Peter Guidi's Blog

Posts Tagged ‘MPC’

Competitive opportunity in a post Durbin world: richer debit rewards as the unintended consequence of the $10 billion exclusion.

In alternative payment, Bank Tax, credit card, debit card, interchange, loyalty, payment, Payment card, Petroleum retailing, swipe fees on October 27, 2010 at 7:16 pm

Dozens of articles have been written about the impact of the Durbin Amendment on the payment card industry, with nary a positive comment in the mix. The focus has been on the punitive impact that the legislation will have on both financial institutions and consumers. The consensus has been that banks will lose significant revenue and that consumers will see more bank fees as costs are shifted to make up for lost interchange revenue. This article takes a different approach and looks at the new market opportunity hidden in the bill, the opportunity for smaller financial institutions to launch aggressive debit reward programs fueled by higher interchange fees.

Under Durbin’s “reasonable debit fee requirement,” there is an exemption for banks and credit unions with assets under $10 billion (this includes 99% of all banks and credit unions). This means that Visa and MasterCard can continue to set the same debit interchange rates that they do today for small banks and credit unions.  Those institutions would not lose any interchange revenue that they currently receive; in fact they could receive even higher rates. Many experts writing on Durbin have concluded that this exception will be meaningless because the networks will be unable to accommodate multiple fee structures and as a result, while exempt, interchange fess on those financial institutions will suffer along with their larger brethren.

The argument is that the required costs and effort, such as network IT changes to accommodate multiple interchange fees, make this outcome unlikely. The recognition that business pressure from small banks and credit unions on the networks, Congress or the Fed could leave the networks with little choice but to develop a two tiered fee structure may alter this conclusion. A few weeks back, TCF, an issuer whose business is above the $10 billion exemption, filed a lawsuit stating, “the thousands of banks exempted from the amendment will be free to continue to charge retailers the current debit-card interchange rate and recover all their cost plus a profit. This will result in an irrational competitive disadvantage for banks like TCF that are subject to the new regulations.” It appears from TCF statements that the idea of 7000 smaller financial institutions issuing a new class of richer debit reward cards seems not only plausible, but probable, and a real threat to their business. The focus on the challenges associated with creating a network pricing schema that allows for multiple interchange rates, rather than discussing the market dynamics, is missing the business opportunity.

The reason this will happen is that the payment card industry is a two-sided market. Durbin treats the payment industry like a utility, but this analysis is mistaken. Durbin and its proponents have argued that the payment card industry lacked competition. This falsity, propelled by an active merchant lobby, found resonance in Congress. In reality, the payment card business is a highly competitive marketplace. It just happens that the competition is between financial institutions fighting for a larger share of the consumer market. The result of this competition is higher fees to those wishing access to the market.  Durbin seeks to upset this market, ignoring the two-sided market economics driving consumer demand.

Consumers will move their purchasing to whatever product provides the most incentives. Merchants will accept the business from any large group of consumers, and Durbin does not allow merchants to discriminate by issuer on a network. What this means is that smaller financial institutions will introduce richer debit rewards programs attracting larger shares of consumers who will then shop at retail locations using those cards. Retailers will not turn customers away because payment method would be become a factor in the consumers choice of retailers, something no marketing department will allow.  This is the result of network effects, and they are the unavoidable economic reality driving the industry. The resulting competitive dynamic is in play: issuers will want to try to drive up fees on the merchant side of the market, delivering greater rewards on the consumer side. Consumers will look for low-fee banking services and richer rewards that are supported by these programs. As a result, millions of consumers will gravitate from the 90 or so issuers affected by Durbin to the 7000 who are excluded. This looks like opportunity.

The real question is how long it will take the networks to code the system to handle multiple prices for issuers. I’d be surprised if the work was not already well underway and available not long after the Fed sets its rates. Durbin will have closed the door on the top 90 issuers, essentially putting them at a competitive disadvantage. But in closing that door, the way has been cleared the remaining 7000 financial institutions to develop their debit rewards business. In many ways Durbin did for the network what they could not do themselves; i.e Durbin eliminated the power of the major issuers and opened the market to the smaller financial institutions.

