Nov 16, 2007

Justifying interchange fees by helping retailers fight return fraud

The holiday shopping season is here. Return fraud is in the news again, right on time. And it’s getting worse. Retailers know what I'm talking about but many people in the payment industry and banking community might not. It's not a problem that banks face. But I talk about this because I believe that payment networks are ideally positioned to help retailers address this problem. Why should the networks do this? To help justify their interchange fees.

Fraudulent returns are expected to total $3.7 billion this holiday season, according to estimates from the National Retail Federation. For the year, retailers will lose about $10.8 billion to return fraud.

Over half of return fraud is attributed to the practice of "wardrobing”, where someone purchases a product, wears it and then returns it to the store for a refund. The practice, according to the NRF study, is on the rise.

Some retailers now require a picture ID when customers return merchandise, so clerks can check a database for possible abuse. This is the only solution available today. It is inconvenient and obtrusive to customers, the vast majority of whom return items in good faith. According to the NRF study, over 90% of returns are perfectly honest and legitimate.

Instead, why not take advantage of payment data to identify potential abuse? A solution which leverages payment data at the POS, with no need for the cost and effort of operating a database and authorization service, and no need for a picture ID, would directly benefit merchants.

I believe that the new competitive landscape (i.e. Visa and MasterCard as publicly held companies accountable to shareholders, competing more fiercely than ever before to get their brands on cards, with interchange being one of the top criteria for banks to choose one brand over another) will cause the payment brands to develop all sorts of new payment features which directly benefit merchants. When people at Visa and MasterCard start asking the question, "What can I do to make my brand much more attractive to merchants, so that they agree to my interchange fees and don't surcharge?" the types of answers that can emerge are endless. My blog has looked extensively at one angle, promotional marketing, which is Welcome's background. Return fraud is another, complementary answer to exactly the same question. There will undoubtedly be others. Other companies like Welcome will emerge with their own specific answers to the question, coming from their own specific areas of expertise.

Welcome is developing new technology that uses data stored within EMV chip cards to automatically authorize valid returns and refunds. It has no impact on a bank’s existing authorization systems, since it only requires data stored within the EMV chip. It simply requires the clerk to key in the original purchase date and the amount. In most cases, the refund is authorized instantly, making it more convenient and less expensive than the ID and database methods that merchants are currently putting in place. We are also adapting the technology to work with traditional magnetic stripe cards so that payment networks can leverage the existing cards already in people’s wallets.

See my prior posts on return fraud here.


Anonymous said...

Funny analogy to link Interchange fees to retailer return fraud. As a payment scheme, interchange goes to paying for the massive global networks that enable payments for the brands. Funny that the real rates are set by the Banks when charging the Merchant for the priviledge of processing their transactions. If this was the area of concern, maybe the Banks should consider helping retailers fight return fraud.
Or is this simply a returns policy to be managed by the retailer & nothing to do with interchange???

James Cranfield said...

Great article. The battleground for the payment schemes as we know is more on the issuing side than the acquiring side, but more attention to delivering real merchant value is moving up the agenda.

A comment on the previous post. Acquirers are coming under pressure to justify merchant service fees. Interchange is a large component of acquirers costs, but they also pay scheme fees to MasterCard and Visa (a small fraction of interchange) and this is what funds the global networks, not interchange. Interchange is a redistribution of costs (in theory at least).