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.

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

ONLY 10 MORE DAYS to view this valuable Gartner report for free! Then we have to take it off our server.

Gartner has recently published a report, titled “Banks' Retail Payment Operations at a Tipping Point”, which we found so interesting that we obtained the right for you to view it.

Here are some of the report’s recommendations for banks:

“Introduce PIVAS [Payment Information Value-Added Services] to reduce pricing pressure from merchants and initiate a virtuous circle for retail payment operations. Merchants must actively support card programs and emerging payment solutions, but they are challenging the pricing model for the interchange. It's time to introduce services such as PIVAS to convince them of the real value of bank-sponsored retail payment networks.”

“An EMV-compliant card would store cardholders' shopping patterns on the chip (for example, how many times the cardholder has used a card at a specific retailer or whether the person has shopped at that retailer).”

“As a result, the retailer will have a platform to deliver tailored promotions at the POS that account for its marketing strategy and the activity and preferences of the customer. The promotion or message can be delivered via a POS receipt.”

Click here to view the report now.

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

Gartner has recently published a report, titled “Banks' Retail Payment Operations at a Tipping Point”, which we found so interesting that we obtained the right for you to view it.

Here are some of the report’s recommendations for banks:

“Introduce PIVAS [Payment Information Value-Added Services] to reduce pricing pressure from merchants and initiate a virtuous circle for retail payment operations. Merchants must actively support card programs and emerging payment solutions, but they are challenging the pricing model for the interchange. It's time to introduce services such as PIVAS to convince them of the real value of bank-sponsored retail payment networks.”

“An EMV-compliant card would store cardholders' shopping patterns on the chip (for example, how many times the cardholder has used a card at a specific retailer or whether the person has shopped at that retailer).”

“As a result, the retailer will have a platform to deliver tailored promotions at the POS that account for its marketing strategy and the activity and preferences of the customer. The promotion or message can be delivered via a POS receipt.”

Click here to view the report now.

Contactless in America: Slow adoption due to lack of merchant interest - what to do about it?

After reporting in April that UK merchants are not interested in contactless (see “London Contactless Launch: Where Are The Merchants?”), Card Technology now reports that contactless adoption in the US is slower than anticipated. Here again, the major obstacle is convincing merchants to accept contactless. But how? Slashing interchange? Or instead providing more value to merchants to get them excited about contactless?

“Vendors predict they will ship only about 25 million contactless cards or fobs this year. That’s up modestly from the roughly 20 million contactless cards or tokens vendors sold in 2006.”

“The 25 million contactless cards and fobs likely to be issued this year compares with the roughly 300 million credit, debit and prepaid cards U.S. financial institutions will roll out in 2007, nearly all of them simple magnetic-stripe cards.”

“Of the largest banks, only JPMorgan Chase has begun a significant rollout, although it has only put contactless chips on part of its portfolio.”

Major scheme initiatives like contactless and mobile payments will fail without active merchant participation. This has been evident to many of us for a long time, but now the realization is starting to go mainstream.

“A major obstacle is persuading more merchants to accept contactless.”

“There are 6 million places where you can use your credit card, 45,000 (contactless acceptance locations) doesn’t excite me.” (John Suchanec, senior vice president of payment technology for Bank of America)

“Until you have a better merchant coverage, there’s clearly a problem. It’s coming along. We would just like to see it come at a faster pace.” (Leigh Malnati, vice president for contactless payments at American Express)

“With rules adopted by the payment card organizations allowing U.S. consumers to make low-value purchases without signing receipts, tapping cards or other tokens to pay is not appreciably faster or more convenient than swiping the cards at the point of sale.” (John Suchanec, senior vice president of payment technology for Bank of America)

Visa has already agreed to lower interchange in the UK to encourage merchant acceptance, and the same might happen in the US. Here are a few prior posts on other ways to encourage acceptance, based on providing more value to merchants through new payment features now available thanks to chip technology like contactless and EMV:

Report: Banks Should Mine Data Troves to Build Merchant Loyalty

How contactless payment brands (PayPass, Visa Wave, ExpressPay) can be much more attractive to merchants

How US banks can use contactless to compete more effectively against alternative payment provider Pay By Touch

Cool payment technology that makes contactless much more attractive for merchants

Blueprint for launching new cash replacement products like contactless

What is much more important than speed at the checkout?

