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July 21 could be a very good day for Internet retailers.
That’s the deadline Congress has set for the Federal Reserve Board to mandate new debit card fees. The Fed proposed in December setting a cap of 12 cents on a debit card transaction, which would represent a huge decrease in fees for online retailers, potentially saving them hundreds of millions of dollars each year.
The losers in this scenario would be the banks that issue debit cards and receive the interchange fees retailers—online and offline—pay as part of the larger merchant discount fees their processors charge them on credit and debit card purchases. The Fed’s Dec. 16 announcement set off a furious campaign by banks seeking to modify or at least delay the fee reduction plan, and a counter-campaign by merchant organizations such as the National Retail Federation in defense of the Fed proposal.
In letters to the key congressmen in March, Federal Reserve chairman Ben Bernanke rejected a delay beyond July 21. That deadline was included in what is known as the Durbin amendment to the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, a measure Congress passed in response to the near-meltdown of the banking system three years ago. Bernanke did say, however, that the Fed would not meet its self-imposed deadline of April 21 for finalizing the debit card rules.
The banks responded by lobbying hard for a delay in implementing the lower debit card fees, and merchants responded with a vigorous counter-campaign that included running television ads backing the new debit card fee rates in the states of swing senators. The matter came to a head June 8 when the Senate voted on a proposal by Sen. Jon Tester, a Montana Democrat, to delay the new rates for a year while the Fed gave the matter more study. The Senate rejected the measure in what merchant trade group the National Retail Federation termed “a landmark victory.”
Even with the proposal to delay the new rates off the table, the Fed still has work to do on several controversial issues. One would give merchants more control over how to route a transaction among payment card networks, a move that could give retailers leverage to negotiate lower fees. Another would exempt from the lower debit card fees smaller banks with assets of under $10 billion. Those banks issue about 20% of U.S. debit cards. The Fed proposal also left open how banks should be reimbursed for investments in fraud-prevention systems, and there remains the possibility that banks would get higher fees to cover those costs.
The Fed is weighing questions like network routing and the small bank exemption, but has held firm on rates, says Steve Mott, a consultant for online retailers. “On rates, they might budge a few pennies, but it won’t substantively change things from the Dec. 16 proposal,” Mott says.
If that’s the case, all retailers, particularly those who sell online, will be big winners. The National Retail Federation has estimated that the Fed proposal would cut merchants’ debit card fees by 70% and save retailers $14 billion a year.
The savings are even bigger in percentage terms for web retailers. That’s because online retailers are charged higher fees on debit and credit card transactions because the primary payment card networks that set interchange fees, Visa Inc. and MasterCard Worldwide, deem more risky what they call card-not-present transactions, that is, purchases not made face to face. This covers orders placed by phone as well as on the web. What’s more, in the bricks-and-mortar world consumers can pay with debit cards and enter a personal identification number, which routs the transaction through lower-cost networks than Visa and MasterCard. Online merchants, with a handful of exceptions, do not accept PIN debit and thus do not benefit from those lower fees.
Online merchants do accept what Visa and MasterCard call signature debit. Visa’s debit interchange on a web transaction is 1.60% of the purchase amount plus 15 cents for most merchants, and slightly less for big e-retailers. MasterCard’s rates are similar.
Here’s the math. The average value of an online purchase made with a debit card is $78.70, according to research firm Javelin Strategy & Research, based on a September 2010 consumer survey. The e-retailer pays debit interchange on that transaction of about $1.40. If that fee were reduced to 12 cents, the retailer would save $1.28—money that goes right to the bottom line.
Javelin’s research further suggests that consumers use debit cards for 29% of online retail and travel purchases. Applying that percentage to the $165 billion in e-retail transactions compiled by the U.S. Department of Commerce for 2010, that suggests that nearly $48 billion in web retail transactions last year were made with debit cards, or roughly 600 million purchases. At a saving of $1.28 per purchase, web retailers could cut their costs by roughly $750 million if the Fed sticks to its 12-cent proposal.
How much any retailer would save varies with how its customers pay. At Build.com Inc., a web-only retailer of home improvement products, just over 10% of transactions are made with debit cards, not enough to make lower fees a big deal, says Brandon Proctor, vice president of marketing. “We ran an analysis as soon as we heard this was coming down the pike to see if it would have a material impact on our profitability,” Proctor says. “But the impact is not a game-changer for us, unfortunately.”
Merchants could potentially steer consumers to pay with debit cards, if that would reduce a merchant’s fees significantly from a credit card transaction. But that’s not the plan at artwork retailer Art.com Inc., which accepts checks and a variety of online payment methods as well as credit and debit cards. “We’re not managing the mix of how people pay,” says Madhav Mehra, vice president of user experience and product management. “It’s customer satisfaction that drives our business.”
Nonetheless, many merchants would benefit from lower debit card fees, as the demographic profile of online shoppers who use debit cards is quite similar to that of all web shoppers, says Beth Robertson, Javelin’s director of payment research. Debit card users do skew a bit younger, with consumers 25-54 somewhat more likely to use debit than others; white consumers are also more likely to use debit, Robertson says. Plus, retailers that sell at lower price points are likely to see more debit use, as the typical online credit card purchase last year was $96.80, versus $78.70 for debit, Javelin says.
Based on that data, Robertson says, “Online merchants carrying a traditional product mix with broad price point appeal would be the most likely to attract debit card users.”
Even if they do nothing, online retailers will come out ahead once the new rates take effect. And if they can come up with ways to encourage more consumers to use debit instead of credit cards, their winnings will be even bigger.