. The fact that interchange has gone up during this period is used as evidence that system is corrupt and anti-competitive. This point is heard when Senator Durbin says that government needs to “reasonably regulate this system”.

Missing from the debate on interchange and what constitutes the costs incurred in processing a transaction is consumer acquisition. Consumer acquisition costs are incurred in at least two areas; enrollment (consumer application) and rewards (loyalty programs & retention), to say nothing about overhead, like customer service. This week both Citigroup and TD Bank launched new “Debit Rewards” programs. Citigroup launched a 5% debit card cash back promotion, while the TD Bank program offers 1 point for every $1 dollar spent. In both cases, these reward programs are only available to consumers who use signature rather than PIN debit. As a consumer, which program should I choose? These are two highly competitive businesses, each offering me a product and a service. Each has put their best foot forward and is universally accepted. Both have used a different approach; one uses point’s, one utilizes cash back, and the choice is mine. If the Durbin amendment is successful and retailer acceptance is selective, and interchange fees regulated, would the consumer have these same choices?

Merchants involved with loyalty programs understand the costs associated with advertising and marketing to drive enrollment and fund reward programs. Industry sources report that up to 40% of all interchange dollars paid by merchants are used to support payment card loyalty programs. That means, in 2008, consumers may have earned up to 19 billon dollars in consumer rewards; a cost borne by the merchant, but also a cost to the issuer (bank).

The suggestion is that high fees are a result of no competition in the payment card market. In reality, the high fees are a result of intense competition. It just happens, that the competition is between banks (issuers) fighting for the consumers’ business.

(http://www.linkedin.com/in/peterguidi)

Does regulated debit “Swipe Fees” mean the end of cobranded debit card programs?

Retailers choosing “open-loop” or “closed-loop” alternative payment system might want to consider the long term viability of the open-loop business model, particularly in light of their campaign to regulate and lower the associated “swipe fees”. 

Affinity, cobranded credit card programs have opportunities for both the bank and the merchant. While the “no or low fee” in-store use of the cobranded card is a big attraction, Retailers also profit from cobranded credit cards when consumers use the card to make purchases. When a consumer uses a co-branded credit card, the accepting merchant pays the “swipe fee”.  The cobranded merchant earning “swipe fees” is an example of network effects in a two-sided market. In this example, the merchant is leveraging their customers to market a bank product. Organizations that have the marketing to reach their customers will get the response needed to make the program successful. Ironically, much of the success will be a result of the high fees paid by the merchants who pay the “Swipe Fees”. 

Retailers evaluating merchant issued ACH decoupled debit card programs consider the same model while evaluating their choice of “Open”, or “Closed” loop payment systems. The question is can the decoupled debit card generate revenue for the issuing merchant in the same way cobranded credit card products do. Ironically, the answer all depends on the “swipe fee” the 3^rd party merchant pays when the consumer uses the card. The higher the fee, the more successful the program. 

In order for an ACH decoupled debit card to work in an open loop system the card must affiliate with a bank, and a network. Today’s interchange rates for PIN debit are already comparatively low. The challenge for cobranded cards is to offer a level of consumer rewards that will motivate the consumer to use the card. This is the reason that debit rewards programs are offered for signature debit and not pin debit transactions. As Merchants anxiously await the passage of the much ballyhooed Durbin amendment, they might consider its impact on the cobranded card. If “swipe fees” for debit are regulated, (decoupled debit card programs included) there will be no dollars in the program for either the consumer, or the cobranding retailer. If the consumer does not receive rewards to use the card, and the retailer is not earning money from the program, the network effects driving the value of the platform will be eliminated, making the cobranded credit/debit card program obsolete.    (http://www.linkedin.com/in/peterguidi)

The Final Frontier: the death of cash as a payment and the merchant’s role in the battle plan.

MasterCard and Visa have identified the enemy; CASH! They have devised the final battle plan, the pre-paid reloaded card. VISA’ ReadyLink and MasterCard’s various solutions including a Wal-Mart payroll card are the weapons. The objective is clear; destroy paper currency and extend the reach of the platform and resulting fees over the last bastion of disintermediated transactions. The result will tax every dollar earned and spent by consumers.

The plan is cloaked in platitudes like; “serving the under-severed” or making the product “Green”. Like lambs off to the slaughter, Retailers have joined in the strategy with 7-11, Marathon and Blackhawk introducing Visa’s pre-paid reloadable card, ‘ReadyLink” to their customers. 

The core of the plan is to attack the enemy at its source, payroll. The concept is simple; prevent cash from ever reaching the hands of the consumer. The most efficient route to achieve the goal is to assure that consumers never receive cash by loading their payroll on a pre-loaded card, rather than receiving a payroll check. Say good bye to the check cashing business! When consumers load payroll onto a card the platform has captured the cash and will now earn fees on every purchase or payment made using the card; this is a brilliant strategy and is classic example of creating network effects. The growth of mobile payments and the preference of the “E-Generation” for electronic media is the sound of the bells ringing the death tome of cash in the future.

Acting is the work of two people-it’s only possible when you have the complicity. VISA estimates that there are 80 million underserved consumers receiving $1 trillion dollars in annual income that rely on cash for everyday transactions. Retailers will look back at their participation in these programs as a tactical error in the fight against transaction fees.

(http://www.linkedin.com/in/peterguidi)

73rd NPECA Annual Conference – What is alternative payment

There are at least two possible ways to answer the question; “What is alternative payment?” one practical, one academic.

Practically, any payment solution that is not MasterCard or Visa is alterative payment. This is true because up to 90% of all card acceptance fees occur at the pump and these two associations, along with AMEX and Discover control a monopolistic percentage of the payment market. Practically, any payment other than the major card associations is an alternative payment. An Academic approach to the question is more elusive.

Suppose that “alternative payment” is a payment where the payment relationship is between the retailer and the consumer. If so, then cash is the ultimate alternative payment?  But what about all the emerging payment systems like NPCA or PayPal, Bling or BillmeLater? Are they alternative payment? What if we changed the meaning to say that: “alternative payment is any system that creates disintermediation between consumers, retailers and their financial institutions”. Does eliminating the network roles and captured costs of the current payment processing network define alternative payment or is there more?

For the convenience petroleum retailer alternative payment is a system that disintermediates the transaction while enhancing the customer relationship. Alternative payments systems allow the retailer to focus on the “Demand-Side” of payment using incentives and tracking data to influence the consumers “Method of Payment” and enhance customer loyalty. The result should be lower card acceptance costs and increased sales. Retailers using this definition will find the final answer to the question, alternative payment is one that delivers additional profit, rather than additional cost to the retailer.