Why an unregulated interchange model is crucial to fostering competition between payment schemes

Statements from regulators indicate that their focus is less on abolishing interchange than on exploring ways to deal with the variations in levels of fees in different markets and for different card products. EU competition commissioner Neelie Kroes recently said that while the commission would not abolish interchange it would continue to assess the legality of current fee levels. The solution usually evoked consists of some form of levelling of fees across the EU, through regulation which would result in payment schemes all adopting the same legislated fee levels. This would be unfortunate. Regulating interchange fees would eliminate a powerful incentive for payment schemes to create innovative products and services which benefit merchants. Payment schemes should be able to compete with each other to make their products more useful and valuable to merchants, their incentive being the ability to generate higher interchange and, in consequence, the ability to attract banks keen on receiving more interchange.

With SEPA, European banks will be able to choose between multiple debit brands for their cards. Payment schemes are competing fiercely to have their brands chosen by banks. Interchange is a powerful differentiator. As competition between schemes increases, there will be a growing desire to raise interchange fees to attract issuers. If the system functions properly, brands that don’t offer enough value to merchants should find it more difficult to raise fees than brands that provide more value.

The current interchange model, with some adjustments, is a powerful tool to foster innovation for the benefit of merchants. If merchants were able to negotiate interchange fees and choose freely between payment methods which give them the most value in relation to their cost, then normal market forces would automatically force card fees to their acceptable levels. However the nature of the payment industry makes it difficult for merchants to negotiate interchange fees.

Capping fees through regulation does not solve the problem because it will not create a market driven system. It will simply cause the current payment infrastructure to ossify at essentially the present level of functionality. With little incentive to innovate for the benefit of merchants, payment schemes will not put much energy into new merchant-centric features. The system will remain essentially as it is today, with innovation focused on new cardholder-centric features. It might be hard to imagine today the types of new payment features which will be attractive to merchants, but this does not mean that payment schemes will not discover them in the future. Abolishing the incentive to search for these new capabilities will guarantee that they are never found.

A viable solution already exists in a growing number of countries. Leaving fees unregulated, but giving merchants the ability, for example, to easily surcharge card brands which are too expensive in relation to their value, creates a powerful incentive for schemes to make their products and services more useful to merchants. In response to this pressure, and to avoid having their cardholders subjected to surcharges, some payment brands will manage to create enough value to convince merchants to accept the higher fees, while others will simply have to reduce their fees. In practice, customers should see little if any surcharging, and merchants will get far more value for their money.

There are many ways in which payment schemes can innovate to make their cards more valuable to merchants. The most effective solutions will focus on leveraging payment data to help merchants solve major problems at the point of sale, in the store, as the card is being used. For example, payment schemes are already beginning to help merchants improve the efficiency of their promotional marketing activities, an industry estimated at $342 billion in the US alone (dwarfing US interchange fees of $40 billion). These budgets can be made more effective by leveraging customer behaviour data available at the moment of payment, for delivery of targeted promotions on credit and debit card receipts. This is my company’s area of expertise.

Another area in which payment schemes could better help merchants is by addressing the issue of fraudulent and abusive returns, which cost US retailers $16 billion annually, eclipsing the $3 billion that banks lose due to card fraud. Over half of returns fraud is attributed to customers “renting” merchandise for free by purchasing a product, for example an expensive camcorder, using it once to record a wedding or graduation, then returning it for a refund. 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. A solution which leverages payment data at the POS to identify potential abuse, with no need for the cost and effort of operating a database and authorization service, and no need for a picture ID, would be very valuable to merchants.

It is reassuring to see that regulators accept interchange as an important part of an efficient payment system. It would be even more reassuring to see regulators recognize the importance of interchange as a competitive weapon between schemes. Competition is fiercer than in the past, what with developments such as SEPA and with MasterCard and Visa becoming profit-driven companies that must show strong growth to investors. There is an opportunity for regulators to leverage this growing level of competition in a way that creates more value for all players. Capping or cutting interchange fees would cause that opportunity to be wasted.

BPI releases new video - when was the last time you saw merchants really excited about a new payment feature?

And how can that excitement be channelled to protect interchange?

This 8 minute video (presented by BPI's Maria Cristina Go at Welcome's annual user summit in Dubai) is a collection of short interviews with top executives at Robinsons, the leading supermarket chain in the Philippines, Nike Women’s stores, a trendy restaurant chain called Bizu and a music retailer. These retail executives describe how they are using data inside BPI credit cards to target their promotions better and make their marketing campaigns more effective. When you watch the video, imagine using it as a tool to get lots of other merchants to also encourage customers to pay with their BPI card.

