Trends & Tactics: Big Merchants Fuel ACH Debit Cards

It’s an obscure transaction code that even many payments people haven’t heard of. But POS, the code established by the automated clearing house network for debit card payments, is surging as major merchants adopt the payment method and offer significant rewards to customers who use it.

The POS code, which technically refers to ACH debit entries initiated at an electronic terminal, saw its volume nearly double in December from the 2.33 million transactions recorded in December 2009 and is up 25% from 3.68 million in December 2010.

That’s according to statistics gathered from the Federal Reserve and presented by Gary Nesbitt, senior vice president at Richmond, Va.-based regional ACH association EastPay, at a conference this spring in Baltimore sponsored by NACHA, the rules-setting body for the ACH.

Unlike debit cards branded by Visa Inc. or MasterCard Inc. and issued by banks, many debit cards that work on the ACH are issued by retailers as loyalty cards. Such cards have been around for decades, but in recent years merchant interest in them heightened as the cost of bank-issued debit steadily climbed.

The cost to merchants for an ACH POS debit ranges from a nickel to 7 cents per transaction, according to Paul Tomasofsky, president of Two Sparrows Consulting LLC, Montvale, N.J. That compares with 24 to 27 cents for a transaction on a card issued by a bank regulated by the Durbin Amendment’s interchange cap or 35 cents to 50 cents on a card from an unregulated bank, he estimates, adding in acquirer fees, he figures.

Such economics have helped attract some major retail brands, such as Nordstrom Inc., Shell Oil Co., and Target Corp. But it is the Target card that may have done the most to account for the recent surge in POS volume, says Tomasofsky, who spoke with Nesbitt.

The Minneapolis-based chain, which introduced its debit card in 2007 as the Target Check Card, rechristened the product in 2010 as the Redcard Debit Card and began offering users a hefty 5% off on transactions as a standard discount. Target offers the same discount on two other Redcards, a proprietary credit card and a Visa credit card.

Similarly, Shell offers 2 cents off per gallon of gas or diesel fuel on its debit product, the Shell Saver Card, and Nordstrom extends rewards points and extra services to holders of its debit card. Target would not disclose statistics related to the Redcard Debit Card.

The increasing popularity of ACH-based debit cards comes after years in which the cards languished in obscurity. They were adopted chiefly by supermarkets, which used them to help control payment costs and salvage razor-thin margins.

Despite their low acceptance costs, the cards come with some significant drawbacks. POS transactions, like other ACH transactions, are not guaranteed payments. This contrasts with PIN-based debit cards offered by banks on the major-brand networks. “This is one reason we saw very little transaction volume in the early days once [bank-issued] debit cards came along,” Nesbitt told his audience.

Another drawback is that POS debits can require extra training for bank and merchant staff who are accustomed to dealing with bank-issued debit cards. “There’s cardholder confusion about what the product is doing, and there’s back-office and training costs,” Tomasofsky said.

But the POS code enjoyed a short-lived renaissance several years ago when a few banks, notably Capital One Financial Corp., introduced so-called decoupled debit cards. These cards drew on funds held by the cardholder at another bank, using the ACH for settlement.

Cap One soon shelved its decoupled initiative, and later Federal Reserve regulations implementing the Durbin Amendment targeted decoupled products, effectively ending bank interest in the concept. Now, it appears to be major retailers that can draw on loyalty databases that are lending impetus to the POS code.

Indeed, for merchants that can track a customer through a loyalty program, and that know that customer has never bounced a check for insufficient funds, “this would be a great product,” Tomasofsky said. “Why pay 50 cents for a guaranteed transaction every time in cases like that?”

Bill Pay’s Costly  ‘Sausage Factory’

It turns out those missing account numbers or little typos consumers make when paying bills can cost billers and others in the payments chain big bucks to fix. A recent study for automated clearing house governing body NACHA pegs the annual cost of such exception processing at about $720 million.

More bad news: the rate of erroneous transactions coming through so-called aggregators, such as banks or bank service providers, while low, is increasing.

“I think it’s a black eye on the industry, that we can’t do a better job here,” says Rob Unger, a senior director at Herndon, Va.-based NACHA who heads the association’s Council for Electronic Billing and Payment.

In the study, Blueflame Consulting LLC examined bill-payment exceptions across a variety of payment channels, including paper, ACH, cards, and other electronic means.

The study estimates the exception rate across all channels at 0.58%. Some 130 million transactions last year needed exception processing at an average cost of $5.58 per item.

