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The GAO released this report last Thursday, on credit card interchange rates. Interchange rates are the rates charged by the banks that issue credit cards, and typically are about 2% of each transaction. These rates are extremely frustrating to merchants because they have been steadily increasing and because merchants (especially small businesses) have no practical means for negotiating these rates. Basically, if you want to accept 
Visa and Mastercard you are stuck with interchange rates. But hue and cry from merchants has caught the attention of the Feds. There are several legislative proposals on the table designed to help control interchange rates, and Congress directed the GAO to create a report on the subject.
The GAO report verifies the perception of merchants that interchange rates have gone up. The report also suggests that issuing banks may exercise market power, such that they can raise rates without losing customers (an economically inefficient state of affairs). That aspect of the report is the good news for merchants and their political advocates. The bad news is that the report criticizes the most commonly proposed approaches for fixing the problem, including (i) setting interchange rates, (ii) requiring disclosure of rates to consumers, (iii) prohibiting card networks from imposing rules on merchants, and (iv) antitrust exemptions to allow merchants to directly negotiate with issuing banks (which would generally be considered an illegal agreement in restraint of trade). The GAO is apparently skeptical that such measures would actually reduce prices for consumers.
While the best solution to interchange rate hikes may need to come from government, there are other transaction costs that merchants can negotiate down, including processing fees (for an earlier blog post explaining the difference between interchange and processing fees, click here). In fact, the GAO report found that the market for processing fees is in fact highly competitive. Each year approximately 1.4 million merchants switch processors (otherwise known as merchant account providers). TransFS tries to make it easier for merchants to make this switch, by setting up an internet auction to find the best-priced processor.
On Monday the U.S. Senate Committee on Commerce, Science, and Transportation released a report summarizing its investigation into deceptive e-commerce business practices. The report highlights the growth of sleazy direct-marketing practices on the internet, particularly companies such as Affinion, Verture or Webloyalty. These companies, which have operated for years through direct mail and telemarketing, exploit consumers’ confusion about the online “checkout” process to sign consumers up for monthly payments in exchange for services that consumers may not want or understand. The report highlights two deceptive practices in particular: (i) “misleading ‘Yes’ and ‘Continue’ buttons that cause consumers to reasonably think they are completing the original transaction, rather than entering a new ongoing financial relationship” and (ii) the “data-pass” process whereby “direct-marketing companies receive automatic transfers of credit or debit card information from a familiar web seller to the third-party membership club.” After “agreeing” to enter into a relationship with direct marketers, consumers are typically charged $10-$20 per month until the consumer cancels the membership. According to the Senate Committee, thousands of online consumers have complained to their attorneys general about these deceptive and misleading practices.
Why would a reputable web commerce company enter into a partnership with a sleazy third-party membership club? The answer is that such partnerships are extremely profitable. Whereas typical internet advertising banners have CPMs (cost per thousand people who view the ad) around $30-$40, third-party membership clubs pay out CPMs of between $850 and $2,650, depending on conversion rates.
However, when reading the frustrated testimonials of customers who feel duped by these deceptive practices, one wonders whether it is truly in the best interest of e-commerce companies to allow third-parties the opportunity to deceive their customers.
CEOWorld Magazine just released a comprehensive review of the best business and corporate credit cards. The market for business credit cards has been becoming increasingly competitive as credit card companies look for new ways to entice small businesses with useful tools. However, as usual, it’s tough to tell which cards are truly interesting vs gimmicks to attract new business customers. Whether your business’s primary needs for credit card usage come from travel expenses or you prefer a certain loyalty program, check out this great article on which card is best appropriate for you.
A recent CardRating.com article noted a trend in the language of credit card companies. In light of economic conditions, card issuers are lauding credit cards as finance management tools. For example:
“American Express promotes its charge cards as an effective cash flow management tool for small business. A few years ago, analysts saw this core American Express product line as a liability. Today, industry watchers celebrate it as a low-risk, high-reward opportunity to generate profits from interchange charges and annual fees.”
JP Morgan Chase has even taken a drastic step in unveiling its new program called Blueprint, which waves interest fees for consumers on everyday items. As with all marketing ploys, make sure to read the fine print. In the case of Blueprint, the average consumer won’t notice much of a change since the program is aimed more towards the affluent consumer.
