“Contractual conflict”; Apple Pay and MCX, the new front in the mobile payments war.

A few years ago, while at one of the major POS annual user conferences, I had the opportunity to socialize with one of the initial members to MCX. At the time, I was with PayPal and mobile payments was more of an idea than a technology. MCX had just been announced and I was learning about the “hush hush, MCX Exclusivity” requirements. I was floored. How could that be good for either the merchant or the consumer? His answer; “They really did not care if MCX ever conducted a single transaction. If allowing Visa/MC into the mobile wallet forced lower overall fees (read cards as well) then MCX would have done its job”. When asked about how profitable CurrentC would be, Lee Scott, former CEO of Walmart said, “I don’t know that it will, and I don’t care. As long as Visa suffers”. It never seemed like much of a business plan to me.

It was all such a secret. I can’t count the number of times I heard; “The first rule of MCX is; you don’t talk about MCX”. Well, judging from the news, things appear not to have worked as planned. The veil was lifted on the MCX story when Rite Aid and CVS Health pushed aside Apple Pay and in doing so revealed a new wrinkle in the mobile payment war, contractual conflict. The notion that an exclusive MCX mobile payment solution might be a lever to force card acceptance fees down seems to have reached its apex. Are retailers willing to say no to Apple Pay? The consumer is caught in the middle.

One of the ingredients in the MCX secret sauce is the idea that retailers will adhere to an exclusive arrangement thus locking out competing payments systems in the mobile channel. As Karen Webster speculates in her 10/27 blog, MCX is likely to have told both Rite Aid and CVS “You simply can’t do it. And, the fact of the matter is that you’ve been caught two-timing with Apple Pay, and that’s clearly a violation of your contract with us.” In doing so MCX is leveraging its big stick, not its economics, product features, or consumer demand, but the strength of its legal teams and the adverse contract its members have signed. “This act by CVS and Rite Aid heralds the advent of the imminent battle in the mobile payment system,” said Anindya Ghose, a marketing and information-technology professor at New York University. Now that lines have been drawn, we will learn if MCX can drive the cost of payment down, or will its own member retailers instead chose to provide their consumers with choice. Call the lawyers.

The Battle of the Titans continues as NACS squares off with the ETA over mobile payment.

Greek Mythology and the payments industry seem to have a lot in common. There’s something similar about CVS and Rite Aids decision not to accept Apple Pay that reminds me of when “Cronus attacked Uranus, and, with the sickle cut off his”…..well, you get the point.

There has been a lot of noise about mobile payment over the last few years. Confusion about technology and economics clouds the issues. Now, in the same tradition of Durbin (legislation) and Brooklyn (litigation), banks and retailers are setting the stage for another battle over mobile payment. The new issue is; does Apple Pay, Softcard and other NFC based solutions simply enable the traditional payment providers (read fees), or is MCX just an anti-competitive alliance of retailers created for no other reason to leverage the emerging consumer acceptance of mobile payment systems to drive the cost of payments down? In the middle is the consumer who simply wants convenience and choice.

The Apple Pay launch opened the latest salvo in the fee/service war. The Electronic Transactions Association is saying that the decision by CVS and Rite Aid to block mobile payments services like Apple Pay, Google Wallet, and Softcard is “anti-consumer and anti-competitive”. NACS, apparently in support of the Retailers MCX relationship is saying that Apple Pay essentially allows “Visa/MasterCard monopoly into mobile payments”. saying “Those two dominant credit card networks have faced a lengthy series of antitrust actions from the U.S. Department of Justice and merchants over the years due to their anticompetitive conduct. Now, they are working feverishly to require merchants to accept their preferred technology, near-field communications (NFC), so that they can extend their dominance into the future.” How supporting MCX, a program that requires exclusivity within the mobile payment channel, even the exclusion of non-VISA/Mastercard 3rd parties is not Anti-Competitive is a bit of a mystery.

Let’s be clear, MCX could allow either Visa or Mastercard into the CurrentC wallet, it’s a business decision, not a technology issue. Apple was clever enough to shift costs (at least for now) to the issuer, rather than the merchant. This opened the door to many merchants avoiding the interchange conversation. Why many merchants have chosen not to join MCX might have something to do with membership fees, product availability, or perhaps that it is an ACH program rather than a new low cost 4^th network. After all, there are many ACH providers, why spend a lot of money joining a coalition only to pay a high membership fee for a product that is already available from other providers?

The reason the industry is lining up to fight over the CVS & Rite Aid decision is because this is another skirmish in a multi-year battle over the fees retailers pay, or banks earn, when consumers make a payment. For retailers simply wanting mobile payment at low cost, the program is available today. Retailers can compete with banks for consumer’s method of payment, that’s the “Competitors Code”. The point is, Retailers don’t need legislation or litigation to drive fees down, competition will do the job. If CVS and Rite Aid don’t want to accept Apple Pay, so be it. On the other hand, how does a restrictive exclusive contract with MCX serve the consumer?

