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The Green Sheet Online Edition

April 11, 2016 • Issue 16:04:01

Heads up, cheaters: Truth will out

By Brandes Elitch
CrossCheck Inc.

If you've been following my articles in The Green Sheet, you know I usually start with a commentary about the wine industry since Cross Check is located in Sonoma County, California. But today I'm going to examine why the recent news about Volkswagen's cheating scandal is so important. There is a lesson for fintech and payments here, too. VW programmed 11 million vehicles to cheat in order to pass tailpipe emissions tests. Why? Here is a brief explanation.

New cars sold in the United States must pass federal standards for emissions; each state cannot set its own requirements. VW engineers believed their cars wouldn't pass these tests without more expensive equipment, so they programmed the software to recognize when a test was being conducted and to lean out the fuel mixture to reduce emissions to an acceptable level just to pass the test. When the test was over, the cars would run normally ‒ with illegal nitrous oxide emissions. Pretty clever, yes?

Too clever by half, it turns out. For decades, VW had positioned itself as a "trusted brand" to consumers. That trust is gone, which reinforces the fact that it takes decades to build a brand and only one bad day to destroy it. Ironically, in marketing diesel cars in the United States, VW targeted environmentally conscious consumers. They won't be coming back.

Issues with diesel engines

The diesel motor has been around for 80 years, but it has never achieved even a modicum of success in passenger cars in the United States. Aside from the shaking and rattling and funky smell, diesel cars are more expensive, and while diesel cars require less maintenance, gasoline-powered cars now go 40,000 miles before the first major service.

Also, federal taxes on diesel are higher than for gasoline. Congress did this to extract fees from the trucking industry for the heavy wear and tear that diesel-powered over-the-road trucks put on federal highways. However, there are still about 600,000 VW and Audi cars here that are emitting illegal levels of nitrogen oxides, which the medical community has linked to serious lung ailments. The situation is different in Europe, where diesel engines are very popular; more than half the cars sold are diesels. Diesels get better mileage and are popular with larger, heavier luxury cars that consume more fuel. Emissions testing in Europe is less stringent and less rigorously enforced than in the United States. Legislators there have promoted diesel because diesel engines produce less carbon dioxide than internal combustion engines, a principal cause of global warming.

Perhaps the biggest issue for VW is that when most consumers list the desirable attributes they want in a new car, "better emissions equipment" is not one of them. And if new equipment drives up the cost of a diesel car, consumers will buy a gasoline car instead. Today's gas-powered cars are pretty darn efficient. They can start with a supercharger and switch to a turbo, and use stop-start technology, full valve control and stratified direct injection. On the horizon are hybrids, electric and hydrogen cars, and more fuel-efficient offerings. This does not bode well for diesels.

Trickle-down trouble

But why did this VW debacle happen? The answer is simple: dysfunctional governance by the notoriously overbearing, autocratic, dictatorial taskmaster: Ferdinand Piech, VW Chief Executive Officer. Piech always boasted that he extracted superior performance from his staff by terrifying them. He wasn't kidding. When the diesel in question was developed in 2008, the senior managers were too intimidated to tell Piech how they accomplished his goals ‒ so they didn't inform him.

Piech was seen as an effective manager; he is now viewed as a dangerous old fool, responsible for a $30 billion drop in stock market value for the firm and on the hook for fines and lawsuits that might cost as much as $40 billion by some estimates. Yes, it all came down to just one person, the CEO. It always does. You might think this is an aberration, but I worked previously for payment companies run by two CEOs with a similar "I know everything" mentality, with similar results. This is not an aberration.

Duplicitous MCC use

How is this relevant to the payments industry? Well, just yesterday I read an article about a payment company that has been in the news a lot recently. The writer alleged that this company deliberately set merchants up at their processor with the wrong Merchant Category Code. Truthfully, I never realized before how lucrative this can be. For example, a bar (MCC 5813) has an interchange rate of 1.65% + $0.10. A restaurant has an MCC of 5812 and an interchange rate of 1.95% + $0.1010.

An ISO that miscodes restaurants as bars with MCC 5813 gets a hidden rebate of almost $3,000 a year per average restaurant. The article quoted a company rep as saying, "Somehow, we were able to set up a restaurant below cost; I never figured out how we did this." If this is true, you can guess the guidance came from the CEO (this is a much smaller company than VW). For a portfolio of a few thousand restaurants, the hidden income from this practice is staggering.

Payment professionals will recognize that the acquiring bank is responsible for verifying that MCCs are correct. The ISO will likely be judgment-proof in a large class action suit; the sponsor bank will not. But in this case, the sponsor bank is one of the largest issuing and acquiring banks, so it is doubtful the card brands will impose any particular discipline, in my opinion.

Underhanded practices

You might think cheating is rare today, but you would be wrong. Cheating in some form is still rampant in the payments industry. Here are some examples of how it's done:

  • The merchant is given one rate in the sales process and then sees a different rate when the statement arrives.
  • The merchant is charged for "card association fees" and "dues and assessments."
  • There is a "PCI non-compliance" charge or a "regulatory" fee.
  • There is a "terminal support fee."
  • There are "Merchant Club" or supply charges.
  • There is a "gateway fee" or "online access fee."
  • The merchant is required to sign a new agreement to process EMV cards, and it contains higher rates and new equipment leases.
People ask me why merchants don't question these charges, and I believe the answer is that many merchants don't read their statements. I know this because when I ask a merchant what he or she is paying for bankcard processing, about 90 percent of the time I am told, "I am paying 1.75 percent."

Payments industry vulnerable, too

Yes, some of the egregious practices of the "good old days" are gone, such as charging $49.99 per month for a five-year, non-cancelable lease on a $500 piece of equipment. But merchants are still paying too much for their bankcard processing. You can see what has happened in Australia, and is about to happen in Europe, as regulators redefine acceptable interchange levels. This is similar to what U.S. legislators did with the Durbin amendment to the 2010 Dodd-Frank Act.

The top 200 U.S. retailers and the National Retail Federation have consistently stated that they believe the card brands are operating in restraint of trade, and they will not back down from this position. The Electronic Transactions Association should be commended for the good work it has done in providing best-practices guidance, but the ETA is, after all, a trade organization, not a regulator.

At Volkswagen, someone figured out that the CEO would never agree to license the Bluetec technology from Mercedes for diesel motors, which would have addressed its emissions problem. After all, it would cost a few hundred dollars per vehicle. Rather than admit technical defeat, the two engineers responsible decided to wing it because they figured the emissions testing could never detect their "under the radar" solution.

ISOs that slip hidden fees in the merchant statements likewise expect merchants will never notice them. There is an old saying, "Truth will out." I suggest that ISOs pay attention to what happened at VW. It could happen here. end of article

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 brandese@cross-check.com.

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