The TCF lawsuit has been both ballyhooed and scoffed at.  No matter the outcome in court, the case will have an impact on the industry. If Durbin passes all of its legal challenges, the irony may be that the consumer will benefit as a result of richer rewards programs from smaller issuers, and merchants will see card acceptance costs rise taking no comfort knowing that they won a battle but lost the war.

“Reasonable and proportional”, issuance and rewards are out, Fraud is in!”?

In alternative payment, credit card, debit card, interchange, merchants, payment, Payment card, retailers, swipe fees on June 24, 2010 at 1:56 pm

Last week I discussed the operational costs associated with issuing cards and retaining members and postulated that the Fed should include these costs in the analysis of “reasonable and proportional costs associated with a transaction”. One reason these costs might be included is to support the competitive product offerings consumers receive from banks to enroll in the various programs that are offered. The expectation being that if these costs are not considered a part of the reasonable cost of the transaction, then the programs would need to be eliminated, thus limiting consumer choice. With the Durbin Amendment nearing agreement and inclusion in the final bill, it now appears that the answer to the question is; no, the regulation says these costs are not included in the Fed’s evaluation used to establish debit interchange fees. The deal reached between Messer’s Frank and Durbin expanded the meaning of “reasonable and proportional to the cost incurred in processing the transaction” to include the cost of fraud in its analysis, a recognition of risk associated with payment card issuance. Moving forward, Financial Institutions have good reason to remain concerned about the Fed’s price setting authority as the language for assessing costs is limited to “incremental costs” excluding operational and other costs like issuance and rewards.

The wild card remains the $10 billion exemption. Watch for a multitude of creative corporate structural changes and new programs from entities’ falling below the threshold. If you think the rate table is confusing now, wait until the banks attorneys’ drive through the Durbin Amendments’ loop-holes! 

(http://www.linkedin.com/in/peterguidi)

Is “Social Justice”, the new rallying cry in the battle over interchange fees? What’s next price controls?

In alternative payment, Bank Tax, credit card, debit card, interchange, loyalty, payment, Payment card on March 18, 2010 at 9:51 pm

 “Pandora opened her jar and unleashed many terrible things on mankind.”

 In February 2010 the Consumers for Competitive Choice (C4CC) released a report called “The Costs of “Charging It” in America” by Shapiro & Vellucci: The report offers a number of conclusions, including the proposition that government regulation of interchange fees is Social Justice. Social Justice is a concept used to describe the movement towards a government regulated socially just world. The report suggests that the economics behind payment platforms, Two-Sided Markets and their inherent “Network Effects” create negative “Regressive Cross-Subsidies”. The suggestion is that interchange fees create a system where the poor pay for the privileges of the rich.

 In a paper written by Bolt & Chakravorti titled “A Review of Payment Card Economics” published in the November 2009 Lydian Payments Journal concluded “There is no consensus among policy makers or economists on what constitutes an efficient fee structure for card payments”. They go on to say “efficiency of payment systems is measured not only by the costs of the resources used, but by the social benefits generated by them”. Shapiro & Vellucci would seem to agree when they add “The current credit card and debit card systems provide valuable services to consumers and merchants and those services involve legitimate costs and therefore prices. Apparently the concept of profit for risk is not in their equation.

Last week a Delaware politician suggested mandating Full-Service Gas as a job creation initiative. Today the NRF urged Senator Dodd to add Interchange reform to the financial services reform bill. The C4CC published report suggests that Interchange Fee Regulation is a morally just cause towards achieving a level of Social Justice. Are retailers ready to see Social Justice added into their margin equation?

(http://www.linkedin.com/in/peterguidi)

Pen or Pin: An expensive decision for the retailer. Are best things in life free, or do you get what you pay for?