The executives describe the problems they face with current advertising and promotional marketing methods. Audrey Tanco at Bizu restaurants sums up the challenges from an ROI perspective: “It is very expensive to communicate to a broad market, so we have to really think of very creative ways to get our customers to keep coming back.”

The video then shows how BPI sets up the campaigns for merchants. This is a new, value added payment service that gets merchants to focus on the value that BPI provides, rather than the cost of payment acquiring or interchange fees.

“The best thing about it?” asks Robin Cu Unjieng, President & Managing Director of Nike Women. “Real Thrills is free.”



BPI is one of the largest issuers and acquirers in the Philippines. The bank runs one of the country’s two private label debit card and ATM networks, in a country with lots of debit cards but virtually none of them Visa or MasterCard debit cards. Their strength across both issuing and acquiring makes it possible for them to launch and operate a closed loop marketing platform for merchants.

Of course, most banks are not structured in this way, not even the largest international banks. And merchants in most countries would prefer being able to target a much larger customer base than a single bank’s cardholders. That’s why banks generally like being part of a branded network like Visa or MasterCard. Imagine a similar video showing how merchants can target their promotions to any customer paying with a Visa card. That's Welcome's new SPICED value proposition. I dare anyone to find a better way to justify interchange fees today.

Petrol stations ban credit cards – is surcharging the only viable solution?

According to this article by the Gulf News in Dubai, fees for accepting credit card payments “increased about a year ago for petrol stations from 1.35 per cent to 1.4 per cent for each transaction and petrol stations were fine with it for a year. It was recently increased again by 0.2 per cent to 1.65 per cent.” And that’s the proverbial straw that broke the camel’s back. Petrol stations across the Emirates suddenly decided to no longer accept credit cards. Terminals will soon be removed while Visa, MasterCard and the banks negotiate with the retailers.

Merchants see credit card fees rising and have little ability to negotiate interchange fees with the payment schemes. If the article is correct, fees have risen from 1.35 per cent to 1.65 per cent in just over a year. That’s 30 basis points. Not just peanuts. To cover this increase, it appears that the debate is primarily on whether or not retailers can or should surcharge purchases paid by credit card.

I understand that merchants must feel out of control and angry about it. But I also understand that the payment schemes need to be able to raise interchange fees in order to compete against each other and attract card issuers. Banks need the fees more and more. Interest margins are not what they used to be, and payment services increasingly need to be funded out of interchange.

A compromise is needed. A pressure valve of sorts, which gives merchants the ability to negotiate easier and gain better control of the fees that they pay, while at the same time allowing payment schemes to continue raising interchange fees to attract card issuers.

I can’t see how surcharging can be avoided. Giving merchants the ability to surcharge certain card products which are too expensive in relation to their value, creates a powerful incentive for payment schemes to create more useful products and services for merchants. Payment schemes will actively innovate for the benefit of merchants if it will help them avoid seeing surcharges applied to their brands. Card brands will be under very strong pressure to either reduce their interchange fees or innovate to make the fees justifiable to merchants. In practice, thanks to these strong pressures, customers should see little if any surcharging actually being applied.

Welcome’s User Summit – Dubai 2007

This year’s user summit was in Dubai. It was bigger and better than last year’s in Athens, but not nearly as good as next year’s!


On the first day of the event, many of us were surprised to see a panel discussion turn into a debate between two panellists, David Riddel of Novantas and Mark Bergdahl of American Express, on the relative merits of cash back versus points programmes. Welcome’s technology has achieved a level of richness which allows people to use it in completely different ways. The points vs. cash back debate is mild in comparison to other debates that are beginning to emerge. Like loyalty vs. promotional marketing. Or bank differentiation vs. interchange protection. All kinds of interesting subjects which will fuel discussions at future summits.

Also on the first day, Manoj Sugathan of Visa presented the new Visa payWave value proposition which now includes Welcome’s technology built-in, for the Asia Pacific region. There is a real opportunity for Welcome’s existing licensees to become value added acquirers for Visa payWave transactions. And they can get there first, before other acquirers, since their POS infrastructure already uses XLS. More information here.

On the second day of the event we saw a series of presentations by banks that are using Welcome technology almost entirely to enable merchant promotions, as opposed to doing points or cash back programmes. BPI presented a wonderful video of interviews with merchants, highlighting the ways that BPI is helping merchants solve major problems. I will do a separate blog post on that video, which is a very useful tool to get lots of other merchants excited and on board.

I have no idea where the next summit will be, but some of you have already suggested a few destinations. Sao Paulo? Paris? Singapore? Reykjavik?

