Digital Money Forum

The price of everything

[Dave Birch] I've just read a couple of pieces about pricing: the Chicago Fed's Letter 266a (September 2009) "Payments Pricing: Who Bears the Cost?" and the SPEED piece by the Deputy Governor of the Bank of Finland, Pentii Hakkarainen, "The future of retail banking: more competition needed". Pentii says that one challenge (to retail banks) is the "dependence of banks on cross-subsidisation, especially of payment services". I agree and I'm not sure that the magnitude of the cross-subsidy from efficient e-payment methods that (because of SEPA) are going to deliver less margin to the least efficient paper and metal methods is appreciated. So the regulators are pushing down the amount of money available for subsidy but will (of course) go beserk if any attempt is made to remove the subsidy.

One way in which they are reducing the amount available to subsidise cash is by pushing interchange fees down. Setting aside whether that's a good thing or a bad thing, it's certainly a thing. Earlier in the year, there was a Federal Reserve Board report "Interchange Fees and Payment Card Networks: Economics, Industry Developments and Policy Issues" that looked at the situation (in the US at least) in some detail. Amongst other observations, it noted that with respect to interchange fees:

1. In general, an efficient interchange fee is not solely dependent on the cost of producing a card-based transaction nor is it equal to zero.
2. An efficient interchange fee may yield prices for card services to each side of the market that are “unbalanced” in the sense that one side pays a higher price than the other.
3. The efficient interchange fee for a particular card network is difficult to determine empirically.

I think the last point is worth emphasising. There doesn't seem to be any reason to suspect that regulators should inherently know what the correct level of interchange should be. It follows, I think, that if the regulators believe that interchange is too high (for whatever reason) then the appropriate path to correction is increased competition.

What doesn't add up

[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 by the always reliable forum friend 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.

Contactless #pass and #fail

[Dave Birch] Having been focussed on some other initiatives for a while, I hadn't been paying much attention to the contactless roll-out in the UK. However, in the last couple of days I've had a couple of interesting experiences. First, I popped into Pret a Manger near Euston to get a latte while I was waiting for a customer. I noticed that they had contactless readers, correctly positioned and apparently turned on. So I paid using my splendid Barclaycard OnePulse card.

That's the story, basically. A contactless terminal, in a useful location, properly installed and working without a glitch. I paid in a couple of hundred milliseconds and left.

Not everything in the garden is rosy though. Yesterday at Cafe Nero I noticed another contactless terminal, once again correctly positioned and turned on. So I tried to pay using my splendid BarclayCard Cashback card but got the message "not authorised". Ever vigilant to explore the contactless envelope on behalf of digital money denizens, I tried a couple of other devices about my person (a sticker on the back of an iPhone and a mobile phone) and the terminal read them correctly, so there was no doubt that it was working. I tried my BarclayCard again. "Not authorized".

I was really surprised by what happened next though. The chap at the till explained to me that contactless cards could only be used a few times before they must be used in a regular chip and PIN terminal ("to make sure that it is really your card") and invited me to use the contact interface. Incidentally, he also told me that more and more people were using the contactless terminal. That's a good sign, and it's from the horse's mouth, so to speak. I knew the offline no CVM count wasn't the problem (you get a different message on the terminal) but did it anyway and, of course, the transaction worked perfectly. So having done the chip and PIN transaction, I then bought a cookie (any excuse) and tried to use the card contactlessly again. "Not authorized". Barclays #fail.

The point of this anecdote it not that one of my cards didn't work properly but that the retailer had clearly trained the staff properly and they understood how the product worked, which I think is evidence of progress that deserves reporting.

The research conclusions identified merchant acceptance as a critical factor in promoting consumer use of contactless payment technology.

[From Alliance Activities : Publications : Issuer and Merchant Best Practices: Promoting Contactless Payments Usage and Acceptance - Smart Card Alliance]

This is undoubtedly correct, but it's not just the terminal penetration that is the measure. It's whether the merchants have trained their staff to exploit contactless properly so that people will be encouraged to give it a try and, when things don't work properly on occasion, help them sort out what's going on. Well done Cafe Nero.

contactless and nfc, retail

The way to a mans heart

[Dave Birch] One of the most basic dynamics in the retail electronic payments world is the cost of transactions and the comparison of costs from the retailers perspective. If we assume honest retailers (ie, they are accounting all cash transactions and not using them to avoid taxes, enable money laundering and so on) then what is the real picture? It's honestly hard to say, clearly one factor is that type of retailer and their average transaction size. Another is whether we account the retailers private costs or the total social costs. I think it's a mistake for regulators to account for the retailers private costs only, especially given my pro-electronic payments perspective! If we only account those private costs then for many retailers, electronic payments will always seem more expensive and therefore it appears that (for example) card users are getting a good deal.

