The Green Sheet Online Edition
August 13, 2012 • Issue 12:08:01
The card company settlement: What's next?
On July13, 2012, Visa Inc. and MasterCard Worldwide agreed to settle antitrust litigation titled the Payment Card Interchange Fee and Merchant Discount Antitrust Litigation. The original action was filed in June 2005. Plaintiffs alleged the card brands violated the Sherman Antitrust Act by unlawfully fixing interchange fees and rules, other network rules and corporate reorganizations, which constituted unlawful price fixing, unreasonable restraint of trade, monopolization, lessening of competition and fraudulent conveyance.
Plaintiffs reviewed 50 million pages of documents and deposed over 400 witnesses. I can't even begin to understand numbers this big. Just for perspective, merchants pay over $30 billion a year in "swipe" fees, according to the National Retail Federation.
A win for the card brands
About the settlement, industry consultant Philip Philliou said, "Hopefully, retailers learn that litigation is not the vehicle to affect change. ... If retailers truly want to change the payment landscape, they need to play a role in building or acquiring a payment network."
Yes, the card companies have to pay more than $6 billion for "alleged past damages" and another $1.2 billion to cut costs for eight months, as well as lift the "no surcharging rule." But they didn't concede any meaningful changes to the interchange system. They don't have to change the way they set rules and prices. And merchants gave up their rights to sue the networks and card issuers over these issues. I expect interchange rates will continue to increase over the long run.
Some observers predict banks and retailers will blame each other for how consumers will be affected, just like they did when the Durbin Amendment to the Dodd-Frank Act of 2010 changed the pricing for debit card transactions, and consumers started paying more for checking accounts.
There is much hoopla about surcharging, but people forget that several states, notably California, New York and Texas, prohibit surcharging. PayPal Inc. doesn't allow surcharging either. Merchants, particularly larger merchants, will have a difficult time convincing consumers to accept surcharging. And, in any event, even if merchants are allowed to surcharge, they cannot charge more than their incremental cost.
Interchange isn't going to change, because today's payment innovations are largely built on credit and debit card accounts. Take Apple Inc.'s iTunes, for example. You pay by typing in your card number, and iTunes has 150 million of them on file. Amazon Inc. already has buyers' card numbers on file, too. The card networks can happily outsource innovation to entrepreneurs who are building new apps, because the networks are the default payments architecture.
Rate hikes on the horizon
As for pricing, rates aren't going down. Industry observer Felix Salmon believes the networks could raise prices by as much as 30 percent without losing any customers. Salmon wrote the following in "The Stranglehold of Payments Networks" published on the Thomson Reuters blog March 29, "Merchants feel forced to accept such cards, while the costs to consumers are well hidden. Visa and MasterCard levy a non-negligible tax on a huge percentage of retail payments in a largely invisible manner, bribing the consumers to force the merchants to pay the tax."
The original concept behind interchange was to help banks issuing credit cards by giving them an annuity revenue stream whenever the cards they issued were used by cardholders. Interchange, which is paid to issuing banks, helped pay their startup fees and for the inevitable losses from bad debt. Now, large issuers devote most of their income to paying for loyalty programs for top-tier customers and pay for this with charges imposed on subprime customers.
Payments without interchange
New payment systems without interchange have been tried, notably Pay By Touch, which failed in 2008, and Revolution Money (originally Gratis Card Inc.) was sold to American Express Co. in 2010 and never gained traction. Sophisticated investors were involved in those companies - and some big money, too.
One alternative is "bank direct payments" in which consumers provide their checking account numbers, and their accounts are debited for payment, usually via automated clearing house (ACH) debits. One issue with this payment option is that NACHA - The Electronic Payments Association rules call for a "commercially reasonable" method of determining the identity of the consumer. But solutions such as CashEdge and Yodlee Inc. exist for dealing with that. Another issue is what happens if the consumer closes the account or if the account has insufficient funds.
You see, this is the beauty of taking a card, particularly in a card-present environment: if the merchant gets a signature and swipes the card, the likelihood of a chargeback is nil. With a credit card, there is online, real-time authorization. You don't have that when you debit a checking account. Of course, you could have the ACH debits guaranteed by a check guarantee company.
An alternative to using traditional ACH debits is to use a PIN debit network, not signature debit, to clear payments. The issue, from a mobile payment perspective, is that this requires Triple Data Encryption Standard encryption, which would be easy enough to do with a small, inexpensive device attached to the keyboard. But so far, no large bank is willing to pay the $10 per device that it would cost to do this.
Developments to watch
Most ISOs and merchant level salespeople serve "small and medium enterprises," sometimes referred to as SMEs. The top 200 retailers are probably going to negotiate directly with the card networks for their rates. The reality is that this settlement is not likely to affect SMEs much. But there are other things that will. Here are some things that ISOs should follow:
- New entrants like PayPal and Square Inc. are targeting SMEs to acquire their card processing business. In some cases, they will supply a free card reader and free mobile apps. Square charges 2.75 percent. PayPal charges 2.7 percent, but it has the added advantage of being able to accept PayPal transactions, and thus invoices and checking account-based payments. In some cases, PayPal can settle funds the same day.
- VeriFone Inc. is emerging as an acquirer - something I would not have predicted for a terminal manufacturer so reliant on the ISO community. It charges 2.7 percent for a "free" account. For an extra $10 a month it will lower the rate to 1.95 percent. VeriFone is in a good position, because the 11 million terminals deployed in the United States will need to be replaced in the next few years, and a great number of them were made by VeriFone.
- Both card networks have spent a lot of money on their own alternative payment platforms. Visa has the V.me digital wallet; MasterCard has the PayPass mobile wallet. This raises the question of whether the dominant contactless payment platform will be the device or whether the wallet will sit in the cloud. A mobile wallet that works in only one environment is not likely to succeed long term.
- SME merchants are under attack. For example, Amazon has a price check app. It allows a consumer to scan a bar code at the store and then check the price on Amazon. Amazon is going to be 8 percent cheaper right off the bat because there is no sales tax, and to boot, the consumer gets an additional percentage off from Amazon.
- Fewer than a dozen large bank acquirers exist. The days of small bank acquirers as "principal banks" are over. However, some acquiring banks have significant credit issues on their books. For example, look at Bank of America. By any statistic (net income; earnings before interest, taxes, depreciation and amortization; cash flow per share; five-year dividend growth rate; quarterly earnings revenue; earnings growth rate; etc.) the bank has issues. If you invested
$100,000 in the stock 10 years ago, it would be worth $55,000 today.
Many large banks will need to increase retained earnings to address loans on nonaccrual. In many cases, large banks cannot even realistically estimate their current exposure to bad mortgage loans. These banks need capital and retained earnings. They are not likely to reduce their merchant processing charges - or any other reliable source of fee income. They will want to see higher interchange fees, not lower.
So there you have it. As the French say, plus ça change, plus c'est la même chose - the more things change, the more they stay the same.
Brandes Elitch, Director of Partner Acquisition for CrossCheck Inc., has been a cash management practitioner for several Fortune 500 companies, sold cash management services for major banks and served as a consultant to bankcard acquirers. A Certified Cash Manager and Accredited ACH Professional, Brandes has a Master's in Business Administration from New York University and a Juris Doctor from Santa Clara University. He can be reached at firstname.lastname@example.org.
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