Networks: Small Tickets, Big Pain

Lauri Giesen

When the Durbin rate cap on debit took effect, it was supposed to give merchants a big break on acceptance costs. But sellers of items like soda and bus fares have seen their costs balloon, and that’s hurting emerging-payments markets.

Lower costs are what most retailers should have seen since the 2010 passage of the Durbin Amendment to the Dodd-Frank Act and the resulting cap on debit interchange, which went into effect Oct. 1. But not all retailers are rejoicing in the effects of this legislation.

Those retailers that have low-ticket sales—particularly average sales below somewhere around $10—are often seeing their total payments-related costs actually go up.

“The government put a cap of about 24 cents per transaction on debit interchange. But not only has that amount become the de facto maximum on interchange, but it has also become the minimum. For retailers with high-ticket sales, there have been lower fees. But for many of our retailers, costs have risen, in some cases even doubled,” says Jeff Lenard, vice president of industry advocacy for the National Association of Convenience Stores in Alexandria, Va.

After the passage of Durbin, the Federal Reserve Board put a ceiling on debit card interchange for issuers with more than $10 billion in assets. Such issuers cannot receive more than 21 cents plus 0.05% of the transaction, plus a 1-cent fraud prevention adjustment if eligible.

Overall, as a result of this ruling, large card issuers are receiving less revenue from debit interchange and retailers are paying less. A recent Federal Reserve Board study shows that the average debit interchange fee for all issuers in 2009 was 43 cents per transaction, a number that had climbed to 50 cents by 2011. But during the fourth quarter of 2011, that average amount for regulated issuers had declined substantially to 24 cents.

‘Unintended Outcome’

But retailers such as convenience stores, coffee shops, vending-machine operators, and transit companies, where $5 or even lower purchases are common, are wondering where the savings are. In fact, they typically are paying more on transactions made with a card subject to the regulation.

That’s because, previously, fees were based on a percentage of the transaction value with special rates for retailers that had low-ticket purchases.

But both Visa and MasterCard said last fall they would simply apply the Fed’s cap across the board for regulated issuers. There would be no across-the-board special deals on low tickets. That means small-ticket merchants are now paying more, rather than less, interchange because of Durbin.

Indeed, interchange costs on a $5 Visa or MasterCard debit transaction have roughly doubled, from around 12 cents to around 22 cents. That happened because the old, unregulated rate included a significant percentage rate and a very small fixed fee of 4 cents, whereas the new, Fed-mandated Durbin cap is almost all fixed-fee, with a tiny percentage rate.

Since that time, Visa has reportedly struck deals for lower fees with a few specific retailers, particularly those exemplifying emerging-payment types such as vending machines, to encourage those segments to grow. However, those deals are not believed to be universal.

“Unfortunately, the elimination of small-ticket rates for regulated debit products is a prime example of the kind of predictable—and unwanted—outcomes of price controls that the industry warned about prior to regulation,” Visa executives said in a statement.

Some merchants believe the higher cost on small-ticket purchases is retaliation by card networks and issuers for the loss of fee revenue on high-ticket purchases. But Zilvinas Bareisis, senior analyst with Boston-based Celent LLC, part of the Oliver Wyman Group, believes it is nothing so sinister.

“It was an unintended outcome of the Durbin Amendment. Whenever you have a switch from percentage-based to flat fees, there will be some who benefit and others who don’t. Those retailers that have a mix of transaction sizes may or may not see much of a difference at all, but costs certainly will be higher for retailers that only sell small-ticket items,” Bareisis says.

In addition, Bareisis warns that the effects of Durbin on prices retailers pay may not always be clear-cut. While some merchant acquirers are directly passing on any higher interchange costs through so-called interchange plus discount fees, not all acquirers charge that way.

Some acquirers charge flat fees or tiered rates where the interchange costs are averaged over various card products. In this arrangement, retailers are charged the same fee per transaction, regardless of what type of card is used.

In that case, retailers may not see a difference in fees based on transaction size or whether it was on a regulated card or not. And acquirers could pass on other fees or charges of their own that would not be immediately apparent.

