Free payment processing

Google has been offering free payment processing to Internet merchants since they launched Google Checkout almost two years ago. Merchants get free credit and debit card processing when they also use Google Adwords, a direct marketing service that displays paying advertiser’s names alongside search results. Could a marketing subsidized payment processing model work for physical face-to-face transactions as well? Could an acquirer offer free payment processing? Not just cheap and very low margin services (where they’re headed to already, due to pressure on acquirer fees and interchange litigation around the world) but free, gratis, without charge.

Wired Magazine’s cover story this month is titled Free! Why $0.00 is the future of business. “A decade and a half into the great online experiment, the last debates over free versus pay online are ending,” writes editor-in-chief Chris Anderson. “In 2007 The New York Times went free; this year, so will much of The Wall Street Journal. Once a marketing gimmick, free has emerged as a full-fledged economy. Offering free music proved successful for Radiohead, Trent Reznor of Nine Inch Nails, and a swarm of other bands on MySpace that grasped the audience-building merits of zero. The fastest-growing parts of the gaming industry are ad-supported casual games online and free-to-try massively multiplayer online games. Virtually everything Google does is free to consumers, from Gmail to Picasa to GOOG-411.”

The article has a good bit of the hyperbola typical of Wired, but it is nevertheless an interesting piece on how the practice of shifting the cost of one thing on to another (i.e. cross-subsidies) has matured at the same time that unit costs of technology continue dropping rapidly. It pretty much comes down to giving things away in exchange for advertising and marketing revenue. That’s echoed by Kevin Kelly, another Internet guru who has also written about the economics of free: “Ads are widely regarded as the solution, almost the ONLY solution, to the paradox of the free. Most of the suggested solutions I've seen for overcoming the free involve some measure of advertising.”

Readers of my blog have heard me rant ad nauseum about making payment more valuable for merchants so that we can slow down commoditization and protect payment fees, including interchange. Is my angle all wrong? I’m wondering now if there is not a more powerful way to accomplish the same thing, but from a very different angle. Instead of resisting downward pressure on payment fees, why not learn from Google and speed the process along? Why not eliminate the fees and make money instead through marketing and advertising services built into the payment transaction? At first glance, this may be impossible for many acquirers to imagine, but when you look a bit deeper at how Google does it, the idea is not so far fetched and the financials work out to the acquirer’s advantage. Which is of course why Google is doing this.

How does Google’s free payment processing model work? For every dollar merchants spend advertising on Google each month, they can process ten dollars in sales the following month for free. Merchants normally pay around twenty-five cents to process ten dollars of sales, so merchants are in effect getting a twenty-five cent discount on ever dollar spent on Google Adwords. Google hopes that by being a trusted intermediary, they can reduce the number of purchase transactions that are abandoned when customers are uncomfortable giving up their credit card information to a merchant. In turn, this would result in more shoppers buying from Google’s AdWords clients and more merchants spending marketing dollars on AdWords.

A Deloitte study shows how Google views the entire shopping experience as a continuum from the first search through to the final purchase, which enables Google to envelop the payment transaction within the shopping context. “Because search-to-purchase firms make their money primarily from merchant advertising fees, rather than on transactions, the potential profits are much greater. 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.”

How would this look in the physical world? Imagine an acquirer offering merchants the following, “For every dollar you spend delivering targeted promotions when a credit or debit card is used in your stores, you can enjoy free processing on ten dollars in sales.” Let’s look at the impact on the acquirer’s margins. Take the same one-dollar paid by the merchant for targeted marketing services, and the same twenty-five cents of processing fees waived on a ten-dollar transaction. In this scenario, the acquirer earns seventy-five cents on that ten-dollar transaction instead of twenty-five. Three times more revenue. Since normal acquiring fees are primarily made up of interchange that goes to the issuing bank, the impact on net margins is much higher. Some of the numbers I’ve been playing with show that an acquirer’s net margins can be five to eight times greater with free payment processing. So this model is even more lucrative for a traditional acquirer working with mainstream physical merchants than it is for Google with Internet merchants.

Things are not all rosy for Google Checkout. Small merchants might not worry a whole lot about letting Google manage the relationship with their customers, but large Internet merchants like Amazon.com and eBay want to have a direct relationship with customers and don’t want Google in the middle (to complicate matters, eBay is a key Google advertising account, yet refuses to offer Google Checkout, preferring instead its own competing payment service, PayPal). Acquirer banks don’t face these challenges in the physical space, where merchants almost never know the customer anyway, unless a loyalty card is used. The whole disintermediation issue is avoided.

One big challenge that acquirers do face is the ability to think differently and to position themselves in the marketing world. Most acquirers are tired of playing in a low margin, commoditized market and many have successfully added new services that generate more profitable revenues from merchants. So they are already going in this direction. It could be a matter of time before an acquirer decides that it would be better to provide payment processing services for free and make money elsewhere, rather than competing with cheaper and cheaper providers.

