Mar 26, 2006

Merchants as customers, not just credit and debit card acceptance locations

Credit and debit card income from merchants, in the form of interchange fees, can represent a third of card issuer revenues, and almost half of American Express revenues, as shown here. Discount revenue (eg transaction fees paid by merchants) is by far the company’s largest revenue source, at 49%. The second and third revenue sources are finance fees, 11%, and card fees, 8%.


The risk of losing a significant portion of this revenue stream will increasingly cause card companies to look at merchants as true customers, not simply as card acceptance locations.

Interchange represents the vast majority of card fees paid by merchants to acquirers, and merchants don't want to pay it anymore. Here is how a Visa brochure pitches interchange to merchants: “Cards are faster and more efficient than cash and tend to lead to higher sales. They are clearly very popular with your customers. Interchange is necessary to cover the issuer’s costs of processing transactions and providing a payment guarantee to the acquiring bank. Without it, consumers would pay more.”

Focusing on the part that the merchant cares about, we’re left with this: “Cards are faster and more efficient than cash and tend to lead to higher sales. They are clearly very popular with your customers.”

Merchants are obviously not convinced that these benefits justify the cost.

American Express is able to add a little more to their pitch: “We provide you with an attractive customer base of premium shoppers with high average spending.”

This has been very profitable for American Express and has caused banks to move towards premium Visa and MasterCard products which also earn higher interchange rates. In markets with regulated interchange, like Australia, some banks have switched parts of their Visa and MasterCard portfolios to American Express cards, which remain unregulated. Today, the number of American Express cards issued by other banks is growing almost 4 times as fast as cards issued directly by American Express.

With the traditional value model, growth is relatively straightforward. A Motley Fool article from 2001 sums it up: “There are two main ways American Express can boost discount revenue and finance revenue: Increase the number of total cards and increase spending per card.”

This simple and elegant strategy has worked well. But the traditional value pitch is reaching its limits. In a presentation last month to investors, American Express chairman and CEO, Ken Chenault, outlined three major risks to growth. Number one, the pressure on the company’s discount revenue from merchants and regulators.

There are already complaints about American Express's strategy of working with banks. "The latest banking trick," is how merchants behind the multi-billion dollar interchange litigation describe the strategy. “Imprint the American Express logo on millions of new credit cards and charge in some cases more than double current merchant interchange fees.”

The old pitch isn’t as powerful as it used to be. “Faster and more efficient than cash, higher sales, and access to an attractive customer base of high spenders,” is not enough anymore. Merchants want more. Actually, no, that is absolutely not true. I'm getting ahead of myself again. Merchants don’t want more. They just want to pay less. It’s up to banks to show merchants that they can provide more. Banks need a new value pitch for merchants, focusing on merchants as true customers.

1 comment:

Ling said...

Another angle is that demand for "credit" is dwindling. Cards are increasingly used more as a payment device than a loan device. Bankers must see the increasing importance of non-interest transaction income, and by extension, place more focus on cardholder/merchant relationships.