Are some banks already preparing for lower interchange fees?

To get ready for a potentially far less profitable card issuing business, some banks could be preparing to focus more heavily on a business that they have traditionally neglected: acquiring. This is what I have heard recently from several consultants and analysts in Europe, and my upcoming conference presentations will focus on this angle.

With credit margins already under pressure due to fewer revolving customers, and with the threat of reduced interchange becoming more real, issuing profitability might be on the way down. Acquiring has been neglected, even abandoned by many banks, so there might be an opportunity for new strategies. Some banks could offset decreasing profitability and revenues on the issuing side by developing new revenue streams on the acquiring side.

This strategy is especially relevant if interchange gets cut. Merchants will be paying less, so there is an opportunity for the merchant’s acquirer to offer new value added services that are paid with a portion of the money freed up by lower merchant discount fees.

What other ways can a bank deal with interchange risks? An individual bank doesn’t have much of a role to play in protecting interchange, that’s the role of the payment schemes. But a bank can choose Visa, MasterCard and American Express products which have a decent and plausible interchange story attached to them, and stay away from card products which generate higher interchange fees but which don’t offer additional benefits to merchants. It’s those benefits to merchants that make the product valuable to banks.

I am working on a more detailed “how-to” list of things banks can do today to prepare for the risk of lower interchange tomorrow.

China

This post has nothing to do with payments.

I know that some people look at my blog to know where I am. I'm in Haikou this weekend, the capital city of China's only major island, Hainan. Everyone has seen the CNN reports of the earthquake victims here, but in China it's on TV everywhere nonstop. Some people are even feeling a bit superstitious that so many things are happening in China the year of the olympics. You get a real sense of a country developing a shared national identity within a larger world. At least, that's the feeling I've been getting from the under forty generations, the ones that came after what they call the lost generations that had to suffer through the cultural revolution.

What's wrong with this picture?

Here's a hint: the maximum amount for a contactless transaction is $25, anything above that requires a normal card transaction.

Correction:

What I originally wrote in this post is not always true, and it turns out not in Singapore in any case. A friend of mine says this about the picture:

"The picture is of the UOB reader in Singapore. Visa payWave cards are accepted on payWave interface for any amount. I have bought curry puff at S$1.50 and coffee at S$4.00 using payWave. Also, Visa payWave limit in Singapore is S$ 100 much above the S$ 25 (I assume you meant S$ and not US$) you mention in your blog. So I think the blog is misleading... "

The problem is that sign, which is confusing. Part of the growing pains of getting merchants to correctly promote contactless, I guess.

“What have you done for me lately?” (Part 2)

(Part 1 is here)

Last week the Boston Globe ran an op-ed piece titled “Leave the ‘plastic’ alone”, essentially saying that merchants should stop complaining about the cost of interchange because payment systems today are so much better than they were 40 years ago. This is a really poor way to protect interchange.

The old days were indeed a big hassle for merchants:

“First, the customer's account number had to be checked against the latest bulletin of stolen-card numbers mailed by the credit-card companies. For purchases above a certain amount, the company had to be called for authorization. If the charge was authorized, a confirmation number was provided, which had to be recorded; the card was then run through the manual imprinter (ka-CHUNK), and the charge slip filled out and presented for the customer's signature. Finally the slip's three copies had to be separated, with one carefully saved for eventual deposit in the bank.”

A Boston Globe reader added these comments to the article:

“Imagine 1960. A hypothetical meeting of owners and CEOs representing millions of businesses is held. A payment option is announced that is faster, improves productivity, and enables virtually all store shoppers to become buyers - and to buy more and more often - with no merchant credit risk. Gasps are heard when the audience is told that 1 billion consumers worldwide could also make a purchase by mail or telephone. The cost: just a 2 percent discount to the face value of any sale. No reasonable mind could doubt that all in attendance at that hypothetical gathering would have jumped at this prospect, and would have seen the cost for acceptance as a bargain.”

The payments industry is definitely much better today, but so are lots of other information based industries, and their costs have all gone down in relation to volume, speed, capacity, etc. Taking this line of reasoning, going back in time a whopping 40 years, can only backfire on the payments industry. The hassles described in the op-ed piece were solved a quarter century ago when electronic payment terminals became widely available. That was the big jump, the big improvement, the WOW! that got lots of merchants excited about accepting cards. Since then, merchants spend much more on payment and have clearly not seen any real improvements substantial enough to increase the value of card acceptance. Otherwise, the Boston Globe article would be focusing on those more recent improvements and the more recent problems that have been addressed.

The op-ed piece concludes with this:

“But Visa and MasterCard are hardly monopolies, and merchants are not without other options. No one is forced to accept Visa and MasterCard; retailers are free to take only American Express or Discover, which operate on a different model and don't charge interchange fees. Online vendors have even more choices, such as PayPal or Google Checkout. And, of course, there are the old standbys: cash and checks.”

Right. So it’s like, if you don’t like my fees, stop accepting my cards. All or nothing. Take it or leave it. (The comment on American Express and Discover is revealing too - both companies do indeed charge merchants a fee for each transaction, which, from any merchant's perspective, are completely identical to interchange fees).

