Eight predictions on the impact of SEPA

First Data's John Chaplin, speaking at the Digital Money Forum in London, makes eight predictions on the impact of SEPA. Before I go through the predictions, I want to first say that the arguments were quite intelligent and persuasive. I found myself analyzing each prediction as John made his argument, then switched and began analyzing why John, as a First Data executive, would be making the prediction. You really can look at each of these predictions on both levels, as a general idea, and then why the prediction is important to First Data.

1 - Every part of the cards business will change. Some banks feel that they won't be impacted by SEPA, or that they are already "SEPA compliant". John's advice: "Think again."

2 - Interchange will survive but at a much reduced level in many markets. Most markets will likely evolve towards the French market, where merchants pay low interchange fees on debit, and consumers pay an annual fee of around 30 Euros.

3 - Many national payment schemes will disappear and MasterCard and Visa will become even more powerful brands.

4 - At least one European debit card brand will emerge and will take at least 15% of the market within 5 years.

5 - Many national processing companies will become uneconomic and cease to exist in their current form. "30 companies doing inter-bank processing in Europe cannot last. Lots of these national processing infrastructures are going to disappear."

6 - Card schemes providing processing will be forced to change and will have to chose what they want to be.

7 - Increased regulatory intervention will happen, as self regulation will not deliver results fast enough. Does anyone really believe that if you are a monopoly in Greece or wherever, that you will happily open up to other networks, processors and brands if you are not forced to?

8 - Large banks and some non-banks will aggressively exploit SEPA freedoms and opportunities.

John throws in two jokers that could disrupt all of these predictions:

1st joker - The European Commission abolishes interchange. The EC is already very angry with MasterCard and could just go ballistic with all interchange models and simply abolish the practice.

2nd joker - Rapid convergence of debit card and ACH processing. These are managed separately today, but they could conceivable converge, and bring about disruptive change.

Where is SEPA taking us? Will there be a third debit card scheme in Europe?

Charles Bryant, of the EBA got this question from the floor at today's Digital Money Forum: "Will there be a third debit card scheme in Europe?"

Answer: "My gut feel is that yes, there will be. It will be a simple debit card, with an acceptance brand, and will combine all of the national brands that exist today. But everything is frozen right now, due to things like interchange uncertainties, the current economic climate, and so forth. The jury's still out, but my gut feel is that yes, there will be a European debit scheme."

The idea of a European debit scheme competing with Visa and MasterCard is a very emotional subject, and the comments here kind of highlight that. At a gut level, yes, many Europeans would like to see such a scheme. But on a cold, pragmatic, business level, it is harder to see how to justify such a brand. What pain would a third brand address? Whose pain would that be? This is not clear to me at all.

A solution to the interchange dilemma

Speaking in London at the Digital Money Forum, Leo van Hove suggests that the only solution to the interchange problem is to raise the price of cash to match its cost, for example through an ATM charge. The dilemma is that no single bank will move first, and banks are not allowed to organize an industry-wide move. The solution proposed by van Hove is for competition authorities to allow banks to move together.

The idea makes tremendous logical sense, but I seriously doubt that any European government would make a move like this that would clearly be designed to make business easier for Visa and MasterCard.

Leo van Hove wrote a very good paper on the European Commission's decision against interchange, published in the Wall Street Journal.

E-Finance & Payments Law & Policy newsletter

The latest issue of the E-Finance & Payments Law & Policy newsletter (subscription required) includes an article titled “Protecting interchange fees through marketing solutions”. It is based on several of my recent blog posts, with additional information on privacy issues.

Here is their summary:

"The key to protecting interchange fees from over regulation is proving their value to merchants, argues Aneace Haddad, chairman of Welcome Real-time. Haddad's company has developed a product that allows merchants to use data stored inside payment cards to deliver targeted promotions to customers at point-of-sale. Haddad explains how solving a problem for merchants, such as marketing, could lead to acceptance of interchange fees as a useful component in the payments environment."

My original paper is available here.

Protecting interchange fees through marketing solutions

The following text is a combination of several recent blog posts, expanded with additional information on privacy issues. It was published in the latest issue of the E-Finance & Payments Law & Policy newsletter.

--

Working with banks and payment schemes across the globe, Welcome has developed a new card applet for payment schemes, called SPICED, which makes it possible for merchants to deliver targeted promotions at the bottom of credit or debit card receipts. SPICED is designed to make payment scheme brands more attractive and useful to merchants, so that brand acceptance and usage are encouraged and pressure on interchange fees is reduced. When a payment brand offers valuable features to merchants, there is a higher chance that merchants will encourage customers to use that brand over others, interchange fees are easier to justify, and the brand becomes more attractive to banks keen on receiving more interchange.

