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A Big Win
Lower debit cards fees can only help e-retailers, but there's work to do to realize the full benefits.
Retailers are poised to benefit from a dramatic cut in the interchange fee they pay for debit card transactions beginning Oct. 1. But they will have to negotiate with payment processors to ensure they get the full benefits, and could test ways to encourage consumers to pay with debit, now that debit fees will be significantly lower than fees for credit card transactions.
The lower debit card fees come courtesy of the Federal Reserve Board of Governors, which announced June 29 a cap of 21 cents on the interchange merchants pay the banks that issue debit cards. With other adjustments the Fed approved, debit interchange could be as high as 25 cents per transaction, still far below the current rate. Today, online retailers typically pay Visa and MasterCard interchange of 1.60% plus 15 cents a transaction or $1.40 on a $78.70 purchase, the average amount of an online debit card transaction, according to payments consulting firm Javelin Strategy & Research.
The Fed acted under the direction of Congress, which last year ordered the Fed to set debit interchange as part of the Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act. That bill, passed at a time of widespread anger at banks following the financial meltdown of recent years, reflects the growing consensus among regulators around the world that merchants have been paying too much to banks in payment card fees. However, the Durbin amendment does not address credit card interchange, which remains unchanged.
Until now it was Visa Inc. and MasterCard Worldwide that set the interchange rate that the card-issuing bank receives on each debit card purchase. Interchange is one component of the discount rate that web retailers pay payment processors for handling debit and credit card transactions; processors build the interchange fee into the discount rate they charge merchants. A typical discount rate for a midsize e-retailer is 2.5% plus 20 cents per transaction.
"This will put more dollars in merchant accounts and ultimately could save consumers money because merchants won't have to upcharge 2% to cover their costs," says Ben Kirshner, CEO of online retailer CoffeeforLess.com. "This is a great day for consumers and merchants. It's not a great day for banks."
While the 21-cent cap represents a big savings for online retailers, some were disappointed that the Fed significantly increased the debit fee from the 12 cents it had originally proposed in December, a proposal that then became the subject of public comment—and intense lobbying by both banks and retailers. "The Fed appears to have taken the easy way out of this politically charged mess, doubling what they originally gave to the banks as fair interchange, citing their interpretations of what cost should be covered by the intent of the legislation," says Steve Mott, a payments industry consultant with BetterBuyDesign.
Besides the 21-cent base debit interchange fee, banks that can demonstrate they have invested in antifraud technology will be permitted to add up to 1 cent. They may also add 5 basis points, or .05% of the transaction amount, to the interchange fee. That translates to about 4 cents on a typical $80 online debit purchase, which likely will bring a typical debit card interchange fee to about 25 cents.
Even with the higher fee, e-retailers have an opportunity to reduce considerably their online debit card acceptance costs. Though the cap won't be in place until Oct. 1, at least one e-retailer is using the summer to prepare.
CoffeeforLess.com, which currently uses the PayPal unit of eBay Inc. as its credit and debit card processor, plans to switch this month to another processor, Discount Payment Processing, which operates acceptcreditcards.net. Kirshner says PayPal has not committed to lowering the fee it charges on debit card transactions as a result of the Fed directive. PayPal declined to say whether it would reduce its debit card processing fee after Oct. 1.
Kirshner says his new processor will pass through the lower interchange, and he expects his savings to be substantial. Approximately 40% of CoffeeforLess.com's $15 million in annual sales are made with debit cards, he says, with the average debit transaction roughly $80. That means the e-retailer sees some 75,000 debit transactions annually; a savings of $1 per transaction would mean $75,000 directly to Kirshner's bottom line.
To realize similar savings, e-retailers, especially smaller ones, need to carefully examine the fees built into their merchant processing accounts, says Tom Pouliot, payment evangelist at Litle & Co., which specializes in handling payments for online and catalog retailers that don't sell through physical stores.
Merchant processing accounts are usually structured in one of two ways, he says. One, called bundled or tiered pricing, separates transactions into subgroups based on the projected risk of the transaction. For example, a transaction in which the address entered by the shopper does not match that maintained by an address verification service might fall into a higher pricing tier than a transaction where the addresses match.
The other type of pricing, which has long been favored by high-volume merchants, is interchange pass-through: The e-retailer pays the interchange rate for the type of card and transaction, plus a per-transaction fee, such as 15 cents.
But what happens when debit card fees fall dramatically—not an everyday event—is not clear, Pouliot says. "Most contracts are mute on what happens if interchange is decreased," Pouliot says. He says retailers "should look at their contracts now and see if they will get any benefit at all."
E-retailers on interchange pass-through contracts should enjoy lower fees once the new rules take effect Oct. 1, Pouliot says. "For those merchants, regardless of size, they're fine. But if the merchant is on a bundled rate, they're really at the mercy of their processor. Then they have to look at their existing terms of their contracts. Can they get out of it?"
Consumers and debit