This is not helpful. The payments industry needs more positive and constructive people who are customer (i.e. merchant) focused and who can promote new value creation instead of all this stuff.

We certainly don’t need regulators setting interchange rates like they did in Australia, but with these arguments we’re just showing them that the industry is happy enough offering essentially the same value as a quarter century ago, for much more money.

Will merchants pass interchange fee reductions on to consumers?

This thought just popped into my mind when I read an article yesterday on Payments News, titled Consumers' Card Rewards Could Be Cut By Interchange Legislation. Scott Loftesness writes, "While merchants are saying that any interchange fee reductions would be passed along to consumers through lower prices, many in the industry say that is unlikely to be the case - and point to the lack of price reductions following action taken by the Reserve Bank of Australia that cut interchange fees significantly in that country."

If merchants pass along reductions to consumers, then their margins would be the same - so why all the cost and effort of lobbying the government to cut interchange? It doesn't make sense. Of course they will keep the savings.

"What have you done for me lately?" (Part 1)

The weather was gorgeous in Aix en Provence this weekend. I browsed through the antiques market on Cours Mirabeau on Sunday, where I found a few old magazine advertisements for banking products (what a geek, right???)


There was a bit of synchronicity involved here. I had just read an op-ed piece by a banker reminding merchants of the old carbon imprint machine days, and how merchants should be happy about today's electronic systems and stop complaining about the cost of interchange. Some of the comments left by others also described the payments world of the 1960's. Then, browsing through the market, I run into these old ads! I had to buy them. I hope you enjoy the ads here. I'll address the folly of bankers living in the past in the next post.



This Crédit Lyonnais ad is from 1960. You could go to any of the 1600 Crédit Lyonnais branches across France and withdraw money simply by showing your checkbook and an ID. Very convenient for the time!









Carte Bleue is a payment card association that came even before the associations which eventually became known as Visa and MasterCard. This 1969 ad shows how the card makes things even more convenient, since you no longer have to present a checkbook and an ID to withdraw cash. Plus, you could use it to pay at 40,000 merchant locations across France. All just by signing. The ad is filled with lots of little things that give an idea of life in the 1960's, including one that surprised me. When you got your card, you were also given a directory of merchants that accept it.






By 1982, Carte Bleue had partnered with Visa and the card offered essentially all the features that we are familiar with today. This ad is now over a quarter century old.









As the song goes, "What have you done for me lately?"

That's part of what merchants are saying today when they complain about interchange fees.

Has interchange regulation in Australia redistributed wealth in favour of merchants?

Mandated reductions in interchange fees in Australia were supposed to cause retail prices to drop, directly benefiting consumers. The whole idea is that interchange is a “hidden fee” that retailers bundle into their prices, and that a reduction in fees charged to merchants would benefit customers. Sounds like basic, logical thinking that you would find in a high school economics and civics class, doesn’t it? As it turns out, the regulatory experiment resembles a high school lab experiment gone wrong.

Here’s another report, this one by CRA INTERNATIONAL (summary, detailed report) that shows how mandated reductions in interchange fees have had the opposite effect of those that regulators were expecting. Retail prices are not lower. Instead, merchants enjoy stronger margins thanks to the lower cost of accepting cards. To make matters worse, banks have pretty much recovered their lost revenue by charging higher cardholder fees and cutting investments in payment innovation. Customers are the losers in this messy experiment.

Robert Stillman, Vice President of CRA INTERNATIONAL, writes, “We believe that the RBA’s intervention has redistributed wealth. There is no evidence that the undeniable losses to consumers from higher cardholder fees and reduced card benefits have been offset by reductions in retail prices or improvements in the quality of retail service. The RBA’s intervention has redistributed wealth in favour of merchants.”

The worse thing about this is that European Commission watchdog Neelie Kroes sees the Australian experiment as a success and wants to reproduce it in Europe. This makes me feel more and more that regulators are simply reacting to pressure from retail lobbyists, cloaking their decisions in some vague benefit to customers (and in Europe, some vague need to create a European payment scheme to compete with US brands Visa and MasterCard). I can’t for the life of me see why any regulator would possibly be doing this if they were not primarily interested in helping retailers improve their margins. What a mess.

At the same time, I can understand how merchants feel powerless as they see interchange fees imposed upon them with no ability to negotiate. “You don’t like our fees? Then stop accepting our cards.” That’s not the right answer. The irony is that a viable solution already exists in a growing number of countries. Leaving fees unregulated, but giving merchants the ability 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 more value for their money.

This solution is echoed in a Wall Street Journal article by economist Leo Van Hove, titled “Regulating in the Dark”. Mr. Van Hove first tears apart the arguments for interchange regulation put forth by the European Commission, then offers the following conclusion:

“So if regulating one payment instrument can have unintended repercussions on substitutes, and a prohibition of interchange fees would be a leap in the dark, what are enlightened policy makers to do? They could simply try to ensure that market forces work, and in particular that merchants cannot be locked in by card networks. To that end, retailers should be allowed to ‘surcharge’ and pass on interchange fees to consumers. Promoting competition among card networks as well as among various payment instruments should also be high on regulators’ lists. More generally, we need policy makers who have a comprehensive vision of the future of our payment system – and who have the political courage to make cash more expensive in order to lower its cost to society.”