Navigating the sea of acronyms in the PCI (Payment Card Industry) can be somewhat scary, so here is a helpful guide to deciphering basic terms.
- CCP- Credit Card Processor.
- DSS- Data Security Standard. This is a standard set by the PCI Security Standards Council by which companies must be compliant to ensure financial data security.
- MAP or MSP- Merchant Services Provider. Another term for credit card processor.
- PAN- Primary Account Number. The actual number on a person’s credit card. It is also encoded in the magnetic stripe and contains the major industry identifier, and a code that ensures the authenticity of the embossed account number.
- PA-DSS- Payment Application Data Security Standard. SSC (see below) managed council focused on helping software vendors create secure payment applications that do not store prohibited data, for example, the PIN number.
- PCI- Payment Card Industry. The debit, credit, prepaid, e-purse, ATM and POS cards’ businesses.
- PIN- Personal Identification Number. A numerical password a user must enter into a system in order to authenticate his/her identity.
- POS- Point of Sale. The location where a transaction occurs, for example, a checkout counter.
- SAQ- Self Assessment Questionnaire. A tool used to gauge a merchant’s level of PCI DSS compliance.
- SSC- Security Standards Council. PCI’s council to develop, enhance, and implement security standards for financial data protection.
- SSN-Social Security Number. Major liability for credit card breaches since cards have access to the SSN of the user.
ApparelNews.net reported that the The Merchants Payment Coalition released a study showing a growing concern from retailers over exaggerated credit card fees. In the US, retailers pay roughly a two percent interchange fee for each credit card purchase. This is compared to a 0.5% interchange fee in Australia, and a 0.3% interchange fee in the EU.
Fed up with paying fees up to six times greater than other countries, retailers are now pushing for action in congress. A bill in the House called the “Credit Card Fair Fee Act of 2009” and the Senate’s “Credit Card Fair Fee Act” propose a system where merchants can together negotiate with banks over interchange fees. These two bills would let merchants have more access to talk to banks in establishing fees. However, Visa and Mastercard retort that merchants have plenty of opportunities to discuss lower fees.
Reform is met with criticism from merchants and consumers alike. About 60% of consumers believe merchants should continue paying the cost of accepting credit cards. Some retailers also believe that reform would benefit large businesses, but would not affect small business.
Last year, US interchange fees were up 33% from 2006. This represents $48 billion in 2008, and $42 billion in 2007. At TransFS.com, we strongly support the reform of interchange fees. Here are some ways for retailers to save on processing costs: (From ApparelNews.net)
1) Buy transaction machines instead of leasing: Buying a machine can cost about $300, while leasing a machine from a fee-processing company can cost $50 for 48 months.
2) Ask customers to use debit cards: Debit cards have lower processing fees, so offering savings on preferred payment methods can often pay off.
3) Use TransFS’s comparison shopping engine: We allow processors to compete against each other to win your business. This results in better pricing for you. We vet all of the processors who bid on our site to make sure they provide the best service and will act in the best interests of you, the merchant (in fact, we even contract the processors abide by certain rules that are merchant friendly).
The pace of articles relating to credit card fees is accelerating at a rapid pace due to the credit card legislation going through congress. In fact, there are so many articles flying around that it is hard to keep up. So, what does that mean for TransFS and for you? It means that we should be filtering the myriad articles out there down to the top handful in order to help you, our valued customers and other small business owners (hopefully soon to be customers), get the skinny on what is happening in the credit card world.
In the last week we found one article that does a great job of summing up some of the key points in the current debate on interchange fees. The article by “Trader Mark” on SeekingAlpha.com puts forth some very interesting merchant-side credit card processing facts that have come to light recently due to the battle in congress around consumer credit card fees. Here are a couple of the more interesting tidbits Mark mentions in his post:
- Visa Inc., MasterCard Inc. and JPMorgan Chase & Co., already squeezed by new U.S. curbs on how credit cards are marketed to consumers, are girding for a renewed battle over $48 billion in fees levied on merchants.
- Lawmakers are promising new rules to bring down the interchange fee, a charge on purchases sometimes topping 3 percent that’s split by the two banks serving the customer and merchant.
- Supporters of the legislation include the biggest retail chains, restaurants and small businesses, which say the fees erode profit and inflate prices.