Report: Banks Should Mine Data Troves to Build Merchant Loyalty

An article in Digital Transactions News suggests that payment data could be tapped as a valuable and useful resource for merchants, thereby helping to justify the interchange fees that merchants pay to Visa and MasterCard.

“Tens of thousands of terabytes of payment data are lying dormant. The data could help shape programs that would get shoppers who go to a particular store often to shop there even more frequently, and could help merchants cross-market products within the store.”

“Visa USA and MasterCard Worldwide have a potent reason to cooperate with merchants in creating these marketing programs. By harnessing their data, they might have an easier time selling merchants on interchange fees. Retailers feel ‘trapped’ by interchange, since they don’t feel they can stop accepting bank cards and yet also believe they’re not getting full value for the rates they’re paying on each transaction.”

In the past, this has been complicated and expensive, since the data had to be processed, mined, analysed and used at some centralized database type machine. Using the data in that manner also triggers all kinds of privacy issues and even security issues if merchants are allowed to use card numbers to track purchase history.

But today, it is possible to use anonymous data embedded within the payment transaction, stored in new generation payment cards like EMV and contactless chip cards, to instantly trigger offers at the moment of payment. There are no additional costs for the merchant, the bank, the processor or anyone else, since the offer is simply printed at the bottom of the standard credit or debit card receipt. There are no privacy issues, since the merchant doesn’t have access to names, addresses or any other personal information that people get concerned about. And there are no security issues, since the merchant doesn’t need to store card numbers anywhere on the system.

Are US banks thinking about chip technology to fight fraud?

An article in the Boston Globe suggests that rising credit and debit card fraud and identity theft could be causing US financial institutions to move towards the same highly secure chip technology that is being roled out everywhere else.

The article quotes TowerGroup's Managing Director, Ted Iacobuzio, who says there has never been a business case for using chips in the US before, but the business case that's emerging is fraud.

Another reason why US companies are moving toward a more secure card are recent federal guidelines that encourage banks to use biometric factors like fingerprints or voice patterns to improve the security of customers shopping online or using automated teller machines. Chips would be needed for their capacity to store the biometric information.

Nilson Report: Fraud losses are a cost of doing business (i.e. not even a nuissance?)

This is tucked away at the back of June's Nilson Report:

"Fraud losses are a cost of doing business, and that cost remains manageable for credit card issuers in the U.S. As long as fraud doesn’t go up above 7.0¢ per $100 in volume (i.e. 7 basis points), issuers will continue to favor customer convenience over security."

7 basis points is a manageable cost of doing business. It's not even the nuissance I wrote about in my prior post (see Card fraud is a nuisance, interchange erosion is life threatening, where fraud losses are compared to the much bigger problem of interchange erosion of 40, 50 or 60 basis points or more).

How interchange value could slip from banks to third party payment processors

In some countries, like the US, banks abdicated ownership of the payment experience when they sold their merchant acquiring businesses to third parties like First Data. If these third parties were to offer merchants an enhanced payment product that supports merchant-centric features built into the credit and debit card payment transaction, and which merchants find very attractive, convenient and easy to use, we could see a major shift in how merchant fees are split.

Today, approximately 80% of the merchant fee goes to the issuer in the form of interchange and 20% to the processor/acquirer. If interchange gets cut in half, like what happened in Australia, we could see merchants agreeing to pay the same amount for a substantially improved payment product, but with 40% going to the issuer in interchange and 60% to the processor/acquirer. That flip would triple the size of the revenue stream to processors and acquirers. Making the moment of payment more valuable to merchants could be the cornerstone of a major organic growth strategy for companies like First Data.

Why isn't this happening in the US today? One reason is that enhancing the moment of payment is not easy. Nobody really owns the moment of payment anymore. Banks certainly don't. The best they can do is issue contactless cards that emulate magstripe cards. Processors don't either, as their primary focus and interest is on responding to requests for authorization. POS terminal vendors kind of own the moment of payment, but only for limited features that don't need additional data at the moment of payment. Pretty useless. The industry has structured itself in such a way that no single company can do deep payment innvoation anymore. You have to get lots of unrelated companies, and their competitors, into the same room and try to get them to work together. A fantastic way to kill innovation.