This is clearly unfair to consumers who use cash. They face a higher cost for goods or services through no fault of their own. In a user-pays society, those using a service should expect to pay its full cost.

[From Editorial: User-pays for credit cards fairer for all - Personal Finance - NZ Herald News]

Indeed. I don't use cash except when I am forced to. So I don't want to pay for ATMs, police escorts to ATMs, security vans, police escorts, tax evasion and all the rest of it. Surely merchants accepting cash should be required to pay a special tax that goes to the police, the revenue and the customs?

OK, perhaps not. But retailers do complain about the cost of electronic payments, claiming that cash is less expensive. There are, however, businesses that have started to refuse cash. One New York restaurant "Commerce" has looked at the bigger picture and come down firmly on the e- side. The owner Tony Zazula, hereby declared a Hero of the Order of Digital Money (my newly-created elite secret society), takes a robust line. Has has stopped accepting cash altogether and is clear about his strategy.

"If you don't have a credit card, you can use a debit card," said the restaurant's co-owner, Tony Zazula. "If you don't have a debit card, you probably don't have a checking account. And if you don't have a checking account, you probably shouldn't be eating at Commerce to begin with."

[From New York Restaurant Loses Its Appetite for Cash - WSJ.com]

Now that's what I call KYC (Knowing Your Customer). And the abandoning of cash helps with Anti-Money Laundering (AML) as well I should imagine. While Tony's firm line on the folding stuff may inconvenience the occasional drug dealer or corrupt politician (which might be a reasonable fraction of the customer base in that area!!) it seems to me that both the restaurant and society benefit: the private and social costs fall together.

cashless, costs, notes and coins, retail

Payments aren't just about payments

[Dave Birch] Speaking at the Cards & Payments Quarterly Thought Leadership seminar, Andy Simmonds of Barclaycard was talking about pan-European acquiring. One of the several excellent and perceptive points he made was that large, pan-European merchants will "take matters into their own hands" unless they get better service from banks. What he meant, I think, was that retailers will either issue their own semi-closed loop payment cards, stickers, watches, hat, badges and whatever else or that they will demand direct access to Visa and MasterCard. Contactless, that well-known Mickey Mouse technology will, I think, have an impact here because it gives retailers and others the ability to move beyond the card format. Let's face it, cards are a bit boring to the average consumer (as are payments, frankly) and so these alternative form factors may have attractions beyond rational product evaluation, if you see what I mean.

contactless and nfc, retail

I didn't understand this story

[Dave Birch] Perhaps it's an age-related disorder, but I'm finding it harder to understand news stories. For example, I happened across this a couple of days ago:

Visa recently made a change to the fees that it charges retailers-something called an interchange rate-and it means that retailers must pay them a lot more when a consumer uses a Visa contactless debit card. In other words, when a consumer walks into a Best Buy and buys a $300 Blu-ray disc player, the amount of money the retailer gets to keep will differ sharply based on which Visa card that consumer chooses to use. By increasing those charges, Visa is trying to make up for some of the money lost through the new law.

[From The Credit Card Reform Backlash - CBS News]

What? There's a higher interchange rate for contactless cards and this results in a higher merchant service charge for contactless transactions?

Best Buy pushed back last week (July 16) when it issued a statement to retail technology publication StorefrontBacktalk that was the retailer's equivalent of a shot across the bow at Visa. Best Buy said that it "is constantly looking at ways to reduce the cost of check lane tender. As part of this exercise, we are evaluating the continued acceptance of Visa-issued contactless payment cards in our stores in light of recent price increases."

[From The Credit Card Reform Backlash - CBS News]

Does anyone know how much Best Buy pays for a Visa contactless debit transaction compared to, for example, a Visa or MasterCard credit card transaction for a customer purchasing a $300 Blu-ray player? I don't understand this story, so I was wondering if one of our US correspondents could read between the lines for me. I don't understand why chains like Best Buy and Home Depot, where the average ticket must be more than $25, are considered prime contactless territory -- do people rush in to Best Buy shouting "quick I need a Dolby 5.1 surround sound speaker system!!" and waving their Visa card in front of them?

United we fall

[Dave Birch] I think that the decision by United Airlines to make some smaller travel agents process ticket sales on their own merchant accounts (and therefore pay the merchant service charge, or MSC) is one of those developments that seems on the margins at the time but actually signals the start of the supertanker's turn. United's new policy, starting 20th July, is for one reason: cost.

United would say only that the move was prompted by rising card-acceptance costs. “Credit card processing costs are escalating at a high rate and represent several hundred million dollars of cost each year,”... All travel-agent ticket sales on cards in 2008 totaled $79 billion, according to ASTA estimates, with an average discount rate of 3%.