‘Not Good Economics’

The result of these higher costs is that some retailers wonder if they can continue to accept cards for low-ticket purchases.

“On a big purchase, a 24-cent fee is not a bad deal. But if you are selling a $1.50 [bottle of] Coke, a 24-cent fee is just not good economics,” says Bill Clark, chief executive of Scottsdale, Ariz.-based Spindle Inc., a new technology firm that is offering electronic-payment services to vending- machine operators.

And the situation can be even worse. “I had one franchisee tell me that some customers of his wanted to pay for a newspaper with a debit card. He told me he will give the paper away first because it costs him more to sell the paper than if he just gave it away,” says Richard Peck, senior director of corporate finance for Dallas-based 7-Eleven Inc.

Some fear the higher interchange-related costs on low-ticket purchases could stymie efforts to expand electronic payments into new markets. Areas such as vending machines, parking meters, mass transit, and the like were just starting to look to emerging technologies to allow consumers to use debit and credit cards to pay for bus rides or Cokes. But while there may be a customer demand for such capabilities, if the costs to retailers and service providers are too high, these programs could be curtailed before they get off the ground.

That has set off a scramble among small-ticket merchants to find ways to lower their costs. Setting minimum purchase sizes for card payments is one option. Some retailers are looking to discontinue the acceptance of debit cards altogether or at least drop more costly cards.

Others are looking to work through their acquirers to negotiate special deals with the card networks, while still others ponder alternative routing plans. Some are even considering aggregating sales so that fixed fees would apply to one big transaction rather than smaller individual ones.

At 7-Eleven, Peck says the cost of accepting debit cards in-store is about “break-even” now compared to what it was pre-Durbin. That’s because, on regulated cards, the chain is paying less on purchases over about $8.50 and more on purchases below that amount, Peck says. An average in-store purchase is between $5 and $6, he adds.

Those stores that sell fuel are paying considerably less in fees on fuel sales due to the high price of those purchases, he adds. But only about 40% of 7-Eleven stores even sell fuel.

‘Exploring Every Option’

In addition to the more costly interchange fees, Peck is concerned about a network-participation fee imposed by Visa as of April 1. That fee can range from $2 to $85 per month per store, Peck says, and 7-Eleven was assessed the highest fee due to the large number of stores in its chain. When that $85 fee is amortized over low-ticket sales, it can be quite substantial, he says.

A Visa spokesperson says the new fixed acquirer network fee includes a lowering of per-transaction fees and should lower overall costs to most merchants. He says the fee is based on merchant size and number of locations, and adds that 80% of merchants are paying $5 or less per store per month, with 60% paying $2.

7-Eleven does not want to stop accepting any cards for fear of angering or confusing customers, Peck says. And while some merchant categories are attempting to negotiate special pricing with the networks, convenience stores are not getting any rate breaks, Peck says.

The chain is examining its options to lower its costs, including offering discounts for cash. It is also looking to see if there are transaction routing changes allowed under Durbin, but so far has not found many alternatives that will offer a significant reduction in costs. “We’re exploring every option that makes sense,” Peck says.

While 7-Eleven does not want to drop any cards, that is not the case everywhere. Malvern Pa.-based USA Technologies Inc., which provides a payments network for vending machines and other unattended locations, last October canceled the ability for its retailers to accept MasterCard debit cards.

A USAT spokesperson says MasterCard was the most expensive card for its customers to accept. The company had reportedly reached a special deal with Visa for lower costs on its transactions.

The spokesperson adds that dropping MasterCard debit has not affected sales because the card brand accounted for only about 13% of the vendor’s debit card volume and most customers have been able to pay with a different card when prompted.

Last fall, USAT’s annual report reflected the company’s concerns over pricing. In the report, the company said 82% of transactions in its network were small tickets on debit cards and 70% of the debit transactions were on cards from regulated issuers.

The report showed the average transaction is $1.67, which means the cost for a regulated debit card would rise from 6.6 cents under the old rates to 22.8 cents under the post-Durbin rate.

Wrangling Deals

Spindle, whose vending program is just getting started, was able to negotiate special limited-time terms with Visa to get its payments services off the ground.

