February 2 2010|07.17 AM UTC

Stan Reybern

How Visa Corners The Debit Card Market With Fees

Category: Credit, NewsTags: , , , ,

Debit cards are such an routine part of commerce these days that we seldom reflect on them. For most consumers, the 2-3 seconds it takes to swipe is about the only time they pay their debit card any mind at all. However, a recent New York Times article reveals that Visa spends more time thinking about debit transactions than anyone — and for good reason. Depending on how we swipe, Visa stands to gain or lose a astronomical amount of money in fees. So much, in fact, that retailers like Costco to Walmart restrict how you use your debit card whenever you buy something. Because so much of this happens behind closed doors, Billshrink decided it was important to sum up the Times’ findings for our readers.

Signature or PIN – A Weightier Choice Than You Think

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Could there be a more inconsequential choice than signing a receipt vs typing your PIN into a keypad? Perhaps not from a customer’s standpoint, but to Visa (and retailers), this question is one of the most important in their entire business. As it turns out, signing a debit card receipt equates to a large retailer paying your bank “an average of 75 cents for every $100 spent, more than twice as much as when you punch in a four-digit code”, according to the Times. This being the case, one might expect retailers to push hard for the PIN method of completing debit transactions. And sure enough, certain big-name retailers do just that. Costco, for instance, “will not allow you to sign for your debit purchase in its checkout lines.” You are literally exhorted by the clerk to enter your PIN instead. Walmart likewise makes the PIN method the standard means of paying in its checkout lines, as does Home Depot. However, beyond a handful of powerful retailers such as these, 61% of all debit transactions in the U.S. are completed via signature. With such compelling incentives at the store level against this practice, why do so many of them permit the signature method, even though it siphons money from the retailer to Visa or MasterCard? And how are consumers affected?

Winning Over The Banks

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To answer these questions, we must first explain the role banks play in all of this. As you may know, it is primarily banks (rather than Visa or MasterCard themselves) that issue debit cards to consumers. While this may seem like a footnote, it is actually vital to Visa and MasterCard’s dominance of debit transactions. Because banks are the primary issuer of debit cards, Visa and MasterCard understandably focus more on pleasing them than on pleasing consumers and merchants. After all, if Visa makes the bank a lucrative offer to distribute its debit cards instead of someone else’s, consumers are more or less stuck with Visa unless they switch to a bank that issues a different card. Furthermore, Visa and MasterCard also decide on the fees merchants pay the cardholder’s bank. So despite the fact that signature debit is unquestionably the higher-priced payment method, Visa has essentially told banks “issue more Visa cards and the processing fees are yours.” Early on, MasterCard responded by promoting PIN debit instead. But as debit cards became the norm at more and more checkout counters, Visa eventually “turned its attention to PIN debit too and increased its marketshare even more.”

“Perverse Competition”

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While it is common in business to mimic the successful behavior of other companies, what is peculiar here is how Visa has succeeded “not by lowering the fees that merchants pay, but often by pushing them up, making its bank customers happier.” It all goes back to banks being the main issuer of debit cards. If Visa and MasterCard got cards into the hands of the public by directly marketing to consumers, there would be no middleman to appease with higher fees. The focus would be, as it generally is, on lowering fees so as to compete and be accepted by more merchants. However, since banks are the major players in debit card issuing, the only way to entice them to issue your card versus some other company’s is offering higher fees. And since Visa and MasterCard can simply dump those fees onto third parties (merchants and consumers), it makes perfect sense for them to do so. What grinds merchants’ gears the most are not the fees Visa collects, but “a separate, larger fee called interchange that Visa makes them pay each time a debit or credit card is swiped.” The interchange fee equates roughly to 1%-3% of each purchase and go directly to the bank to “promote the issuance of more Visa cards.” In 2002, interchange fee revenue stood at $20 billion. Today, that number has increased to $45 billion. While being interviewed for the New York Times story, Ronald Congemo (former CEO of regional PIN-based network Star Systems) remarked that “what we witnessed was truly a perverse form of competition. They competed on the basis of raising prices. What other industry does that?” Visa hasn’t been without its critics and challengers, of course. The Times refers to “more than a decade of litigation of antitrust investigations into high fees and anticompetitive behavior”, foremost among them a settlement in 2003 where Visa settled for $2 billion.

