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
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
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.”
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
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
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.