Here is a link to my prior post on why an unregulated interchange model is crucial to fostering competition between payment schemes, where I describe several ways in which payment schemes can innovate and create valuable new features and services for merchants.

Interview: Card loyalty and rewards trends

Recently, two payments journalists in two separate interviews asked me similar questions on trends in card loyalty and rewards programs. Here is a paraphrase of some of the questions, along with my answers.

“Card rewards programs appear in Europe to be merchant based whereas in the US the bank funds the rewards directly. Why do programs work so differently between the US and Europe?”

In fact, most banks in Europe also offer bank-funded points and cash back rewards, just like US banks. The difference in some programs comes from a structural difference between how banks in other parts of the world are organized. Outside the US, you can frequently find large national banks that are big in card issuing and big in merchant acquiring at the same time. For example, in the UK, three banks dominate the acquiring market, RBS, Barclaycard and Lloyds. These three banks are also very large card issuers. Banks that are involved in both issuing and acquiring can leverage their organizational structure to develop deeper relationships with merchants and create more value for their card programs. US banks do not have huge market share in acquiring, and thus have more trouble developing such relationships with merchants.

“What is the goal of banks working with Welcome?”

Many banks use Welcome’s technology to enhance their loyalty and rewards programs, through a combination of bank-funded points or cash back as well as merchant promotions delivered only on the bank’s cards, i.e. “on us” transactions. In this context, the promotions are seen by merchants as an extension to the bank’s loyalty or rewards program.

Welcome is now beginning to provide the acquirer division within banks the ability to offer promotions on all cards, not as an extension to the bank’s loyalty program, but instead as a value added service that can be charged to merchants in the same category as other promotional marketing services that the merchant pays for.

A bank’s acquiring division could use our software purely for “on us” transactions, or could also explore a combined approach, for example by providing merchants the ability to offer promotions on all cards, at a fee per targeted message/promotion, yet privileging the bank’s cards by making the promotional fee on those cards free. The objective in this case is to satisfy the merchant’s need to target the largest number of customers, while also getting the merchant to encourage customers to use the bank’s card more. We can explore many different combinations of business models.

“Are points programs thriving, or are they on the contrary doomed to disappear?”

It often seems that every bank has a points programs, and that they are all absolutely identical. Add to that the growing pressure around the world on interchange, and it is easy to understand that points and cash back programs have clearly reached the point that they have to evolve into something new and different.

Banks have two ways of looking at the cost issue, essentially by asking themselves one of two very different questions. Some banks seem to be asking, “How do I reduce the cost of my loyalty program and get merchants and other partners to fund part of that cost?” Other banks are beginning to look deeper at the original objectives of loyalty programs, objectives that can sometimes be achieved through other means than traditional loyalty points or cash back.

For example, if the bank is trying to establish stickiness and encourage usage, perhaps this can be achieved by adding a contactless feature in partnership with the local transit system. Barclaycard is doing this in London with the London underground. Of course, the feature won’t help Barclays outside London, but for London cardholders, having a single card to get in and out of the underground could prove to be stickier and more “loyalty generating” than what we normally think of as loyalty when we focus too specifically on techniques like points and cash back.

Another example is through merchant promotions, where merchants can leverage all card transactions to offer instant promotions based on prior usage, right on the credit or debit card receipt, for a fee, whereas doing the same thing on the cards from a specific bank or even a specific payment scheme is free to the merchant. This would clearly give the merchant an incentive to put signs in the store encouraging customers to use that bank’s or scheme’s cards, and offer some promotions specifically to encourage usage of those cards. Tie in a lower interchange rate on those cards, and the merchant will get even more excited!

“Could coalition loyalty programs be the answer to get merchants to fund more costs?”

Coalition loyalty has been around for many years, yet I have only seen two countries, Canada and the UK, where these programs work on a decent scale. Both of these countries have similar retail market structures. In both the UK and Canada, customers can choose between two or three major food retailers, two or three major petrol retailers, two or three major multi-category department stores, and so on. A coalition program that combines one retailer in each category can be a viable proposition to customers, since most customers are likely to shop at each of those retailers anyway. But in most other countries, where the choice of retailers is larger, a coalition loyalty program will inevitably leave out several key retailers that a customer prefers to shop at. So you haven’t seen successful coalition loyalty programs take off on a big scale across the world, in spite of the fact that they have been around for many years.

Candidates for "Best innovation in a loyalty programme" use XLS

I just noticed that two of Welcome's customers have been shortlisted for this year's Cards International Global Awards. Of the four banks that are shortlisted in the category Best innovation in a loyalty programme, two use Welcome's XLS software.

Bank of the Philippine Islands - BPI Express Credit Real Thrills

Kasikornbank Smart Shopping Programme

Congratulations to both for being shortlisted!