Merchants Aren’t The Only Losers

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By this point, some have no doubt concluded “so what? As long as I’m not personally paying more who cares about the merchant?” Pragmatic as this may seem, it is a short-sighted view of the situation. Contrary to general assumptions, merchants (even huge, publicly-traded ones) are not bottomless pits of money. They have finite resources and compete in what are usually very competitive markets. If they are repeatedly stuck with higher and higher fees, it is inevitable that these costs will at least partially be passed on to consumers. So although consumers are not necessarily being charged more immediately for their purchases, it is virtually unavoidable that they will pay more gradually, as prices slowly rise to reflect the higher fees merchants pay on debit transactions. Sure enough, the National Retail Federation says interchange fees cost the average household over $400 in 2008. Nor are high prices the only way of passing the costs to consumers. Fewer clerks, less convenient hours and diminished customer service can also be substituted for price increases, none of which are likely to make consumers happy or more eager to shop there. Unfortunately, it is not easy for merchants to go around Visa. While many merchants would be perfectly happy prohibiting the use of Visa debit cards — and therefore eliminating the associated fees — Visa’s rules require merchants to accept debit cards if they choose to accept Visa credit cards like the popular Citi Forward card. At the end of the day, any merchant who refuses Visa credit cards is committing retail suicide. Indeed, Visa reportedly processed 40 million transactions in the financial year ending June 2009.

The Long-Term Outlook

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Offensive as the ever-escalating fee game might be to consumers and merchants, it does not appear to be going away anytime soon. In fact, the Times reports that debit transactions are projected to overtake cash by 2012. With Visa and MasterCard firmly entrenched in the infastructure of banks and merchants, it is difficult to imagine a newcomer taking the industry by storm and lowering fees. And while the justice department has repeatedly investigated the two cardmakers, the aforementioned $2 billion settlement is the most extracted from Visa thusfar. Even that suit, which unshackled merchants from the “honor all cards” rule and permitted them to accept or deny any card they wished, relatively few merchants actually stopped taking Visa. Indeed, the suit was dismissed by one observer the Times interviewed as “much ado about nothing.” While Visa temporarily lowered fees on signature debit, they began steadily raising them on PIN debit – again, passing them on to banks and leading competitors to do likewise. With both regulatory and legal action having been ineffective to date, and debit card usage only becoming more widespread, it looks as though consumers and merchants will simply have to accept Visa and MasterCard’s fees as the cost of doing business with their cardholders.

It is now more important than ever to verify that you are holding the right credit cards for your lifestyle. Let BillShrink show you the way.

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{ 21 comments… read them below or add one }

Marc February 2, 2010 at 10:06 am

I think your numbers on Visa are off – they processed “40 million” transactions in 2009? Maybe that’s through the Visa PLUS Debit network, not Interchange. They see millions and millions of credit transactions daily.

All in all I’m not sure what the point of the article is…Visa makes money whether you use credit, signature debit, or PIN debit? That’s pretty much a given. Maybe it’s not obvious to those that don’t work in financial services, I’ll give you that. There’s definitely a difference in cost to the merchants to process credit versus debit, but there’s a cost to the cardholder too when a PIN is used rather than a signature. (And the difference in price isn’t all that big anymore exactly because rates have risen). It may not be hard dollars, but it equates to a liability shift. If my PIN is used (notice I didn’t say “If I use my PIN”) then I’m on the hook for the transaction and must prove to the bank that someone took my money…and the money is gone from my account. If I use a signature, then the merchant is on the hook as soon as I dispute the charge. For branded debit cards, the money still leaves my account but it’s a lot easier getting it back when I DON’T use my PIN.
Plus PINs are high value targets and are skimmed and used with cloned cards to get cash. Don’t use the PIN unless you’re aware of the consequences to you, as a cardholder, and the increased risks associated with the PIN.

You want to make sure Visa and MC don’t make money – use cash that you withdraw from your bank inside the branch – or at your bank’s ATMs – properly protecting your PIN.

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Charles February 2, 2010 at 10:08 am

There are several benefits to the consumer:
-Incredible convenience, access to your funds anywhere in the world
-extended warranties on big ticket items
-greater backing from both your bank and visa when disputing partial transactions (ie. hotel resort fees and other after the fact fees)

These benefits may not be worth $400, but they’re definitely not worth zero and somebody has to pay for them.

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Eric February 2, 2010 at 10:16 am

“Could there be a more inconsequential choice than signing a receipt vs typing your PIN into a keypad? Perhaps not from a customer’s standpoint…”

When the consumer chooses signature instead of PIN, he benefits directly via his debit card’s rewards program, which probably requires signature. So the choice is hardly inconsequential.

