Rewards Account for 44% of Interchange Cost, Report Concludes

The costs of air miles and other perks and rewards account for 44% of bank card interchange, while card issuers' cost of funds and profit margins take 35%, and network branding efforts account for 3%, according to a new report issued this week. Just 13% of the acquirer-paid fee goes toward various transaction-processing costs from which merchants derive a direct benefit. For many merchants, “A New Business Model for Card Payments,” released by Diamond Management & Technology Consultants Inc., Chicago, will confirm long-held suspicions that interchange fees were subsidizing increasingly generous cardholder giveaways and other marketing programs used by issuers to fight card saturation and pump up usage. But the report also underscores how much in the dark it says most retailers are regarding details of the fees, which acquirers pay issuers and then pass on to merchants as part of retailers' discount fees. Indeed, interchange has sparked growing resentment among merchants as much for its seeming murkiness as for the fact that the rates have risen steadily in recent years. “Merchants really have little idea where their interchange dollars go,” says the report. Moreover, it points out that “in addition to the lack of transparency into where the money goes, the fee structure itself can be confusing to merchants,” with scores of rates depending on type of card, type of merchant, and other factors. The report comes as the controversy over interchange has led to a slew of anti-trust cases filed by merchants against Visa USA, MasterCard Worldwide, and several major banks, alleging interchange is anti-competitive. Pressure from this litigation has led the bank card associations to respond to merchants' charges that the networks have been less than forthcoming with details about the fees. Visa this week posted its interchange rates on its Web site, making them publicly available for the first time. Up to now, the association had only officially released the fees to its members. MasterCard Worldwide has said it too will post its rates starting Nov. 1 and will cap interchange for gasoline transactions (Digital Transactions News, Sept. 5). But these gestures have done little to placate merchants. The Merchants Payments Coalition, a group of merchant trade groups formed last year to press for interchange relief, this week welcomed Visa's move to post its rates but blasted the association for maintaining what it called a “bewildering” rate structure. It also called on Visa to fully release its operating rules, a document Visa has said it will make available but only in return for signed non-disclosure agreements. “Our position is clear,” said Mallory Duncan, chairman of the coalition and senior vice president and general counsel for the National Retail Federation, in a statement. “The collective setting of interchange fees by Visa and MasterCard violates the antitrust laws.” Meanwhile, merchants are not likely to draw much solace from the Diamond report, which points out that components of interchange such as cardholder rewards programs, network branding, issuers' cost of funds, network servicing (4% of interchange), and network rewards (1%) are aimed at constituencies other than retailers. “None of these costs really goes toward benefiting the merchants,” conclude the authors, Carl J. Hugener, a partner at Diamond, and Amy Dawson, a principal in the firm.