Does Industry Lack Conviction for Interchange Fight?

 

 

 

Let’s call it the Mobius Defense. You know what I’m talking about – circuitous reasoning, spun by individuals who are so wed to their opinions that they can’t imagine life any other way.

I had a chance to witness this first hand during a public debate on interchange recently. A lawyer representing the status quo offered up this argument: the economic meltdown that began last year was a direct consequence of the federal government not adequately regulating the sub-prime mortgage market, and that’s why we shouldn’t let the government regulate interchange.

I was blown away. There are plenty of arguments one could make in defense of interchange, and this was the best they had to offer? Give me a break!

If proponents of interchange are intent on winning this battle they need better ammunition than that.

What about concrete facts?

For example, can the Merchants Payments Coalition or any other foe of the interchange status quo provide concrete evidence that lower interchange results in lower prices to consumers?

That question was raised a few times last month during the Federal Reserve Bank of Chicago’s 2009 Payments Conference. (This year’s conference was titled “Payments Pricing: Who Bears the Cost?”) But the closest thing to an answer I heard from anti-interchange camp went something like this: it wouldn’t be very significant on a per-purchase basis – perhaps the difference between paying $0.98 for a soft drink instead of $1.00.

Even the Reserve Bank of Australia, which has been leading a multi-government attack on interchange, has been hard pressed to prove the extent to which merchant cost savings from lower interchange are being passed on to consumers in the form of lower prices.

In a paper released last April, the Australian Central Bank estimated that merchants had interchange savings of $1.1 billion in 2007 from mandated price caps. However, it added “no concrete evidence has been presented to the Board regarding the pass-through of these savings.”

Merchants in the U.S. have been claiming for years that interchange is a cash cow, bringing in tens of billions of dollars every year to banks and the card companies. A few months ago, I asked Mallory Duncan, the National Retail Federation’s chief lobbyist, if he could explain the source of NRF’s assertion that banks are reaping a windfall of $48 billion a year from interchange. It turns out that they’re using numbers from a report that’s at least 5 years old and updates are merely extrapolations of that data.

Now, I don’t know about your businesses, but my business has undergone plenty of changes over the past 5 years, and I doubt there is a bank or a merchant in business today that would, for example, assess the risk of lending us money based on 5-year-old financials.

Payments acquirers and their allies need real ammunition to counter claims such as these, not tenuous arguments that go nowhere. Maybe it’s time for the industry (or the card brands) to invest in some honest research of its own.

 

Patti Murphy

patti@takomagroup.com

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Payment System Pricing Negotiations As Blood Sport

It seems the stalwart yet feckless defenders of our freedoms collectively known as the U.S. Congress are at it again. Struggling against two disparate groups of special interests, both of whom, it is rumored, consistently drop off huge bags full of unmarked bills as attention getters, our representatives have proposed legislation that, if enacted, will force their own special brand of free enterprise on the payments world. First we consider H.R. 2695, The Credit Card Fair Fee Act of 2009. We will tackle the Senate version, S. 1212 of this special madness in my next blog.

H.R. 2695 purportedly levels the negotiating playing field as it relates to how much merchant should pay for accepting credit and debit cards at the point of sale. In the House’s defense, the current market-based solution is a bit arcane with dozens of players piling on fees and charges that are almost incomprehensible and in many cases indefensible. Granted the big guys pay a lot less than little guys, ostensibly because they generate more volume thus get better pricing. But even the big guys continually bitch to Congress and everybody else that will listen that they pay a lot more than they should.

Congress has apparently listened, at least to the rustle of all that purported cash. Their proposed solution however is so much more than hapless, it is bizarre. It could only be made more bizarre if they had all of the negotiators enter a cage, buck naked and each carrying knives and the survivors get to set prices. In fact, that may improve the outcome. Here is what they propose for real, at least in the House version.

