Flat-Fee Pricing on PIN Debit Hurts Acquirer Margins, Expert Says

Americans now spend more than half a trillion dollars a year on PIN-debit cards, but the merchant-acquiring industry is still adjusting to consumers' embrace of point-of-sale debit. At the same time, debit card pricing is shifting from a simple, flat-fee model to a more complex one, which is raising the stakes for acquirers as they try to make a profit in a rapidly changing environment. Those are some of the conclusions in a new report from Mercator Advisory Service Inc. dubbed “The Economics of Debit Acquiring”. Drawing on primary research involving numerous acquirers as well as secondary sources, report author David Fish estimates PIN-debit dollar volume was $525 billion to $550 billion in 2008. That's an impressive achievement for the surviving electronic funds transfer networks, which started out in the 1970s and early '80s doing nothing but switching ATM transactions. Fish notes that some acquirers still price PIN-debit transactions on a traditional flat-fee model to their merchant customers even though many EFT networks now set interchange?the single biggest component of merchants' payment card expenses?for some transactions on a percentage-of-the-sale basis, much the way Visa and MasterCard set interchange on most credit card and signature-debit transactions. The percentage model generates more revenue than the old flat-fee approach, and by failing to reflect those new pricing realities in their merchant discount rates, acquirers may be leaving money on the table, according to Fish, a senior analyst at Maynard, Mass.-based Mercator. “Those that have not done so risk being left behind,” Fish tells Digital Transactions News. “Profitability could be damaged.” Fish says “the run-up in EFT network pricing has been fairly recent,” and it's mostly the result of networks competing for issuers' business. When a network raises interchange, card issuers?which receive the interchange revenues?pump out cards with that network's brand, causing the network's transaction volumes to rise. According to a story in Digital Transaction magazine last September that cited data from the Federal Reserve Bank of Kansas City and other sources, the average interchange generated by a $50 PIN-debit sale at a small retailer quadrupled between 1996 and 2007, from 9.9 cents to 40.1 cents. The biggest increases have come in recent years. By and large, however, PIN debit still usually costs merchants less to accept than signature debit, which is cheaper than credit cards. Acquirers technically are responsible for paying interchange, but they typically pass the full expense on to their merchant clients through a variety of pricing models. Fish acknowledges that merchants are footing the bill for higher PIN-debit interchange. There may not be much they can do about it, however, because consumers increasingly favor debit over credit card payments, and EFT networks continually try to curry the favor of issuers. “They're really the driver here?the banks that are customers of the networks,” says Fish. Thus, acquirers' main job is to adjust to the new realities. Those that haven't already changed their discount rates to reflect the more complex underlying EFT network pricing should do so because percentage-based pricing offers greater opportunity for acquirer margin, especially since average PIN-debit sales are rising, according to Fish. But that's just the start of an effective pricing strategy. Acquirers also need to adjust their “least-cost-routing” strategies in order to minimize expenses, Fish says. With most U.S. debit cards now sporting the Visa or MasterCard brand on the front and at least one EFT network brand on the back, a debit card sale typically offers merchants at least two routing choices. Many big retailers use so-called PIN-prompting, in which the POS terminal automatically prompts the cardholder to enter her PIN when the card is swiped. Smaller merchants, however, still rarely employ PIN-prompting even if they accept PIN-debit cards, according to Fish. “It has not kind of filtered down to the mom and pop,” he says. “There are plenty of mom and pops that are perfect candidates for debit cards, but may not have steering in place.” Merchants and their acquirers also need to refine their PIN-prompting techniques, according to Fish. That's because as EFT network pricing has grown more complex?not only because of percentage-based interchange but also because of the removal of some transaction caps?PIN-debit may not always be the cheapest option. “Bigger merchants prompting for PINs, it may not be an advantage for them,” says Fish. Meanwhile, the need for better data security is upsetting another long-standing practice of acquirers and independent sales organization, that of giving POS terminals with PIN-pads to merchants at low cost or even free, and then recovering the expense through future transaction charges. With Visa Inc. telling merchants that PIN-entry devices need to comply with requirements arising from the Payment Card Industry data-security standard (PCI) by mid-year, acquirers and ISOs may find that giving away new equipment might become too expensive. “The free-terminal phenomenon is probably not going to carry on much longer,” says Fish. “I think the folks that got into that game are finding themselves a bit stretched because of it.” He adds that, “Possibly there is some opportunity for equipment sales as PIN-debit proliferates even further, but really the equipment I think is secondary to the processing. It's the per-click model that everybody wants.”