New bloggers to watch: Thad Peterson and Adam Levitin

Thad Peterson of Maritz has just started a blog called Banking on Customers. His first post covers the customer experience at the moment of payment, The Magic Moment as Thad puts it. Thad is at the forefront of a disruptive evolution in the card loyalty industry. As most readers of my blog know, bank loyalty programmes are almost entirely funded through interchange. As pressure on interchange grows, loyalty practitioners like Maritz will adapt to a new world, making do with much less interchange revenue to fund credit card points and cash back programs, and, in parallel, looking at merchants as the true customers since they are the ones that actually fund everything. Thad’s blog will be a valuable place to watch this evolution unfold.

Readers of my blog know that I am a big fan of Adam Levitin’s work (here are prior posts on Adam’s work). Well, Adam has recently written a series of posts on the Credit Slips blog. His article titled “Who’s Paying for Your Rewards Points?” is characteristic Adam Levitin. It is great to see him presenting his ideas in a blog format which, if he keeps it up, will allow us more frequent access to his insight on topical subjects. Hey Adam, when are you going to start your own blog?

SPICED card technology helps payment schemes protect interchange fees

SPICED was designed to make payment scheme brands more attractive to merchants, so that merchants will encourage customers to use that brand over others, interchange fees become easier to justify, and the brand becomes more attractive to banks. What we’ve done is create a very simple and fast applet that offers a set of core promotional marketing features which appeal to merchants in all retail segments. The SPICED card applet supports a variety of promotions designed to help merchants attract and excite occasional customers, something useful and valuable for any merchant. A recent Deloitte study suggests that merchants are willing to pay 7-9% for a full payment service which attracts new and occasional customers and actually delivers sales (vs. 2% interchange for payment alone). This capability of SPICED is so powerful that it is the main message in a print ad that Welcome recently launched.

Here are several SPICED features that provide merchants a way to target occasional shoppers:

Competitive Shopper Messages/Coupons. Merchants can avoid losing customers to the competition by recognizing occasional customers that are probably shopping elsewhere and instantly offering an incentive on the next purchase. For example, a petrol retailer can recognize an infrequent customer that has not been to the chain in over 30 days, and instantly print an offer encouraging the customer to come back the next week. It is difficult and expensive for merchants to achieve a similar result using existing data mining and direct marketing techniques, whereas with SPICED, the feature is built into the payment transaction and the offer is simply printed at the bottom of the credit or debit card receipt. There is no need for merchants to operate a separate database, or integrate with bank systems, or use any other equipment other than traditional payment terminals. Merchants simply accept payment scheme brands with the SPICED applet built-in and ask their acquirer or terminal service provider to set up the campaigns of their choice.

Smart Sampling Offers. Merchants can encourage customers to try higher margin products and services by giving a different surprise sample at each visit.

Game Programs. Merchants can avoid the cost and trouble of complicated loyalty programmes and build continuity through games based on cumulative spending or number of visits.

SPICED also supports promotions designed to help merchants reward frequent shoppers:

Frequent Shopper Coupons. Merchants can avoid giving high value promotions to all customers by delivering their most valuable coupons after a certain number of visits or cumulative spending. For example, rather than offering a “Buy 1 meal and get 1 free” promotion to all customers, McDonald’s can give the offer only to customers that have eaten there 3 times in the last month, printed at the bottom of the customer’s normal credit or debit card receipt.

VIP Service Vouchers. Merchants can avoid loss of margins when offering high value services by identifying their best customers and surprising them with VIP treatment.

SPICED is part of Welcome’s XLS payment technology, so banks already using XLS can upgrade their POS terminals to accept payment scheme brands equipped with the SPICED applet and make their acquiring services even more valuable to merchants.

Merchants will pay 7-9% for a full payment service which delivers sales vs. 2% interchange for payment alone

Merchants complain about paying 2% for payment processing, most of which is interchange, yet, according to a new report by Deloitte, they are willing to pay 7-9% to companies like Google that envelop the e-commerce payment transaction within the online shopping context and actually deliver sales. The study looks at online purchases only, but I am excited about how the same ideas can be applied to real-world purchases. Last week, at Welcome’s 2007 User Summit in Dubai, several banks gave presentations which showed how they were achieving impressive results by enveloping the payment transaction within an overall service that solves real problems for merchants (like identifying and attracting infrequent customers and encouraging them to spend more, which is a really big problem). These banks are already involved in real-world implementations of the ideas promoted by Deloitte in the online space.

Deloitte describes “search-to-purchase” as a new business model which views the entire shopping experience as a continuum from the first search through to the final purchase. Payment is only a small part of the overall experience (see the PaymentsNews post, “Is the Retail Payments Industry Headed for Disruption?”).