[From News]

Never mind the average 3% MSC, the figure I thought was really shocking in this report was that brick-and-mortar agents account for nearly half of all airline ticket sales. I haven't been in a travel agency for years (except to buy prepaid payment cards), all my personal travel is bought via web sites and all our corporate purchases go through invoices, so I was genuinely surprised to read that....

At the same time, airlines depend on so-called traditional, or brick-and-mortar, agents for somewhere between 40% and 50% of their ticket sales, with online agencies accounting for another 20% to 25%,

[From News]

Wow. To me, that was a genuinely surprising statistic. Anyway, that led me to wonder if people buy airline tickets with debit card given the price incentive -- many airlines make an explicit charge for credit cards, but no charge for debit cards -- or if the benefits of a credit card in these circumstances are seen as being sufficient to outweigh any surcharge.

Personally, I never buy airline tickets using anything other than a credit card, even though many airlines surcharge and try to get you to use debit cards. That's because if anything goes wrong -- let's say the airline goes bankrupt, for example -- then if you paid with a credit card you'll get your money back. I'm more than happy to pay for the peace of mind. My top tips for avoiding fraud: use a credit card for everything in all circumstances and never use your debit card for anything except ATM withdrawals.

credit cards, debit cards, retail

Thought experiment: cash crash

[Dave Birch] A couple of people mentioned to me that my post about replacing cash is based on the assumption that cash will go away, whereas cash is a very conservative technology. This is true, of course. But the fact that cash is losing market share only very slowly does not mean that it could not see a more rapid drop in the future. Nevertheless, it would appear that the cashless store remains as a common as the paperless office, to repeat a frequently-used analogy. However, as The Economist recently pointed out, while fantasies about the paperless office began in the 1960s and are still derided by lazy commentators as "as likely as the paperless bathroom", the truth is that it takes a generation to effect change. The use of paper in American offices has indeed been falling, but the decline didn't begin until 2001 (paper use per office worker has fallen by about a sixth since then). Perhaps cash will take a generation to go away as well. What then? Suppose all of the cash in Britain went away and was replaced by electronic cash instead. What would happen? Well, let's begin the thought experiment by trying to figure out how much cash there actually is. Narrow money (M0) is the amount of notes and coins in circulation.

The total amount of cash in the UK is just over £50bn, with about £43bn circulating outside the banks and £7bn in banks' safes, tills and cash machines.

[From BBC NEWS | Magazine | Where has all the money gone?]

If that went away, the first thing that would change is tax: the government earns interest on that £50 billion loan that we are granting it in exchange for bits of paper and metal and that interest -- a couple of billion per annum -- would need to be replaced by other tax revenue. Oh well. At the least the cost of government would be made more explicit. But I don't think the government would see a net loss: after all, no cash means less tax evasion so we can reasonably claim that the transition to e-money will be revenue neutral and the economy as a whole will be much better off because of the high social cost of cash (resources would be freed for more productive activity).

A couple of billion! Actually, it's not that bad. Much of the £43 billion outside the banks isn't really circulating: it's under mattresses and in jam jars. The euro has steadily been replacing the dollar and the pound in drug-dealer's stashes though, so let's say that two-thirds of M0 is the circulating medium of exchange, say £30 billion for a round number. If the seigniorage on that is five percent, that means around £1.5 billion per annum remitted to the government (which tallies roughly with the Bank of England's figures I think). Where is that £1.5 billion going to come from? Perhaps the government will cut spending accordingly by reducing waste and getting rid of pointless programmes... no, maybe not.

Harry Clarke, RingGo

[Dave Birch] Following his army career and MBA at Cranfield with stints at Mercury Communications and the Automobile Association, Harry Clarke was one of the founders of automated transaction handling company Cobalt Telephone Technologies. Started in a portakabin in 1997 with just £20k of largely redundancy money, Cobalt today cites Manchester United, four UK airlines and Ten London Boroughs as clients and has processed well over £250M of parking ticket payments. Under Harry’s leadership Cobalt has, since 2005, been heavily focussed on the commercial development of RingGo, a mobile phone parking payment service. RingGo has now established itself as the UK’s leading brand of phone parking with a dominant presence in London, in Western England and also South Central England in particular. In this podcast, he talks about growing a real cash replacement business and discusses where it might go in the future.

Listen here in either [Podcast MPEG4] or [Sound-only MP3] format.

Olga Morawczynski, University of Edinburgh

[Dave Birch] Olga Morawczynski is a Ph.D candidate at Edinburgh University where she is researching... She has been living in Kenya, conducting ethnographic research on the M-PESA money transfer scheme. In this podcast she shares her observations on the scheme and discusses some ideas about the future.

Listen here in either [Podcast MPEG4] or [Sound-only MP3] format.