When you look at innovation in the payments industry, there is one over-riding determining factor that prevents or hinders the NBT – a massive legacy. This legacy infrastructure today facilitates 95billion transactions on an annual basis just in the EU, and with less than 10 basis points of transactions causing exceptions. This is a huge mountain for any new player to climb and so consequently most of the ‘innovation’ that makes it to the consumer or business customer is typically an evolution of existing methods or a new layer that supposedly makes things more convenient or secure.
Typically innovation does not include the fundamental business model – after all, if it ain’t broke, don’t fix it (as the saying goes). But today the financial services industry is being challenged to do things differently by regulators, consumers and merchants alike. The new draft of European payment regulations by the EC (here) and various components of Dodd-Frank in the US have driven the current model to breaking point and yet still there is abstract refusal from MasterCard, Visa et al to publicly consider a good rethink of the way we pay for the way we pay.
Fundamentally it comes down to this – the major costs in a payment transaction are in checking that all the parties involved are who they say they are (authentication), that the required funds are available (authorisation), and then processing the transactions and subsequent movement of funds (clearing & settlement). Typically authentication costs are borne by both the payees bank – known as an acquirer in card terminology and who will have rolled out POS terminals, ATMs, ePayment infrastructure (such as iDeal) or through support for Payment Service Providers; and by the payers bank – known as an issuer in card terminology and who will have paid for the infrastructure to issue cards, support online banking or provide a branch network. However, the costs for maintaining the payers account and authorisation fall squarely with the payers bank – and it is for this reason that they are usually compensated by the payees bank through the fabled multilateral interchange fees, or MIFs. As clearing and settlement are seen as back-office operational and reconciliation functions, they are also typically funded from both sides.
A payer receives from their bank an ‘easy’ way to pay for goods and services – either through a simple transfer, giving the payee permission to take money from their account, or through a card transaction (see more). For this they typically pay a current account fee or card fee. A payee (often a merchant or utility) is provided with an easy way to collect funds in receipt of the goods or services that they provide – either through taking the money from the payers account, receiving a transfer or accepting a card transaction. For this they typically pay a transaction fee or merchant service charge which, for example, in Belgium is more cost-effective than accepting cash when the transaction value is higher than around 10 EUR. The merchant service charge typically includes the costs and profit for both the payer and payee banks, passed from one to the other through the MIF. Typically the payer will not be charged for making an electronic payment unless the payee decides to surcharge them in compensation for the MSC. Still with me?
So every transaction triggers this big merry-go-round of money that has cost implications of its own and typically is funded (when it all boils down) by the fees and other value implicit in the current account of the payer. Which is you and me. But we can’t really see what it is we’re paying as a bit is taken by our bank, a bit is written off due to the other money that our current account makes for the bank, a bit is taken by the merchant through the cost of goods, and a bit through surcharges.
Wouldn’t it be better if we all just paid for our bit of the costs in an open and transparent way? Say for example the cost to a payer bank for issuing and maintaining a debit card – with a three year issuance cycle, a typical chip debit card will cost 5 EUR to issue, maintain and process transactions. Costs increase as transactions increase – so why not recoup these costs directly from the payer, it is after all saving them time (to get cash), money (the EU estimates the cost of cash is 300 EUR per family per year), making life more secure (harder to steal than cash), traceable (easier to recoup/cancel if stolen) and more convenient (can be used on the web or for other remote payments). Charge payments just like a mobile phone bill – basic cost for the facility and then a charge for usage. Then heavy users pay more.
On the merchant/payee side, the charge would come down as they no longer need to compensate the payer’s bank – paying only to have the ability to accept payments, which with the new mPOS model can already be a tiny amount – and then the same cost per transaction for payment guarantee and timely receipt of funds to their account. Essentially costs go to the party gaining from the service – which is the way that most businesses function.
If you’ve ever seen the early presentations from wannabe-European 3rd scheme PayFair, this balanced approach was their original business model. It didn’t work at the time because the pressure on the MIF model wasn’t great enough – but perhaps now it’s time to go back and reexamine that approach, or take another fundamental path to rethink how we pay for how we pay – and perhaps this will open the door to a flood of new innovative services in the same way that Facebook, Twitter et al managed to monitise their own ‘transaction’-based services.
- Understanding the New Credit Card Rules (quicken.intuit.com)
- Mobile Credit Card Processing (creditcardprocessingsoftware322968.wordpress.com)
- Apple Is About To Enter The Field Of Mobile Payments With The Â€œI Walletâ€ Patent (creditcardprocessingsoftware322968.wordpress.com)