Cover Story: What’s This FANF Thing All About?

Born of the transformed world wrought by Durbin, Visa’s new acquirer fee is either a rational response to changed economics or a diabolical exercise of raw power, depending on whom you ask.

By John Stewart

Bruce Reisman is an angry man.

“I’m not a happy camper. I’m constantly looking for ways to save my customers money and I keep getting blindsided by new fees,” he seethes. But the latest fee really has him boiling. It’s the Fixed Acquirer Network Fee, introduced in the U.S. market in April by Visa Inc., the world’s largest payments network.

“Whoever figured out that fee structure must be brain dead,” rages Reisman, proprietor of a one-man independent sales organization, or “broker,” as he prefers to call it, based in Atlanta.

Acquirers are paying the new fee, which applies to both credit and debit card transactions, and, as expected, passing it on to the merchants in their portfolios. That’s making for equal parts anger, consternation, and confusion among merchants.

“Consternation would be putting it mildly,” says David T. Bellinger, director for payments at the Association of Financial Professionals, a Bethesda, Md.-based trade group for corporate financial officers. The AFP’s members “do not like this fee at all,” Bellinger says.

Reisman tried to mollify his clients, which are largely business-to-business sellers, by getting his processor to stop rendering paper statements. The money that move saved offset at least part of the fee. But not enough, apparently. “They’re still upset about it,” he says.

Chewing up Spreadsheets

The FANF, as it’s commonly called, is really a multipronged fee structure whose actual toll on an acquirer—and hence on a merchant—depends on a number of factors, including merchant type, whether the merchant sells face-to-face or not, number of locations, and, for certain merchants, sales volume.

At the same time Visa introduced the fee, it lowered and eliminated a few others. It argues the fixed nature of the new fee rewards merchants that route more volume through Visa. Indeed, Visa says the net effect of FANF, its other pricingtweaks, and new incentive spending is that most merchants will pay less, not more.

That’s got more than a few retailers chewing up spreadsheets trying to figure out the FANF’s impact and how that impact compares with the cost of the former network fee structure.

“We’re still in the process of evaluating it,” says Frank DiNuzzo, managing director for marketing performance at American Airlines Inc., which did $17.9 billion in passenger sales last year, about one-third of it through its Web site, AA.com.

While the big carrier hasn’t arrived at any conclusions yet, DiNuzzo is clear about one thing. “We don’t like incremental fees,” he says. “We don’t want to add cost to our transactions.”

‘Huge Impacts’

In some ways, the FANF couldn’t have come at worse time. While it has nothing to do with interchange fees—Visa pockets FANF proceeds, whereas interchange goes back to the card issuer—the new network fee followed a titanic struggle over debit card interchange and arrived just before the settlement of a massive antitrust case over credit card interchange.

Nerves were rubbed raw on both sides of these battles, leaving little sentiment on the merchant side for yet another fee related to card acceptance. Compounding the issue for merchants is what they see as a paucity of information about the fee. Visa itself has said little about it outside of bulletins to acquiring banks. And what guidance merchants have found simply confounds them.

“There’s no information for the merchant to see if he’s getting screwed,” complains Michael Schumann, co-owner of Traditions Class Home Furnishings, a three-store chain based in St. Paul, Minn. Schumann is a veteran of the battles over card fees, having been an original plaintiff in the mammoth antitrust case over credit card interchange that was settled in July (Trends & Tactics, page 9).

Still, Schumann is sure of a few things. One is that the FANF doesn’t hit him all that hard. With just three stores, he pays $2 per month per store. But, he adds, “I know merchants that have had huge impacts.”

This disparity comes from the fact that, while the fee is “fixed” within the individual tiers in each of the FANF tables, it rises inexorably as you move from one tier to the next. A high-volume retailer with a relatively modest 99 outlets, for example, pays $8 per store, or $792 per month—the same per-store fee as a merchant with as few as 51 stores. If that retailer opens just two more locations, however, the fee jumps 50%, to $12, for a tab of $1,212 per month.

