By Ken Musante
Eureka Payments LLC
We are lucky to be in the payments business. Yes, competition is stiff and, yes, we deal with continual changes, but that's because our sphere is lucrative. Nobody is fighting to get into the newsprint business.
Competition is a byproduct of a healthy industry, and as difficult as it remains to sell our services, it is the selling entity that will continue to be critical to whatever future that evolves. And given that selling entities require effective distribution, I believe a strong distribution model can set a payment enterprise apart today and in the future.
Not only is our industry lucrative, but payment processing is delivered by multiple players, each needing its own profit margin. We rely on a four-party system (six if you count the processors) for exchanging payments between two parties. Outsiders look at what we do and the revenue made by each party and chortle over the profits they could make by squeezing out one or more parties.
The irony is the two-party system was invented long before card payments came to be. It was called a cash transaction, and it was the inherent problems with cash that allowed card payments to flourish. In short, cash is an inferior form of payment in some cases due to security, physical weight or bulk of the cash, transportation costs, accuracy, and evidentiary record.
Card payments solve many of these issues; however, to support ubiquity and security, card associations were formed. Their role was to develop and enforce the rules and transfer pricing. Over time, the associations became for-profit card networks, also referred to as card brands and card companies. Although they still develop and enforce the rules and pricing, they have added an additional cost: a profit for themselves.
Since becoming publicly traded companies, the card networks have raised fees substantially. The following are fees that were implemented or radically increased after the card brands became for-profit companies:
These are in addition to the assessments, which were historically the only fees considered when calculating the card networks' expense (even though there exist a multitude of smaller fees, which amounted to little more than a rounding error). And unlike interchange, these fees are paid to the card networks directly.
Said fees have been wildly profitable for both Visa Inc. and MasterCard Worldwide. Also, some argue that as for-profit companies, the card brands are now better prepared and able to take advantage of emerging markets and changing environments.
Unfortunately, the fee increases have either been borne by merchants or absorbed by acquirers. In either case, they have increased the attractiveness of any alternate system, be it cash or an emerging payment system.
Coincidentally, shortly after Visa and MasterCard became for-profit companies, the Durbin Amendment to the 2010 Dodd-Frank Act was implemented, placing a ceiling on debit card interchange. This significantly lowered the total cost of accepting debit cards, even with the previously noted increases from the myriad card company fees.
Because interchange is such a large portion of the total cost of transaction processing, by lowering and capping that portion of the cost, it pushed down the total cost of acceptance for check cards, and made solutions competing for debit interchange less desirable.
Before the Durbin Amendment, decoupled debit appeared to be a promising innovation: a consumer's debit payment was handled by a third party, unrelated to the consumer's bank, which essentially 'decoupled' debit from the corresponding checking account.
This would allow a third party to earn the interchange on the transaction at the expense of the consumer's bank. Durbin killed this innovation before it got started and took down companies like Bling Nation Inc. and Tempo Payments Inc. as collateral damage.
Bling and Tempo were formed before the Durbin Amendment was conceived. They relied on the existing interchange structure when calculating their forecasts and their offerings. With the cap placed on interchange for check card transactions, the alternative they provided was suddenly and dramatically less attractive.
Despite the demise of decoupled debit and the hundreds of failed startups in the payments space, we will continue to see new entrants and innovative competitors.
Some like eBay Inc. subsidiary Paypal Inc. will develop a toehold and flourish alongside traditional payments. Because of the industry's continued growth, there is room for additional entrants to prosper without disrupting the existing infrastructure.
Moreover, some of these solutions do not involve significant changes in consumer behavior. Consumers can pay with their cards through Paypal so, in some cases, consumers do not even see this as different.
Square Inc., too, can be a potential disrupter to traditional payments and easily adopted because consumers are not required to change their checkout habits.
The Federal Reserve reported on its survey of nearly 2,600 respondents about mobile banking and payments in Consumers and Mobile Financial Services 2013.
Despite the significant increase in the percentage of consumers using mobile devices and smartphones to access mobile banking, the study supports the difficulty in changing consumer behavior at the POS: only 6 percent of respondents reported they used their phones to make a purchase at a POS.
The two factors limiting consumer adoption are security and a sense that the solutions "don't offer any real benefits to the user over existing methods."
The study stated, "More than a third of mobile phone users who do not use mobile payments don't see any benefit from using mobile payments and find it easier to pay with another method." Unless there is some incentive for consumers, they will continue to pay using their existing habits. So what does all this mean? I'm not sure. But I am certain that distribution will be highly valued regardless of the winning solution.
In the interim, companies will continue attempting to circumvent Visa and MasterCard and will lose millions doing so - until one succeeds. And that company will reap rewards beyond my imagination - so long as it has a distribution system.
Ken Musante is President of Eureka Payments LLC. Contact him by phone at 707-476-0573 or by email at kenm@eurekapayments.com. For more information, visit www.eurekapayments.com.
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