- The debate pits the largest card lenders including JPMorgan and the two biggest payment networks, Visa and MasterCard, against Wal-Mart Stores Inc. and Target Corp. Interchange is the second-biggest cost after payroll, Target said, and merchants want to negotiate lower payments collectively without running afoul of antitrust law. (remarkable statistic)
- The Credit Card Fair Fee Act would let merchants bargain together on interchange rates and designates the Department of Justice as arbiter. Card networks and lenders would be forced to disclose components of the fee and how banks share the money.
- In a typical transaction, the retailer’s bank deducts 1.9 percent from proceeds of the purchase, a sum known as the merchant discount rate. The largest portion — the interchange fee — goes to the bank that issued the card. The bank for the merchant keeps what’s left. Interchange fees average 1.7 percent of the purchase, according to JPMorgan analyst Tien-tsin Huang.
- Visa and MasterCard get paid a processing fee from each bank of 15 to 18 cents on a $100 purchase, Huang said in a June 5 report. MasterCard and Visa process about 58 billion transactions annually, company filings show.
- Visa Europe Ltd. faces an antitrust complaint from EuroCommerce Inc., a retailer group that said this month that stores should be able to negotiate fees. MasterCard settled in April with European Commission antitrust regulators by reducing credit card interchange to 0.30 percent.
- JPMorgan, Bank of America Corp. and Citigroup Inc., last year’s biggest bank card lenders, don’t detail interchange revenue. (i.e. they are not transparent)
- “In every other aspect, merchants have the ability to negotiate and reduce their costs except this one,” said Jennifer Hatcher, spokeswoman for the Arlington, Virginia-based institute. Target lacks leverage because it’s “simply not realistic” to stop accepting cards, said Eric Hausman, a spokesman for Minneapolis-based Target
As we already know, Mastercard and Visa are not entirely forthcoming with their fee structures and it is next to impossible to negotiate the interchange fee due to the market dominance of just two firms (i.e. this isn’t really a free market since there is virtually no competition). If Target has trouble negotiating their rates then the rest of us don’t have a chance.
For now we will have to wait and see where this goes. In the meantime, we at TransFS can help business owners lower their credit card processing fees through our reverse auction system where credit card processors compete for your business. Check it out if you want to save on your credit card processing fees and let us know what you think.
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 …
Lately I have been really geeking out on the Federal Reserve website, which has lots of great data. Today I was looking at Report to the Congress on the Profitability of Credit Card Operations of Depository Institutions, a deep analysis of the profitability of credit card issuers. To do this analysis the fed takes advantage of the fact that there are many banks whose primary business is issuing cards and that those banks need to report their profitability and return on assets to the Fed, FDIC and other regulators. Here is what I learned:
- Issuing credit cards is a good business with return on assets between 2% and 4% depending on the year. Compare this to the overall profitability of banks from another Fed Bulletin entitled Profits and Balance Sheet Developments at U.S. Commercial Banks in 2007 which shows overall bank return on assets varying between 0.2% and 1.6% over the same time period. Clearly credit card issuing has historically been more profitable then most other banking products.
Credit Card Issuer Return on Assets
- At the end of 2007 there were $917 billion in consumer credit card balances outstanding, I wonder how that has changed since then.
- There were about 600 million Visa and Mastercard credit cards at the end of 2007 and another 100 million Discover and American Express.
- There were 5.2billion credit card offers mailed out in 2007 – around 17 per person in the US, or around 52 per household. The response rate was around 0.5%.
- The average credit card interest rate was around 14%.
Credit card issuers make money in two ways, first by charging merchants credit card processingfees for each transaction (for visa and mastercard those fees are called Interchange) which is collected by the credit card processor and passed along to the bank that issued the credit card (about 30% of their revenue), and second by charging fees and interest rates to the consumer for any balances that are carried (about 70% of their revenue) which are billed directly to the consumer.
This was pretty exciting, Truecostofcredit.com, our free tool that helps consumers and business owners understand the cost of accepting credit cards, was posted on the Freakonomics Blog at nytimes.com.
Steve Levitt, one of the most interesting people I know and a former professor of mine (and co-author of the best-selling economics book Freakonomics), called it “nifty”! If you are an economics geek like me, this is pretty much the most exciting thing that can happen.
The article can be found here The True Cost of Credit.