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40 February 2, 2010 at 10:18 am

so basically we feel it finacially by the raising of products?

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Ted February 2, 2010 at 10:46 am

As Charles mentions aboe PIN and signature based purchases are not the same and it is the differences between them that consistently make me sign rather than PIN enter.

Also while I will grant you that $400/household is a reasonable number I seriously doubt that my backing off my usage of signature based transactions would do the overall cost of the products I purchase. Rrather I believe it would just increase the profit margins for the businesses where I make the purchases.

To that end I’ll take my extra benefits from signature based at Walmart’s expense. Add to that that the “Evil” bank is also paying me up to $200 a year to use my card and I can’t see a compelling reason for me to switch (although I do PIN for local businesses and tip in cash due to the fees).

Finally the arguement that eliminating the “middle man” would somehow reduce expense is patently wrong. The perfect example is American Express which; up until the last few years, direct marketed and did not allow 3rd party issuers and still charged almost twice as much (to the merchants as either Visa or MasterCard in ’06 Amex Interchange was 3.25% Visa was 1.67% for card present transactions – This is why many stores won’t take Amex).

This is not to say that I don’t think regulatory controls on this industry aren’t past due as the inmates are certainly guarding the prison but regardless I won’t switch to PIN… then again I use a mileage based credit card rather than a checkcard anyway.

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mike February 2, 2010 at 11:06 am

Seems like the best thing for merchants to do is to have cash discounts…

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James Gill February 2, 2010 at 11:16 am

your story implies that VISA has been raising interchange fees in order to make more money, but this is simply NOT true. Interchange ranges from 1% to 2% and has for years and years. What has changed — and why income has gone up — is the AMOUNT OF DEBIT CARD TRANSACTIONS — and that is why the revnue has increased. The fees hav stayed the same. Consumers love debit cards are are “voting” by using them more and more. You also neglect to point out that electronic payments guarantees the merchant will be paid, unlike checks that can bounce, and that the merchant has no liability under the system. In essence, that is the price for the 1-2% fee from a debit or credit card — the merchant gets paid immediately and does not have to worry about fraud or checks bouncing/insufficent funds. Finally, cyber-criminals are targeting retailers to hack into their computer systems to steal consumer debit and creidt card information, and guess what? The BANK or CREDIT UNION pays for these fraud losses — NOT THE MERCHANT, even though clearly it was the merchant’s negligence to protect the data, not the bank or credit union! In fact, Interchange runs about 1-2% of all transacation volume, but system costs associated with losses from fraud, data security breaches, along with non-payment run 5-6% of all transation volume — well in excess of interchange’s 1-2% rate. The electronic payments systemis a marvel of modern world, you can go to Russie or China and get cash with your debit card, we need to think very carefully about messing with it, since it affects so much commerce.

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matt February 2, 2010 at 11:34 am

You have significantly more options when disputing a transaction by processing as credit instead of debit.

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Dave February 2, 2010 at 11:34 am

Debit cards have rewards programs? This seems like a scam to get the higher fees if it requires signature purchases. So you pay 3% in fees and get a 0.5% reward back on average – what a deal!

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James February 2, 2010 at 11:41 am

The free market eventually will cause banks to compete by offering higher rewards on the credit cards with the higher merchant fees to entice new customers and existing customers to switch to them.

I’m sure that you can see this now with the plethora of rewards/cash back programs. My card pays me 1% directly of each purchase, which I’m sure comes from the bank’s kickback from Visa.

My point being, there’s a ceiling on how high these fees can go before funds start getting funnelled back to the consumer.

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john February 2, 2010 at 11:42 am

As a small retailer I will give discount for cash. The cash discount usually more than the fees, Cash in hand worth 2 visa in the bush. God forbid I get a charge-back or some idiot forgets that they bought something from me and blocks the charge.

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The Heretic February 2, 2010 at 12:31 pm

I always give the choice to the merchant – credit (signed) or debit (PIN). Many choose debit. Restaurants don’t think about the choice for the most part, they choose credit.

If the item is a large expenditure, I give the merchant a choice – check or card – for me it all comes from the same account as I never buy anything I don’t have already have the money for (i.e., I have no debt and I don’t use credit cards, only my debit card). I paid with a check for my $11K motorcycle last year and the merchant very much appreciated that.

But I don’t carry my checkbook with me and I don’t carry a lot of cash either, nor do I pay cash for most things unless they are under $5. Then there is the issue of buying things online.