The ten largest credit and debit issuers, the ten largest acquiring banks, the ten largest “covered” credit/debit electronic payment system (more on that in a minute) and the ten largest merchants (based on credit/debit dollar and transaction volumes) will all provide the Attorney General with an itemized list of costs associated with providing or accessing a “covered” electronic payment system. For good measure all parties have to provide copies of the processing contracts each has with each merchant. And they have 30 days in which to comply.

A “covered” electronic payment systems, btw, is one that processes at least 20% of all bank issued credit card and debit card transactions occurring during the last year. That precludes all but one or two processors – everybody else please wait outside, we will inform you of the outcome later if you are good. I have it on fairly good authority that the largest processors have absolutely no clue as to their cost structures so whatever they send in should probable be clearly labeled “fiction.” Merchants have it easier as they have cancelled checks to refer to, compensating balances and promotional allowances notwithstanding.

Each of the players mentioned above also have 30 days in which to submit to the Attorney General a negotiation schedule and if they miss the deadline the AG will set the schedule for them. These negotiations are designed to result in a fairly and equitably derived price that all merchants will pay for access to the credit and debit authorization and settlement systems regardless of size or volumes – one size fits all. Wal-Mart will pay the same as the local shoe store. Understand that we are not talking about interchange, we are talking about discount – the whole price for access.

Once completed, the negotiators have to file the agreement with the AG disclosing how the deal affect the U.S. and international marketplaces, how the fees are broken out by player a comparison of prices across the largest ten international markets and other conditions. Read very carefully, prices negotiated under the auspices of this proposed legislation will have international implications. Hmmmm. It must be noted that ISO have no say in these negotiations whatsoever but card issuers do. Perversely, Credit Union with assets of less than $1 billion are exempt from this bill. WTF! They wouldn’t be included to begin with given their size. Another lobby heard from!

Finally, two major issues are not addressed in this finely crafted piece of proposed legislation. We have no clue as to what to do when, not if negotiations fail to come to a satisfactory conclusion. And we have no idea as to how long the prices will remain in place, nor do we see a mechanism for adjusting them should market conditions change. Apparently these are not significant enough to take into account. Free enterprise be damned – full speed ahead!

Paul Martaus

paul@martaus.com

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Opening the Rails of Open Loop Networks

It was 1997 when the VP at Qwest Communication International's Prepaid Division asked me if it would be possible to create a point-of-sale activation network that wouldn't require the merchant to install any new hardware or software but could still activate a long distance phone card.  This was the same question the division manager at MCI Prepaid had asked me in 1996, but MCI had such a hodgepodge of back office systems that complicated the answer to a degree that warranted it unachievable.

But with Qwest, they had a single platform.  One place that controlled the database of PINs and card numbers that would allow for a single point of entry.  At Qwest, the marching order could be achieved.  All we needed to do was get our hands on a 'credit card-like' BIN and have the network keep it out of settlement.  This used to be called pre-auths and it was a standard fare offering in ISO 8583.  But in 1997, that wasn't the case.  Nevertheless, it was clear we needed the type of BIN that any new bank or credit union wanting to launch a new credit or debit card program carrying the Visa or MasterCard logo would need.

The Qwest VP wanted his sales people to be able to walk into any merchant's store and without that merchant doing anything differently, have the ability to activate the Qwest long distance phone card.  The VP envisioned the following scenario:  My sales person walks into a merchant store and asks the merchant to attempt to make a long distance call with the card the salesperson would hand to that merchant.  The merchant would take the card, dial the toll-free number, input the PIN as printed under the scratch-off area on the card and then enter the destination phone number.  The call would fail.  Then, the Qwest salesperson would ask the merchant to swipe the card through the merchant's EXISTING POS terminal, enter a penny in the value field (POS terminal downloads will stop a transaction if there is no dollar amount entered into the value field) and send the transaction through for authorization.  The message back would say, "APPROVED."  The salesperson would then ask the merchant to attempt to make the call again.  This time, the call would go through.  The merchant would stand there in amazement, wondering what magic the salesperson had performed under the merchant's very watchful eyes.  It was a powerful selling tool for Qwest Prepaid. 