And that doesn’t take account of any Web-site activity that merchant may do. The monthly FANF for sales online ranges from $2 all the way up to $40,000, depending on which of 16 volume tiers applies. Again, the range within each tier can be very wide. A merchant with nearly $800,000 in monthly Web sales, for example, pays the same $120 fee as one that does $200,000.

The effect, then, is that, within any given tier, the merchant’s per-transaction cost descends as he adds stores and volume. When he adds enough to jump to the next tier, though, his transaction cost jumps as well.

That’s by design. Visa intends its fee to encourage merchants to route as much volume as possible to Visa. If they do cross over to a new tier, they can bring their per-transaction cost down by adding yet more volume.

When Visa rolled out the FANF, it made a few other changes, as well. It scrubbed a so-called risk identification services fee, which had been one-tenth of a penny per transaction. And it lowered its network acquirer processor fee for debit card transactions from 1.95 cents to 1.55 cents per transaction. The same fee for credit remains at 1.95 cents.

For transactions going to Interlink, Visa’s PIN-debit network, the switch fee dropped from a flat 3.5 cents to 2.25 cents plus 0.08%. That means acquirers (and so merchants) will pay less on any Interlink transaction under $15.62.

Visa is also paying out more in so-called incentives, or cash bonuses, to get merchants and banks to route more transactions to the network. These bonuses amounted to $614 million in the quarter ended June 30, up 37% from $448 million in the same period in 2011. How much of this swag went specifically to merchants is hard to tell, as Visa doesn’t break that out.

‘A Sea Change’

The net impact of all these moves, including FANF, is negative to Visa’s revenue, the network says. Estimates of how much the FANF alone will raise vary, and Visa isn’t saying. Eric Grover, an analyst who follows the company closely, estimates FANF will generate $432 million annually under current conditions.

Sounds like a neat little bonanza for Visa. But offset against this are the incentive payouts, the reductions in the other acquirer fees and in the Interlink switch fee, and the fact that the bottom has fallen out of Interlink’s pool of transactions.

For the June 30 quarter, Visa reported Interlink had lost more than half its traffic compared to the year before, with volume down 54%, or an estimated $52 billion. Fewer transactions, less switch-fee revenue.

Not coincidentally, much of this downdraft came in the April-to-June quarter. “Their PIN-debit share fell off a cliff,” notes Grover, who runs a consultancy called Intrepid Ventures in Minden, Nev. Nor does Visa expect Interlink to recover all of that traffic, despite moves like the FANF. Network executives have said publicly that a certain loss of share in PIN debit is permanent.

The travails at Interlink and the advent of the FANF are closely related events, and they have a common origin: the Durbin Amendment to the Dodd-Frank Act of 2010. Most payments-industry people know the Durbin Amendment for the caps it mandated on debit card interchange for issuers with $10 billion or more in assets.

But Durbin mandated a number of other things as well, among them the notion that all debit cards should work on at least two networks not under the same owner, and not otherwise affiliated.

The Federal Reserve, which the amendment charged with implementing its mandates, made its rule on network routing effective April 1. But even before that date, debit networks were scrambling to pick up business at the expense of Visa, since the Visa-Interlink combo was the most common one that Durbin broke up.

Suddenly, obscure PIN networks like MasterCard Inc.’s Maestro are enjoying heady growth. “Maestro was a non-player prior to Durbin,” notes Grover. Now, he says, “there really has been a sea change. Maestro has now vaulted to being a strong number-two to Visa.”

Maestro isn’t the only beneficiary. First Data Corp., owner of the Star debit network, posted a 14% increase in debit card issuer transactions in the June 30 quarter year over year, 10 percentage points of which the company credits to Durbin’s routing rule. That’s after allowing for client defections.

