Is ACH Really Cheaper Than Paper Checks?
Electronic Check Presentment.A Solution Looking for a Problem-Part II
The current direction toward check-Point-of-Sale Truncation (check-POST) transactions is based on a misplaced belief that the tried-and-true paper check is a more costly payment vehicle than clearing direct deposit account (DDA) items using the ACH settlement system. The belief that paper checks are an expensive, or more expensive, payment option is what is driving the search for a "cheaper" solution. This is the reason I titled this story, "A Solution Looking for a Problem." In this second installment, we will look at the question of how the belief that paper checks are more expensive to process than ACH has come about, and if this belief is well founded.
The argument goes like this:
1 Paper checks are more expensive to process than ACH.
2 Because checks are more expensive to society, the public good is served by changes in monetary policy that will support movement to electronic or alternate private sector initiatives to eliminate the paper check.
3 When society uses a less desirable (more expensive) process to meet society's needs it must be due to factors other than cost.
4 The only other factor is the benefit of "the float," the delay in payment that benefits the payor at the expense of the payee.
5 These steps define the over-use of checks, and support the government's initiatives that are currently supporting the pilot programs undertaken by the National Organization of Clearing Houses and The Electronic Check Council.
6 It makes sense for businesses to invest in a new infrastructure to handle ACH payments, and that both the old paper-based system and the new ACH system must co-exist for several years while paper checks continue to decline.
The notion that checks are expensive to handle comes from a couple of reports produced and widely circulated by The Hackett Group, a management consulting firm, and by David B. Humphrey, a Florida State University professor who has taken the "Hackett" study and created an argument for the overuse of checks as a payment option. Professor Humphrey is a primary source for check information and trends for The Nilson Report, and one of the reasons Nilson had difficulty with the 1996 Check Study produced by The Green Sheet, Inc.
In a 1993 report The Hackett Group determined, through a survey of its client base, what they thought was the cost of handling a paper check payment. The study attempted to determine "best practice" costs of the Hackett clients in the preparation of an invoice, the cost of writing a check, and the cost of the labor, postage, and paper goods for the sending, receiving, and posting of a subsequent accounts receivable item. While this study certainly said a lot about Hackett clients, which tended to be larger businesses many of which were in manufacturing, it may say little or nothing about the cost of paper checks in general.
One of the most important reasons the Hackett cost cannot be adopted as the universal cost of check preparation is that only 40% of all checks prepared are similar to those of the study. Since 55% of all checks are prepared by individuals, these checks do not share most of the allocated costs of the Hackett study. As individuals, we do not include labor in the cost of check preparation since we do not generally pay someone to do this preparation. In addition, the Hackett study did not recognize the fact the some of the largest recipients of checks use lock box services. These services, based on massive economies of scale, can process an item far more efficiently than a business generally can through its own accounts receivable function. The lock box accounts for a reduction of more than 28% of Hackett's calculated cost of posting an item.
Another very interesting point is that Humphrey takes the cost as built by the Hackett study and concludes that many of the costs associated with checks are simply not present in an ACH or electronic payment. The most notable example would be postage. Coming back to the lock box process, the idea that the receipt of a large ACH payment is the same as a lock box receipt of payment, only without the original postage, is very naãve. Lock box operations not only receive and bank the payments received on behalf of their clients, they also enter and create a tape output with paper notes to follow. While in the ACH scenario payment is received, it has no recordable client information or account numbers, and still therefore must be "processed." The cost of entry is certainly more than zero, and the cost of paper is 28% lower.
Now, what about this "float" thing that is supposed to be the reason checks are "overused" based on cost. Since 1987, the value of the float has declined over 90%, from an average of $1.04 to $.09, and yet checks have continued to grow. In a recent study prepared by Kirstin E. Wells, Senior Analyst, Division of Reserve Bank of Operations and Payment Systems, Board of Governors of the Federal Reserve System, Ms. Wells ".overturns the conclusion of a 1990 study by David Humphrey and Allen Berger, .which found that check float is responsible for the popularity of checks.."
In the report published in the Federal Reserve Bank of Minneapolis Quarterly Review, Volume 20, Number 4, Fall 1996, pages 2-12, we learn, "If checks are actually not more costly to society than electronic instruments, then there should be little incentive, in an efficient market, for users to shift to a different means of payment."
We also discover:
1. Check costs are lower than thought.
2. ACH costs are greater than thought.
3. ACH as an alternative is not an alternative at all.
Through the careful work of Ms. Wells, we learn that there is another possible explanation for the persistent use of checks: Users see checks and electronic payment instruments not as close substitutes for each other, but rather as very different instruments. "Checks may be used more, in other words, simply because users prefer them to other ways of making payments," notes the Wells study.
In short, the check continues to have a lot of appeal as we approach the end of the century. It continues to be our nation's most familiar payment method and it works well. We have time tested standards to support the continued use of the check. We have a national infrastructure for check collection, including the U.S. mail, the check processing capabilities at every depository institution or its agent, local clearings, correspondents, banks, and perhaps for a couple more years, the Reserve banks.
Most merchants accept checks because consumers use them, and they can be collected with relative ease. For electronic payments to supersede check payments, we will need an array of electronic choices that give consumers and businesses the combination of attributes they enjoy with checks today: simplicity, universal acceptance, convenience, control, and above all else, low cost. While various media sources continue to suggest that the demise of the check is imminent, the truth is that ".little work has been done to examine consumer choice of monetary vehicles and their reaction to changes in the costs associated with value transfer."1 With a gross loss of just over 1%, the check remains the nation's least expensive payment alternative.
1. If three articles, a case study, and references to other information you can read about ECP hasn't been enough for you, don't miss the 1997 National Electronic Check Presentment Conference in Atlanta, Georgia, September 22-24, 1997. Call 800-224-9889.