“There is a huge difference between cheap and free,” Says Wired’s Chris Anderson. “Give a product away and it can go viral. Charge a single cent for it and you're in an entirely different business, one of clawing and scratching for every customer.”

Hmm. Clawing and scratching for every customer. Sounds like today’s payment processing world.

Google seems to want to move into the physical world too, starting with Google Maps on petrol pumps that provide drivers information on hotels, restaurants and other local merchants, plus coupons to get you to go to those merchants. Will Google want to close the loop with a free payment service for those physical merchants? (play scary movie music here)

Contactless has a much bigger foe than security: apathy

Retailers are very pragmatic people. If something makes sense, works well and solves real problems, they’ll adopt it. Otherwise, no chance. While the banking community hypes up contactless cards and mobile payments, retailers are saying something different.

Evan Schuman of StorefrontBacktalk writes about the problems he ran into when he tried using his contactless card:

“Taking some cabs in New York City this month, I was thrilled to see the contactless devices in the backseat, only to be told by three different cabbies to not use them because customers were complaining about getting double-billed.

Cynically, I thought, maybe the cabbies have some financial incentive to poo-poo the wireless cards.

This week, visiting three different grocery chains in New Jersey, tried unsuccessfully to use my contactless card there. The first time, a cashier looked at me as I asked about using my contactless card.

"It never works," she said. In what way? "It will take the card and then tell you that the card's been declined. But if you then slide it (magstripe scan), it will instantly go through." Showing kinship with Iowans, I tried it. Sure enough, it errored in the exact way the cashier had described.

I deliberately tried the same effort at two other chains, discovering the same problem, with cashiers and managers telling me that it's common.”

Right now, contactless doesn’t solve significant problems for retailers. It’s not addressing meaningful pains. Without that, retailers won’t get excited.

“Contactless has a much bigger foe than antennae-equipped cyberthieves or malfunctioning POS interfaces,” writes Evan Schuman. “Apathy.”

Goat traders pioneer mobile payments and banking

From CNN.

Uncovering the hidden value in interchange fees

OK, I know that’s a provocative title, but bear with me.

My last post showed how printing targeted promotions at the bottom of POS receipts costs merchants a few cents per impression versus close to a dollar for traditional direct marketing campaigns. The customer checking out right now hasn’t been here in over a month? Print a special offer to encourage him to come back in the next few days. Try doing that with direct mail. And imagine how much it would cost.

Substantial savings are possible because of hidden value in the payment transaction, or in other words, hidden value within the interchange fees paid by merchants.

Let’s take a hypothetical fast food chain, convenience store chain and supermarket chain, with average transactions of $7, $20 and $30. These retailers are probably paying average interchange fees per transaction of 25¢, 60¢ and 80¢ respectively. Merchants think of the fees as a “hidden tax”, and they compare them with utilities like electricity, water and gas. Banks need to focus much more on the marketing value of their services, and get merchants to see payment as another marketing and advertising channel rather than simply a tax or utility.

But it might be too late for this to help protect interchange. Banks too often see interchange as purely a legal issue. The industry as a whole is not moving fast enough to build new value linked to those fees. It’s possible that interchange will continue getting clobbered all over the world, and cut to a fraction of current rates. In their place, new fees will arise for the marketing features that some of the more nimble banks will add to their merchant services offerings. In other words, the financial value hidden within the payment system would shift from issuers to acquirers. Now that would be revenge for the banks that went against conventional wisdom and kept their acquirer activities over the past decade, wouldn’t it?

How much will merchants spend on payment information value added services?

PIVAS – Payment Information Value Added Services: A platform that lets retailers deliver targeted promotions at the POS, via credit or debit card receipts (lots more here).

A few of my prior blog posts provide some insight into the value of marketing rich payment services, mainly at a macro level. For example, there’s the Deloitte study that shows that merchants will pay 7-9% for a full payment service which delivers sales, versus 2% interchange for payment alone. Also, we know that several promotional marketing tactics frequently used by merchants (direct marketing, in-store advertising, couponing, games, sampling…) represent a combined industry of over $100 billion in the US alone.

Another angle is to look at the cost to an individual merchant of delivering printed promotions, special deals or messages to customers. I’ve pulled a few examples from a Morgan Stanley report. See other examples here, here and here. Costs are generally stated in CPM, or cost per thousand, but I have stated them in costs per individual impression.

Mass distribution methods generally cost advertisers a few cents per impression. This includes newspaper advertisements (2¢ per impression), free standing inserts, i.e. coupons in the Sunday paper (less than 1¢), shared direct mail methods such as coupon books (4¢). But how about targeted communications?

For most retailers, the only way to target distribution is through direct marketing, database rentals and postal mailings. At 90¢ per impression or more, most merchants have to use targeted distribution channels very sparingly, especially in low value sectors like quick service restaurants, supermarkets, convenience stores and petrol stations.

