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What doesn't add up

By Dave Birch posted Oct 12 2009 at 7:51 PM

[Dave Birch] I'm still curious about US debit interchange rates, just as I was a couple of weeks ago when I misunderstood a magazne article on the topic. Remember that in the US, PIN debit (which grew out of regional ATM networks) costs less than signature debit, so you would expect merchants to incentivise the use of PIN debit or you would expect signature debit rates to fall towards PIN debit rates. In fact, since signature debit rates (via Visa and MasterCard) have remained fairly stable, what has happened is that PIN debit rates have moved up towards signature debit rates. Looking for some recent figures....

the average interchange cost for a small retailer on a $50 face-to-face purchase processed on a PIN-debit card with a major electronic funds transfer network logo in 1996 was 9.9 cents. By 2007, that same sale generated 40.1 cents in interchange... In contrast to PIN-debit pricing, signature-debit interchange has been stable since 2005... a small retailer in a $50 card-present sale with a Visa check card would pay interchange of 66.5 cents, and 67.5 cents on an equivalent MasterCard Debit transaction.

[From News]

Now, I reckon that the same retailer in the UK would pay 10p for a transaction that they pay 40 cents (30p) for in the US. So, I'm missing something here. Why does a debit transaction cost a merchant so much more in the US? For $50 transactions, setting the cost at 15 cents or 30 cents is not a make-or-break decision. But, obviously, for many merchants (especially in the cash-replacement potential market sector that I am interested in) the average sale is much smaller and a 40 cent charge on a $4 transaction eats up a lot of the merchant's margin.

The chain’s average ticket is $6, a level at which it’s difficult to make money after deducting interchange, Jones argues. Currently, credit cards account for about half of sales.

[From News]

So unless I'm missing something else about the cost structure, the only interpretation of these figures is that merchants in the US simply pay a much higher fee than merchants in (for example) the UK do. Our friends at Payments News pointed me to a recent report that suggests that that is precisely the right interpretation.

U.S. swipe fees are: more than two times the rates in the UK and New Zealand, four times the rates in Australia, and over six times the cross border rates recently agreed upon by MasterCard and the EU

[From Merchants Publish A Look at Interchange Fees Outside the US]

Why is this gap so big? Surely the US market is just as competitive as the UK market? I read a recent analysis from Peter Jones of Payment Systems Europe -- who put the average merchant fee at 1.8% in the US and 0.8% in Europe -- and he attributed the difference to the competitive issuing market in the US, with card companies competing to attract consumers by offering ever-higher rewards and charging the merchants for them. You can see why merchants object to this: but what should they do? James van Dyke of Javelin has some sage advice.

Merchants have some valid concerns about the payments industry, but they should push back on their advocacy-group partners and lobbyists on the viability of this interchange campaign. The interchange debate is fundamentally an issue between differing camps of business entities, and to position it as a consumer-advocacy issue will ultimately be fruitless for the merchant community in my opinion.

[From Javelin Strategy and Research » The merchant cost-of-interchange debate: what are the facts?]

Yes, the cost of cards needs to come down. But the way to do this is by encouraging competition, not by whining to regulators.

A key reason why is that there's no way that regulators can calculate what the merchant fee should be. The Commission uses the "tourist" test as the benchmark. A tourist comes to a retailer they have never been to before and may never visit again. How much is it worth the retailer to accept a card rather than cash? This, according to the Commission, is the true value of the card payment. But they are wrong. As Peter Ayliffe, head of Visa Europe puts it,

We have already made it clear that, while we accept the merchant indifference test, we do not accept cash as the comparator for credit and therefore disagree with the Commission’s proposed rate on credit interchange.

[From Visa Europe rejects claims from the European retailing community]

Using cash as the benchmark in this way does not correctly account for the social cost of cash, which is spread across consumers, merchants and governments. Should the regulator set the cost of cards at the cost of cash to the merchant, or the cost of cash to society (which is higher)? If the former, then they are subsidising the retail community at the expense of everyone else. If the latter, then the winners (everyone) are diffuse but the losers (retailers) are not, and political fall-out is inevitable.

Surely the right answer is to leave the fees to the marketplace but make it as easy as possible for competitors to enter the marketplace?

These opinions are my own (I think) and presented solely in my capacity as an interested member of the general public [posted with ecto]

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Surely the right answer is to leave the fees to the marketplace but make it as easy as possible for competitors to enter the marketplace?

Hear hear! And, separate payment systems from banking (or whatever banks think they do these days).

Where I am, the local geek paradise store gives a 2% discount for cash over direct debit. Clearly interchange fees are more a model of market power and ability to generate fees than any "social" cost. Visa's rejection of a comparison that is unfavourable to them is obvious and silly.

Also, I'm not entirely convinced that cash is socially worse. Mason & Porkess just published an article at http://www.newlawjournal.co.uk/nlj/content/chip-pin-fallacies that suggests to me that chip & pin is more risky for the holder than cash.

Yes, leave it to the marketplace and competition, for sure. Whine to the regulator only when there is no effective competition.

I get 1 per cent cashback reward on all my credit card spend. To me, that indicates that interchange on credit cards must be too high - interchange on debit cards tends not to support reward schemes. Should society subsidise my credit card usage?

If regulators are unable to calculate the true cost of cash, then how can we determine the cost of using any particular payment instrument?

Instead of fixing the fees, perhaps the regulator could allow the merchant to pass on the cost for accepting the payment instrument, if they so wish? We'll then see a marketplace and competition between cash and the various card types.

In practice, the merchant will attribute some value to the additional business that accepting a card brings. The difference between that and the cost of accepting the payment instrument will become apparent at the point of sale.

In this model, if the current interchange is correct, the merchant can give me the 1 per cent cash reward for using my credit card in his store. Maybe.

Interchange is right up there with black holes and quantum physics in terms of my understanding. It certainly is totally obscure to consumers.

One major shift here which you allude to is the introduction and promotion of new premium credit cards AND attaching higher merchant fees to those cards, so help recoup the higher membership fees.

It occurs to me when a consumer presents those cards, the merchant has little choice but to accept the card and higher fee.

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