Factors driving interchange rates down
By Seth Priebatsch
Chief Ninja, LevelUp
"Interchange" is a word that's talked about a lot in the payments industry. At its most basic, interchange is the fees businesses pay to credit card processors to swipe your credit and get paid — or, the cost of moving money. So, why all the brouhaha on interchange? Businesses are sick and tired of paying high fees and getting very little in return. Customers are sick and tired of seeing prices of items tick upwards as businesses are forced to charge more to cover the cost of interchange.
Businesses spend an exorbitant amount of money each year to accept credit cards — to the tune of $50B. Yep, that's $50 billion. Businesses could reinvest the money they've been spending on interchange to better connect with customers, enhance marketing initiatives, and grow faster and smarter. Just imagine for a second the economic stimulus the country would get if all that money was put back into the business to drive growth, or back into the pockets of customers to lower costs.
In the past 30 years, interchange fees have mainly gone in only one direction... up. Luckily, things are starting to change and I think we're going to start seeing interchange being driven down. The days of a 3 or 4 percent interchange rate are beginning to look numbered, and here's why:
There are nearly 200 players in the mobile payments space, with more entering daily. New opportunities are providing businesses with alternative payment options that are outside of Mastercard and Visa's clutches. While there might be 1000+ credit card processing companies, they're all based on the Mastercard/Visa rails which provides a fixed floor. But not so with many of these new payment options. As such, traditional methods of payment (cash, credit cards) are facing an increasing amount of competition and merchants are starting to pay attention.
It's unlikely that cash and credit cards are going away anytime soon, but it only takes a small shift in volume (maybe 5 percent) for the card issuers to start paying attention. There are a number of ways for them to react, but if history is any guide, one of them will be to start lowering their prices... Or, alternatively, they could find ways to offer more value to their merchants. Either way, competition is offering merchants new ways to accept payments and this will lower fees over time.
The second thing that's driving down costs for merchants is rapid innovation, and, like much innovation these days, much of it is centered around mobile. Mobile payments are starting to gain significant traction among consumers, accounting for $640M in 2012 and expected to have grown by an additional 234 percent in 2013.
QR codes, NFC, peer-to-peer payments, card emulation... the list of new technologies trying to disrupt the payments space goes on and on. These new alternatives are challenging the current payments system and shedding light on the opportunities for businesses. This innovation is beneficial in two ways. The first, as discussed above is that more competition will naturally drive costs down. The second is that alternative payment options are focusing on value "beyond the transaction." There are new payment options out there that provide tangible information to help grow their business, like data analytics, to help drive sales and increase revenues. New options are allowing small businesses access to the same technology and analytics that were previously reserved for big-box retailers or e-commerce sites only. These additional value propositions not only help businesses, but also provide new ways for payments companies to monetize, removing the need for them to make all their money off of interchange. With two (or more) revenue lines, suddenly lowering interchange is a lot more feasible.
The Durbin Amendment is designed to introduce competition in the debit card processing network and limit fees for businesses. For all of its unintended consequences, Durbin Legislation is actually helping to drive down interchange; it's opening up competition for non-card-brand network players and lowering debit card fees. While it is certainly rife with controversy, this amendment is opening up new ways to move money that will, over time, contribute to a less expensive payment processing ecosystem.
Business owners are smart and savvy. They pay attention to trends, focusing on finding new ways to set their business apart. Business owners are also conscious of ROI, and how much they're spending to attract and retain customers. They understand there is some cost to accept payments, but are becoming more and more frustrated at the high swipe fee costs from traditional credit card processors and minimal return for those fees. Businesses are looking to new, innovative solutions to provide more than just payment processing — they want to understand and better connect with their customers. In short, merchants are ready for a new payments ecosystem and where there's this much demand from a group this big and influential, a solution can't stay away for too long.
Let me clear: I don't see interchange rates going away entirely in the near future... although I do think it will happen eventually. A lot of powerful wheels are in motion to significantly reduce the interchange rates that merchants currently pay. Right now the impact might be small, but it's growing quickly. In a few years, 3 to 4 percent interchange could be relegated to the same bit of history as $1.99 international phone calls.
If you didn't have to pay interchange fees, what would your business spend the money on?
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Photo provided by Flickr user 401(k) 2012.