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After 37 years in the business, Toronto tour operator Conquest Vacations is closed for business citing, among other things, “unrealistic and unreasonable demands by the credit card processing companies”.
When you make a purchase with a credit card, Visa and Mastercard gaurantee that the product will be delivered. If the product is not delivered, the issuing bank (like Capital One) can go to the acquiring bank (like Wells Fargo) to get the customers’ money back. The acquiring bank can collect from the credit card processor, and the credit card processor can collect from the merchant.
As a result, the credit card processor bears significant risk if the merchant goes out of business and isn’t able to deliver the product. Particularly in travel, where a vacation might be booked months in advance, the amount of risk to the processor can be large.
When the processor gets too worried about that risk, it stops accepting payments for that merchant. If a business cannot accept payment from customers it quickly goes out of business.
ATA Airlines went bankrupt and left its credit card processor to foot the bill.
Revolution Money’s announcement of $42 million in fresh funding was the big payment systems news last week. Revolution offers a credit card with dramatically lower processing fees, a flat 0.50% compared to the greater than 2% typically paid by merchants, as well as MoneyExchange, a free online payment service similar to PayPal. While many are excited by the prospect of an alternative payment system, considerable doubt exists about whether Revolution will be able to succeed.
Revolution has financial support and executive leadership from major players in the financial services industry, including top credit card issuer Citigroup, and backing from AOL co-founder Steve Case, but building a competitive payments system will be no easy task. While the payments system has evolved over the decades, pioneer Diners Club is a relatively minor player now and upstart PayPal has become a serious competitor in recent years, the established participants have a significant edge at this point and it will take considerable resources and ingenuity to compete successfully.
How to attract merchants and cardholders to a payment system is the classic chicken and egg problem. Existing card networks have chosen to make merchants bear the bulk of the costs. Cardholders who pay off their balance in full each month, not only pay nothing for the service but can earn significant rewards from using their cards. In contrast, the Revolution Card is far more attractive to merchants than consumers. The low, flat rate for processing the Revolution Card is incredibly beneficial to merchants but leaves Revolution with little room to offer the same sort of rewards and benefits cardholders have come to expect from their Visa or MasterCard. Instead, the company encourages merchants to offer their own customer incentives. While this enables merchants to be more flexible and customized about passing on the benefits from lower processing fees to customers, it creates a far more complicated and unpredictable reward scheme for cardholders. Revolution has built a sizeable list of major merchant participants such as Whole Foods and Office Depot, but the Revolution Card website lists incentives for only 8 merchants which appear to apply only to their co-branded cards rather than the primary Revolution Card. The main cardholder benefit emphasized by the company is enhanced security due to pin-based authentication. However, it seems a stretch to imagine many cardholders will consider this sufficient compensation for the loss of generous rewards.
Nonetheless, it’s certainly an interesting time in the payments space as issuers cut credit lines and raise interest rates on loyal customers. Perhaps enough disgruntled cardholders could turn the tables in Revolution’s favor. Stay tuned as we investigate the life of a Revolution cardholder further …
Book Review: PayPal Wars
Paypal Wars was a really fascinating book, telling the story of Paypal’s early years in the late 1990s. The most incredible part of the story to me was how Paypal began losing 3.5% on every transaction, 2.5% to interchange fees and 1% to fraud. Over time they figured out the fraud and also began to move transaction volume away from expensive credit cards to lower-cost methods. First, they used the ACH network, which is almost free to enable people to fund their accounts. Second, as their network grew, they were able to internalize more transactions. They also began charging the recipients of Paypal payments and were able to make a positive spread on each transaction by the time they went public in 2001.
Building a new payment network is extremely expensive. It took visa and mastercard many years and hundreds of millions of dollars to build theirs. Paypal had the advantage of being able to ride on top of two existing payment networks – credit cards and ACH – which greatly accelerated their pace of expansion, they were able to get 10M users in a few years, a feat which took visa and mastercard much longer. However, they had to pay for that benefit, resulting in huge losses over their first years in business.
Paypal’s transaction volume is growing at an very rapid pace, reaching $60B in 2008 with plans to double that volume by 2011. Such volumes will give Paypal clout on par with American Express and Discover, although still well short of that wielded by Visa and Mastercard. It will be interesting to see what impact the emergence of a 5th payment network will have on the payments industry.
Interchange Rate Increase
Periodically Visa and Mastercard (independently, of course, since collaborating would probably violate antitrust laws) recently announced changes to their interchange rates and assessments. Those who read this blog regularly know that interchange rates are the revenue that goes to the credit card issuers (like Capital One and MBNA) and that assessments are the revenue that goes to Visa and Mastercard.
I recommend checking out a pretty detailed article on P.8 of the April issue of Digital Transactions Magazine. In this latest round of interchange rate changes, both Visa and Mastercard increased rates by about 4% on several categories of rewards cards and decreased rates by about 2% on several categories of non-rewards cards. Since the majority of transaction volume is rewards cards (and growing), this will likely result in a net increase for most customers.
Visa and Mastercard are also both adding an additional $0.02 per transaction fee that is not passed along to card issuers – visa’s is called the Acquirer Processing Fee and Mastercard’s is called Network and Brand Usage Fee, which should generate around $600M in additional revenue each year for Visa and Mastercard.
Unfortunately this will result in credit card processing costs increasing for nearly everyone. Business owners, please check your bills carefully next month to see how these new credit card processing fees are being applied. Hopefully your processor is passing them along directly, and not using it as an opportunity to increase their own profits by adding a markup.
The network access and brand usage fee is a $0.0185 per transaction fee established by Mastercard in the spring of 2009. It is similar to assessments, in that the fee is kept by mastercard, not passed along to the credit card issuing banks. This fee replaces a $0.005 per transaction fee.
Visa at the same time established a similar fee called the Acquirer Processing Fee, a $0.019 per transaction fee which also replaces a previously $0.005 per transaction fee.
The April issue of Digital Transactions magazine estimates that the NABU will generate an additional $185M each year for Mastercard.
Visa Acquirer Processing Fee
The acquirer processing fee is a $0.0195 per transaction fee established by Visa in the spring of 2009. It is similar to assessments, in that the fee is kept by visa, not passed along to the credit card issuing banks. This fee replaces a $0.005 per transaction fee.
Mastercard at the same time established a similar fee called the Network Access and Brand Usage Fee (NABU), a $0.0185 per transaction fee which also replaces a previously $0.005 per transaction fee.
The April issue of Digital Transactions magazine estimates that the Acquirer Processing Fee will generate an additional $432M each year for Visa.
As you can see (if you are reading this post on the TransFS.com website), we are gearing up for a major redesign of our website. As a first step, we’ve rolled out the new design to our blogs… so that we can get a sense for how everything looks, and get some feedback.
We hope you like the new design. We arrived at it using CrowdSpring (more on that in a follow-up post)… and we’re incredibly happy to be working with a talented new designer who is helping to bring the site to life.
You can expect to see this design rolled out to the rest of TransFS over the next week or so. Please let us know what you think!
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About TransFS
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