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……

Who gets to choose? Durbin’s provision on “multi-homing” and the prohibition on network routing exclusivity.

Here is the question:  When considering Durbin’s requirement prohibiting exclusive debit transaction routing arrangements, does the merchant or issuer choose which second unaffiliated network is available to route transactions? The answer is unclear and its implications impact both the intent of the regulation and the technology required to implement the rule.

Thus far, the majority of interest in Durbin is focused on the impact of interchange fee regulation with little attention on the second aspect of the provision; network exclusivity and transaction routing. Durbin has two provisions, the second of which says “that neither the issuers nor network may restrict the ability of merchants to direct the routing of the transaction”.  The rule is intended to foster competition between networks. The concept being that when at least two unaffiliated networks compete for transaction routing, the price merchants pay will optimize.

The Board is requesting comment on two alternative rules prohibiting network exclusivity: one alternative would require at least two unaffiliated networks per debit card, and the other would require at least two unaffiliated networks for each type of transaction authorization method. Under both alternatives, “the issuers and networks would be prohibited from inhibiting a merchant’s ability to direct the routing of an electronic debit transaction over any network that may process such transactions.” Some have suggested that the answer to this question lies in the currently available least-cost routing selections available to consumers between PIN and Signature debit. In this scenario debit cross-routing is the solution to network exclusivity. One expert suggests that “one such solution would be Visa for signature debit and Maestro for PIN debit. They are not affiliated, and thus fulfill the requirements of the first alternative.” The existence of the second alternative makes it clear that the Fed has not yet decided whether signature and PIN debit are one market.”

The contradiction is between the intent of the regulation and the Boards’ rule making process.  The differentiation between routing based on a transaction or a card may delineate the type of routing available, but it does little to foster routing competiveness. The intent of the regulation is to foster competition between networks.  Allowing the Issuer to choose the second network by pitting the PIN and Signature networks against each other is a weak proposal. On the other hand, if merchants choose the second network from a multitude of routing options competition will emerge, but how does that work? In order for the merchant to have a choice between a variety of networks, Issuers would have to support routing on all networks. In this scenario merchants might choose different networks on a location or regional basis? Implementing this type of network routing matrix will mean substantial changes in the infrastructure and business rules. The time and effort to create such a system is currently unknown. If competition between networks is the congressional goal this seems to be the correct interpretation.

The alternative interpretation is for the Issuer to offer the merchant a choice of two networks. In this case every Issuer would be forced to offer two networks for processing a transaction.  As an example, Visa and MC may have to route each other’s transactions. The merchant would be able to choose which of the two available networks to route the transaction.  Presumably, creating competition. As a result the merchant would choose the cheaper of the two. However, this scenario does not assure the merchant choice and adds the possibility that the Issuer could offer a second network with higher fees. In this case the second network would be the more costly option resulting in no opportunity for merchant savings.

How a two-network solution is allowed under the final version of the regulations remains unknown. It does seem that merchant choice fits congressional intent more clearly than Issuer choice, even if the technical challenges and costs to develop such a system are currently not contemplated or that the rule making process appears to miss the point.

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Debit or Credit, the role of merchant-issued rewards and the consumer’s choice of method of payment.

On December 16, 2010 the fog began to lift on where Section 1075 of the Durbin Amendment would lead as the Federal Reserve Board issued its proposed interpretation of the legislative language. One question on many peoples mind is how the new regulations will impact consumers. Voices on the banking side seem skeptical that the regulation will have any positive impact for consumers sighting Australian studies where retailer prices appear unchanged as bank fees rose and payment options declined.  On the other side of the argument, the National Retail Federation welcomed proposed regulations saying “a significant reduction in the fees would result in lower costs for merchants and could lead to discounts for their customers.”

NRF Senior Vice President and General Counsel Mallory Duncan said. “The combination of reducing rates and allowing retailers to offer discounts will go a long way toward stopping the current scheme where big banks take a bite out of consumers’ wallets every time they use a debit card.” He goes on to say that the NFR “will work closely with the Fed as these regulations are finalized to ensure that the reduction in fees – and the amount of money retailers can offer customers as a discount – is maximized.” And so it seems that the stage is set for retailers to offers consumers discounts if and when they use a debit card to pay for their purchase.

In a recent article published in PYMNTS, Katherine M. Robison of O’Melveny & Myers LLP says that “while the Board says it understands and appreciates the importance of debit cards to consumers, it is disturbing how little the interests of consumers entered into its justification for the Proposal”.  She goes on to say that “The debit card market is a two-sided one, with merchants who accept debit cards on one side and consumers who use them on the other.” Her point being that in this two-sided market an action that may decrease consumers’ demand for debit (say by making debit transactions less appealing to them) will ultimately decrease the utility of debit to merchants.  Further, if Banks add fees to the checking account or the use of the debit card while eliminating reward programs consumers will also find debit less appealing. She adds “So while lower interchange fees may encourage more merchants to accept debit cards, at that point there may be fewer consumers who want to use them.” Enter the role of merchant issued rewards.