Although Clark declines to reveal details, he explains, “We worked with our acquirers to get targeted promotion rates that allow our customers to accept cards.”

Without the promotional rates, the economics were not there for vending-machine acceptance of debit cards. “We have gotten some promotional pricing that was very specific to our program and is only guaranteed for a period of time. We hope the [card networks] will see the need for this pricing to be permanent,” Clark says.

Another service provider hoping to wrangle a deal is the Utah Transit Authority, which began accepting traditional mag-stripe and contactless credit and debit cards to pay for single fares on buses.

“It’s too early to tell, but we are concerned about what the cost of card acceptance will be,” says Craig Roberts, manager of technology development.

Credit and debit payments thus far have been minimal at the transit authority because it has yet to engage in widespread promotions of the payment option, Roberts says. And while the authority wants to begin promoting the payment option, it is concerned about the new economics.

Currently, the typical fare is less than $2.50 with a few fares going up to $5.10. “We can’t afford to pay 21 cents to 25 cents a transaction on fares where the vast majority are under $5 and the most common fare is $2.35,” Roberts says.

He is hopeful that his agency will be able to work out some type of promotional fare with the card networks. “The conversations I’ve had with Visa and MasterCard show they are anxious to get transit authorities to accept contactless payments and they recognize this is a substantial new market for them,” Roberts says.

But unless they come up with a special rate for the transit industry, this substantial new market may never come about, he warns. Still, Roberts is hopeful something can be worked out. “We are optimistic that Visa and MasterCard will want us to become a model for other transit agencies with regard to contactless payment. We are hopeful that they will come up with a pricing model that will allow that to happen,” he says.

If not, the transit authority is looking to develop some type of aggregation program that can make card payments more economical.

“We could take a bunch of small charges and settle them in one larger chunk,” he explains. For example, aggregating 10 $2.35 fares as a $23.50 sale and then applying a flat 21-cent fee would be much more economical than applying a 21-cent fee to each $2.35 fare.

Another option Roberts says his agency is looking at is developing an agency-issued prepaid card that riders could fund with their bank-issued credit or debit card. Then riders could charge or debit an amount, say $50, to put on the card and the agency would only pay interchange one time on the $50 transaction to fund the card.

“We don’t have such a program in place today as single rides are our only payment option,” Roberts says. But he adds a prepaid option might be an alternative if better pricing on single fares is not found.

One payment executive stunned by the higher fees is Albert Bogaard, chief executive and founder of Atlanta-based Parkmobile USA Inc. His firm provides a service that allows consumers to use a special app on their mobile phones to pay for parking at select locations. Already, Parkmobile has its service operating at 320,000 metered locations in 28 states.

Since many of these meters are located in mass-transit parking lots, the average ticket size is only about $3. Prior to Durbin, Parkmobile had been paying about 8.5 cents in interchange fees on a $3 payment. But Bogaard says his company’s bill for the month of March shows it is now paying about 24 cents on an average transaction—triple the cost.

Parkmobile has been unable to qualify for special deals because its transactions are considered card-not-present, even though the service takes a number of measures to prevent fraud. Card-not-present transactions carry an interchange premium because they are considered riskier than card-present payments.

Bogaard says he has talked to the card networks to no avail. “MasterCard says it is trying to repair this problem, but we have not heard anything specific. All we are hearing is that this is an unintended consequence of Durbin and there is nothing anyone can do,” he says.

Before the new rate cap kicked in, the service was experiencing high growth. In the Washington, D.C., market, for example, Parkmobile’s transactions had grown so that it was handling 42% of total payments at 17,000 meters.

Celent’s Bareisis believes the networks need to deal with the situation on a case-by-case basis and grant concessions to merchants where there is the likelihood they won’t be able to continue to accept debit card payments under current pricing models.

He points to video rentals, where prices often range from $1 to $1.25 and where transactions are typically paid for with a debit or credit card. He explains that a 21-to-25-cent cost is not reasonable on a $1 or slightly higher purchase.

“Visa has the most to lose from this, as it is the leading provider of debit. It will need to be more aggressive on pricing for the small tickets if it wants to grow these emerging markets,” he says.