So why is this happening in lots of other parts of the world? Unlike banks in the US, banks in virtually every other country are moving or planning to move to EMV chip cards, a key technology that makes it much easier to create new payment product enhancements. Another reason is that Welcome has found a way to engage in deep, end-to-end payments innovation without involving lots of unrelated companies. We established a single payment software development organization over ten years ago that develops software for the full end-to-end solution, the back-end system software, POS terminal software and card software. So deep innovation can be done quickly and efficiently without involving everybody and his uncle.

Today, more and more banks around the world are attracted to this very unique vision. We saw the opportunity many years ago but did not expect it to take so long to get here. Had I known, I would have probably chosen another line of business. Everyone's effort and tenacity (or pathological stubbornness, in my case) is now paying off. Welcome's revenues are growing at 50% per year and our ebitda at 100%. And we are just beginning what we call our "phase 2" development, with a much larger total addressable market than phase 1. But more on that in a future post.

The pains of travelling and paying in a world moving to EMV

Paying abroad is becoming more inconvenient for US cardholders as they travel in a world quickly moving to EMV chip cards.

The explosion in ATM/debit card fraud shows how fraud can move to the US from other parts of the world, like the UK, where card issuers are adopting the more secure EMV chip card standard. Some US banks have responded by putting a temporary hold on all ATM transactions in the UK, leaving some customers stranded. Cardholders are advised to alert their bank when they plan to travel, and to carry multiple cards for multiple accounts and extra travellers’ cheques, just in case. Wow. Blast to the past. Back to the good old days of travellers' cheques and envelopes filled with cash.

US travellers are also being warned that paying in places like Britain could become more of a hassle, since British banks require all local card transactions to be done using new “chip and PIN” cards. Apparently, some merchants are unaware that old style American cards don’t need a chip and can simply be processed the old way, by swiping the card and checking the signature. California's San Jose Mercury News tells customers, "You may have to insist if you want to use your card. "

I remember this happening to me in France almost 15 years ago, after all cards had been converted to chip and I was still using my US issued Visa card. Outside the tourist areas, merchants would sometimes try to insert my card in the chip reader before realizing that it was a foreign card needing to be swiped. Wait, there’s more. Merchants in France have lost the card swipe wrist movement. They often don’t swipe fast enough, or they swipe too fast, or they swipe the side of the card that doesn’t have a magnetic strip. They rub the card on their sleeve then try again. When they can’t get the wrist movement right, most are happy to let me take the terminal and swipe my card through myself.

As US banks invest in contactless cards, which are chip cards after all, it would be really smart (and inexpensive) to put the EMV standard contacts on the front of the cards so they can be used in any EMV terminal anywhere in the world. I don't have the faintest idea why they are not doing this.

The reporter for The Mercury News writes, "I still don't know whether American Express, Diners or MasterCard are also switching to new technology, or whether it has yet spread to other European countries. I also haven't heard whether card companies in the United States plan to adopt the new system, although, given the results in Britain, it certainly sounds like a good idea."

Yes, a good idea indeed.

Another 'Exciting-new-card-versus-boring-old-card' picture

Here is another restaurant in Karachi, also with side by side promotions for UBL and Standard Chartered cardholders, similar to my prior post.

Standard Chartered pretty much followed UBL around all over the place, adding their promotion next to UBL’s.

See my prior post on how the old, traditional card payment system only lets Standard Chartered offer simple, boring, low value promotions, whereas UBL’s new generation chip based payment system allows merchants to offer much more valuable, targeted promotions.

Presentations and soundtracks from last week’s Payments World Asia conference

A number of people wanted an electronic version of my presentations at the Payments World Asia conference last week, in Singapore. Here are the links to both of my talks.

CONTACTLESS:

The first talk was on contactless. Will contactless change the global payments landscape? What is the value proposition for contactless? Is contactless poised for explosive growth in Asia or will this be the next fad? How do contactless cards accelerate the transition from cash to card for small ticket purchases? The contactless presentation is here, and the accompanying soundtrack is here, if you want to get bored hearing my voice drone on and on.