In alternative payment, Bank Tax, credit card, debit card, interchange, loyalty, payment, Payment card on February 3, 2010 at 9:49 pm

Debit cards are making news as the consumers preferred method of payment. Financial industry analysts predicted that debit cards would overtake credit cards and would start a change in the loyalty offering and other types of card incentives from credit to debit cards. It was never predicted that it would happen so quickly with such a tidal-wave type of shift. One major transaction processor, revealed that membership in credit card reward programs has declined from 71% of the consumers surveyed in 2008 to 67% this year. While at the same time, the participation in the debit reward programs has increased markedly from 34% of consumers surveyed in 2008 to 45% this year. This trend is expected to continue as consumers struggling under the load of credit card debt move to debit.

PCI PED deadlines appear like a fog bank on the horizon, big, dark, impenetrable and getting closer. Retailers are faced with the decision to either upgrade from older, no-secure PIN pads to PCI PED approved pads at significant cost, or to accept all cards as “signature” at the pump paying the higher “signature transaction fee”.

Meanwhile, banks are sending a conflicting message as retailers are now faced with PIN debit transaction fees that are nearly equal to signature debit transaction fees.  Adding injury to insult, Financial Institutions are offering consumers aggressive “debit reward” programs based on consumers’ choosing ‘Signature” rather than PIN.  Rewarding the consumer for using signature debit is essentially bribing the consumer to use a more expensive form of payment. One major bank recently released its “Swipe & Sign” program offering consumers a $10.00 gift certificate from Amazon.com for one “signature debit transaction” at a grocery store. The result is retailers are paying for more expensive Signature based debit transactions. This is a “dammed if you do, dammed if you don’t” situation. 

Retailers are wondering if the upgrading to PCI PED pin pads is worth the expense. They face a situation where the lower cost PIN debit rate is going away at the very same time banks are rewarding consumers to use signature debit. It appears that the banks are saying “no” to PCI PED upgrades.

(http://www.linkedin.com/in/peterguidi)

Interchange fees: Obama’s next bank tax target

In alternative payment, Bank Tax, credit card, debit card, interchange, loyalty, payment, Payment card, Uncategorized on January 22, 2010 at 9:40 pm

The law of unintended consequences is that actions of people—and especially of government—always have effects that are unanticipated or “unintended.” – Rob Norton, Fortune magazine

Beating up on the banks has a nice populist ring to it and so President Obama tailored this week’s proposed tax on banks to tap into public anger at Wall Street. Retailers’ might be concerned that Members of Congress sitting on the House Financial Services Committee confuse anger with Interchange fees and this populist anger. The White House press secretary would not discuss how a possible bank fee would fit into Obama’s fiscal year 2011, but Retailers can be sure that adding some of that $48 billion dollars in interchange fees to tax revenues will look like an appealing target.  

Meanwhile, in the debate over interchange fees, retailer’s predictions of lower interchange fees, meaning lower consumer prices, clashed with the opinions of those in the financial sectors with dueling articles in both the Wall Street Journal and New York Times.

2010 will bring high anxiety as congress schedules votes on both H.R 2695 & H.R. 2382. We can only wonder what kind of difference Scott Brown will bring to the debate. Can legislation or litigation succeed and what happens if these efforts fail, is it time to seriously consider competition? What if the Federal Government sees Interchange as a new source of General Funding, how will retailer fight for lower interchange fees if the Federal Government sees them as a source of tax revenue? (http://www.linkedin.com/in/peterguidi)

Passing on the savings: Do lower interchange fees mean lower retailer prices for the consumer?

In alternative payment, credit card, debit card, interchange, payment, Payment card, Uncategorized on December 9, 2009 at 7:49 pm

Oscar Wilde once said “There are many things that we would throw away if we were not afraid that others might pick them up”. The same may be true of interchange fees and margins.

This month the Competitive Enterprise Institute (CEI) published a report called “Payment Card Networks under Assault” which makes the case that capping interchange fees will hurt consumers, charities, community banks and credit unions. One of their primary claims is that retailers would not pass on savings from lower interchange fees to consumers. The CEI points to the GAO report which concluded that “consumers may not experience lower prices and retailers could pocket the entire windfall resulting from any reduction in interchange fees”.  Meanwhile, the Consumers for Competitive Choice (C4CC) called for interchange fee reform stating that reform would spur job growth, and as expressed by one President of a 90 store chain who is paying nearly 3.5 million dollars in interchange fees saying: “lower fees would mean lower costs for consumers”.