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 fees it would continue to assess the legality of current fee levels. The solution usually evoked consists of some form of leveling 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 the level of 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 fees and, in consequence, the ability to attract banks.

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 key is to focus on leveraging payment data to help merchants solve major problems. SPICED accomplishes this by helping 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). Retailers spend tens of billions of dollars each year on tactics such as direct mail, premiums and incentives, retail in-store promotions, couponing, loyalty marketing, games and sampling. These can be made more effective by leveraging customer behavior data. But obtaining that data is difficult and costly and, in addition, existing techniques that rely on sending offers by mail require customers to provide personal details that many prefer not to divulge.

When a payment scheme is SPICED, merchants can use data stored inside the cards to deliver targeted messages and promotional offers at the POS, at very low cost. For example, a coffee chain can recognize an infrequent customer that has not been to the chain in over 30 days, and print an offer at the bottom of the card receipt encouraging the customer to come back soon. Alternatively, 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.

It is difficult and expensive for merchants to achieve similar results through 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 card receipt. There is no need for merchants to operate a separate database, perform complicated and sensitive integration with bank systems, or use equipment other than traditional payment terminals. Merchants simply accept payment brands with the SPICED applet built-in and ask their acquirer to set up the campaigns of their choice. Also, since the data available at the moment of payment is anonymous and non-sensitive, payment schemes can avoid the privacy and security issues which occur when payment data is used for direct marketing purposes.

There are three major drawbacks with offers sent by mail:

1 - Cost. Offers sent by mail must be printed then inserted into envelopes, often bank statements. In contrast, an offer at the bottom of a card receipt adds a few centimetres of paper and is otherwise free.

2 - Privacy. Imagine finding an offer from Carrefour in your bank statement, which you receive at home several weeks after you last went to Carrefour. You probably understand that your bank is tracking your buying habits and is encouraging you to go to Carrefour, a retailer that you perhaps don’t often shop at. Did privacy warning bells just go off? Compare that to receiving the offer on your debit card receipt while paying at Carrefour. The effect is completely different.

3 - Contextual relevance. When you receive an offer by mail, there are chances that it won’t go into your wallet since you are examining your mail, not your wallet. When you receive it at the POS, your wallet is open, waiting for your card to go back in. The probability of keeping the offer is much higher.

Promotional marketing is one area in which payment schemes can help merchants. There are others. For example, fraudulent and abusive returns cost US retailers $16 billion annually, much more than bank losses due to card 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 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. 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.

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. The current interchange model, with adjustments for fully market driven fees, is a powerful tool to foster innovation for the benefit of merchants. 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. Some payment brands will manage to create enough value to convince merchants to accept the higher fees without applying surcharges, while others will simply reduce their fees. In practice, customers should see little if any surcharging.

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 and will simply cause the current payment infrastructure to ossify at essentially the present level of functionality. Schemes will put little 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.

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.

Are international card schemes better equipped than domestic schemes to win SEPA market share?

Welcome’s Pierre Boces has published a whitepaper that compares strategies for payment scheme competition on the new SEPA battleground.

“Domestic card schemes have yet to get to grips with the challenges that they are likely to face with the SEPA Cards Framework. Still thinking as processors, they remain focused on saving costs for European issuers rather than offering value-added services and innovation.

“Meanwhile, international card schemes are mastering the subtleties of interchange pricing models and have launched a multitude of products worldwide. They appear better equipped to offer payment products to European issuers that will increase revenues through higher interchange.”

Making MasterCard's Maestro the preferred debit brand in post-SEPA Europe (seminar presentation with audio)

How could a new generation Maestro debit card product, with built-in features that create lots of value for merchants, compete better in the bold, new post-SEPA European market?

This presentation has audio linked in, so it is just as if you were at a conference. Well OK, not quite, because I can't offer you the coffee and fantastic cookies that you usually get. But hey! It's free, and you don't even have to leave home!

I want to do others like this to show how Visa's Vpay debit product might compete in Europe, or how an EAPS product would compete. I also expect to do full audio seminar presentations on contactless products like Visa payWave and MasterCard PayPass, as well as pieces on premium cards. That is, if people are interested enough after this one.

I hope you enjoy this.

National debit scheme fights for its life – is this a preview of SEPA consequences?

Singapore’s NETS debit card scheme issued a response to attacks by the local consumer association a few days ago, explaining why the scheme was forced to adopt the interchange fee model used by Visa and MasterCard. The words used in this press release are quite poignant. Is this the future facing Europe’s national debit card schemes?