“Merchants consistently told us that their biggest commerce challenge, one for which they would gladly pay, is finding new customers. Innovations by search-to-purchase players are solving this valuable job. An unintended consequence of those innovations is an increasing merchant perception that the convenience of retail payments at point-of-sale is no longer a “hard” or valuable job—consequently, the merchants would apply pressure to pay. By contrast, merchants equate the costs associated with search-based advertising with that of a commission-based salesperson—one who works 365 days a year and brings in new customers constantly without ever calling in sick. For that level of closed sales, merchants will gladly pay more commission. Solving this difficult, valuable job is at the heart of search-to-purchase’s disruptive potential.”

“The profit margin for solving the merchants’ commerce problems and delivering new customers and/or closed sales is two to three times that of the payments transaction fee. Data shows merchants will pay between 7-9% for delivery of a sale vs. 2% for merely processing the payment.”

Deloitte provides some interesting advice to traditional payment industry players that want to avoid getting written out of the emerging e-commerce business model.

“The first step in taking advantage of the emergent ecommerce buying model is a change in perspective. The online payment experience must be viewed through a different lens. In order to obtain a larger share of the 7%-9% merchants will pay for a sale, retail payments companies need to make significant adjustments. They must think beyond the transaction itself—they should be asking themselves hard questions and looking at their own business models to see where they have a strategic advantage and how it could be leveraged in the online platform. Retail payments companies should also consider restructuring bank/merchant relationships to help subsidize advertising, further strengthening the bank-merchant relationship and preventing disintermediation.”

Deloitte couldn’t resist some crystal ball gazing. They estimate that online purchases will skyrocket from 9% of retail commerce to more than 30% within just ten years. These figures have always been way off and it is surprising to still see consultants make such bold statements. (On another note, I just read an excellent book that severely discredits MBA and Nobel-prize credentialed experts who make their living from economic forecasting. It’s called The Black Swan, by Nassim Nicholas Talib. After reading the book, you look at things differently. People that make bold economic forecasts begin to appear silly and incompetent).

At best, consultants and analysts can sometimes provide a qualitative glimpse of a potential future. Where they shine the brightest, however, is their analysis of current conditions, and that part of the Deloitte study is quite good. I almost ignored the entire report when I read the 30% forecast, but I stuck with it and am glad I did. Whether online purchases are 9% or 30% of total retail sales doesn’t matter much really, since I am interested in applying the ideas to the much larger market of real-world purchases. Whichever way you look at it, real world purchases will remain much bigger for a long time to come. Let’s fix some real world problems and make payment much more attractive for merchants, so that the 2% they pay in interchange seems like peanuts compared to advertising and promotional marketing budgets.

Actually, come to think of it, we’re just going back to the roots of the payment card industry. When credit cards were first introduced, customers were able to buy things that they might not have bought without a card. Credit card companies were essentially delivering sales to merchants. Somewhere along the line, the culture of solving problems for merchants was lost and the basic payment function became a low value (but expensive) commodity.

Here are a few prior posts on ways that payment cards can be used to help merchants attract and excite occasional customers:

How focusing on acquisition features (rather than loyalty) can lead to better protection of interchange fees

Finally, an ad about new ways to protect interchange!

Gartner: payment schemes need to offer merchants new promotional marketing capabilities at the POS to reduce pressure on interchange

2007 Promo Industry Trends Report: which categories have the greatest potential to help justify interchange fees?

PROMO Magazine has published its latest industry trends report. The survey reveals a blurring of advertising and promotions budgets, meaning that “promotion can no longer be viewed as below the line-a term that used to be an insult on Madison Avenue.” One survey respondent wrote, “Advertising’s down, promotion’s up...it’s getting hectic as they overlap.”

42% of marketers surveyed intended to increase consumer promotion spending this year. Only 7.2% expected to reduce it. Another interesting statistic: over a third of respondents are doing more cross-promotions with outside partners.

Several promotional marketing categories are of special interest to banks looking at tapping into new budget categories to justify interchange fees. In-store advertising alone is a $42 billion industry in the US, around the same amount as total interchange fees paid by merchants last year to accept Visa, MasterCard, American Express and Discover cards. Spending on loyalty programs is still at $2 billion, like last year. That’s the same as sampling ($2 billion) and just a little more than games ($1.8 billion). Direct marketing still tops the charts at $53 billion.

Building promotional marketing features into the payment transaction can go a long way towards justifying interchange fees, even if only a small portion of these budgets get linked to receipt promotions triggered through the use of payment cards. Unfortunately, payment marketing people for the most part only focus on loyalty when they should also be talking about other tactics as well, such as games, sampling, coupons, etc.