Printing targeted promotions at the bottom of POS receipts is obviously much less expensive. It can help merchants see more value in bank owned payment networks. And it can help attract new revenue streams to banks (as I was writing this piece, I received a report that merchants are paying one of Welcome’s bank customers 5¢ to 30¢ per transaction - plus the normal campaign management and setup fees ranging from thousands of euros per year to tens of thousands … but that’s another story for another blog post).

There is another, similar, POS based distribution method, Catalina Marketing’s checkout coupon service, which I didn’t mention earlier because it is almost exclusively paid by consumer goods manufacturers and limited to supermarkets. Companies like Procter & Gamble pay around 7.5¢ per printed impression, and even more when offering a coupon to buyers of the competitor’s product.

More companies are adopting an interchange based ROI sales pitch

This company has developed an interesting interchange based ROI story for banks. Here’s the pitch:

“Bill Pay Solution Enables Card Issuing Financial Institutions to Earn $150 Per Consumer Per Year in New Interchange Revenue”

(PaymentsNews recently reported on the company, Yodlee, and their press release.)

I find this interesting because it is so direct and in your face. Who wouldn’t want to earn more interchange revenue without doing much more than linking to this vendor’s service?

I wrote last year about an ad that Welcome did on protecting interchange, and I mentioned that it was just a matter of time before other companies took a similar approach. I also expect that we will be seeing ads from companies taking the reverse angle, targeting merchants, processors and ISO's and showing how to cut costs by reducing interchange fees.

Acquiring margins are squeezed, yet profits are up – what’s the story?

The average interchange rate in the US has increased by 22% in ten years, yet total actual fees charged to merchants, including interchange, have only increased by 11% (see Aite Group report, An Acquiring Paradox: Discounts Are Squeezed, But Spreads Are up). Acquirers appear to have swallowed a large portion of the increased interchange by lowering their own transaction fees, presumably in response to merchant pressure. It’s tough being on the front lines.

“Back in 1995, the average discount rate, or the charge to merchants for card processing as a percent of the sale, was 1.87%, with 1.4% for interchange and 0.47% for the acquirer. Interchange is a component of gross revenue that acquirers must pass on to card issuers, so the acquirers’ share of discount revenue was 25.1%. In 2004, the average discount rate was 2.08%, with interchange accounting for 1.71% and acquirers’ revenues 0.37%. That means the acquirers’ share was 17.8% of discount revenue.”

Why have acquirers agreed to this? Do they enjoy being squeezed? Obviously not. Some have managed to work their way around the problem. The Aite report points out that some acquirers have compensated by adding administrative fees, application fees, statement fees, and lots of miscellaneous fees. So merchants now pay for things that used to be free, or rather were implicitly included in the acquirer’s transaction fees.

As interchange gets challenged and cut around the world, acquirers may have more room to breathe and may be able to further develop services to merchants, for additional fee revenue of course. When interchange goes down dramatically, some merchants could be willing to spend more on other services provided by an acquirer. These merchants would be spending less overall than they were in the past with full interchange, yet they would be getting more value out of electronic payments. Basically, they could be enjoying lots of new services for free. In this scenario, the value would come from acquirers, not issuers, and would be reflected in the acquirer’s portion of revenues, not interchange.

Here’s a wild idea. Imagine that an acquirer provides a new service that helps merchants encourage customers to use their debit cards rather than mileage heavy credit cards. An automated steering feature. Merchants benefit by cutting the overall cost of payment processing, since there would be fewer high interchange transactions. The cut in costs could more than justify merchants paying an additional fee for the acquirer’s service.

“Waiving the signature for transactions under $25 just torpedoes contactless.”

Two recent articles highlight the critical problems that contactless faces, which I’ve written about many times over the past couple of years. Now that the problems seem to be widely understood, I find myself writing much less about contactless and NFC payments. What in the world am I going to complain about now?

The Charlotte Observer writes about Visa and MasterCard’s no-signature policy which lets customers swipe their credit cards for purchases under $25 without signing the customary receipt (see You don't need to sign it, sir! Credit-card companies want swipes for small purchases, too).

“Visa and MasterCard tout its convenience, calling it a win-win for retailers and consumers. But the card companies hope it will be a win for themselves, too, as they seek to extend their reach in places like toll booths, taxicabs and car washes.”

In another recent piece, research firm Aite Group says that interchange fee discounts are needed to get merchants excited about contactless, since they’re not excited about any of the other benefits (see Merchants Need Interchange Breaks to Adopt Contactless).

“Most merchants don’t see enough benefit in the speed of throughput offered by contactless technology. Contactless transactions are faster even than cash, according to card-network studies, but may not be fast enough to offer a tangible advantage over simply forgoing a signature and swiping a card. Bank card network rules allow stores in certain merchant categories to process transactions without a signature for payments under $25, the transactions contactless technology is aimed at.”

Contactless has always been positioned on one single merchant benefit: speed. So waiving the signature for transactions under $25 just kills contactless.

The technology can do lots more of course, but has never been positioned in any other way.