How Merchants’ Quest for More Customer Loyalty Could Give New Life to Decoupled Debit

Might decoupled debit rise again? It very well could, according to some payments experts, and the light on the hill is the decoupled debit card issued by the battered and bruised discount retailer Target Corp.

For nearly three months, Target has weathered a storm of bad publicity after confirming a data breach that compromised 40 million payment card numbers as well as non-card data on 70 million customers. Although Target has reported it, almost overlooked in many of the news stories is the fact that its private-label debit and credit  Redcards were not compromised in the breach.

The debit version of the Redcard is proving especially successful, according to analyst Gil Luria, vice president of equity research, financial technology, for Los Angeles-based Wedbush Securities. As of last October, the Target-issued debit card accounted for 10% of Target’s sales, up from the low single digits in 2009, and has annualized volume of about $6 billion, says Luria, who has studied Target’s payments program. Target executives have said the debit Redcard holders spend 50% more than they did at Target before they got their cards, according to Luria. The credit version of the Redcard accounts for about 8% of sales.

“Target’s success already makes this a meaningful trend,” said Luria, who spoke Tuesday on a panel about decoupled debit at the BAI Payments Connect conference in Las Vegas. Although other merchants have considered payment systems based on the low-cost automated clearing house network, including decoupled debit, as ways to offset their expenses for accepting major-brand debit cards, Luria says Target’s motivation “is about loyalty, it’s not about interchange.” He later added: “I think there’s an actual possibility here that store-branded debit cards will take off.”

The big credit card issuer Capital One Financial Corp. attracted many curious observers in 2007 when it began testing a MasterCard-branded debit card that it issued for its customers, who then linked it to their checking accounts from other financial institutions—hence, the decoupling of the debit card from the financial institution holding the demand-deposit account (DDA). The card used the MasterCard network for authorization and earned Cap One regular debit card interchange, but settlement occurred over the ACH.

Cap One offered to share some of the interchange with large merchants who partnered with it on promotions, according to session moderator Paul Tomasofsky, president of Montvale, N.J.-based Two Sparrows Consulting LLC. Later, however, Cap One, quietly ended the test in 2008.

Another player that tried to make a go of it in the early days of decoupled debit was Tempo Payments, which offered private-label ACH debit cards for merchants, mostly convenience stores. But Tempo closed in 2011 after the Federal Reserve Board’s new rule implementing the Durbin Amendment in 2010’s Dodd-Frank Act changed the economics of debit and made it about 20 cents per transaction cheaper for merchants to accept debit cards from regulated big banks rather than Tempo’s cards, which charged 44 cents.

Nowadays, however, Target and other merchants are focusing on ways to generate more sales through loyalty programs linked to debit cards, according to panelists. Target’s card offers a 5% discount, unusually high for a debit card but possible for Target because of its product mix of groceries and higher-profit hard goods, according to Luria.

Processor First Data Corp. has a decoupled debit card program called ConnectPay administered by its TeleCheck check-services unit. Merchants numbering in the “low double digits,” mostly convenience stores/gas stations and grocery stores, use it, and they have a total of several thousand locations, says Mark Wallin, general manager of TeleCheck and ACH services at Atlanta-based First Data. The program has “hundreds of thousands” of cardholders, he adds.

While ConnectPay’s user base isn’t huge, “it is probably our product that has the greatest interest right now,” says Wallin, who also was on the panel and notes that the card program enables merchants to offer incentives and rewards to shoppers. “The biggest piece is the consumer loyalty that it drives,” he said.

Some 48% of customers of ConnectPay merchants reported increased frequency in fuel purchases as a result of the program, according to Wallin. “The merchants can drive incremental rewards to the consumer based on how they pay,” he said.

Many ConnectPay merchants control losses by using TeleCheck’s check-guarantee and other risk-reduction services, he says.

If Target, First Data, and PayPal Inc., which uses the ACH to debit many customers’ accounts, represent Act II of decoupled debit, then even more growth could come from an Act III if the budding Merchant Customer Exchange (MCX) mobile-payments system under development by some of the nation’s largest retailers finds success. MCX, whose sponsors include Wal-Mart, Best Buy, 7-Eleven, and other merchants representing $1 trillion in annual payments volume, hasn’t committed to a specific payment model yet, but it reportedly is eyeing the ACH and has announced a deal with mobile-wallet technology provider Paydiant Inc.

Analyst Luria sees MCX as eyeing the success of Target and Starbucks Corp., the leader in private-label mobile payments. “If you take away what Starbucks has done and Target has done, you see what MCX wants to do,” he said. He added that if MCX gains traction, it would siphon considerable volume from the expected growth of Visa-MasterCard debit volume in the next few years.