 Would a retailer pass on savings to consumers if interchange fees where lowered? Here’s another question: Will retailers use discounts to compete with credit card companies for the consumer’s method of payment? And if they do, what methods are available; price roll back for ACH or cash credit pricing? As the ball goes back and forth on this issue, both sides need to be cognizant that Congress is looking for solutions that benefit the consumer. Unless the retailers can demonstrate that they are willing to provide lower retail prices to consumers for less expensive forms of payment, why should Congress believe that consumers will benefit from a cap on interchange fees?  (http://www.linkedin.com/in/peterguidi)

Market Power or Perfect Competition: The “Apples and Oranges” of the interchange pricing debate.

In alternative payment, credit card, debit card, interchange, payment, Payment card, Uncategorized on November 27, 2009 at 6:38 pm

Market Power gives a firm the ability to employ anti-competitive tactics like predatory pricing without losing customers to competitors. During testimony on H.R. 2382, the Representative of The Merchants Payment Coalition stated that “there is no competitive market for interchange fees – just naked price fixing”. On the other side, the Representative from The Electronic Payments Coalition called interchange an “important element(s) of the successful, competitive banking experience” adding that “interchange reflects a merchant’s fair share of the costs” (sic.) of the system.

Last weeks GAO report found that Merchants’ are in fact paying more to accept credit cards, but also added that “network competition in the credit card market may be contributing to rising interchange rates”.

Two-sided markets exhibit “Network Effects” when two groups of users are attracted to each other, in this case retailers who accept payment and consumers who make payment.  “Cross- Side Network Effects” occur when enough users are attracted to one side that the other side will pay dearly to reach them.  In this case, retailers are the “money side” and they pay to accept cards as a form of payment, while consumers are the “subsidy side” who receive incentives to use the cards as a form of payment. Linking these two groups together is the primary value of the payment platform creating powerful Cross-Side Effects.

Retailers’ accept cards as payment because so many consumers use cards for payment. Competition between card issuing banks to capture consumers, and networks to capture banks is intense as evidenced by the multiple offers for high earning rewards credit and debit products and their users. Retailers ultimately see the cost of this competition reflected in rising interchange fees, particularly the higher rate fees for reward based programs. The question is; does this competition between networks and financial institutions for the consumers’ payment business justify the increasing rates paid by retailers to accept these forms of payment or does it constitute a monopolistic example of a market failure?

http://www.linkedin.com/in/peterguidi

Interchanges fees and fairness, who’s money is it anyway?

In alternative payment, credit card, debit card, interchange, payment, Uncategorized on November 12, 2009 at 9:06 pm

Last month the House Financial Services Committee took testimony on H.R. 2382 from both the Financial Industry and representatives of the Merchants Payments Coalition which represents NACS. Both parties represented their point of view. On the retailer side, the argument remains that the retailers are unable to negotiate with the card associations for lower prices. Retailers expressed that banks and card associations are monopolistic so, congress should act to legislate and control fees or at least give retailers the ability to negotiate for lower fees and that the payment providers should be subject to Anti-Trust legal action. The key evidence being the “outrageous” swipe fees retailers pay to accept a credit card. On the other hand the Banks cried foul claiming that retailers are simply trying to use their power to gain the valuable credit card payment services without having to pay a fair price. The credit card representatives presented an argument demonstrating that interchange fees are fair, and in fact are undervalued.

This raises the question: Why would Merchants accept payment cards if the fees associated with the card are greater than the benefits? Interchange is a fee for a service that brings value to consumers and retailers and while retailers may have choices about method of payment, or even alternative payments, it turns out that promoting a method of payment is expensive and time consuming. It’s so much easier to put a sticker on the door that says” MasterCard and Visa” accepted here.  Eleanor Roosevelt once said, “It is not fair to ask of others what you are unwilling to do yourself” and therein may lay the answer. (http://www.linkedin.com/in/peterguidi)