Blueflame found that 0.51% of bill payments coming through banks and service providers could not be posted because they needed exception processing due to errors. A similar study in 2007 pegged the bank/aggregator exception rate at 0.4%.

Rather than stopping a bill-pay transaction coming through the bank channel that contains an account-number error, billers frequently accept it and then they or processors attempt to fix it. “As much as billers complain, they still want that payment,” says Unger.

Incorrect account numbers often get through because many billers don’t provide to aggregators the so-called account masks, or internal logic, for their account-numbering systems. It’s easier for billers to resolve such errors when consumers pay online through biller-direct sites because the masks are at hand and the online system can prompt the payer to re-enter the number. Sharing such account-formatting logic “can go a long way in reducing errors,” says Unger.

The resolution process for an erroneous transaction through a bank site can involve contacting the consumer, attempting to edit the transaction, or even cutting a paper check to the biller, a process that contradicts the intent of electronic bill pay.

Typically, an aggregator will keep submitting a bad number, or it will translate a bad number into a good one. Or parties will use, when available, so-called scrub files that say, “‘replace bad numbers with these updated good numbers,’” Unger says. Billers absorb most of the resolution costs, though aggregators may pick up some.

Related solutions to the problem, according to NACHA, include developing directories or shared databases to verify account numbers, structures, and billing/remittance details; enhancing communications among billers, banks, and processors, especially for resolving exceptions; and increasing the options to correct or validate account numbers by sharing scrub files or master-account files.

How quickly preventative measures will take hold is unclear. “In the wide-open industry there are no rules; there are agreements, but there no rules,” says Unger. “It really is a sausage factory out there.”

Some Consumers Just Love Their Checks

For years, the growth of electronic payments has been fueled by the conversion of check writers into card users at the point of sale, but now those days may be coming to an end.

Research, as well as the experience of one major retail chain, indicates the check writers who remain are likely to continue writing checks. “They’re the hard core of the hard core, the last ones left,” said Paul McAdam, senior vice president for enterprise strategy at processor Fidelity National Information Services Inc. (FIS).

That core is a relatively small but hardy breed. Some 11% of consumers say paper checks are their primary method of payment in stores, according to research McAdam presented at the NACHA Payments conference in late April.

Some check users might be induced to use debit cards, McAdam argued, since 41% said they’d start using the plastic if retailers stopped accepting checks. But this group’s fidelity to paper will be hard to overcome. About 91% of the check writers say they expect their usage to remain the same over the coming year, while 2% say they will write more checks, according to FIS’s research.

Even carrots and sticks may not work. Asked whether they’d write fewer checks if their bank charged a dime per item, only 30% of the “hard-core” check writers said they’d use checks less often. Just 24% would write fewer checks if they could earn rewards for credit or debit card usage, according to the research. “Eighteen percent said, ‘There’s nothing you can do to persuade me to write fewer checks,’” said McAdam.

“There are committed check writers, they aren’t going anywhere,” Daphne Gilliam, ACH/check product manager at Wal-Mart Stores Inc., told the audience at the conference. Indeed, she says, Wal-Mart doesn’t try to convince check-using customers to stop writing checks. Instead, it adopted several years ago a chainwide program of converting paper checks to e-checks using the ACH’s POP application.

To be sure, checks as a percentage of overall transactions at Wal-Mart have declined steadily for years as customers started using cards, Gilliam said, without disclosing numbers. But she adds that in the current fiscal year, for the first time, that decline may flatten out. “What we have now is hard-core, committed check writers,” she said.

A number of factors account for this strong attachment to paper. Check writers at Wal-Mart tend to be persons on fixed incomes who are “glued” to checks because they like the float they offer (though methods like the ACH and image exchange have reduced float significantly in recent years), Gilliam told Digital Transactions News.

They also like the paper-based but simple record-keeping function of a check register, she says. “Keeping track of spending is really a big issue” with this group, McAdam added. Still, when asked if they would use checks less often if they were offered an electronic method of record-keeping, just 30% said they would, he said.

As a group, the committed check writers tend to skew older, though only one-third are over 65, according to FIS’s research.

Correction

Owing to an editing error, the box headlined “How Durbin Is Waking up EFT” on page 30 of the May 2012 issue misstated the corporate ownership for the NYCE electronic funds transfer network. The network is owned by Fidelity National Information Services Inc. (FIS). Digital Transactions regrets the error.