Consumers could benefit from a rewards battle between merchants and banks for their method of payment. On one side will be the issuers of credit cards, on the other will be the retailer and the winner could be consumer as they rack up rewards by choosing either credit or debit. Their choice will be simple, choose to use a bank issued credit card and earn rewards like airline miles, or choose a debit card (either bank or merchant issued) and earn retailer funded rewards. The decision will be based on which offer the consumer finds more attractive? 

Over the last five years a variety of alternative payment providers. Like National Payment Card Association, have brought forth payment technologies like merchant issued debit cards designed to circumvent the traditional payment processing network delivering a lower cost transaction to the retailer. Now with the Fed’s proposed interpretation of the rule, bank issued debit cards will carry similar fees and so the retailers will face an analogous implementation challenge. How does a merchant motivate a consumer to use a lower cost form of payment? Merchant rewards are the obvious answer. And so the question is; will retailers recapitalize the cost difference between a traditional credit card transaction and the new debit fee and use the savings as a reward? And if not, why would the consumer choose to use a debit card rather than a credit card? Retailers will face a variety of challenges leveraging these new fees to their advantage.  Most notably is that the possibility that a debit transaction with merchant funded rewards may actually cost more than the original bank fee for a debit transaction. 

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“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.

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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.

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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.

What decision factors should retailers use when choosing between an open-loop vs. closed-loop alternative payment solutions?

Prevailing wisdom is often wrong.  Mark Twain said: “Every generalization is dangerous, especially this one”.

The prevailing wisdom on payment is that open-loop systems are superior to closed-loop systems. Open-loop payment systems have four stakeholders; consumer, merchant, issuer, and network. It is generally accepted that successful payment systems offer the consumer at least three attributes; simplicity, safety and desirability. This has lead to the mantra that only ubiquitous payment products can achieve “top of wallet” status. The reason being that the consumer wants one method of payment rather than multiple options as a matter of convenience; consequently, it’s simple and desirable.

Yesterday, Target announced they are dropping its Visa cobranded program. The Target program was one of Visa’s largest cobranded programs. This decision is the strongest sign yet that merchants are reevaluating the benefits of offering general-purpose credit cards. Target said they tested a Target credit card and that research indicated that the Target credit card drove more sales. The test made a clear case for its private-label cards over general-purpose cards. So much for “prevailing wisdom”.

Closed-loop payments systems have two stakeholders, the consumer and the merchant. When a payment system creates disintermediation between issuer and the network (acquirer) the result is increased engagement between the retailer and the consumer. Engagement is good for business. If consumers are interested in single purpose cards, as Target’s test indicated, why share the relationship with two other parties?

Prudent retailers will consider the results of Target’s decisions and other trends in payment before making a final payment system decision. Recent research indicates that 38% of consumers will reduce the use of their credit cards. Visa has reports that debit usage has surpassed the use of credit. Last week VISA announced an increase in Debit rates. Retailers looking to leverage these emerging payment preference trends should consider closed-loop ACH decoupled debit. (http://www.linkedin.com/in/peterguidi)

Market Power or Perfect Competition: The “Apples and Oranges” of the interchange pricing debate.

Market Power gives a firm the ability to employ anti-competitive tactics like predatory pricing without losing customers to competitors. During testimony on H.R. 2382, the Representative of The Merchants Payment Coalition stated that “there is no competitive market for interchange fees – just naked price fixing”. On the other side, the Representative from The Electronic Payments Coalition called interchange an “important element(s) of the successful, competitive banking experience” adding that “interchange reflects a merchant’s fair share of the costs” (sic.) of the system.

Last weeks GAO report found that Merchants’ are in fact paying more to accept credit cards, but also added that “network competition in the credit card market may be contributing to rising interchange rates”.

Two-sided markets exhibit “Network Effects” when two groups of users are attracted to each other, in this case retailers who accept payment and consumers who make payment.  “Cross- Side Network Effects” occur when enough users are attracted to one side that the other side will pay dearly to reach them.  In this case, retailers are the “money side” and they pay to accept cards as a form of payment, while consumers are the “subsidy side” who receive incentives to use the cards as a form of payment. Linking these two groups together is the primary value of the payment platform creating powerful Cross-Side Effects.

Retailers’ accept cards as payment because so many consumers use cards for payment. Competition between card issuing banks to capture consumers, and networks to capture banks is intense as evidenced by the multiple offers for high earning rewards credit and debit products and their users. Retailers ultimately see the cost of this competition reflected in rising interchange fees, particularly the higher rate fees for reward based programs. The question is; does this competition between networks and financial institutions for the consumers’ payment business justify the increasing rates paid by retailers to accept these forms of payment or does it constitute a monopolistic example of a market failure?

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