“The market has changed considerably in the past 22 years and NETS has to respond to these changes, particularly in the advent of growing competition from international debit cards that provide a more attractive revenue stream to card issuers."

"The reality is that if NETS wants to ensure its future presence, it has no choice but to bite the bullet and re-align its business model to continue operating in a sustainable manner. Should NETS chooses the option of inaction, Singapore retailers would ultimately be left with only a debit payment service run entirely by international card schemes which charge higher rates.

"The Exercise would let NETS continue its mission for the past 22 years – as a homegrown company committed to offering the most competitive cashless payment services to Singapore retailers.”

From NETS perspective, this appears to be a cost management issue, with card issuers demanding more revenue from the scheme, in line with what they would get from Visa and MasterCard. NETS is simply passing the cost on to merchants.

Unfortunately, the payment industry has focused so heavily on costs for so long that it is hard for many people to shift focus and provide substantial new value to merchants. This is also very true for Europe's national debit card monopolies, who could soon be struggling under similar market pressures as NETS.

See the full press release here, and my prior post on the subject here.

Debit card competition forces Singapore’s NETS to increase interchange fees – will SEPA have the same effect in Europe?

Europe’s SEPA debit card initiative is intended to create competition between debit schemes and break up the old national debit card monopolies. Something happening in Singapore right now could give an idea of what might soon happen in Europe.

Currently, Singapore’s national debit scheme, NETS, charges merchants between 0.35 and 0.55 per cent of purchases. Starting next month, this will be increased to 1.5 to 1.8 per cent to bring it closer to Visa and MasterCard debit card fees.

In an article today in The Strait’s Times, Chief executive officer Poh Mui Hoon said NETS will be squeezed out of the market if it does not raise its rates, because banks may no longer issue NETS cards, opting instead for the more lucrative debit cards.

The president of the Consumer’s Association of Singapore is angry: “What happens when other debit and credit cards adjust their fees upward? Will Nets do the same?” (see "Nets fee hike: Case of unfair monopoly?")

I briefly mentioned the NETS fee hike in my earlier blog post, “Will SEPA unleash the genie of spiraling interchange fees?”

The basic payment service has become a commodity. Merchants want to pay as little as possible for it and consumers don’t want to be surcharged. Merchant and consumer associations will fight unilateral price increases, and the authorities in many countries will probably side with them.

At the same time, higher interchange is irresistible to card issuers, who will clearly choose the payment scheme that provides the highest interchange, whenever they have the choice. The schemes need to innovate and create significant value to justify the fees that merchants pay. In the case of NETS, merchants will be paying three or four times more than in the past, so NETS must provide MUCH more value than before. What a bind!

There is a way to solve the problem: the payments data hidden within each transaction is very valuable to merchants if it can be exploited at low cost and without raising privacy concerns. This has become Welcome’s core competency over the years. All of Welcome’s bank customers use our software to make their cards much more valuable for merchants. Until recently, our customers were the (too few) banks that agreed with our vision. Now, increased competition between payment schemes and increased pressure from merchants is causing a larger number of participants to seriously consider adopting the same outlook.

Sources:
Consumer Association of Singapore concerned about impending NETS fee hike

Nets fee hike: Case of unfair monopoly?

Case slams NETS fee hike as a ‘great disservice’ (also see the accompanying video clip)

Nets fee hike means more will use cash, credit cards

Will SEPA unleash the genie of spiraling interchange fees?

EU regulators are encouraging the emergence of multiple regional debit schemes, to the detriment of the national debit monopolies that exist across Europe. Banks will finally be able to choose between multiple debit brands. Not just Maestro and V Pay, but other new regional schemes that are quickly emerging to compete head to head with Visa and MasterCard.

At last week’s Cards and Payments conference in Berlin, a bank executive who was speaking on a panel about SEPA (the EU’s “Single European Payments Area” directives responsible for this increase in competition) mentioned very happily that he would now be able to choose the debit card brand that provides the most profit. He was clearly thrilled with this new competitive environment. Someone in the audience asked if that meant that he would choose the scheme that provides the highest interchange. The bank executive smiled, “As I said, we will choose the scheme that gives us the most profit.”

This new and fundamentally different competitive landscape will be a reality January 1st 2008, the date at which SEPA goes into effect. MasterCard and Visa are ready today with their Maestro and V Pay debit brands. The regulators want more competition, more players, and more schemes. At the conference in Berlin, the European Association of Payment Systems, a consortium of national debit monopolies, announced that they were grouping together to create a regional scheme with its own payment acceptance brand, EAPS. Interestingly, France’s Cartes Bancaires, the biggest of the old guard debit monopolies, showed no interest in joining the consortium and instead seemed to indicate that they wanted their brand to go regional and to compete head to head with Maestro, V Pay and EAPS.