Hence the implosion in Interlink volume. And hence the FANF. With a new fee that encourages concentration of volume at Visa, the number-one network can make a bid to at least slow the erosion of volume to competing systems. At the same time, the fee helps boost the ratio of fixed to variable revenue, a key goal at the network, which is saddled with high fixed costs.

But it’s that concentration idea—coupled with what Visa’s critics call its market power, or ability to compel merchants to accept its brand—that makes some people nervous.

The FANF “does have the impact of incenting any party that’s paying the fixed fee to route the maximum traffic” to Visa, notes Mark Horwedel, chief executive of the Minneapolis-based Merchant Advisory Group, a trade group for large merchants that concerns itself with payments matters. That’s not good for merchants, he says, since their interests lie in less concentration, not more.

Also, smaller networks can’t get away with something like the FANF, Horwedel argues. Merchants wouldn’t be sending them enough volume to make a difference in per-transaction pricing. “Merchants would tell you goodbye,” he says.

Others are concerned because the fee’s concentration incentive comes on top of Visa’s dominant market share in card transactions. “If we had a competitive marketplace, [the FANF] could be reasonable,” says Janet Langenderfer, founder of Vision Partners & Associates LLC, a consulting firm that works for merchants. “But the fact is the merchant doesn’t have the option of not accepting Visa and doesn’t have control over what card the customer uses.”

In that context, she argues, the FANF “becomes a tax for accepting Visa cards, and it becomes a punishment for not using the Visa network.” Visa officials would not comment on the record for this story.

Possibly in response to concerns like these, the U.S. Department of Justice in March opened an investigation of the FANF and Visa’s PIN-debit business. The investigation involves possible violations of the Sherman Antitrust Act. Visa said this spring it has met twice with DoJ officials and supplied materials.

The potential impact of the inquiry is impossible to predict, but Grover figures it will be hard for Justice to make a case while Interlink is shedding market share.

And while Visa could please shareholders by increasing the FANF, the investigation for now is likely putting a brake on any such idea, he adds. “Given the DoJ has Visa in its crosshairs, I would think the better strategy would be to lie low for a while,” he observes.

‘A Race to Zero’

Visa may lie low, but competing networks must scramble to counteract FANF’s effects. MasterCard, which doesn’t have a dominant position in debit to protect, has not introduced FANF-like pricing, though earlier this year it did impose an annual licensing fee for acquirers based on volume.

The Iowa-based Shazam network, which serves chiefly smaller merchants across the country, hasn’t seen much of an impact from FANF yet but is bracing itself for one, says Dan Kramer, senior vice president of marketing and merchant operations. “Eventually it will reach our constituency, we know that,” he says. “It will start at the top and work its way down.”

To combat any deflection of volume, Shazam is looking at offering lower pricing to merchants that are willing to assume more risk, says Kramer. The inevitable result, though, is that overall pricing for all debit networks teeters on the precipice of a free fall. “Now we have to be more aggressive in terms of our pricing,” he says. “With Durbin, we’re in a race to zero.”

So is the FANF working as intended? It’s still early, and “we’re in uncharted waters,” said Visa chief financial officer Byron H. Pollitt in a July 25 conference call with stock analysts. But, he added, “to date, we’re pleased.”

Merchants appear to be less pleased. While they may get a break by concentrating volume, they could still be paying more to their acquirers in Visa network fees than they were before April 1.

“Everyone I’ve talked to says that even if they switched all of their volume [to Visa], they still couldn’t make up that fee,” says the AFP’s Bellinger. The notion that merchants that switch volume are better off, he says, is a “smokescreen” for what amounts to a price hike.

Some merchants, too, may balk at the idea of sending so much volume to a single network. “The really sophisticated merchants are saying, ‘If I concentrate my volume to Visa, guess what, when it’s time to re-up, I’ve lost my leverage,’” says Ashish Bahl, chief executive of Acculynk Inc., an Atlanta-based software company that works with debit networks to allow Web- and mobile-based PIN debit transactions. “It’s brilliant for Visa, terrible for the merchant.”