EMV BEST PRACTICES:

I also gave a longer presentation on Friday, during the Frost & Sullivan MasterClass. This presentation addressed best practices for successful EMV implementations that Welcome has learned working with banks around the world. It covered 5 key factors for success and 7 common but critical mistakes. The one hour session is a scaled down version of an introductory three hour marketing strategy session which we have done with a number of banks. The EMV best practices presentation is here, and the accompanying soundtrack is here.

Wan Ling did a fantastic job making sure Welcome had tremendous visibility throughout the conference and the exhibition. Kudos, Ling!

Former Bush adviser arrested in return fraud scheme using credit cards

Retail return fraud, a $16 billion problem almost always linked to credit and debit cards, is back in the news again, with Time Magazine, The Washington Post, The New York Times and dozens of others reporting on a bizarre incident last week.

Claude A. Allen, who until recently was President Bush's top adviser on domestic policy, was arrested and charged with theft following a bizarre incident at a Target store that detectives allege was part of a year-long spree of fraudulent refunds that netted him more than $5,000 in credits to his credit cards. "He would buy items, take them out to his car, and return to the store with the receipt," a police statement said. "He would select the same items he had just purchased, and then return them for a refund."

Return fraud, also known as return abuse or refund fraud, is estimated to cost US retailers $16 billion annually, dwarfing ATM/debit card fraud estimated at $2.75 billion. The problem generated a good bit of media attention last Christmas, during the shopping season.

Banks don’t lose any money from return fraud. It’s the merchant’s problem. But a credit or debit card is almost always involved, so banks can help stop the practice. Why should banks care? Anyone who reads this blog knows that US retailers are angry about paying $27 Billion a year in interchange fees and not getting much for their money. Here is an opportunity to modernize the traditional payment card by providing a solution that helps fight retail return abuse and refund fraud and makes cards more relevant and attractive to merchants. In other words, an opportunity to protect all that interchange revenue.

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.

I’d like to see this work on all cards already issued with XLS, so the cards don’t have to be reissued later, and merchants can simply activate the new feature in their payment terminals when they want to use it.

Prior post:
Returns fraud

Returns fraud

Fraudulent and abusive returns are a major source of losses for retailers around the world, costing US retailers $16 billion annually and dwarfing bankcard fraud estimated at $3 billion. 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 full refund. Returns fraud also occurs when merchandise is stolen and then returned using receipts that may have been forged or found in trash bins. Thieves also “shoplist” at stores by obtaining a receipt, then shoplifting the items listed on the receipt and returning the items for a full refund.

Bank cards are often at the centre of returns fraud schemes. Thieves purchase items using stolen credit or debit cards, and then return them for a refund on another bank card. In other cases, thieves have broken into shops and used the merchant’s payment terminal to refund hundreds of transactions using stolen debit cards, which were then immediately used to withdraw cash at ATM machines.

Some retailers no longer provide refunds at all, and give vouchers or gift cards instead. Other retailers require customers to present a picture ID such as a driver’s license when they return an item, so the clerk can check a database for possible abuse. All of the current approaches are inconvenient, obtrusive or both.

Why not use EMV? Chip cards were designed primarily to combat bankcard fraud but the technology is sufficiently adaptable to support many other features. Why not take advantage of the chip to identify returns fraud and abuse in addition to bankcard fraud? A solution which leverages chip card technology to automatically identify potentially fraudulent or abusive returns, with no need for the cost and effort of operating a database and authorization service, and no need to ask the customer for a picture ID, would benefit banks, merchants and customers. And it would put the banking community in the excellent position of helping retailers solve major, quantifiable problems.

More on returns fraud:

• “Return Fraud and Abuse: How to Protect Profits”, David Spates and Mark Hilinski, Center for Retailing Studies, Texas A&M University, September 2005.
• “Retailers crack down on repeat returners”, Andrea Coombes , MarketWatch, September 28th, 2004.
• “Many Unhappy Returns for Retailers”, Elizabeth Woyke, Business Week Online, August 5th, 2005.