Qwest's bank at the time was Bank 1, which just happened to have a board seat with Visa.  So we approached the bank and got a good reception.  And they approached Visa and got the same kind of reception.  Both companies allocated resources and began discussions to determine how the transactions would be kept out of Visa's Base II settlement system.  That was in January 1998.  By August 1998, we had a working system that Qwest called SAFER - Secure Activation for Every Retailer.  About 8 years later, Qwest sold their prepaid portfolio to IDT.  Once again, the telephony-centric folks at IDT had not a clue what this SAFER thing was all about.  So they put it on the shelf. 

Meanwhile, my partner brought Mellon NSD to InComm with the same concept.  This was right around the time NSD was getting sold to US Bank, which is where it sits today under Elan Financial Services' umbrella.  This means that InComm has had a 4-series Visa BIN since 1999.  InComm's IT unit, having spent their lives in telephony, didn't use the asset to its fullest extent.  They simply didn't know what they didn't know.  And they were also fearful (or mindful) of the Dorf patent, something MasterCard licensed but Visa hasn't even acknowledged (at least not that I know of).  But that InComm BIN is still out there and can be used for non-financial transactions.  Something I called 'event notification' (which will be topic for another time - there's a whole business here in getting non-financial transactions from existing POS infrastructure).  Indeed, I worked for a start-up in the early 00's and we used the InComm BIN to distribute funds via gift cards to settle a class action law suit against Toshiba where the card could only be used at Best Buy, Circuit City, DAC/Insight, CDW and Comp USA.  It worked like a dream. 

So here we are more than 10 years later and we still don't have the ability to exploit the grand networks that the payments industry has created over the past 40 years to accomplish anything more than what it set out to do.  Now that's progress!!  But why?  Why can't we use these networks to perform other transaction types that have meaning to both the merchants and the vendors that sell to them.  Why did Blackhawk and InComm have to go through the machinations of building host-to-host interfaces to these merchants in order to sell their gift cards from their GCMs?  Why, indeed, didn't Visa and/or MasterCard rule the roost in terms of POS activations - something the telephone industry dubbed POSA.  This question is particularly applicable to InComm - who will tell you that they just couldn't achieve the flexibility with their US Bank 4-series Visa BIN that they could with a H2H interface.  Ok, fair enough.  But why!!!!???

The answer lies with the card networks' Fraud and Risk management departments.  Sometimes it rests with the brand cops.  You know, those people in Purchase and San Francisco who think that if the brand isn't accompanying the transaction, the transaction must be invalid.  Not worthy of routing.  Not helping the cause.  And who cares whether it makes us money or not?

Clearly, at the outset, this kind of thinking was applicable, particularly when the networks were 501c3 companies.  These are (or were) the kind of companies that need to spend every nickel they make because they're NOT-FOR-PROFIT. 

Today, the landscape has changed.  And because they are now FOR PROFIT companies, sooner or later their new shareholders will start asking the question that every subordinate has ever heard from any supervisor - WHAT HAVE YOU DONE FOR ME LATELY?  And something tells me the answer isn't going to lie with the people who are in charge of protecting the brand.  Nor will the answer lie with those who are responsible for protecting the integrity of the transaction, although I have to admit, the role of the anti-fraud and risk management people strike me as something that will always be needed. 

While branding will remain important, it won't be the be all and end all of it all.  Which means the branding cops will have to re-think how they approach the branding issue.  That is, it's no longer just about the brand.  It's now about exploiting the great and comprehensive infrastructure we've spent the past 40 years or so building.  It's about time for us to exploit the opportunities that are staring us in the face and that we've been prevented from exploiting because of our fears, whether those fears emanate from risk or just plain brand positioning. 

I think it's time we begin allowing non-financial or event notification transactions over VisaNet and Banknet.  It will create new revenue streams for both networks, give them an ability to differentiate themselves (something they've always struggled to do) and give the entrepreneurs another venue to pursue.  And it has an awful lot of implications for all of those who are attempting to figure out the reload issues for the general purpose prepaid programs already in the market. 

Peter Quadagno
peterq@quadagno.com

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