et ready for customer and merchant confusion and squawking over transaction fees.

Both Visa U.S.A. and MasterCard International announced new, higher interchange fees, effective April 1, 2005 (see "Visa 2005 Interchange Fees," The Green Sheet, Dec. 27, 2004, issue 04:12:02, and also "MasterCard U.S. Region 2005 - 2006 Interchange Programs and Rates" on page 26 of this issue).

But these rates won't affect all merchants the same. Nor will all transactions, even those that seem alike, be priced alike.

That's because Visa hiked interchange rates on certain transactions initiated with cards tied to rewards programs. If no one earns points or miles as a result of charges being posted to cardholder accounts, or when transactions involve select merchants that have negotiated special interchange deals (mostly large supermarkets and behemoths like Wal-Mart Stores Inc.), rates remain unchanged from the current ones.

The Visa interchange hikes will hit restaurants hard, and also independent supermarkets, say experts who have studied the changes.

MasterCard announced across-the-board increases, upward of 12% in interchange for consumer credit and corporate cards. MasterCard also told its membership to expect a new interchange schedule for its upscale World category of cards.

The two card Associations took strikingly different approaches to debit card pricing this time. MasterCard left signature debit rates untouched, while Visa reduced rates on several categories of signature debit (check card) transactions.

Here are a few examples of how the impending rate hikes will play out:

1. A restaurant that takes a Visa card tied to a rewards program will see the base cost of that transaction rise by at least 36 basis points (or 0.36%).
2. An independent grocery store that accepts the same card will incur interchange that amounts to 41 basis points plus $0.05 more than if the transaction involves a Visa card not tied to a rewards program.
3. In the case of a service station, the interchange will increase 22 basis points on Visa-branded rewards cards, unless the card is used at the fuel pump, in which case interchange will increase 15 basis points plus $0.05.
4. For a retail establishment that accepts MasterCard, the base interchange on standard consumer card transactions increases by about six basis points.

Interchange is simply the baseline fee that transaction acquirers pay card issuers. The retail price charged to the merchant (the "merchant acceptance fee") also includes fees for processors, acquirers, ISOs and any other organization that touches a transaction. (Interchange is, however, the biggest potion of the merchant acceptance fee.)

So what gives? Some folks speculate that the price hikes are a result of the massive hits the Associations and member banks took on the Wal-Mart settlement.

And perhaps that played a role. The most probable reason, though, is competition from American Express Co. (AmEx) for card-issuing banks.

One thing is certain: ISOs and the feet on the street will have a devil of a time explaining to clients why multiple transactions for the same amount of money at the same business establishments are priced so differently.

Taking Account of AmEx

The layout of the Visa 2005 interchange fee schedule illustrates how AmEx and its focus on higher-dollar travel and entertainment transactions is a crucial driver of the change.

The schedule now includes three different rate structures: one for traditional cards, one for rewards cards, and one for "signature" cards, a category for high-end rewards programs.

MasterCard's announcement that it planned to hike interchange on its upscale card products lends further credence to the AmEx factor in changing bankcard interchange.

The payment card business always has been bifurcated. In the early days, it was Visa and MasterCard.

More recently, it's been the bankcards and the non-bank cards, with Visa and MasterCard dictating that member banks could not issue non-bank cards, such as Discover Financial Services and AmEx cards.

A U.S. Supreme Court ruling effectively vaporized these "exclusionary rules" last fall.

Since then, AmEx, which charges higher interchange to compensate for its delivery of high-spend cardholders, has been wooing banks in earnest, with the promise of interchange rates that beat out Visa's and MasterCard's.

Mega-bankcard issuer MBNA Corp. was the first to jump aboard the AmEx deal wagon, and in a recent analyst call, the company reported significantly increased revenues tied to the interchange it gets on AmEx cards.

Sanford C. Bernstein & Co., a New York equity research company, estimated in a research note last spring (before MBNA signed on with AmEx) that MBNA generates 33% of risk-adjusted revenue (i.e. revenue less credit and funding costs) from interchange.

Interestingly, in that same research note, Bernstein analyst Howard K. Mason illustrated how the cost of funding rewards programs diminishes profitability.

He put the cost of funding a high-end airline rewards program at roughly 1% of card spending, for example, compared with "premium" interchange, which at the time was running 1.8% - 2.0%.

Clearly, the need to make rewards programs more rewarding to issuers has a lot to do with new interchange strategies at Visa and MasterCard.

"AmEx has MasterCard and Visa running scared," said another analyst on condition of anonymity. This analyst also noted that both Visa and MasterCard are locked in to bargain basement deals with megastores and large grocery chains, which doesn't leave a whole lot of room for maneuvering.

Changing Nature of Interchange

That Visa and MasterCard are revamping interchange in a bid to keep banks from crossing over to AmEx suggests that the nature of interchange has changed, indeed.

More significantly, the changes could also spark some unwanted interest from state and federal government lawyers and legislators.

Originally, the Associations intended interchange to serve as compensation to card issuers for the risks associated with extending credit to the cardholder. Today it's a major part of the money-making equation.

Bernstein analyst Mason estimated that fully one-quarter of bankcard issuer revenues accrue from interchange.

Not surprisingly, the National Grocers Association (NGA) doesn't like the trend toward higher interchange. The trade association raised the issue of interchange pricing last year in testimony before the Federal Trade Commission and the Department of Justice (DOJ).

NGA has also taken issue with special pricing deals Visa cut with large retail chains, especially supermarkets that compete with its members. You can count on this group to grouse even louder once its members (independent grocers) start getting hit with new, higher interchange on rewards card transactions.

Visa and MasterCard have recently had plenty of experience defending interchange practices, both in the United States and abroad.

Challengers have included a huge contingent of retailers (the so called Wal-Mart suit), the DOJ, the Reserve Bank of Australia, the European Union and the United Kingdom's Office of Fair Trade. Things are apt to get a lot more interesting in the months ahead.

First Data Targets Small Dollar PINs

In other interchange, the STAR ATM/POS network, a unit of First Data Corp, plans incentive interchange pricing for businesses where ticket amounts are relatively low, and where cash is still king.

Businesses including quick service restaurants (QSRs), which have already shown interest in credit card acceptance, and movie theaters, are businesses that in the past couldn't justify card acceptance fees.

As prices at these establishments increase, card acceptance becomes increasingly more viable. The fact that major QSR chains are already wired for cards should help, too.

Heck, when was the last time you spent less than $25 at a movie theater? Or, when was the last time a family of four could eat at McDonald's for under $20?

Patti Murphy is Contributing Editor of The Green Sheet. E-mail her at patti@greensheet.com .