That leaves sales agents like Reisman steaming. “I love this business, I love dealing with people,” he says, but “I’m just fed up.”

He blames the decisions by both Visa and MasterCard to shed bank ownership and go public, MasterCard in 2006 and Visa two years later. “It’s all about the bottom line,” he laments. “Visa and MasterCard had a heart before they became public.”

Does the FANF Unfairly Favor Aggregators?

Critics allege the new fixed acquirer network fee (FANF) from Visa Inc. hands so-called merchant aggregators like PayPal Inc. and Square Inc. an unfair cost advantage relative to traditional acquirers and independent sales organizations.

The FANF is a complicated affair but generally speaking mandates that acquirers pay a monthly charge tied to the number of locations maintained by each client merchant. The rate schedule for card-not-present merchants, fast-food outlets, and aggregators, however, requires a fee linked to merchant volume. In nearly all cases, acquirers simply pass the new fees on to merchants.

Because the schedule for aggregators tops out at $40,000 monthly, regardless of additional volume, ISOs that serve thousands of locations could end up paying substantially more and could be at a competitive disadvantage, says Henry Helgeson, president of Merchant Warehouse, a Boston-based company. “It begs the question, why wouldn’t every ISO become an aggregator?” he says.

A merchant aggregator processes transactions for merchants on its own merchant account, rather than establishing an account for each seller. This allows these merchants, which are often so-called micro-merchants, to begin accepting transactions much sooner and with less underwriting and other process work.

PayPal and Square, the mobile-acceptance startup, are prominent examples of aggregators. While aggregation was once restricted to card-not-present merchants, recently enacted rules changes at Visa and MasterCard Inc. extended the practice to physical points of sale. Merchants that exceed $100,000 in annual card sales for either brand, however, must establish a conventional merchant account.

Because ISOs pay by location, some argue they will be liable for substantially higher payments than aggregators with the same volume. Helgeson, for example, expects Merchant Warehouse’s annual FANF toll will exceed $1 million, or roughly double the maximum fee for an aggregator. “This is a net positive for aggregators,” he says. “They will have an advantage over ISOs and the [traditional] merchant account.”

What’s more, the new Visa policy hands this advantage to competitors like PayPal, which work to divert volume away from higher-cost card networks to the lower-cost automated clearing house, Helgeson argues. “A lot of those [PayPal] transactions are clearly falling off of Visa and MasterCard cards,” he notes.

Visa did not respond to a request for comment regarding the FANF and its impact on aggregators and ISOs.

But not all ISOs agree. Unlike ISOs, aggregators absorb fees like the FANF rather than passing them along to merchants, so merchants aren’t affected while the aggregators’ costs increase substantially, says Jeff Fortney, vice president of ISO channel management at Clearent LLC, a Clayton, Mo.-based ISO that has published a FANF explanation on its Web site.

At the same time, aggregators are serving a merchant market most ISOs would consider uneconomical for a conventional merchant account, Fortney says. “They’re going into a market with somebody we wouldn’t sign any way, and sooner or later they’ll be big enough that we will sign them,” he says.

In any case, the apparent pricing advantage for aggregators may well prove short-lived. “I think you’ll see a closing of the gap over the next several quarters,” says Todd Ablowitz, chief executive of Double Diamond Consulting Group in Centennial, Colo. He argues the FANF was intended to encourage mobile payments through micro-merchants that might otherwise have been uneconomical to sign, but that pricing advantage was never meant to be permanent.

Ablowitz, whose firm advises ISOs on how to adopt the aggregator model, says he tells them to seek reasons other than the FANF’s pricing differences to move into merchant aggregation. “We’re advising clients that if aggregation is effective for you, there may be some added incentive to do that short-term,” he says. “But I wouldn’t do it for that reason.”