Overall, merchants don’t want to deal with checks and consumers don’t want to carry a lot of cash.

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Anonymous February 2, 2010 at 12:42 pm

retail companies should offer a discounter of 1-3% off thier total order if they pay in cash.

Or small companies that refuse to accept credit cards, should just add a fee to the customer if the customer chooses to pay via credit card.

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Pat February 2, 2010 at 1:07 pm

If you are a consumer pin transactions have almost zero benefit. While signing your name has several advantages:

-extended Warranty
-better dispute options
-Earn rewards points

My debit reward points alone earn me two airline tickets a year.

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Money_Man February 2, 2010 at 1:31 pm

Really? So if we all started entering our PIN, we should assume that the retailers would lower prices or increase other services – BS! They are money hungry like everyone else and you wouldn’t see a change I’d bet. I’ll keep taking my reward points which earn me well over $400 year in rewards. Sounds like a no brainer to me.

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Coward February 2, 2010 at 2:14 pm

As Eric says, a lot of banks give reward points for signing and no points for PIN transactions. I guess VISA pushes the banks for signature transactions and banks in turn push us.

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Wow February 2, 2010 at 2:29 pm

Seem like a bunch of fan boys above this post. The point of the article Marc was to inform the public that the Banks and Visa/MasterCard are raising fees with no end in sight. Also that the Credit Card company is using the banks to do its dirty work.

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matt February 2, 2010 at 4:39 pm

I’m surprised the article didn’t mention rewards. Both of the banks I have used for a debit card only give me rewards if I do a signature transaction.

I would use pin or cash to lower the fees merchants pay, but that makes me worse off because I’m not getting the rewards that everyone else is getting. In fact, everyone is paying these fees whether or not they use a debit card since everyone pays the same price.

If stores offered a 1% discount for using cash instead of debit/credit, I would immediately stop using my cards, as would a lot of other people I’m sure. There might be something in the rules for accepting Visa that keeps them from doing that, though.

I wonder how much accepting cash costs? Armored cars and cash handling can’t be cheap, and someone has to pay for it.

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Cody February 2, 2010 at 11:30 pm

Also if you pay by credit, there are laws that prevent the consumers from being charged for the use of the card in most cases. When you use your debit card no such laws apply, and while not all retailers do, I know for example a lot of fast food restaurants and some smaller shops will charge anywhere from $.50 to $1.50 to use a debit card.

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Teresa February 25, 2010 at 9:41 am

Regardless of who DOES benefit from the higher or lower Visa/Mastercard fees charged to merchants, it’s obvious who DOES NOT benefit: the banks or credit unions that ISSUE the cards! Why not? Because the liability for fraudulent transactions ends up on THEIR plate. If a bank customer disputes a transaction, its up to the bank to refund the money – all the merchant has to do is prove it got ANY signature. Even if the signature is clearly not even the same NAME as on the card, that merchant is off the hook. So in the long run, I would think it’s the bank that suffers most. This being the case, I can’t imagine why merchants think customers and banks should simply roll over and accept the merchants pushing PIN, just because it’s less expensive for the MERCHANT. Seems obvious that since the bank ISSUES the card, and the bank is the one stuck with the LOSSES on the fraudulent card transactions, there SHOULD be a correlation between THAT and interchange rates (income the bank gets for transaction volume). As someone else already stated here, the expense to the banks FAR outweighs the minimal amount of income they get from the transaction. And it’s not like banks could just choose NOT to offer the cards – nobody wants an account that can’t be accessed with a platic card anymore! I think when a bank suffers, its customers suffer: since banks are absorbing those fraud and program losses, how can they make this up other than to raise loan rates, account fees, etc.? A 1/2 % higher loan rate, even on a small loan, is way more than $400 per year! Talk about affecting the consumer – customers shoud think twice about choosing PIN over signature – it WILL cost them in the end, and when their local bank suffers (as opposed to a big retail merchant), it’s sure more likely to trickle down faster to the bank’s customer, as opposed to the trickle-down from the merchants.

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Brian September 12, 2011 at 5:31 pm

Some mentioned giving cash customers a discount. This may have changed in recent years, but when I helped a small business sign up to accept credit cards, the merchant agreement specifically prohibited the merchant from charging different prices for cash versus credit transactions. Also, they were prohibited from setting a minimum purchase for credit card use.

Now, chances are a small merchant could do these things and not get caught. But, all it takes is one dispute/chargeback and things unravel.

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