I doubt EU regulators expected SEPA to cause interchange fees to rise, and I got the sense that the national debit monopolies like Cartes Bancaires and the members of EAPS are just now beginning to understand this aspect of payment brand competition. But the potential of rising interchange fees is high. A card will only carry one Euro-wide brand. It has to be Maestro, V Pay or one of the emerging regional brands. And now that banks finally have a choice, it will be irresistible for them to choose the brand that offers the highest interchange. The old European national debit brands have never had to deal with this before. EAPS and Cartes Bancaires will need to learn fast in order to compete with Visa and MasterCard who already have lots of experience using interchange as a major competitive weapon.

I was struck with how people talked about interchange. People from the EAPS consortium, all of them processors, kept referring to low interchange as a major advantage that their scheme would have over Maestro and V Pay. I couldn’t get my head around this until I realized that they were thinking like processors, for whom interchange is a cost of doing business which they need to bundle into their merchant fees. The lower the interchange, the better. They were certainly not thinking like bankers, for whom interchange is a profitable revenue stream that goes straight to the bottom line. A major wake-up call and mind shift is waiting to happen.

Something similar happened a few months ago in Singapore, with the country’s NETS debit card brand owned by the major local banks. NETS has always been the cheapest card payment method for merchants, with a fixed transaction fee much lower than the interchange fees on Visa and MasterCard debit products. But the banks that own NETS have grown tired of not getting interchange revenues out of their debit cards, and apparently pretty much told the organization that either it finds a way to generate interchange for the banks, or the banks will issue scheme debit cards instead. The result? Merchants received a letter from NETS saying that they would now be charged interchange fees on NETS transactions, a unilateral decision which has not gone down well with merchants.

What about European merchants? Won’t they resist spiralling interchange fees? Tensions are already high, with merchant associations fighting across the region for lower interchange or simply the right to surcharge and pass the fees on to customers. Since the only reasonable way to deliver higher fees is to give more value to merchants, there is growing pressure on payment brands to innovate for the benefit of merchants. The payment scheme that offers the most value to merchants will be able to deliver the highest interchange fees and attract the most issuers. Payment schemes that are positioned as low interchange products, offering little more than today’s basic commoditized payment service, are much less attractive to banks and could end up on far less cards than other brands.

My conference speech in Berlin was on the second day of the event. I was already going to talk about protecting interchange, but the first day’s discussions on SEPA made things so much clearer that I took advantage of East to West jetlag and spent the predawn hours completely redoing my presentation. Here it is.

I will be back in Europe in a few weeks, speaking at the Contactless Cards conference in London, on June 26th. Contactless is a whole other story, but interchange is still at the heart of it (as we saw recently with Visa’s decision to reduce interchange fees on contactless payments in the UK in response to merchants’ lack of interest, and a similar lack of interest slowing contactless growth in the US). I will be talking about ways to make MasterCard Pay Pass and Visa Pay Wave much more attractive to merchants so that deployment can happen more smoothly and more profitably than what is currently being experienced.

Very exciting times in the payments industry!

Related posts and how Welcome Real-time helps protect interchange:

Prior posts on interchange

Prior posts on data mining

How Welcome helps payment schemes justify higher interchange and compete for bank market share

Secret bank talks, debit card competition, and the opportunity to really stand out

Reuters reports that European banks are in secret talks to set up a pan-European debit card to challenge MasterCard’s Maestro, which has emerged as potentially the dominant regional debit card brand. The initiative would of course challenge Visa as well, but Visa’s regional debit scheme, V Pay, does not seem to have gained widespread support.

The European Union’s decision to create a single European payments area (SEPA) is forcing Europe’s national debit brands into extinction. MasterCard and Visa already have viable SEPA-compliant solutions for banks, but it always seemed obvious that the same banks that own the national debit brands would group with their counterparts in other countries to create a regional brand in order to avoid seeing a US based company dominate debit card payments.

All of the existing debit brands offer essentially the exact same payment features. Maestro, V Pay, the current national debit brands and presumably any new pan-European debit brand all offer the same simple, basic, commoditized features. Hopefully this new level of competition in Europe will force at least one of the players to focus on a clear product differentiation strategy.

There is a real opportunity for someone to look at debit cards in a fresh new way. Imagine the strategic impact if one of the brands were to focus on making payment much more attractive to merchants, so merchants prefer that debit brand over others and are willing to pay higher interchange. Wouldn’t that cause banks to want to issue more debit cards with that brand? How could a bank executive justify issuing cards with a lower-interchange brand, even if the brand is European-owned?